Effect of Change in Demand, Cost Estimates and Lot Sizes on EOQ

For people among us, who are not aware of sensitivity analysis, it is a technique for systematically changing crucial parameters to determine the effects of change.

Considering the factors involved in EOQ estimation, when we substitute different values into numerator or denominator of the formula, different results may arise.

Change in Demand Rate

When demand rises, Lot size shall also increase. But in smaller proportions then actual demand.

Change in the Setup Cost or Ordering Cost

An increase in setup costs causes an increase in EOQ as well and vice versa.


Change in the Holding Cost

This relationship is inversely proportional. If holding cost of an item increases, EOQ decreases. Conversely a decrease in holding cost will allow us to have increased lot sizes. Larger lot sizes are justified by lower handling costs.

How to Calculate EOQ

Considering that all the assumptions discussed in previous post to calculate EOQ are being satisfied, a cycle begins with Q units held in inventory, which happens when a new order is received. During the cycle, on-hand inventory is consumed at a constant rate because demand is known with certainty. As the lead time is a constant, a new lot can be ordered so that inventory falls to 0 precisely when the new order is received.

Formula for calculating EOQ (Q*) is as follows:

Where 

D = annual demand (units per year)

S = cost of ordering or setting up one lot (in currency)

H = cost of handling one unit in inventory for a year