October 18, 2009

How useful is the Basic Fixed–Order Quantity Formula

I was trying to think of a good alternative approach that could help a company to reduce waste costs using previous data for production. This made me think back to a model which I was taught a few years ago called the Basic Fixed-Order Quantity Formula, which used data such as the annual purchase cost, annual ordering cost, annual holding cost, the annual demand and also can help to derive the point at which new stock needs to be ordered or produced. The positives of this model are that it takes everything into consideration, including the price of holding the stock that is produced that is over the demand, which related nicely to the problem we were set where we needed to decide on a good approach for looking at production numbers.. However, the more I thought about the model, the less convinced I was, and I began to notice a large number of negatives. The model does not take into account seasonal effects in demand, as only an annual demand is included into the calculation. There are clearly a large number of products where the demand will not be the same at all points of the year (eg umbrellas). Another large negative is the assumptions that are contained in the situation - in the given problem, we do not know all of the information that is needed to make this calculation. Also, the costs are just accepted when a Basic Fixed-Order Quantity Formula is used, rather than attempted to be reduced. It is clear from this that the exercise wanted us to think about recommending that the company view a larger range of figures rather than just the demand from the previous month or the target or the same point last year, but at the same time, the model that I thought could be the correct answer isn't appropriate either.

oh well, time to think of a new model!

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