Page 388 - Orlicky's Material Requirements Planning

CHAPTER 21 Historical Context 367

The basic formula is

Quantity 2AS
iC

where A is annual usage in units, S is ordering costs, i is annual inventory carrying cost
rate as a decimal, and C is unit cost.
The economic order quantity (EOQ) turns out to be a poor ordering quantity in the
typical manufacturing demand environment. The EOQ equation is totally insensitive to the
timing of actual, discrete demands (requirements) arising during the period that the EOQ
is intended to cover following its arrival in stock. Once future requirements for an inven-
tory item are precisely determined and positioned along a time axis, it can be seen that the
square-root approach in the EOQ calculation does nothing to balance the lot size against
either the timing or the quantity of actual requirements. For example, demand for an item
over a 10-week period may be determined in advance to be, by week, 20-0-20-0-0-0-0-0-20-
0. The EOQ for this item may turn out to be 50, more than needed to cover the first three
weeks’ requirements but not enough to cover the next requirement in the ninth week. The
“remnant”‘ of 10 pieces will be carried for eight weeks without any purpose. Note that the
EOQ still would be 50 if the 10-week demand were 20-0-40-0-0-0-0-0-0-0 or 20-0-0-0-0-0-0-
0-0-40. In the first instance, the EOQ would fail to cover the first three weeks’ requirements,
and in the second, the excess 30 pieces would be carried for nine weeks without being able
to satisfy the requirements of the tenth week. In any of these cases, the EOQ is determined
solely on the basis of setup cost, unit cost, carrying cost, and annual usage. The derivation
of the EOQ formula rests squarely on a basic assumption of uniform demand in small incre-
ments of the replenishment quantity, that is, gradual inventory depletion at a steady rate,
which then allows the carrying cost to be calculated for an “average” inventory of one-half
the order quantity. This basic assumption is grossly unrealistic vis-à-vis a manufacturing
inventory and therefore fatal to the validity of the technique.
The stock replenishment, order-point, and order-quantity techniques dominated the
pre-MRP world in both actual practice and the inventory control literature. The reason for
this is historical. The field had been conditioned in favor of the philosophy expressed by
these techniques because the pioneering theoretical work in inventory control generally
was confined to the areas of order point and order quantity. This work had been stimu-
lated by the fact that problems of order point and order quantity lend themselves to the
application of mathematical statistical methods that have been known and readily avail-
able for quite some time. The inventory control problem was perceived as being essen-
tially mathematical rather than one of massive data handling and data manipulation, the
means for which simply did not exist before the computer and MRP.

Analysis and Categorization of Inventory by Function
The fact that the chronic problems of manufacturing inventory management now can be
solved, however, is due not to better mathematics but to better data processing and com-