Question

Alex got a letter from Faucet Masters expressing that the company had adopted a new minimum-order-size policy. Consequently, faucet number 36543 should be ordered at a minimum of 130 units. This new requirement caught Alex by a surprise as it was about three times the amount he has been ordering. Through a quick rough calculation: (3+?)/2, Alex figured out that tripling the order quantity will raise the management cost associated with this faucet by nearly 67%. Alex was very uncomfortable with such a cost increase. Furthermore, given the current low inventory level of this item, Alex knew that a new order would have to be placed soon, and he was determined to find a resolution even sooner.

Jefferson Plumbing (Alex's company) sells a variety of plumbing supplies at its store in Richmond, Virginia. Because space is a premium in its city location, Jefferson tends to keep only small inventories and replenish them often. With an annual holding cost of $10 per unit for faucet 36543, Alex knew that increasing the order quantity to 130 will have a drastic cost impact. At the same time, he hoped that ordering a large quantity would reduce the number of orders. At an ordering cost rate of $100 per order, that may help a little. However, he was still concerned with his 67% increase estimate.

Alex asked himself, “Should I place large orders of faucet 36543, keep them in our warehouse at an annual holding rate of $1 per unit, and ship small batches to the store?” However, when Alex recalled that each time the store places an order from the warehouse there is a charge of $50, he was not as sure about the advantage of this approach.

(a) Now, when Jefferson incorporates the warehouse, (and IF he uses EOQ method), how many units should be ordered from the supplier to the warehouse? How many should be delivered from the warehouse to the store?

(b) Based on the order quantity you got from part (a), please draw the Warehouse Inventory Level Pattern.

(c) Is the above Warehouse Inventory Level Pattern in part (b) efficient or not? Please explain through calculation.

AVERAGE YEARLY DEMAND IS 100 UNITS

Answer 1

(a) Jefferson should place orders for 130 units from the warehouse from the supplier. MOQ will be around 14.50 months demand (please see the calculations below). So there is no scope for increasing the order size.However Stores should reducing the order size from Warehouse to around 22 units per order to avail the benefits of trade off between higher ordering costs but it will help in reducing inventory holding costs.1) Present order size = 130/3 = 44 (after rounding off)

(2) New Minimum order quantity policy of supplier 130.

(3) Additional annual inventory holding cost (per annum) of Jefferson plumbing is $10 (130 - 44) = $ 860

(4) Annual ordering cost as per existing ordering system = $10 x 130/44 = $ 30.

(5) Therefore extra costs under new ordering system (c - d ) 830 $

(6) Average yearly demand is 100 units. Assuming that the demand is uniform through out the year, the monthly demand works out to 9 units per month (after rounding off). Therefore inventory holding of ware house is 130/9 = 14.50 months after rounding off.

(7) Pro Rata Annual hoding cost of inventory is $ 1 /12 * 14.5 = 1.21 $.

(8) So costs for supplying from warehouse to stores based on existing requirement is $ 50 + 44 * $1.21 = $ 103.24

(b) Based on the EOQ of 130 units, the ware house stock is equivalent to 14.50 months inventory holding.

( c ) The existing warehouse inventory level pattern would be efficient,(as aginst holding by stores) since costs associated with holding the inventory at warehouse would be $ 103.24 (see note 8 above) as against holding the inventory at Richmond stores were the costs would be $ 830 (see note 5 above).