Question

Tottenham Berhad is a trading company. The management team is concerned about the storage capacity to maintain stock levels. For the benefit of the management team, discuss about the usefulness of EOQ model and elaborate the criticisms associated to the implementation of this model.

Answer 1

EOQ stands for Economic Ordering Quantity. It considers the tradeoff between ordering cost and storage cost. The cost minimising order quantity is EOQ.

Advantages of EOQ:-

1) Minimizes Holding Costs - EOQ maintains tradeoff between the ordering and storage cost. It may suggest buying a larger quantity in fewer orders to take advantage of discount on bulk buying and minimizing order costs.

2) Specific to the Business - Another advantage of the EOQ model is that it provides specific information related to a particular business regarding how much inventory to hold, when to re-order it and how many items to order.

3) Reduces Storage Costs - Another important advantage of EOQ is that it helps to know the correct quantity of items to be ordered and the frequency of order. Because of the same, businesses do not order anything above as required by the EOQ thereby reducing the storage costs.

However, there are also certain criticisms associated to its implementation. They are:-

1. Having mathematical calculation - The major disadvantage is that it requires the concepts of maths like algebra. In small companies, people are not very expert in maths. Also, its calculation is very typical because it requires accuracy.

2. Based on assumptions - What quantity will be demanded by the customer in market and what quantity should be hold in our stores are totally based on the assumptions. The assumptions sometime may be right or may be wrong and this is the demerit of the EOQ model. On the basis of these assumptions, employees do the further mathematical calculation for exact quantity of material. So it requires continues monitoring of inventory level. So the effectiveness of the EOQ model is limited by these assumptions.