Logistics and Supply Chain Management, 4th Edition

CREATING THE RESPON S I V E SU P P LY CHAIN

109

The EOQ can be easily determined by the formula:

2AS

EOQ =

––––

i

where,

A = annual usage

S = ordering cost/set-up cost

i = inventory carrying cost

So, for example, if we use 1,000 units of product X a year, each costing £40, and

each order/set-up costs £100 and the carrying cost of inventory is 25 per cent then:

2 × 1000 × 100

EOQ =

–––––––––––––––––

= 141

40 × 0.25

The problem is that this reorder quantity means that we will be carrying more

inventory than is actually required per day over the complete order cycle (except

on the last day). For example, if the EOQ were 100 units and daily usage was 10

units then on the first day of the cycle we will be overstocked by 90 units, on the

second day by 80 units and so on.

To compound the problem we have additional inventory in the form of ‘safety’

stock, which is carried in order to provide a safeguard against demand during the

replenishment lead time being greater than expected and/or variation in the lead

time itself.

The result is that we end up with a lot of unproductive inventory, which repre-

sents a continuing drain on working capital.

The Japanese philosophy

It has often been said that the scarcity of space in industrialised Japan has made

the nation conscious of the need to make the most productive use of all physical

resources, including inventory – whether this is true is of academic interest only –

what is the case is that it is the widely held view in Japan that inventory is waste.

An analogy that is frequently drawn in Japan is that an organisation’s invest-

ment in inventory is like a large, deep lake (see Figure 5.11). Well below the

surface of this lake are numerous jagged rocks, but because of the depth of the

water, the captain of the ship need have no fear of striking one of them.

The comparison with business is simple: the depth of the water in the lake

represents inventory and the rocks represent problems. These problems might

include such things as inaccurate forecasts, unreliable suppliers, quality problems,

bottlenecks, industrial relations problems and so on. The Japanese philosophy is

that inventory merely hides the problems. Their view is that the level of water in the

lake should be reduced (say to level ‘B’ in Figure 5.11). Now the captain of the

ship is forced to confront the problems – they cannot be avoided. In the same way

if inventory is reduced then management must grasp the various nettles of forecast

inaccuracy, unreliable suppliers and so on.