Determining ordering point

In the EOQ model, the leas time for the procurement material is assumed to be zero. Consequently the ordering point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instant replenishment of stock, the level of inventory jumps to the original level from zero level.

However, in real life situations, one never encounters a zero lead-time. There is always a time lag from the date of placing an order for materials and the date on which the materials are received. As a result, the ordering level is always at the level higher than zero. If the firm orders the goods when the inventory level reaches the reorder point, the firm will never run out of goods. The decision on how much stock to hold is generally referred to as “Order point problem” that is how low should the inventory be depleted before it is reordered.

The two factors that determine the appropriate order point are the:

a)      Procurement or delivery time stock (inventory needed during the lead time) and;

b)     The safety stock, which is the minimum level of inventory that is held as a protection against shortages.

In summary, the efficiency of the replenishment system affects how much delivery time is needed.

Determination of level of safety stock involves a basic trade-off between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.