How to Best Understand the Problem with Lot Sizes

What This Article Covers

  • Introduction to EOQ
  • The History of EOQ
  • Specific Lot Sizes and Issues
  • Changeover Costing Example
  • What Do You Know About EOQ?
  • Dynamic Order Quantities
  • Our Work on EOQ

Introduction

Lot sizes allow a company to order economically. Lot sizes that are simply based on demand, or specific orders (so-called a lot for lot) are often not economical or order or produce in. There are several approaches to determining economic lot sizes.

There are several approaches to determining economic lot sizes.

The History of EOQ

Economic order quantity (EOQ) is one of the oldest formulas in inventory management. It was first developed by Ford W. Harris in 1913. Since its introduction, EOQ has been one of the most important and most durable formulas in inventory management. EOQ is one technique of performing what is known as lot sizing. There is no perfect way to lot size as is alluded to in a quotation from Ford W. Harris’ paper on the EOQ.

“In conclusion, it may be well to say that the method given is not rigorously accurate, for many minor factors have purposely been left out of the consideration. It may be objected that interest and depreciation should be figured, not only on original cost, but also on the setup cost, since that has to be incurred before the parts can be stocked. Such refinements, however, while interesting, are too fine spun to be practical. The general theory as developed here is reasonably correct to be found to give good results.”

Here Harris proposes that specific other factors could be used, but he feels confident that the formula encompasses the most important factors for driving orders.

Specific Problems with Lot Sizes

Specific problems with lot sizes come down to first — determining the exact factors to use, which as described by the previous quotation — is always a question.

Secondly, the factors that are used are not stable as the quantities change. This is explained by George Plossl in the following quotation.

“The use of formulas to calculate “economic” order quantities poses several significant problems. The assumption made in the formula derivations that inventory carrying costs and ordering costs vary uniformly with lot size are generally not valid. These costs cannot be assigned a specific, constant value over a range of lot sizes; this value will vary with the total inventory. Either too large an increase in inventory or too many orders being generated can result from application of the formula.”

Therefore, while ordering costs (and if the item is produced, it is ordering costs setup or changeover costs) are considered the same regardless of the quantities involved. When does this not hold in reality?

To further this point, the estimation of precise changeover costs is quite difficult because it depends on what product is being transitioned to. For instance, observe the following changeover matrix.

Changeover Table

Product Being Moved FromProduct Being Moved ToChangeover Cost
Product AProduct B$250
Product BProduct A$600
Product CProduct A$1200
Product AProduct C$300

Notice that the changeover value depends upon what value is being changed over from and to. However, lot sizing must be set up without knowledge as to what the from and to products are (unless the lot size is computed each time manually). Using an average will not help, although it sounds appealing, as in most situations the average value to too far off of the actual value. 

The following quotation goes a step further and critiques the benefits of dynamic order quantities.

Dynamic Order Quantities

A dynamic order quantity is just allowing the system to change the quantities ordered rather than ordering the same amount for each order. Dynamic order quantities are most definitely the status quo in how MRP is run in companies.

“Dynamic order quantities are a mixed blessing in an MRP environment. While they reflect the most up to date version of the materials plan, they change frequently the item’s component requirements and thus also their planned coverage. A re-computation of a parent planned order quantity will often cause MRP to reschedule component item released orders, in addition to revising planned order quantities and schedules in future periods.

While some nervousness inevitably arises in normal operations, it can be greatly amplified by lot sizing techniques recomputing lot sizes automatically. This can and should be avoided. Many users of MRP systems freeze quantities of planned orders within the span of the cumulative product lead time, so that these orders cannot change gross requirements on lower levels that may be covered by replenishment orders already released.”

Conclusion

These are interesting observations that are not brought up with much frequency. George Plossl, one of the deepest thinkers on the topic of MRP and inventory management, apparently placed a high emphasis on reducing nervousness in the plan. I have found it very difficult to get my clients to take this position — whenever possible the preference seems to be to update as frequently as possible.

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References

Lean and Reorder Point Planning Book


Lean and Reorder Point 2

Lean and Reorder Point Planning: Implementing the Approach the Right Way in Software

A Lost Art of Reorder Point Setting?

Setting reorder points is a bit of a lost art as company after company over-rely upon advanced supply planning methods to create the supply plan. Proponents of Lean are often in companies trying to get a movement to Lean. However, how does one implement Lean in software?

Implementing Lean in Software

All supply planning applications have “Lean” controls built within them. And there are in fact some situations where reorder points will provide a superior output. With supply planning, even within a single company, it is not one size fits all. The trick is understanding when to deploy each of the approaches available in software that companies already own.

Are Reorder Points Too Simple?

Reorder points are often considered to be simplistic, but under the exact circumstances, they work quite well.

There are simply a great number of misunderstandings regarding reorder points – misunderstandings that this book helps clear up.

Rather than “picking a side,” this book shows the advantages and disadvantages of each.

  • Understand the Lean Versus the MRP debate.
  • How Lean relates to reordering points.
  • Understand when to use reorder points.
  • When to use reorder points versus MRP.
  • The relationship between forecastability and reorder points.
  • How to mix Lean/re-order points and MRP to more efficiently perform supply planning.

Chapters

  • Chapter 1: Introduction
  • Chapter 2: The Lean versus MRP Debate.
  • Chapter 3: Where Supply Planning Fits Within The Supply Plan
  • Chapter 4: Reorder Point Planning
  • Chapter 5: Lean Planning.
  • Chapter 6: Where Lean and Reorder Points are Applicable
  • Chapter 7: Determining When to use Lean Versus MRP
  • Chapter 8: Mixing Lean and Reorder Points with MRP-Type Planning