Case Study in Using a Fixed Order quantity System
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Abstract
Consolidated Electric is a multinational corporation that deals with the production and distribution of electronic gadgets. Following their worldwide operations in purchasing of inventories and sales of their finished products, the company is faced with huge challenges of successfully managing their inventory systems while at the same time maintaining a perfect customer interaction. A Q system of inventories has proved to be a successful way of managing their inventories since it allows for a seamless reordering of materials. It not only saves on costs but also helps to maintain good customer clientele for the company. Below is a graphical representation of a Q system showing the Ordering and Cost levels.
Ordering versus holding cost
Introduction
The current global supply network has proved to be a complex ordeal for many companies. Most companies are continuously forced to balance their main trade-offs when managing their complex inventories and adhere to their planned production schedules. They strive to meet customer demands. In some cases, manufacturers and suppliers must collaborate when looking to build an end to end visibility and transparency across all areas of the value chain, especially those industries with affiliates across the world. Implementing an effective and optimized inventory management system is a key driver in mitigating many trade-offs that companies experience in their day to day operations (Balcik, Bozkir, & Kundakcioglu, 2016). Organizations have to weigh their transport costs, warehousing strategies, and the parameters involved in planned production processes. The management of inventory systems plays a core role in strategic planning and the daily operation of a company’s production and supply channel.
Case study
In the case study of Consolidated Electric, the company has experienced customer service trade-off with their inventory systems. Consolidated Electric operates a highly dynamic and globalized electric appliances market. Their supply chain control is marred by the complexities around the electric appliances market. For Consolidated Electric to effectively manage the foggy supply chain channel and deal with the market characteristics, they have to reconsider their inventory systems strategy. Consolidated Electric is looking to achieve the demanding break-even target in sales while maintaining its operations excellence in customer service. The supply chain management department means that they are more likely to realize better supply chain management at the expense of lower stock targets. The existing association between the two objectives of the company demands an intelligent inventory management system that measures up to the global supply chain management competence, which can provide insights into the dynamics between their perceived customer service quality and their dynamics in inventory levels. There are several options that Consolidated Electric can consider to optimize their inventory systems in a quest to achieve their organizational objectives.
The Fixed Order Quantity System
Popularly known as the Q system, this is an inventory system that facilitates automatic reordering of fixed materials when the stock at hand reaches a reorder point. In the Q system, the fixed quantity of the materials ordered is also the economic order quantity. The system aims to maintain a company’s stock within the maximum and the minimum limits whenever a new consignment arrives (Bedyaeva & Kapitanov, 2015). A Q system facilitates for a predetermined quantity of a specific material to be ordered at a particular period. It helps limit the mistakes that accrue from reordering, thereby saving on warehouse space to store finished goods. Besides, a Q system reduces unnecessary expenditures that would prove useful when utilized in other parts and processes of the business.
When applying the Fixed Order Quantity system to the operations of Consolidated Electric, we have first to select the ordered quantity Q. As explained, several inventory costs are involved in the holding cost and the ordering costs of materials and finished products. Consolidate Electric should target to select the best order of quantity, one that minimizes the holding and ordering costs. To calculate this, we look at the annual inventory cost and find the organization’s minimum order quantity. In this computation, we consider that the total annual cost is the sum of the annual ordering cost, the annual purchase cost, and annual holding cost.
Total cost = Ordering Cost + Purchase Cost+ Holding Cost
TC = DC + (D/Q) S + (Q/2) H
Where
TC is the total cost
D is the annual demand
C is the unit cost
Q is the ordering quantity
S is the ordering cost
H is the holding cost.
In the first section of the equation, DC represents the annual purchasing costs of items. It is the product of the annual demand D and the unit cost C of each item. The second part of the equation (D/Q) S represents the annual cost, which is the product of all the orders placed in a year (D/Q). The cost of each order made in the year S. The last section of the equation represents the annual holding cost. The average inventory held (Q/2) and the annual holding cost per inventory H are determined.
As seen in the graph in the appendix, the behavior of the two costs is co-dependent. The inventory holding cost is directly proportional to the order quantity Q. Higher-order quantities results in Consolidated Electric, holding more inventory (Boyd, 2017) (Gunasekaran, Patel, & McGaughey, 2014). However, it also means that the company will order less frequently, thereby decreasing ordering costs. Consequently, a smaller order quantity leads to a lower holding cost. Consolidated Electric should aim to pick an order quantity that minimizes both the ordering and the holding costs, which is the lowest point of the total cost curve in the graph in the appendix. Placing that argument to computation, the best optimal order quantity EOQ can be calculated by the following formulae.
EOQ = 2√2DS/H
Roles of Fixed Ordered Quantity Systems in Meeting Customer Service and Cost Objectives
A Q inventory system aims to identify the optimal number of product units that an organization should order. When properly applied to business processes, a company stands to minimize their buying, delivery, and storage costs. The Q system formula is often manipulated to determine the different production levels and order intervals for organizations with huge supply chains and high variable cost. A Q system of inventory is a vital funds management tool for companies. It assists companies to control the number of funds tied up in their inventory balances. Other than human resources, inventory is one of the largest assets to business organizations. When sufficient inventory processes are carried out, business organizations can effectively meet the needs of their customers. The funds saved from efficient inventory systems can be used by companies to push other objectives that can create more value for the companies.
The Q system of inventory determines the reorder point of a company’s inventories. If the inventory falls below the threshold point, the Q system formula triggers business organizations’ need to place an order for more units (Sanders, 2014). A perfectly determined reorder point prevents business organizations from running out of inventories. As a result, companies can continually fill their customer orders, thereby keeping them satisfied. A Q system of inventory also raises the alarm when a business organization is running out of inventory. It prevents companies from losing their customers and clients due to a shortage of inventories.
Conclusion.
The inventories of a company are one of the most valued assets in a business organization. Companies must strive to manage their inventory systems efficiently. In this way, companies can avoid high overhead costs that accrue with the over-ordering of inventories. Companies can also maintain a satisfied customer base from the use of an efficient inventory management system by avoiding the trade-offs that accrue from costs and customer satisfaction. A fixed ordered quantity system has proved to be a successful inventory management system by facilitating a seamless reordering system of materials depending on the current conditions of a company’s inventories.
References
Balcik, B., Bozkir, C., & Kundakcioglu, E. (2016). A literature review on inventory management in humanitarian supply chains. Surveys in Operations Research and Management Science, 101-116.
Bedyaeva, A., & Kapitanov, A. (2015). The study of the influence of warehouse replenishment rate on an inventory management system with a fixed order quantity. Journal of Machinery Manufacture and Reliability, 698-703.
Boyd, K. (2017). The Economic Order Quantity Formula. In K. Boyd, Cost Accounting (pp. 122-130). New York: Springer.
Gunasekaran, A., Patel, C., & McGaughey, R. (2014). A framework for supply chain performance measurement. International Journal of Production Economics, 333-347.
Sanders, N. (2014, January 23). Inventory Policy in a Fixed-Order Quantity System. Retrieved from InformIT: https://www.informit.com/articles/article.aspx?p=2167438&seqNum=8