Operations Management: Processes and Supply Chains, 12th Edition

Economic Order Quantity

Supply chain managers face conflicting pressures to keep inventories low enough to avoid excess inventory holding costs but high enough to reduce ordering and setup costs. Inventory holding cost is the sum of the cost of capital and the variable costs of keeping items on hand, such as storage and handling, taxes, insurance, and shrinkage. Ordering cost is the cost of preparing a purchase order for a supplier or a production order for the shop, while setup cost is the cost of changing over a machine to produce a different item. In this section, we will address the cycle inventory, which is that portion of total inventory that varies directly with lot size. A good starting point for balancing these conflicting pressures ...