CH 12

In inventory management, what is the "Order Cost" (K)?

The fixed cost incurred per order that remains constant regardless of the quantity purchased.

What comprises the "Holding Cost per Unit" (h)?

The combined costs of capital, storage space, and maintenance required to keep one item in stock for a specific period.

In the EOQ model, why is "Purchasing Cost" typically excluded from the optimization goal?

Because the total annual cost to buy units remains constant regardless of the batch size when no discounts are present.

What is the operational definition of "Lead Time" in the context of the EOQ model?

The constant time delay between placing an order with a supplier and receiving the items.

What is Cycle Inventory?

Inventory that exists because a firm purchases or produces in batches rather than unit by unit.

In the EOQ framework, what is the formula for Average Inventory relative to the order quantity Q?

Average Inventory = Q/2.

What does Inventory Position represent in a continuous review system?

The sum of on-hand inventory and on-order inventory minus any backorders.

What is a Tier?

A specific quantity of product representing a single layer on a pallet, often used as a constraint for order multiples.

What is a Distribution Center (DC)?

A facility used to receive bulk shipments from suppliers and redistribute products to retail locations or consumers.

What happens to the number of orders per year if a firm doubles its order quantity Q while demand R remains constant?

The number of orders per year is reduced by 50 percent.

Why is the holding cost percentage applied to the purchase cost per unit rather than the selling price?

Because the opportunity cost of capital is based on the cash locked up in the inventory's acquisition cost.

In the EOQ model, what is the fundamental tradeoff when deciding on a batch size?

Balancing the cost of ordering frequently against the cost of storing large quantities.

A manager increases order sizes to reduce delivery frequencies. What is the direct operational consequence on costs?

Annual ordering costs decrease while annual holding costs increase.

Under the EOQ model, at what point is the total cost function C(Q) minimized?

At the order quantity where the annual holding cost equals the annual ordering cost.

How do Stockout Costs influence the basic EOQ model's assumptions?

The model assumes all demand is satisfied from inventory to avoid stockout costs.

A firm experiences a 25% increase in its fixed order cost (K). How will this influence the EOQ?

The optimal order quantity will increase.

What is the primary reason firms incur high holding costs for small items like pharmaceuticals?

The high value per unit creates a significant opportunity cost of capital.

In the EOQ cost function, what shape does the EOQ cost curve take?

A U-shaped curve.

Why might a firm choose a batch size that is NOT the EOQ?

To accommodate shipping constraints such as full cases, tiers, or pallet requirements.

What occurs to the holding cost per unit of time if the order quantity Q is doubled?

The annual holding cost doubles.

What is a Quantity Constraint in inventory procurement?

A supplier requirement that orders be placed in specific multiples, such as full cases or pallets.

When faced with an integer multiple constraint, how should a manager determine the order quantity?

Compare the total costs of the feasible quantities closest to the EOQ and choose the lower-cost option.

How does Continuous Review differ from periodic review?

Inventory is monitored continuously and an order is placed immediately when the reorder point is reached.

Under the EOQ assumption of Reliable Lead Time, when should an order arrive?

Just as the on-hand inventory reaches zero.

What is the managerial purpose of a Distribution Center?

To achieve economies of scale by consolidating shipments before sending smaller batches to stores.

In a scenario with quantity constraints, is the quantity closest to the EOQ always the cheapest?

No. A quantity farther from the EOQ may have a lower total cost.

Why is Inventory Monitoring more critical for high-value items?

Higher unit costs increase the financial impact of holding inventory.

How do pallets improve warehouse efficiency?

They allow workers to move large quantities quickly and safely using forklifts.

If a manager must choose between ordering slightly above or below the EOQ because of case sizes, what determines the decision?

Whichever quantity minimizes total annual ordering and holding costs.

What is the primary operational risk of ignoring lead time?

The firm will likely experience stockouts before the next shipment arrives.

Which assumption of the EOQ model states that the demand rate does not change over time?

Demand occurs at a constant rate R.

What is the Scarcity Effect in retail inventory?

A phenomenon where limited inventory increases demand because consumers perceive the product as popular or exclusive.

According to the EOQ model, what happens to Q* if the demand rate (R) quadruples?

The optimal order quantity doubles.

How does the Economies of Scale principle apply to inventory management costs?

As demand increases, inventory costs as a percentage of purchase costs decrease.

What is Product Substitution in the context of variety management?

When customers buy a similar but less-preferred product because their first choice is unavailable.

Why does increasing product variety often lead to less efficient inventory management?

Demand is split across more items, reducing demand per item and losing economies of scale.

What is the Square Root Rule regarding demand and EOQ costs?

When demand doubles, the EOQ and total EOQ costs increase by about 41%.

In the EOQ model, what does the assumption that inventory never spoils imply?

Every unit purchased will eventually be sold at full price.

How does a high holding cost affect a firm's willingness to offer product variety?

It makes the firm less willing to offer variety because low-demand items are expensive to stock.

Under what condition is purchasing cost relevant in an inventory decision?

When quantity discounts change the purchase price per unit.

What is the first step in evaluating a quantity discount opportunity?

Calculate the EOQ using the discounted price.

If the EOQ at the discounted price is below the minimum discount threshold, what should be done next?

Compare the total annual cost of the regular EOQ with ordering the minimum discount quantity.

Why are firms generally more price-sensitive to quantity discounts than consumers?

Small discounts can significantly increase profits and justify larger inventories.

What is Opportunity Cost of Capital?

The return a firm could have earned if its money were invested elsewhere instead of inventory.

How does a Reliable Lead Time simplify inventory planning?

It allows orders to arrive exactly when needed without requiring safety stock.

What is the impact of batching on average inventory?

Batching increases average inventory because products remain in stock while the batch is sold.

Why might a marketing manager and an operations manager disagree on product variety?

Marketing wants more variety to attract customers, while operations wants less variety to reduce inventory costs.

What is the relationship between the demand rate (R) and holding cost (h) units?

Both must use the same unit of time.

Why did the Girl Scouts limit the number of cookie flavors offered?

To reduce operational complexity and inventory costs.

How does stocking up influence consumer behavior?

Large inventories encourage consumers to use products more quickly.

What is the formula Q* = √(2KR/h) called?

Economic Order Quantity (EOQ).

A firm has very low demand for an item. What is the likely inventory cost as a percentage of its purchase price?

It will be high because fixed ordering costs are spread over few units.

What defines operational efficiency in the EOQ model?

Minimizing the total ordering and holding costs.

Why is the EOQ model essential for firms but less useful for personal purchases?

Small inventory inefficiencies can greatly reduce a firm's profits.

In the sawtooth inventory pattern, what does the vertical jump represent?

The arrival of a new order of size Q.

In the sawtooth inventory pattern, what does the downward slope represent?

The constant demand rate R.

How does average inventory change if a firm quadruples its order quantity?

Average inventory quadruples.

What does a 3% profit margin imply about inventory management?

Poor inventory management can eliminate a firm's profits.

What is Setup Time?

A fixed amount of time required to prepare for production, similar to a fixed ordering cost.

How does the EOQ model suggest managers handle low-demand items?

Discontinue them or accept that they will have high inventory costs.

Why does a Distribution Center typically have a lower holding cost percentage than a retail supercenter?

Distribution centers have lower storage, maintenance, and facility costs per square foot.

What is a Fixed Cost for Delivery in a supply contract?

A shipping or handling fee charged per shipment regardless of the number of units shipped.

In the discount decision process, what is Qd?

The minimum order quantity required to qualify for a discounted price.

Does doubling demand double the total cost of managing inventory?

No. Total inventory costs increase by only about 41% because of economies of scale.

What is the effect of an 8% discount for a full truckload on batch size?

It encourages ordering much larger batches, increasing average inventory.

How does Inventory Turnover relate to the EOQ model?

Higher order quantities result in lower inventory turnover because inventory stays in storage longer.

What is the "Just Right" order quantity in the EOQ model?

The order quantity that minimizes total ordering and holding costs.

In the ordering cost formula K(R/Q), what does R/Q represent?

The average number of orders placed per unit of time.

Why might a firm ignore spoilage in an EOQ model for pharmaceuticals?

Demand is high enough that products sell before they expire.

What is the consequence of having an order quantity much smaller than the EOQ?

Ordering costs become excessively high.

What is the consequence of having an order quantity much larger than the EOQ?

Holding costs become excessively high.

How is holding cost per unit per year (h) calculated if only a holding cost percentage is given?

annual holding cost percentage * purchase cost per unit.

In a distribution center, why is the order cost often higher than at a retail store?

It involves greater coordination costs and longer travel distances within larger facilities.

When evaluating a quantity discount, why is annual purchasing cost added to EOQ costs?

Because the discount changes the purchase cost, making it part of the total annual cost.

What is the unit-of-time consistency rule in EOQ?

Demand rate, holding cost, and ordering cost must all use the same time units.

If a firm's demand quadruples, how much average inventory will it hold if it follows EOQ?

Twice as much average inventory.

Which cost dominates when the order quantity is very high?

Holding cost.

Which cost dominates when the order quantity is very low?

Ordering cost.

If a supplier requires an integer multiple of a tier and the EOQ is 1.5 tiers, what should the firm do?

Compare the total annual costs of ordering 1 tier versus 2 tiers and choose the lower-cost option.

True or False: The EOQ model assumes the purchase price per unit does not depend on order quantity.

True, unless quantity discounts are specifically included.

What are Handling Costs in the context of broken cases?

Extra labor costs required to open cases and count individual units.

How does the opportunity cost of capital relate to the interest rate?

It is often based on the interest rate or return the firm could earn elsewhere.

If a firm's holding cost is higher than its ordering cost at its current order quantity, what should it do?

Decrease the order quantity to move closer to the EOQ.

What is Constant Delay?

The assumption that the time between placing an order and receiving it is always the same.

In the Walmart Listerine case, why was variation in weekly demand a concern for using a single EOQ?

Because EOQ assumes constant demand, while demand variation may require safety stock or different order sizes.

What is the annual purchase cost calculation?

Annual demand (R) * the purchase cost per unit.

Why does average inventory equal Q/2 under the EOQ model?

Inventory decreases at a constant rate from Q to 0, making the midpoint the average.

Why is inventory turnover generally better for high-demand items?

High-demand items benefit from economies of scale and spend less time in inventory.

What happens to the EOQ if holding cost per unit (h) increases?

The EOQ decreases because the firm wants to hold less inventory.

If a firm orders 1,000 units when the EOQ is 500, what will be true?

Holding costs will be significantly higher than ordering costs.