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UPSC MainsMANAGEMENT-PAPER-II201215 Marks200 Words
Q7.

If the company wanted to minimize the sum total of annual ordering and inventory carrying costs, what should the company's order quantity be for the display unit?

How to Approach

This question requires applying the Economic Order Quantity (EOQ) model, a core concept in inventory management. The approach involves understanding the components of total inventory cost (ordering and carrying costs), the EOQ formula, and then calculating the optimal order quantity. The answer should clearly state the formula, define the variables, and demonstrate the calculation. A brief explanation of the assumptions underlying the EOQ model would add value.

Model Answer

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Introduction

Inventory management is a critical aspect of operations management, directly impacting a company’s profitability and customer satisfaction. A key challenge is determining the optimal order quantity – the amount of inventory to order at a time to minimize total inventory costs. The Economic Order Quantity (EOQ) model, developed by Ford W. Harris in 1913, provides a mathematical framework for addressing this challenge. It balances the trade-off between ordering costs (costs associated with placing and receiving an order) and carrying costs (costs associated with holding inventory). This answer will calculate the optimal order quantity for the display unit, assuming the company aims to minimize the sum of these costs.

Understanding the EOQ Model

The Economic Order Quantity (EOQ) model is a mathematical technique used to determine the optimal order quantity that minimizes the total inventory costs. These costs primarily consist of ordering costs and carrying costs. The formula for EOQ is:

EOQ = √(2DS / H)

Where:

  • D = Annual demand in units
  • S = Ordering cost per order
  • H = Holding or carrying cost per unit per year

Applying the EOQ Model to the Display Unit

To calculate the EOQ for the display unit, we need the values for D, S, and H. Let's assume (as the question doesn't provide these values) the following:

  • Annual Demand (D) = 1000 units
  • Ordering Cost per Order (S) = ₹50
  • Holding Cost per Unit per Year (H) = ₹5

Substituting these values into the EOQ formula:

EOQ = √(2 * 1000 * 50 / 5)

EOQ = √(200000 / 5)

EOQ = √40000

EOQ = 200 units

Therefore, the company's order quantity for the display unit should be 200 units to minimize the sum total of annual ordering and inventory carrying costs.

Assumptions of the EOQ Model

It’s important to note that the EOQ model relies on several assumptions:

  • Demand is constant and known.
  • Lead time (time between placing an order and receiving it) is constant and known.
  • Ordering cost per order is constant.
  • Holding cost per unit per year is constant.
  • Purchase price per unit is constant.
  • No stockouts are allowed.

In reality, these assumptions may not always hold true. However, the EOQ model provides a useful starting point for inventory management decisions.

Sensitivity Analysis

A sensitivity analysis can be performed to understand how changes in demand, ordering cost, or holding cost affect the optimal order quantity. For example, if the holding cost increases, the EOQ will decrease, and vice versa.

Conclusion

In conclusion, based on the assumed values for annual demand, ordering cost, and holding cost, the company should order 200 display units per order to minimize total inventory costs. The EOQ model provides a valuable tool for optimizing inventory levels, but it’s crucial to understand its underlying assumptions and consider performing sensitivity analysis to account for real-world complexities. Effective inventory management is vital for maintaining profitability and ensuring customer satisfaction in a competitive market.

Answer Length

This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.

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Additional Resources

Key Definitions

Economic Order Quantity (EOQ)
The Economic Order Quantity (EOQ) is the optimal order quantity that minimizes the total inventory costs, balancing ordering costs and holding costs.
Holding Cost
Holding cost, also known as carrying cost, represents the total cost of storing and maintaining inventory, including costs like warehousing, insurance, obsolescence, and capital tied up in inventory.

Key Statistics

Inventory costs typically represent 20-30% of total business costs (Source: APICS, 2023 - knowledge cutoff).

Source: APICS (Association for Supply Chain Management)

Globally, approximately $1 trillion worth of inventory is written off annually due to obsolescence (Source: McKinsey, 2022 - knowledge cutoff).

Source: McKinsey & Company

Examples

Toyota Production System

Toyota’s Just-in-Time (JIT) inventory system, a cornerstone of the Toyota Production System, aims to minimize inventory levels by receiving goods only as they are needed in the production process. While not strictly EOQ, it shares the goal of reducing inventory costs.

Frequently Asked Questions

▶What happens if the assumptions of the EOQ model are not met?

If the assumptions are not met, the EOQ may not be the optimal order quantity. More sophisticated inventory management techniques, such as safety stock calculations and periodic review systems, may be necessary.

Topics Covered

OperationsManagementInventoryInventory ControlCost Optimization
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