Economic Order Quantity (EOQ)
One of the most common business decisions faced by a manager is determining the optimal number of units of products to purchase whenever an order is placed.
Mark Jelinik is responsible for purchasing the copier paper supplies for Ulan Insurance Group. After 8 years on the job, Mark has a good feel for the job and predicts that he will need to purchase a total of 24,000 boxes of paper for the coming year, each box costing $35. Mark estimates that it costs $50 each time an order is placed. The general agent of Ulan Insurance has assigned a cost of 18% to funds allocated to supplies. Although Mark has been placing orders only once a quarter, he wants to explore the possibility that a different ordering schedule could be more economical when ordering paper.
EOQ analysis determined that the optimal number of boxes for Mark to order at any one time is about 617. With this optimal order quantity, Mark must place about 39 orders over the course of the year. Under this system, costs are reduced by a little over $15,000 when compared with the original ordering schedule of 6,000 boxes a quarter.