Methodological Lessons of

The EOQ Model and its Many Adaptations

By Praf Joglekar
La Salle University, Philadelphia, PSA 19141 (joglekar@lasalle.edu)

The Economic Order Quantity (EOQ) model is based on numerous unrealistic

assumptions.
However, the EOQ model is a robust and adaptable model.
Robustness means that even substantial errors in the estimation of its parameters
often lead to total cost errors that are significantly smaller in magnitude. For
example, a 20% mistake in the estimation of demand (or per order ordering cost,
or per unit carrying cost) leads to less than one-half of 1% increase in the total
cost. Thus, the assumption that demand (or ordering cost or carrying cost) is
known is not a very costly assumption even when violated.
The model's adaptability is best described as below:
When demand is not constant per week or when lead-time is not constant, the
perpetual inventory system with the reorder point model (ROP) can help minimize
the costs of variability during lead-time. In these situations, we do not change
EOQ (i.e., the decision on "how much" to order per order) but we do change our
"when to order" decision. We order when supply-on-hand drops to ROP level. The
EOQ continues to minimize the annual costs of ordering and carrying, while the
optimal ROP (based on appropriate stochastic model) minimizes the annual costs
of shortage and excess.
When the delivery of the ordered goods is gradual (as in the case of internal
production or JIT supplies), the Production Order Quantity (POQ) model -- an
adaptation of the EOQ model -- attains the objective of minimizing the annual
costs of setup and carrying.
When quantity discounts are available, the EOQ model can be adapted to account
for the annual cost of product purchase in addition to the costs of ordering and
carrying.
Situations of product interdependence can be optimized by developing an EOQ
for a "bundle" of interdependent products in the proportion of their annual
demands.
Given the robustness and the above adaptations of the EOQ model, a
methodological lesson for operations Management students is that when faced
with a complex problem situation, we should first build a simple model (one that
simply denies many real-life complexities) and then see if the model is robust
and adaptable to accommodate the denied complexities. Often, the model does
turn out to be adequately robust and adaptable.
 2

Finally, the EOQ model is a trade-off model that tries to balance the annual cost of
ordering against the annual cost of carrying. Such trade-off situations are common
in numerous managerial problems including such problems as:
• Determining the sophistication of the forecasting technique used - where
the trade-off is between costs of doing the forecasting versus the costs of
incorrect forecasts,
• Determining the frequency of preventive maintenance - where the trade-off
is between costs of doing the maintenance versus the costs of breakdown,
or
• Determining the sample size for a work-standards study - where the trade-
off is between costs of doing the observations versus the costs of incorrect
work-standards.
Given its robustness, the EOQ model suggests that in such trade-off situations,
what is important is to have reasonably good (but not necessarily the most
precise) estimates of the relevant parameters. After all, near the optimum, the
costs of substantial errors in parameter estimates are relatively very small.
In short, when faced with trade-off situations such as the ones described above,
managers should not fret over the accuracy of their data, nor should they shun
the mathematical model used. If they use reasonable estimates of parameters and
use the suggested mathematical model, they will be fairly close to the optimum
solution.
As students of business administration, you should not leave this knowledge of the
methodological aspects of the EOQ model in your brain compartments for the
"inventory theory" or the "operations management." Recognize that these
methodological lessons are widely applicable in other areas of managerial and
personal decision-making.