Page 165 - Orlicky's Material Requirements Planning

144 PART 2 Concepts

■ Deterioration from long-term storage and handling
■ Recordkeeping
■ Taxes and insurance on inventory
■ Storage costs for equipment, space, heat, light, and people
■ Cost of capital invested in inventory, or foregone earnings of alternate invest-
ments
Ordering and inventory carrying costs rarely can be determined from traditional
cost-accounting data; they have to be “engineered” specifically for each company’s oper-
ations. While ordering costs can be estimated fairly accurately, they should be actual out-
of-pocket costs and only costs that are affected by the decision of how many to buy or
make.
Carrying cost, expressed usually as a decimal fraction of inventory value, may
appear precise but in reality will be only very approximate. Estimates of several factors
obviously will be little more than educated guesses at best, particularly the last one list-
ed earlier. Which of the two choices is used for this factor depends on company policy.
In practice, carrying costs vary from as low as 15 percent to as high as 80 percent per
year and can change during a year. Higher values are used by companies that must pro-
cure outside capital rather than use retained earnings and by those who believe that lot-
sizing decisions should be charged at the same rates the business expects other capital
investments to earn. Many professionals in inventory management believe that detailed
studies to estimate carrying costs are unwarranted. They prefer to view these as “man-
agement policy variables” to achieve management’s objec tives in inventory investment.
Increasing the carrying cost used in EOQ computations will result in smaller lot sizes,
and vice versa. Thus the inventory carrying cost in use at any given time reflects the pre-
mium that management is putting on the conservation of capital.
Order sizing creates cycle-stock or lot-size inventory in both order-point and MRP
approaches. In reality, the average amount of such inventories is not equal to the theo-
retical one-half of the quantities being ordered, as assumed in traditional EOQ calcula-
tions. In MRP, the lack of validity of such an approximation is clear. Order quantities
determined by such techniques for a given inventory item will equal net requirements for
one or more planning periods, causing the quantity ordered and the inventory to vary
significantly from one order to the next.
The number of periods covered by an order quantity will be affected by the relative
continuity of demand for the item. In cases of very intermittent demand, the order quan-
tity often will equal the requirement for only one period. This usually also will be true for
all assembled items because of typically minor assembly setup considerations.

LOT-SIZING TECHNIQUES
The most widely recognized approaches to lot sizing are as follows:

1. Fixed order quantity (FOQ)