- The question of where can EOQ be implemented is important to answering how to apply this approach.
- We cover the background of EOQ.
The question of where can EOQ be implemented is critical to determine when to use a non-forecast based method of supply planning (reorder points) and forecast based planning (like MRP). EOQ stands for Economic Order Quantity.
EOQ is a way of calculating reorder points.
Introduction to 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.
Here the fields the Min ROQ Base (Reorder Quantity) and the ROQ (Reorder Quantity) are the relevant fields. Here the Min ROQ states that one must order in a minimum quantity of 2,880 units. The Qty Increment of 144 units means that after the minimum is met when more than the minimum is required, the item may be ordered in increments of 3,024, 3,168, 3,312, etc. The other alternative in this application is to set the Min ROQ Basis to Days, and in that case the Min ROQ and the Qty Increment would not reflect units, but would reflect days.
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. Economic order quantity is actually one of the oldest formulae in inventory management.
The development of EOQ is, in my view, the most interesting story I can recall reading of all of the supply chain management calculations I have investigated.
The History of EOQ
EOQ was first developed by Ford W. Harris in 1913. As with the development of MRP, the originator of EOQ was not an academic. In fact, at the time he developed EOQ, he did not even have an undergraduate degree. EOQ has proven to be one of the most durable calculations in all of inventory management and has held up remarkably well.
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.
The 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.
A fixed, known setup cost
Constant deterministic demand
Instantaneous delivery (infinite capacity)
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.”
Using Economic Order Quantity in 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 car loads, 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 car load, 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. 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.
The rule of when to apply reorder points is simple, although the specifics of how to create a threshold for mathematically determining when a product location combination should be placed on a forecast based planning approach like MRP and when it should be placed on a non-forecast based approach is a bit more involved, and is something we cover in the article How to Understand Segmentation Versus Inventory Optimization.
This article answered where can EOQ be implemented. Where can EOQ be implemented is essentially a question of where reorder points can be implemented as EOQ is a very common way to calculate reorder points. You can test our EOQ calculator at the link How to Best Use the Economic Order Quantity Calculator.
And it comes down to forecastability of the product location combination. If the forecast is of reasonable accuracy, then MRP can be used. If the forecast is high in error, and cannot be improved much beyond this error, then a reorder point will normally perform better than creating a forecast.
One of the best ways to understand how to set reorder points externally, we developed an approach where reorder points are calculated externally, which allows for a higher degree of control, and for the average inventory to be coestimated in a way that provides an observable total system inventory, holding cost, service level and a picture of what is happening to the overall system. This is called the Brightwork Explorer. Calculating individual parameters like reorder points without an appreciation for the systemwide does not make any sense.
Brightwork MRP & S&OP Explorer for Order Optimization
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:
Search Our Other Reorder Point Content
This topic is covered in depth in the following book.
Lean and Reorder Point Planning Book
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.
- 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