Experience shows us that at low levels of demand, JIT is the preferred method, whereas EOQ has the cost advantage for an item with a high demand. In a lean environment, inventories are reduced (not allowed to build up), thereby requiring less storage space and manpower to receive, count, store, pick and deliver it. For example, if you reduced your product costs your EOQ will go up. If the bank interest rates are low, your lot size will go up. In both of these situations, your inventory levels will go up which is contradictory to the expected benefit of a lean operation. On the other hand, with a lower interest rate you would be able to borrow at a good interest rate to add more storage space for the entire excess inventory. Additionally, you would have to ensure that your inventory carrying costs are reflective of all the costs of storing that excess inventory.
The sum of its usability
The experienced supply chain practitioner will check each application of EOQ to be sure that it is valid for the practical situation at hand. With a thorough understanding of EOQ, the technique can be used to yield some of the following benefits by its modification based on experience:
- Establish minimum quantities to reflect a supplier’s minimum purchase of quantities or batches of items made from one unit of raw material, e.g., steel bar or sheet
- Set a maximum ceiling stock figure for bulky, high density or difficult-to-handle stock items where storage space limitations exist
- Base adjustments on multiples of packaged lots (dozens, skids or unit packs), shipment loads (LTL, TL or FCL), or units of material issue (drums, bundles, pails, pallets and barrels)
Remember, EOQ balances supplier/vendor order size, order frequency, the timing of orders and storage and handling to minimize costs and improve efficiencies as orders flow through the supply chain system. Companies that have a steady demand for stock are the most suitable for the application of EOQ. Consequently, EOQ is not used (nor should it be used) in every type of company and industry. It is commonly used in an MRP manufacturing environment where the ordering of stock is constant and repetitive. EOQ also has its use for purchase-to-stock distributors and MRO storage facilities that have to plan for forecasted demand and/or have to generate multiple orders.
Thomas L. Tanel, C.P.M., CTL, CCA, CISCM, is President and Chief Executive Officer of CATTAN Services Group Inc., College Station, Texas. He has an international reputation as a Subject Matter Expert and Seminar Leader in Logistics and Supply Chain Management.