Organizational Behavior

The economic quantity (EOQ) model dates back to 1915. The formula is generally credited to Ford W. Harris, wh argued in his book Operations and Cost that effective management of inventories is critical to sustained profitability. EOQ's objective is to minimize the total cost of inventory. The inventory holding cost include housing costs (building rent, taxes, and insurance), investment costs (interest payment), material handing costs (equipment and labor cost) and other miscellaneous expenses (pilferage, scrap, and obsolescence). The holding cost increase as the order quantity increases, because larger average inventories need to be maintained. On the other hand, as the quantity ordered increases, the annual setup or ordering cost per unit decreases (for instance, material handling and tooling may be made more efficient as the quantity purchased increases). Mathematically, the EOQ model demonstrates that the optimal reorder point occurs when the total setup cost is equal to the total holding cost.

Material requirements planning (MRP) is a set of tools designed to manage components where the demand for the items is linked to another demand. For example, the demand for TV antennas is linked to the demand for TVs. To determine the number of antennas needed, a TV manufacturer starts by determining the number of TVs that will be built and when. Once management forecasts the demand for TVs, quantities required for all other components such as antennas, knobs, and screens can be computed, because all component are dependent items. MRP helps a company reduce inventory costs and ensures that all items will be available when needed. Consider the following example: "Nancy Mueller turns quiche into cash. Her firm, Nancy's Specialty Foods, is designed for today's busy lifestyle, producing 750,000 prepackaged, frozen quiche hors d'ouvres each month. MRP software has been key to her growing success. MRP is the primary management tool that keeps the ingredients and labor coming at the proper times and the schedule firm. Once Nancy's Specialty Foods knows the demand for her crabmeat quiche, she knows the demand for all of the ingredients from dough, to cheese, to crab meat, because all of the ingredients are dependent."