EOQ (Economic Order Quantity) - Use for managing Customer Orders - asking help

S

Sharpin Zou

#1
Dear all, Understand that EOQ is widely used for managing the purchasing orders for Raw Material/parts in purchase department. But we are Requested from our boss recently to set up a calculation model for managing the customer orders - EOQ for customer order. I have very limited experience in using the EOQ. Could you please to help clarify below question? Thank you very much!

1. Is the model EOQ=Square Root of (2*D*Co/Ch) still suitable for the this purpose - EOQ for customer order?

2. If yes, what should the D, Co and Ch stands for, especially how to set up the definition for Co (order cost)?

By the way, our company is a chemical company with batch process. We have hundreds of SKU and have both MTO (make to order) and MTS (make to stock) models.. :eek:
 
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S

Sharpin Zou

#3
Re: EOQ- use for managing customer orders-asking help

:thanx:Thanks, Harry,
yes, the definition of EOQ is used for managemnet of the purchasing orders and to achieve a good inventory control fro raw materials/parts. Is there a sample for using EOQ for manageing the customer orders. Is the calcuation formula is still suitabel in this case?:eek:
 
B

Bill Pflanz

#4
The EOQ formula that you have provided is the most basic method for determining the order amount at the lowest cost of inventory while still meeting customer demand. It assumes that demand is constant, purchases are received instantaneously, and quantity discounts for purchases are not possible. The equations become more complicated as demand and production amounts vary, quantity discounts are given, and safety stocks are added to avoid running out of inventory.

EOQ refers to the order amount of the inventory item not the customer product order. D is the annual demand for the inventory item and must be determined from historical demand rates. The ordering costs are all of the costs related to purchasing it and include purchase department payroll and all the costs associated with placing an order. The holding costs are all the storage costs including the capital costs, taxes, insurance, and losses due to spoilage or obsolescence. Forecasting demand will require some work with your sales and production staff for each product and raw material. You will also need to work with your accounting department to determine an estimate of the costs which may vary depending on the inventory item.

Since you also describe a production environment, you may have to use a Production Run model that takes into consideration that demand is not constant. It will not be as simple as just applying the EOQ formula that you have shown. These theories are taught in business schools usually under the title of Quantitative Analysis or Methods and text books are readily available.

I now teach this theory in a Quantitative Analyis class but I also worked in the oil and chemical industry. Theoretically EOQ can be applied but it would involve a significant amount of work. For companies such as yours with hundreds of products, expensive material requirements planning (MRP) software systems are sometimes used. I think you need to have a better understanding of the purpose of EOQ before you can implement it.

Bill Pflanz
 
S

Sharpin Zou

#5
:thanx:Dear Bill, thank you very much for the explaination. I am now quite clear about the EOQ in purchase orders. But The purpose that we are going to use EOQ for managing the customer product orders is to try to identify the economic order quantity for our finish product so that we can achieve the lowest of overall logistic cost (freight, warehouse/inventory for finish products, order setting cost, ...).

Looks like the EOQ formula above is not a solution for my cause. Could you advise any other applicable method for this case? Many thanks.

Should we use MOQ (minium order quantity) for it?
 
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B

Bill Pflanz

#6
The EOQ is appropriate to use to control total inventory costs (warehouse and other holding costs + ordering costs). It can be applied to finished product in the same way as for raw materials. The production run model described in my previous posting is used to determine how much product to produce each month to minimize your inventory costs of finished product. A difference is that ordering costs are replaced by setup costs which are costs associated with producing different products. For the chemical industry it would be costs for cleaning equipment etc. to prepare for the next batch.

My accountants included freight costs for shipping to a customer as part of the cost of sales. If you have multiple production sites and multiple distribution sites then it is possible to determine minimum freight costs using a linear programming model that is also a quantitative analysis method.

I think you are looking for one universal method to minimize costs and I think you will need to use a variety of methods.

Bill Pflanz
 
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