Managing Inventories: Determining Order Quantity

Abstract

Cycle-stock ordering decisions, including cost-element considerations, are examined. Students will see that as materials flow from suppliers through a firm's operations to customers, the cost-effectiveness of inventory investment is improved by the development and implementation of an inventory management system.

Excerpt

UVA-OM-1395

Rev. Feb. 28, 2013

MANAGING INVENTORIES: DETERMINING ORDER QUANTITY

A large amount of information is reported in the literature of inventory management on the development of rules for deciding how much to order (lot size) under various conditions. Regardless of the particular situation, constructing a cost model of the problem that captures the relevant characteristics of the situation shapes nearly all decision rules.

In some situations, mathematical procedures like differential calculus are applied to obtain specific decision rules. The Economic Order Quantity rule (EOQ) presented in the following pages is one such rule that is used in business situations. It is important to understand the specific mathematical model used to develop the decision rules to avoid using the rules incorrectly. Studying the mathematical model allows us to understand the assumptions that are being used. We can then ask whether those assumptions are realistic in the specific situation of interest. From a managerial perspective, the specific mathematical techniques used to determine the decision rules are less important.

Ordering in batches or lots is often economically advantageous. This policy creates cycle-stock inventory. Under the simplest assumption of level demand, the optimal rule is given by the EOQ formula, which is usually credited to Wilson because he first developed the model around 1915.

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Keywords: economic order quantity, inventory management, relevant costs