## Executive Summary

• We cover the Economic Order Quantity formula and the applicability of the Economic Order Quantity and EOQ and perishability and quantity discounts.
• EOQ can be calculated for both production and procured products.

## Introduction: The Origins of the Economic Order Quantity

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. You will learn about the calculation of EOQ, reorder points and the other factors which are included into the calcuation of EOQ.

## What is the Reorder Point?

The reorder point tells the system when to reorder, while the economic order quantity tells the system how much to order; as such they are necessarily highly integrated values. EOQ is one method for performing what is generally known as lot sizing. The lot size is the quantity in which the item is produced or procured and therefore it is set at the production location combination in the product master.

## Common Methods of Lot Sizing

Common methods of calculating the lot size are the following:

• Lot for Lot: This is confusingly named because lot for lot is simply a lot size based upon the net requirements in a particular period. Therefore it is essentially no lot size. Using lot for lot sizing would be considered Lean as the company is only producing or procuring what it absolutely knows that it needs.
• Economic Order Quantity: This bases the lot size on a financial calculation.
• Periodic Order Quantity: This is simply the economic order quantity, but stated in terms of a reorder frequency.

## The Applicability of the Economic Order Quantity

Some have proposed that because EOQ does not automatically adjust with the variability of its inputs, it cannot be used for more product location combinations (PLC’s) with more variable demand history, and this is true – if the data provided to the EOQ is not periodically changed. Therefore, it must be periodically recomputed for the entire product location database. It would be relatively easy to make the EOQ formula continuously altered based upon changes on its inputs, but I have yet to see this functionality in any supply planning application.

## Validity and Applicability of EOQ

EOQ was originally developed for a production lot sizing. However, the book Factory Physics states the following with respect to EOQ:

“For example, in 1913, Harris published his original EOQ paper and established a precise mathematical standard for efficiency research with his famous “square root formula” for the lot size problem. While elegant, this formula relied on assumptions that – for many real world production systems – were highly questionable.”

1. A fixed, known setup cost
2. Constant deterministic demand
3. Instantaneous delivery (infinite capacity)
4. A single product or no product interactions

“Because of these assumptions, EOQ makes much more sense applied to purchasing environments than to the production environment for which Harris intended it. In a purchasing environment, setups (i.e. purchase orders) may adequately be characterized with constant costs. However in manufacturing systems, setup costs cause all kinds of other problems (e.g., product mix implications, capacity effects, variability effects). The assumptions of EOQ completely gloss over these important issues.”

This is the very well-known sawtooth pattern, which is a feature of the stocking level rising to its highest point when a new procurement order is received or a new production order is completed, and with the stocking level declining to its lowest point right before the procurement order is received or right before a new production order is scheduled. The minimum stock level should be the safety stock, which the inventory level may consume due to variability in demand or supply.

EOQ actually has a number of slight adjustments to the formula used to account for different requirements, like the calculator included at this article which calculates an EOQ in the case where the company wants to build inventory.

## EOQ and Perishability

There can be scenarios where the shelf life of the product does not allow for the full EOQ to be ordered. In this case, the EOQ formula should not be used, and the shelf life time converted into units, should be used instead (Silver and Peterson).

The same issue applies to products that go through frequent revisions, where ordering the EOQ would or could result in significant obsolescence. EOQ must also be managed versus storage capacity. In general, storage capacity is less expensive than accepting increased costs through shorter production runs. However, this does not seem to have much influence with companies because they cannot quantify how their production costs change from changing the length of production runs.

Therefore, philosophy rather than facts tends to rule the day with a much greater focus being placed in inventory and storage costs rather than production costs. Although, this greatly depends upon the company. Some companies work exactly the opposite, focusing very little on reducing inventory and being primarily focused on minimizing procurement costs through buying in very large and uneconomic quantities. The question becomes quite a bit more grey for procured items where the costs to be traded off are quantity discounts and order costs.

## Using Economic Order Quantity Formula in Live Systems

After EOQ’s calculation, it is most often placed into the minimum order quantity field which all supply planning systems have. This sets the minimum order level. However, sometimes other factors that are larger than this – such as when products must be purchased in rail carloads, set the actual minimum order level. In that case, no EOQ calculation is necessary. The minimum order quantity is the carload.

While the formula is one of the easiest in supply chain to calculate, many companies do not determine their unconstrained products (that is unconstrained by minimum order sizes such as with the example of the carload, or minimum package quantities) on the basis of EOQ. However, there really is no reason aside from work effort to not do so – and in fact, the work effort is quite low.

## Economic Order Quantity and Forecast Error

The higher the forecast error, the less use the EOQ value is. This is because as the forecast error increases, the likelihood that the quantity will be consumed declines. However, this is no different from any other supply planning parameter; supply planning parameters have the highest value when the forecast is most accurate.

## EOQ and Quantity Discounts

If there are quantity discounts, the calculation below will not be accurate. For instance, the formula below may propose an EOQ of 184 units. If the price per each at this level is \$50, then this is a total cost of (184 * \$50) + 45 or \$9,245. However, if the quantity discount kicks in at 200 units and this discount is 15%, then 16 more units could be obtained for \$8,538. This would be a missed opportunity. This can be easily calculated for an individual item, but this cannot really be systematized because supply planning applications do not have EOQ functionality or even step function min lot sizes. Typically this is handled by procurement as they are up to date on the volume discounts and will increase the orders to meet the discount.

## How Often is EOQ Actually Calculated?

For whatever reason, most companies don’t get around to calculating EOQ or, if they do calculate it, they do so very infrequently. Students at university are often told that EOQ is frequently used in industry, when in fact it isn’t (this is just one of the misrepresentations of supply chain management on the part of college courses and supply chain textbooks). But this does not mean that it should not be used. EOQ certainly adds value and quantifies and then trades off the most important costs for making an ordering decision. That is the truth of how understaffed supply chain management departments are. They often do not have the staffing to apply elementary inventory management techniques that are over 80 years old.

## Deriving EOQ Order Cost or Cost Per Order

If the item in question is procured than the standard term order cost or cost per order which is often used with the EOQ formula is correct.

## EOQ For Procured Items

EOQ is often first introduced to people as the order cost or cost per order from a supplier. If you discuss this topic with companies, you will often hear order costs around \$12 discussed. In fact, there are many web pages that estimate the ordering cost in the low teens. This is inaccurate and does not show appreciation for what the EOQ formula represents.

The order cost or cost per order for EOQ is supposed to moderate the number of orders that companies place, which means that the order cost or cost per order includes all the costs of placing the order. This includes not only the cost of placing the order in the system (which is the lowest cost portion of the order) but also the cost of receiving the order. The cost of moving the order into stock. The cost of tracking the order and following up if the order is not delivered, etc.. For this reason, once all the total ordering cost is considered, that is the cost of the initial order.

That is all the way to put away, an order cost of between \$60 to \$75 seems reasonable for many items. However, certain items can be much higher than this. Larger, more difficult items to manage should receive greater economies of scale in receipt and put away than smaller items. Once you move to ordering extremely large units, such as industrial equipment, the order cost or cost per order rises again. But on the other hand, as a percentage of the cost of the item, the order cost or cost per order cost may decline.

## EOQ Internally Produced Items

If the EOQ is being calculated for an internally produced item, then the order cost or cost per order becomes the “ordering and setup/changeover cost.” This is the cost of changing the line over to a new product. Unfortunately, few companies have costings for their changeovers. Therefore, this usually takes some time to develop these costs.

## EOQ and Production Planning

If the item in question is procured, then the standard term “ordering cost,” which is often used with the EOQ formula, is correct. However, if the EOQ is being calculated for an internally produced item, then the order cost becomes the “ordering and setup/changeover cost.” This is the cost of changing the line over to a new product. This is because what is called the ordering cost is really just the total costs for initiating the replenishment. Unfortunately, few companies have realistic costings for their changeovers. Therefore, it usually takes some time to develop these costs.

## Conclusion

Order cost or cost per order estimation is tricky, and no one can say exactly what an ordering cost is for a particular item. Companies can use variable order cost or cost per order to change depending on the product.

One thing for certain is that the order cost or cost per order that is often presented on websites on the topic does not represent what the EOQ is meant to represent regarding the total order cost or cost per order.

To calculate the EOQ formula online, see our EOQ Calculator at this article.

Also, learn about the limitations of EOQ at this article.

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Improving Your Supply Planning, MRP & S&OP Software

Brightwork Research & Analysis offers the following supply planning tuning software, which is free to use in the beginning. See by clicking the image below:

## 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

EOQ is calculated in supply planning systems.

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below:

## Executive Summary

• The Economic Order Quantity (EOQ) formula can be used 1) when an item is replenished in lots or batches and 2) when sales or usage rates are uniform and low compared to the rate at which the item is produced.
• The EOQ formula is limited to situations in which demand for an item is stable. It is not a reliable formula for items that 1) are subject to seasonal production fluctuations, 2) part of an assembly line, 3) have limitations such as die life, 4) have different space costs, 5) have different quantities for runs and orders, and 6) with hold points.
• There are many different EOQ formulas, each with its own set of assumptions. Applications often offer a small number of EOQ formulas. If the assumptions associated with your item don’t align with the pre-given formulas, it is possible to calculate the EOQ outside the system and upload it.

## Introduction to the Standard EOQ Formula

The EOQ formula is used to determine order batching. You will learn about the assumptions of the EOQ formula and when it is applicable.

## What is the Standard EOQ Formula?

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.

• Since its introduction, EOQ has been one of the most important and most durable formulas in inventory management.
• It contains some important assumptions of EOQ model that are often undiscussed, but important to using the formula properly.

## George Plossl on the Assumptions of Economic Order Quantity

Economic order quantity is discussed as an important consumption based parameter to set.  George Plossl points out in the book Production and Inventory Control; there are some important assumptions of economic order quantity which make the use of EOQ valid.

This quotation related to economic order quantity assumptions is listed below:

“The right quantity to order is that which best balances the costs related to the number of orders placed against the costs related to the size of the orders placed. When these costs have been balanced properly, the total cost is minimized. The resulting ordering quantity is called the economic lot-size, or economic ordering quantity (EOQ). The EOQ concept applies under the following conditions: The item is replenished in lots or batches, either by purchasing or manufacturing, and is not produced continuously. Sales or usage rates are uniform and are low compared to the rate at which he item is normally produced, so that a significant amount of inventory results. The EOQ concept does not apply to all items produced for inventory. In a refinery or on an assembly line, for example, production is continuous and there are no lot-sizes as such. The bulk of the jobs in a make-to-order plant are made lot-sizes ordered by the customer. Limited tool life, short shelf life, economical price of raw material and other constraints override the application of EOQ techniques. Nevertheless, the concept has broad application in industry, since most production is not continuous and individual lots of material are being taken from one inventory, processed and then delivered to another inventory.”George Plossl

## Assumptions of EOQ Model

• EOQ assumptions are critical in determining the applicability of EOQ to a scenario.
• The assumptions of EOQ model are that costs can be traded off. With the standard EOQ formula, the assumptions EOQ model is that holding costs and ordering costs are the costs to be used.

## How to Use the EOQ Formula for Pull Forward or Stock Building

Economic order quantity is one of the oldest formulas in inventory management. However, it is not an adjustable formula; unlike the dynamic safety stock calculation, it cannot account for variability. Therefore, it must be periodically recomputed for the entire database.

## When is the EOQ Formula Applicable?

EOQ is used in conjunction with reorder point (see this link for the Reorder Point Calculator, and it applies under similar circumstances:

1. The item is replenished in lots or batches, either by purchasing or manufacturing and is not produced continuously.
2. Sales or usage rates are uniform and are low compared to the rate at which the item is produced, so a significant amount of inventory results. – Production and Inventory Control: Principles and Techniques

However, economic order quantity can be used in circumstances where sales vary over the year by changing the EOQ value. This is another reason why it is good to perform an external calculation of supply parameter values in a way that can be adjusted and then uploaded to a system.

## How the EOQ Formula Can be Adjusted before High Periods to Build Inventory

Companies often receive a disproportionate amount of demand in one reoccurring period. The EOQ value can be adjusted and then uploaded to the supply planning system in advance of this increased demand to build inventory to the right level more economically. There are two differences regarding doing this versus using the standard EOQ calculation.

1. The timing must be right – that is the larger economic order quantity formula must be calculated sufficiently ahead of the demand increase.
2. Add the percent increase to the calculator.

## How the Economic Order Quantity Formula Calculation Form Works

This form requires input to provide output. However, it also has default values. You can change any input value and the rest of the formula — the output will change immediately. You can continue making changes, and the form will always update without having to press any button or refresh.

This calculator assumes that the location receives the entire order at one time. However, this assumption does not always hold. For the non-instantaneous receipt, EOQ calculator see this article.

## What Economic Order Quantity Can’t Consider

EOQ is designed for stable demand situations. What will follow is a list of scenarios that are anything but steady state, however, EOQ is not the only approach to inventory planning that has difficulty in managing these situations.

## Item 1: Seasonal Production

Many products have a seasonal sales pattern. It is not unusual to see much of the anticipated requirements produced well before the season to keep production fairly level throughout the year. During this inventory building, the inventory that is being added is anticipation inventory, not lot size inventory, and the regular EOQ model does not apply.

Instead of balancing ordering costs against inventory the company is now trying to store man hours. For this reason, many seasonal items are produced in one lot size per year.

## Item 2: Assembly Lot Sizes

Another typical situation encountered in real life is the problem of determining lot sizes for assemblies and their components, and once again the extreme situations present the clearest examples. An assembly composed of unique components not used on other assemblies should have its lot size calculated taking into account all setup costs for the components of the assembly, and most of the components should be manufactured in the same lot sizes as the assembly.

## Item 3: Die Life

Costs associated with limitations, such as the life of a die set used in a blanking press, are seldom included in the EOQ formula. The calculated EOQ for an item might indicate that 20,000 units were the most economical lot size, whereas the normal die life might be 30,000 units. Because of the high cost of regrinding, refitting and setting up a die, it is almost always practical to tie the economic lot sizes into the die life.

In this case, the calculated lot size would probably be increased by 50,000 units.

## Item 4: Space Costs

There is no specific allowance in the simple EOQ formula for the fact that the space cost for different items can be very different indeed. Shipping cartons usually have a low unit value, a very attractive discount schedule and take up great amounts of storage space.

On the other hand, electronic components have a very high unit cost and take up very little storage space. Especially with bulky items, an estimate of total space requirements resulting from EOQ calculations is essential.

## Item 5: Actual Run vs. Order Quantities

It has been the author’s experience that ordering quantities indicate on records and the ordering quantities used in the factory can frequently be quite different. Any comparison of new lot sizes with the present order quantities to determine the effects and economies of change should be based on the actual lot amount being processed in the plant, not the amount requested by the production control department.

## Item 6: Hold Points

“Many items are dealt with by a sequence of operations. The ordering cost must then include the sum of the setup costs for all operations. If set up on one of the early operations is a highly substantial proportion of total setup costs, it may be economical to establish an inventory called a hold point beyond this high setup operation.” – Production and Inventory Control: Principles and Techniques

On pulling production forward, this same emphasis is covered with a procedure rather than with EOQ in this link.

## How to Best Use the EOQ Calculator with Non-Instantaneous Receipt

There are actually many EOQ formulas or EOQ model — each for a different environment and different problem. However, this is the EOQ model that is used in most supply planning systems — although it does not necessarily make it the right EOQ model to use for your business or for different segments of the product location database.

George Plossl brings up this point well in the following quotation:

“Frequently, for example, the entire lot size is not received into stock at once. The manufacturing rate may be such that it takes several days or even weeks for the complete lot to be made and delivered into stock. While production is going on, partial deliveries to stock are made, but withdrawals are also made during the period. Consequently, the average lot size inventory will not equal one half of the lot size, as it does where all the lot is received at once. This situation, given  the rather formidable name of non-instantaneous receipt, can be handled by using a modification to the basic EOQ formula.” – Production and Inventory Control: Principles and Techniques

The EOQ model he is referring to replaced the denominator of the inventory carry cost with the inventory carrying cost (as a decimal fraction per dollar of average inventory * (1-the usage rate, in the same units as the production rate divided by the production rate), which is emulated in the form below.

• This modified formulas is not available within any supply planning system I am aware of.
• This is why we have been promoting the concept of calculating EOQ outside of the systems through supply planning parameter optimization and then uploading this to the system as a stored rather than calculated value. This is how to arrive at an optimal order quantity calculator.

## How the EOQ Model Calculation Form, Optimal Order Quantity Calculator Works

This form requires input to provide output. However, it also has default values. You can change any input value and the rest of the formula — the output will change immediately. You can continue making changes and the form will always update without having to press any button or refresh.

## Conclusion

The history of the development of economic order quantity turns out to be interesting. It’s a story of how a high school educated engineer made of the most enduring contribution to inventory management. But most companies that use EOQ are unaware of the EOQ assumptions of economic order quantity. This leads to things like applying order costs which are too low and reducing EOQ’s overall usefulness.

There are in fact many economic order quantity formulas to choose from each with different EOQ assumptions. Therefore, if one does not fit the EOQ assumptions of the requirements, another EOQ formula can be used.

The vast majority of applications only provide a small number of economic order quantity formulas to choose from, but any EOQ formula can be calculated outside the system and imported.

• EOQ can only see the fundamental trade-off between inventory cost and order cost — therefore to account for different scenarios, it must be adjusted.
• A common misperception is that these issues listed above are handled by more sophisticated methods. In a few cases (such as with seasonality & space costs) this can be true — but in actual live systems, it is almost always not the case. In fact, it can be easier and more straightforward to account for these factors through parameter calculation as is explained our application the Brightwork Explorer.

## Brightwork EOQ Articles and Calculators

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:

## 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

Plossl, George W. Production, and Inventory Control: Principles and Techniques, Second Edition. Prentice Hall, 1985.

Harris. Ford W. How Many Parts to Make at Once. Factory, The Magazine of Management. 1913.

I cover EOQ and other consumption settings in the following book.

## 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

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below:

## Executive Summary

• Ordering quantities are often the focus of supply chain planning as they directly impact the frequency with which things are done.
• The Economic Order Quantity (EOQ) tells the system how much to order at a reorder point.
• Safety stock is often required due to variability in lead-times and the volume of a forecast. In a scenario in which there is zero forecast error and zero supply variability, the safety stock is zero.
• Safety stock is only necessary under 2 scenarios: 1) when actual demand exceeds the forecast, and 2) when the supply lead time exceeds the actual lead time. In these scenarios, safety stock can be calculated over lead time demand or demand between replenishments.
• A specific example is used to demonstrate the relationship between order frequency, order quantity, and safety stock.

## Introduction to The Safety Stock and Ordering Quantity and Frequency Scenarios

While not often discussed, the topic of ordering frequency is linked to all of the other subjects that are frequently discussed. These subjects include items such as:

• EOQ
• Safety Stock
• Min Lot Size

That is quantities are much more often a focus of discussions in supply chain planning. It directly affects the frequency with which things are done.

An excellent place to start off this analysis is to look at a straightforward ordering pattern. This occurs with a level demand as is shown in the graphic below.

## Safety Stock

Safety stock is one of the best-known concepts in supply chain management. Every MRP application and advanced planning application on the market has either a field for safety stock or can calculate safety stock.

Notice that safety stock is not required because of lead-times or because of the volume of a forecast – it is because of the variability of either of these two components. The second most important thing to understand about safety stock is that variability is projected – it is probabilistic and therefore subject to error. If the variability was predictable, a lower level of safety stock could be maintained – however, variability is generally not predictable.

## Economic Order Quantity

The reorder point tells the system when to reorder, while the economic order quantity tells the system how much to order; as such they are necessarily highly integrated values. EOQ is one method for performing what is generally known as lot sizing. The lot size is the quantity in which the item is produced or procured and therefore it is set at the production location combination in the product master. Here it is in Demand Works Smoothie on their Policies Tab.

## Min Lot Size

The creation of lot sizes (discrete quantities of a good to be produced or purchased at a given time or per order) is based on the selected lot-sizing procedure. The exact sizes matter because, in each production level, the lots are usually produced completely before being passed on for further processing.

## Scenario 1: No Forecast Error or Supply Variability

• Because the demand is entirely level and there is zero forecast error, a mere economic ordering quantity if (EOQ) of 750 units can be placed once every three months. This is true even though the lead time is only two weeks. This ordering quantity is represented by the orange line. This quantity is received into inventory every three months.
• Because there are zero forecast error and zero supply variability, there is also zero safety stock.

Now that we have covered a scenario with no variability, let us add variability and add see what happens to safety stock.

## Scenario 2: Forecast Error and Supply Variability

Now we will change the scenario to include variability. The forecast error for this product is now 14.6% and the lead time variability has been modified to 7.4%. Both errors apply over the procurement/production (supply) lead time. However, safety stock is only necessary under the following scenarios:

1. When actual demand exceeds the forecast.
2. When the supply leads time exceeds the actual lead time.

If the reverse happens, then we are only left with excess stock.

Notice how the forecast error changes when we are only concerned with negative forecast error.

Both errors or variations are averages.

If we put together a sample of forecast error and procurement/production lead time history, it might look like this.

## History of Forecast Error and Lead Time Variability

JanFebMarAprMayAverage ErrorAverage Error for Safety Stock Purposes
Forecast Error History20%-25%+15%+10%-3%14.6%-5.6%

1. The error is much smaller when we do not take into account errors that do not pull from stock.
2. This is what we will increase our starting stock level for, which is -5.6% + -5% = -10%, or 10%.

The safety stock here is not statistically calculated in this scenario. Instead, it is a mean error — or a service level at exactly the 50th percentile. This means we need to add the twin variabilities that sum up to 10%.

This is how much we have to increase in stock. The stock required to cover the possibility that both the supply is late and the forecast is in error. If both of these events do not occur, then we will have carried excess stock.

The next question is what should this increase be calculated over.

There are two options:

1. Lead Time Demand
2. Demand Between Replenishments

Let us discuss each in detail:

## Lead Time Demand

The standard answer is that the bump in stock should be over lead time demand. The order frequency is once every three months — but the lead time is 1/2 of a month. Enough safety stock is necessary to cover the two-week lead time — if demand spiked, we could place an order before the next regular order date.

• The lead time is 1/2 of a month, and the average monthly demand is 250. So 250 units is one of the parts to the formula.
• The 50th percentile sums to 10%.
• Therefore 10% should be multiplied by 1/2 * 250 or 125. This brings a safety stock of 12.5.

## Demand Between Replenishments

The EOQ was already calculated, and it was determined that this product at this location should be ordered once every three months. With a 1/2 month replenishment time, the flexibility does exist to keep a little safety stock, but only by taking on a risk that an order will have to be placed on the next standard order date or reorder date, and that is less economical.

To enforce the EOQ, the 10% increase would be applied to the three-month demand of 750 units, which would bring the safety stock to 75 units. Because the safety stock is 75 units, the plan is for that 75 units to be carried throughout the duration, and therefore this bumps up the ending inventory of each month by 75 units.

Now we are ready to make the safety stock statistical, which means using a service level.

## Scenario 3: Forecast Error and Supply Variability + Service Level

Scenario 2 would only offer the appropriate safety stock for up to 50% of cases, or what is called the 50th percentile on a normal distribution curve. However, in most cases, companies have a service level, and this means moving up the distribution curve, which of course gets more expensive. 95% is a very common service goal, so let us apply this service level to our safety stock.

This will mean converting 95% to an inverse value — which happens to be 1.644.

• So now we take the 75 units and multiply them by 1.644 which yields 123.3.
• Because our error is a composite value of both demand and supply variability, this level of safety stock should cover us for 95% of the scenarios.

## Conclusion

This article was all about showing the trade-offs on order frequency, order quantity (EOQ) and safety stock. The order date is as important as the order quantity. The order date is the timing of the order, and the order date accuracy can be tested and checked historically.

This article used statistical safety stock, but not the standard formula — because we prefer our own as is explained at the following link.

Also, learn about the limitations of EOQ at this link.

## EOQ Quiz

This quiz will test your basic knowledge level of EOQ.

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:

## References

Plossel, George. Orlicky’s Material Requirement’s Planning. Second Edition. McGraw Hill. 1984. (first edition 1975)

## Safety Stock and Service Levels: A New Approach

### Important Features About Safety Stock

Safety stock is one of the most commonly discussed topics in supply chain management. Every MRP application and every advanced planning application on the market has either a field for safety stock or can calculate safety stock. However, companies continue to struggle with the right level to set it. Service levels are strongly related to safety stock. However, companies also struggle with how to set service levels.

### How Systems Set Safety Stock

The vast majority of systems allow the setting of safety stock by multiple means (static, dynamic, adjustable with the forecast in days’ supply, etc..). However, most systems do not allow the safety stock to be set in a way that is considerate of the inventory that is available to be applied.By reading this book you will:

• Understand the concepts and formula used for safety stock and service level setting.
• Common ways of setting safety stock.
• Service levels and inventory optimization applications.
• The best real ways of setting both service levels and safety stock.

### Chapters

Chapter 1: Introduction
Chapter 2: Safety Stock and Service Levels from a Conceptual Perspective
Chapter 3: The Common Ways of Setting Safety Stock
Chapter 4: The Common Issues with Safety Stock
Chapter 5: Common Issues with Service Level Setting
Chapter 6: Service Level Agreement
Chapter 7: Safety Stock and Service Levels in Inventory Optimization and Multi-Echelon Software
Chapter 8: A Simpler Approach to Comprehensively Setting Safety Stock and Service Levels

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below:

## Executive Summary

• This is an introduction to the economic order quantity formula.
• We analyze Ford W. Harris’ original economic order quantity paper.
• We cover using the economic order quantity in production planning systems.

## Introduction

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.

## Who Developed the Economic Order Quantity Formula?

Companies and universities tend to claim the invention of most everything.

As with the development of MRP, the originator of the Economic Order Quantity Formula was not an academic, and unassociated with any company. He was simply looking for a way to make rational ordering decisions with some quantitative support. This shows two important developments in supply chain planning were developed outside of the traditional system.

• MRP Development: Orlicky, Plossl & Wight were employed at JI Case and Stanley Tools in the 1960s. They were trying to solve inventory problems at these companies. But JI Case and Stanley Tools did not contribute to the work.
• EOQ Development: Ford W. Harris had no affiliation and was not an academic. While he later became an attorney, at the time he developed the EOQ formula, he had only a high school education.

This is not exclusive to supply chain innovations. For instance, Einstein had no university affiliation when he wrote his papers while employed as a patent clerk. He later gained university affiliation with top schools after he did his most important work. Not only did Einstein have no university affiliation when he wrote is four breakthrough papers, but he had also applied for, and been rejected as a high schools science teacher in the years before his discoveries.

## Issac Newton, College Drop Out?

Another example is Issac Newton did have a university affiliation. He was not a professor when he developed his theories of calculus, optics, and gravitation. These were all established while he was away from Cambridge for two years. Newton’s papers could not be published for roughly 13 years because the head of the Royal Society was envious of Newton. He took credit for anything Newton published. Therefore, Newton stopped publishing during this time. Finally, this individual died, and Newton became the head of the Royal Society. Therefore what are widely considered to be the two most significant scientists in history had no university affiliation when they made their discoveries.

## An Analysis of Ford W. Harris’ Economic Order Quantity Formula Paper

Most people find out about EOQ second hand. The original paper How Many Parts to Make at Once is quite good. It is not only well laid out, but it is also well written. In fact, far more so than the vast majority of papers I have read by academics. That is people with much more education than Harris had at the time. It is also short compared to other academic papers in the field. Some interesting quotations from this paper follow:

“The writer has seen the practical workings of a first class stock system and does not wish to be understood as claiming that any mere mathematical formula should be depended upon entirely for determining the amount of stock that should be carried or put through on an order. This is a matter that calls, in each case, for trained judgement, for which there is no substitute. There are many factors of even more importance than those given in this discussion.”

This is quite an interesting quotation because subsequent authors to wrote on EOQ had a strong tendency to present the EOQ formula as much more final in nature.

“But in deciding on the best size of order, the man responsible should consider all the factors that are mentioned. While it is perfectly possible to estimated closely enough what effect these factors will have, the chances are many mistakes costing money will be made. Hence, using the formula as a check is at least warranted.”

This quotation envisions the EOQ as a check to compare against human judgment. This paper was written in 1913, and there were not computers in use in this or any other area. The EOQ formula that was being proposed by Harris would be calculated by hand. Supply planning software applications do not compute EOQ formulas.

## Changing the Cost of Computing the EOQ Formula

This changes the cost of computing the formula. It also changes the interpretation of how the EOQ formula can be used.

One would like to go back in time to ask Harris a question.  That question would be given the advantages that we have in computing power; he would still think the same thing he wrote back in 1913.

“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 indeed other factors could be used, but he feels confident that the formula encompasses the most important factors for driving ordering. Of course, it is also an interesting statement, because his basic EOQ formula has been added to over the following years with many different additional costs and considerations.

## List of EOQ Formula Adjustments

Just a sample of these are listed below:

• EOQ Revisited with Sustainability Considerations
• Study of EOQ-based Inventory and Transportation
• EOQ and Inflation Uncertainty
• An EOQ Model for a Perishable product with Special Sale and Shortage
• Optimal Replenishment Cycle in an EOQ Model with Defective Items
• The Stochastic EOQ Model with Random Sales Price
• An EOQ Model for Deteriorating Items Under Credit Options
• EOQ Model with Stock-Dependent Demand

## Using Economic Order Quantity Formula in Production Systems

After calculating the Economic Order Quantity Formula, the output is most often placed into the minimum order quantity field. This sets the minimum order level. Sometimes other factors such as the larger than this level — such as when products must be purchased in rail carloads. In that case, the no EOQ calculation is necessary. The minimum order quantity is the carload.

The formula is one of the easiest in supply management chain to calculate. Many companies do not determine their unconstrained (that is unconstrained by minimum order sizes such as with the example of the carload or minimum package quantities) products by EOQ. However, there is no reason aside from work effort not to do so. The fact is, most companies don’t get around to calculating EOQ or if they do calculate it, they do so very infrequently. Students are often told that EOQ is used in industry very frequently — when in fact, it isn’t.

But this does not mean that it should not be — it certainly adds value and quantifies and then trades off the most relevant costs for making an ordering decision.

That is the truth of how lean the staffing is in supply chain management. They do not have the staffing the apply elementary inventory management techniques that are over 80 years old.

While it would be easy to place this into supply planning systems in the parameters of the product record, it is not done. Software vendors tend to assume that companies will periodically calculate the value externally.

## Conclusion

The history of the development of economic order quantity turns out to be interesting. It’s a story of how a high school educated engineer made of the most enduring contribution to inventory management. The EOQ formula is coded into nearly every supply and production planning application that exists.

To calculate the EOQ formula online, see our EOQ Calculator at this link.

Also, learn about the limitations of EOQ at this link.

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:

## References

I cover EOQ in depth in the following book.

## 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

EOQ is calculated in supply planning systems.

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below:

## Executive Summary

• This is an introduction to EOQ calculator or EOQ formula calculator.
• We cover how to calculate Economic Order Quantity.
• We cover the Economic Order Quantity Calculator, EOQ Formula Calculator, and a Quantity Discount Model.

## Introduction to the EOQ Calculator or EOQ Formula Calculator

• Economic order quantity (EOQ) is one of the oldest formulas in inventory management.
• It was first developed by Ford W. Harris in 1913 (interestingly, as with the development of MRP, the originator of EOQ was not an academic).
• This EOQ calculator or EOQ formula calculator will allow anyone to calculate EOQ quickly. One can calculate EOQ in a spreadsheet for a large number of product location combinations.

## Reorder Quantity Formula

EOQ is one type of reordering quantity formula. Any reorder quantity formula can be used. All that has to occur is that the assumptions of the reorder quantity formula must be agreed to by the entity that intends to use it. Most software has a rather small number of options for its reorder quantity formula. However, when calculated externally, an entity can use any reorder quantity formula that it wants. It can then upload the results of the reorder quantity formula to their ERP or other supply planning system.

## EOQ for the Production Order Quantity or the Purchase Order Quantity

EOQ can drive production order quantity as well as procurement order quantity. The production order quantity then drives the purchase order for the finished good. But once the finished good production order quantity is determined, the bill of material can be explored to determine the purchase order quantity. One of the criticisms of EOQ is that the bill of materials is not exploded.

That is untrue as what are called requirements strategies can be set differently for every part of the bill of material. This is covered in my book on reorder point planning which is shown at the bottom of this article.

When companies search for a purchase order system or purchase order software

EOQ is not an adjustable formula; unlike the dynamic safety stock calculation, it cannot account for variability. Some have proposed that this means it cannot be used for more product location combinations (PLCs) with more variable demand history — and this is true — if the data provided to the EOQ is not periodically changed. Therefore, it must be periodically recomputed for the entire database.

This is the standard relationship between cycle stock and safety stock with a stable order quantity. The inventory is reduced by orders — hopefully only occasionally dipping into safety stock.

## Economic Order Quantity Calculator, EOQ Formula Calculator, and the Forecast Error

The higher the forecast error, the less use the EOQ value is. This is because was the forecast error increases, the likelihood that the quantity will be consumed declines.

However, this is not different from any other supply planning parameter. Supply planning parameters have the highest value when the forecast is most accurate.

## EOQ Calculator with Quantity Discount Model

If there are quantity discounts, the calculation below will not be accurate. For instance, the formula below may propose an EOQ of 184 units. If the price per each at this level is \$50, then this is a total cost of (184 * \$50) + 45 or \$9245.

If the quantity discount kicks it at 200 units and this discount is 15%, then 16 more units could be obtained for \$8538. This would be a missed opportunity. This can easily calculate EOQ for an individual item, but this cannot be systematized because supply planning applications do not have EOQ functionality or even step function min lot sizes.

This means that when you purchase a system, it will in almost all cases not have a quantity discount model as part of its EOQ functionality. It is easy to create a quantity discount model as part of your EOQ externally and then import the hard-coded EOQ values into the system. But normally calculating an EOQ with quantity discount model is not done. This is often seen as too much “work.” And rather than calculating things like EOQ with quantity discount model outside the system, there is a strong preference for many companies to use the software as is.

Rather than calculate EOQ, batching typically is handled by procurement as they are up to date on the volume discounts and will up the orders to meet the discount.

## How the EOQ Calculator Form Works

This form requires input to provide output for the Economic Order Quantity Calculator. However, it also has default values. You can change any input value and the rest of the formula — the output will change immediately. You can continue making changes, and the form will always update without having to press any button or refresh.

This calculator assumes that the location receives the entire order at one time. However, this assumption does not always hold. For the noninstantaneous receipt, EOQ calculator see this article.

Also, learn about the limitations of EOQ at this article.

## Conclusion

This is a way to calculate EOQ easily. The best way to calculate economic order quantity is normally in a system or a spreadsheet. One can calculate economic order quantity as one wishes and then upload the result to any supply planning system. There are many EOQ formulas and many ways to calculate EOQ that are different from the standard model. To calculate economic order quantity in a way that is different from the standard EOQ formula in ERP or other supply planning systems, to calculate economic order quantity is the way to go.

This page is provided to have a fast way to calculate economic order quantity and EOQ formula calculator online.

## EOQ Quiz

This quiz will test your basic knowledge level of EOQ.

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:

## 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

Plossl, George W. Production and Inventory Control: Principles and Techniques, Second Edition. Prentice Hall, 1985.

Plossel, George. Orlicky’s Material Requirement’s Planning. Second Edition. McGraw Hill. 1984. (first edition 1975)

Harris. Ford W. How Many Parts to Make at Once. Factory, The Magazine of Management. 1913.

Silver, Edward A. Peterson, Rein. Decision Systems for Inventory Management and Production Planning. Second Edition. John Wiley and Sons. 1985.

The background for the economic order quantity calcualtor is covered in the following book.

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below:

## Setting the Right Inventory Carry Cost Percentage

• What is the Background on Inventory Carry Cost?
• What Inputs Make Up the Carry Costs?
• Experience in Estimating Inventory Carry Cost
• Estimating Inventory Carrying Cost
• What Factors Increase or Decrease the Inventory Carry Cost Percentage that is Applied?
• What Do You Know About EOQ?
• Our Work on EOQ

## Introduction

Inventory carry cost is necessary for the supply chain as it allows a company to determine its costs of keeping inventory. It is also a key input into the economic order quantity, which in its base formulation (there are many EOQ formulas) trades off the cost of carrying inventory versus the cost of ordering inventory. EOQ sounds like a very straightforward formula until you ask companies to estimate their inventory carry cost and order cost.

## Inventory Carrying Cost Inputs

You generally cannot simply go to the finance department in a company as they tend to know the cost of money, or the capital cost of the company, but not the other costs associated with inventory carry cost. This is a combined cost which accounts for:

1. The cost of capital
2. The cost of the storage facility for the product
3. The cost of the product becoming obsolete or going bad (say as in in the case of perishables)
4. The cost of the product being damaged while being stored

## Experience in Estimating Inventory Carry Cost

I have asked about this value for many clients to perform modeling and create EOQ driven ordering quantities and frequencies. They almost always tell me that they don’t have a good number. They then ask me if I know of one.

George Plossl does a good job of explaining the arbitrary nature of such estimations in the book.”

Production and Inventory Control.” I have a quote from the book below:

“Inventory Carrying Cost: The inventory carrying cost is a useful concept (albeit an artificial one) required by the mathematical formulas used in lot-sizing calculations. As listed earlier, many separate elements are assumed to make up this cost. Obsolescence is a reality in any inventory but this cost element in the inventory carrying cost varies widely with time and is not the same for different items in an inventory (that is, it is highest for style items). This would indicate that a different carrying cost might be used for each item in the stock list. This is obviously impractical and an average figure is usually chosen, either for all products or for each major type of product. Identical reasoning applies to deterioration costs. The whole discussion is purely academic. The inventory carrying cost has practical use only as a management policy variable which, rather than being a fixed. magic number, is one that should be manipulated to attain the overall objectives of the company. “ George Plossl

## Estimating Inventory Carrying Cost

Inventory carrying cost is an estimation of the percentage of the product cost that in consumed in holding the product for one year. It is often used in inventory formulas as well as cost optimization. In many popular articles that cover the subject superficially, it is often stated that a good inventory carrying cost is between 20 to 25%.

I could spend lots of time estimating this for each company, as pointed out by George Plossl, the value would always be an average. And will be too high for some products and too high for others. The major item I look for is how perishable the company’s product is. If it is more towards the perishable end of the spectrum, I increase the inventory carry cost; If it is not, I decrease the inventory carry cost.

## Conclusion

One of the current (2016) issues with using a value between 20 and 25% is that they have tended to be created when interest rates and inflation (which is built into interest rates) was higher. Therefore, those companies that use the higher figure would tend to overestimate inventory carry cost. One of the perplexing things about using quantified values for both order cost and inventory carry cost is that the order quantities become much higher than is “politically acceptable” within companies.

This is one reason that companies often ignore quantification of order quantities and determine the order quantity using judgment methods.

See our EOQ calculator at this link.

Also, learn about the limitations of EOQ at this link.

### Remote Supply Planning Consulting

The software space is controlled by vendors, consulting firms and IT analysts who often provide self-serving and incorrect advice at the top rates.

• We have a better track record of being correct than any of the well-known brands.
• If this type of accuracy interests you, tell us your question below.

## Order Sizing and Optimization

Order optimization is necessary in order to get the predicted value from ERP and other supply planning applications. The Brightwork MRP & S&OP Explorer does exactly this, and it is free to use in the beginning until it sees “serious usage.” It is permanently free to academics and students. See by clicking the image below:

## References

Production and Inventory Control: Techniques and Principles 2nd Edition,” George Plossl, Prentice Hall, 1985

## 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

## Software Ratings

Brightwork Research & Analysis offers the following free supply planning software analysis and ratings. See by clicking the image below: