EOQ Model Adaptation for Interdependent Products

By Praf Joglekar
La Salle University, Philadelphia, PSA 19141 (joglekar@lasalle.edu)

A common assumption of the EOQ model is that the various products in a company are
independent of one another and hence one can develop the economic order quantity for
each product independent of any other products. However, it is well-known that in real
life many products are interrelated. Some products are components of larger assemblies
and must be procured in the proportion of their usages in those components. For some
other products, the interdependencies arise from the fact that they are often procured from
the same vendor. In such cases, most companies decide that they cannot develop an
optimal order quantity using the EOQ model. Instead, they decide to use Materials
Requirement Planning (MRP) software that makes sure that the interdependent products
are procured together in the proportion of their individual demands. However, typically,
MRP software does not try to minimize the total annual cost of ordering and carrying the
products under consideration.

In the following example I show that, in cases where products are interdependent, the
EOQ model can be easily adopted and the total cost of ordering and carrying
interdependent products is minimized.

Suppose you are the procurement manager of a company. There are two most important
items (A & B) in your inventories, both of which are obtained from the same supplier. The
cost of ordering is $10 per order whether you order one item at a time or both the items
together. The cost of carrying for item A is $1.60/unit/year. For item B, it is
$1.00/unit/year. The demands for A & B are respectively 4,000 units/year and 5,000
units/year. Define the various alternatives you have available. Find the costs of carrying
and ordering for each item assuming separately developed EOQs for each. Then develop
an optimal policy for always ordering both items. Find the total costs of each approach
and compare them to determine which strategy is the best.

First, consider ordering A and B separately

If we order A and B separately, the data, the optimal decisions, and the optimal costs of
ordering and carrying each product can be summarized as:

D = Demand per year
S = Ordering cost per order
H = Holding cost/unit/year
EOQ = Order quantity/order
TC = Total cost of ordering
and carrying/year
Product A Product B
= 4,000 units/year 5,000 units/year
= $10/order $10/order
= $1.60/unit/year $1.00/unit/year
= 223.61 units/order 316.23 units/order
= $357.77/year $316.23/year

Thus, when ordered separately, the sum total of the optimal ordering and carrying
costs for the two items will be $674/year.
 2

Now, consider ordering A and B together

If we always want to order the two products together, we must order them in the
proportion of their annual demands. Otherwise, we will either get too much supply of one
product or too little of the other.

Hence, we define a “bundle” consisting of 4 units of A and 5 units of B.

In terms of these bundles,

D = Demand per year = 1,000 bundles/year
S = Ordering cost per order = $10/order
H = Holding cost/bundle/year = (4x1.60 + 5x1) = $11.40/bundle/year
EOQ = Order quantity/order = 41.89 bundles/order
That is, we should order 4x41.89 = 168 units of A + 5x41.89 = 210 units of B every time
we order

TC = Total costs of ordering and carrying per year = $477/year

This represents a saving of $196.51 (or approximately 29% of the costs incurred
when ordering separately).

In short, even when products are interdependent, the EOQ model can be used with a
simple adaptation whereby we conceptualize a “bundle” of the interdependent products in
proportion to their annual demands and then obtain the optimal number of such bundles to
order. The saving promised by this adaptation can be substantial. Hence, MRP designers
should incorporate this approach so as to minimize a company’s annual costs.