Economic Order Quantity (EOQ) is a fundamental inventory management tool used by businesses to determine the optimal order size that minimizes total inventory costs. These costs typically include ordering costs (e.g., shipping, handling, and paperwork) and holding costs (e.g., storage, insurance, and spoilage). By calculating EOQ, companies can strike a balance between ordering too frequently (which increases ordering costs) and ordering too much (which increases holding costs).
The EOQ model assumes steady demand, constant costs, and no stockouts. The formula is:
EOQ = √(2DS / H)Where:
D = Annual demand (units)
S = Ordering cost per order ($)
H = Holding cost per unit per year ($)
This formula derives the quantity that minimizes the sum of ordering and holding costs.
Cost Efficiency: EOQ helps businesses reduce unnecessary expenses by optimizing order sizes.
Inventory Management: It ensures sufficient stock without overstocking, freeing up capital and storage space.
Operational Stability: Consistent ordering schedules improve supply chain reliability.
Suppose a retailer has:
Annual demand (D) = 10,000 units
Ordering cost (S) = $50 per order
Holding cost (H) = $2 per unit per year
Plugging into the formula:
EOQ = √(2 × 10,000 × 50 / 2) = √(500,000) ≈ 707 unitsThe retailer should order 707 units each time to minimize costs.
Assumptions: EOQ assumes constant demand and costs, which may not hold in volatile markets.
Exclusions: It doesn’t account for bulk discounts, stockouts, or variable lead times.
Simplicity: Complex supply chains may require advanced models.
EOQ is a powerful tool for businesses seeking to optimize inventory management. While it has limitations, its simplicity and effectiveness make it a staple in operations. By understanding and applying EOQ, companies can reduce costs and improve efficiency, ensuring they remain competitive in dynamic markets.
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