Inventory Control

Today’s post is by Randy Russon, founder of TOPCFOS

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As I was pursuing my Bachelor’s degree in Finance during college days, I took a most interesting class from an adjunct professor who was an expert at inventory control. He taught us a very powerful concept about inventory control called the economic order quantity. Wikipedia defines the economic order quantity as, “Economic order quantity (EOQ) is the order quantity that minimizes the total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson Formula. The model was developed by Ford W. Harris in 1913, but R. H. Wilson, a consultant who applied it extensively, is given credit for his in-depth analysis.” Economic order quantity simply means the following.

In the world of retailing, firms around the world spend millions of dollars carrying large amounts of inventory on their shelves to serve their customers. Stores such as Walmart®, Target®, and The Home Depot® have millions of dollars tied up in inventory on their shelves. The goal with carrying this vast amount of inventory is to never be out of stock when a customer decides to purchase an item. At the same time, they don’t want to have too many items for sale on the shelf since it costs millions of dollars to hold this inventory for sale. This brings up the following interesting observation in the world of retailing. Have you ever observed the merchandising system that Bed Bath and Beyond® uses?

They go out of their way to stock way more than they should of products they sell. They completely ignore the economic order quantity model. When you go into purchase an item you look above you and there are dozens and dozens of the same item displayed on the wall that are for sale. I personally believe they do this for psychological reasons. When a consumer sees lots of inventory for sale, it subliminally inspires more purchases. They are not even coming close to following the EOQ model. The EOQ model applies to other types of businesses as well. For instance, manufacturers rely on the EOQ model to minimize their cost of inventory. Anytime a company has to carry parts on a shelf, the EOQ model is there to help them reduce this cost of inventory. The EOQ model is only one small aspect of this in-depth subject of inventory control.

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