Economic Order Quantity (EOQ) & Re-Order Point (ROP): Past Concepts with Lessons for the Present

Jovy Jader // Uncategorized

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July 12, 2017  

Someone once said “Today’s systems and procedures were designed to meet yesterday’s problems.” This maxim holds true especially if the problems continue to persist in the present. However in most cases, the problems are long gone but the systems and procedures meant to address them continue to be enforced, which end up being costly to the firm.

As one newly-hired executive lamented: “Why do I have to countersign this bunch of documents in which I have no idea about the technical details?” And the usual reply will be “That has been the practice since seven (7) years ago when an audit issue was discovered and the proposal was that documents should pass through your office.”

This scenario continues similarly as well in industries. At the start of the industrial revolution, demand for products were so huge that the major constraint was the ability of factories to serve demand, thus workers’ productivity in terms of pieces produced was the key business measure. With huge demand, whatever factories produced got sold. Thus, all management interventions were in improving the productivity of factories by keeping machines and people busy.

Today, as consumers have more choices due to firms making available multiple product variants, many manufacturers stick to the idea of keeping machines and people busy, not realizing that goods produced continuously do not necessarily lead to goods sold at the lowest cost especially if goods spend time as inventory on the factory floor or warehouse.

In Inventory and Operations Management, two (2) concepts are worth discussing:

Re-Order Point (ROP)

With thousands of items to manage and without the aid of modern computers, firms in the mid-20th century adopted the Re-Order Point (ROP), an inventory tool that simply tells managers when to replenish inventories. Without ROP, inventory managers would only react when items would run out or when salespeople & factory managers would complain about unavailable products or materials. The introduction of ROP was a welcome innovation that helped revolutionized inventory management.

ROP, in fact, is widely used today. Families buy groceries when they see their food at only a few days’ supply. They don’t wait for the food to run out. Administrators requisition for office supplies when stocks reach a “low point.”

ROP works on the assumption that the items ordered are certain to be consumed within the immediate future. ROP assumes that there will always be demand for items. But as item life-cycles shorten given the constant introduction of newer products with more attractive features, it has become less certain for items to be used over the long-term. Obsolescence becomes a higher risk with ROP.

Economic Order Quantity (EOQ)

If ROP answers the question “When to buy?” Economic Order Quantity (EOQ) addresses “How much to buy?” At its conception, EOQ went hand-in-hand with ROP in greatly helping firms manage inventories. EOQ provided managers a cost effective way of determining the quantity to be purchased based on two parameters: the cost of holding inventory and the cost of purchasing the item. While the concept looked good, most managers would attest that deriving EOQ for every material or product was an enormous task. Moreover, others would ask to where the “Economical” in EOQ was beneficial to: the firm, its vendors, or its customers?

With the advent of state-of-the-art information technologies (IT), firms now have the ability to match replenishments with actual demand. ROP and EOQ gradually have lost their popularity.

ROP and EOQ were practical concepts and they still are in some firms. But as modern IT systems provide real-time demand data, firms have been able to match purchases with actual sales. Inventories have been reduced even as more products enter the marketplace.

The effectiveness of ROP and EOQ stemmed from simple ideas and clear policies. Organizations may find it opportune to review their policies and practices as failure to do so may lead to consequences that would be too difficult to fix.

About the Author

Mr. Jovy Jader is a Management Consultant and Regional Speaker on Supply Chain Management. He has directed and implemented Supply Chain Management projects both local and international which have resulted to company-wide improvements in revenue, working capital, total cost, and service levels. Mr. Jader was formerly with Procter & Gamble Philippines and Coopers & Lybrand/PricewaterhouseCoopers.

Jovy Jader

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