Aesop’s famous fable tells the story of an ant that, in anticipation of a tough winter and thanks to its financial solvency, stores a lot of food. The cicada, taking care not to increase its working capital, cannot store as much food and when winter comes it finds that it doesn’t have enough provisions, so it goes to the and in search of help. The ant offers its help, but in exchange for an increase in price…
I cannot exactly remember the fable, but more or less I think I got Aesop’s message. Whoever has financial capacity also has power! This might be an excessively subjective interpretation, but what is a goal nowadays and in the current recession we are still in, it is essential for companies to take care of their working capital. The Lean philosophy takes us to the one piece flow or pull systems with the aim of reducing the inventory.
It is evident that when negotiating larger volumes we can get more competitive prices. The question is, what is more beneficial? To pay the ant more when we need material or to bear the financial costs of holding the stock for months and also contemplate the possibility of it becoming obsolete?
The Economic Order Quantity (EOQ) is a fixed quantity model that seeks to determine the lowest total cost possible by finding the graphical intersection of the ordering costs and the maintenance costs. This method is only valid under certain hypothetical conditions, but we can use it as an example to explain our idea, so let’s look at it graphically:
The original ECP formula (D= annual demand, S= indirect costs of purchases per unit, H=Annual maintenance cost per unit) dates back to 1913 when there were no purchase management systems and it took a lot of ants for the manual management of the purchases. Today there are improved formulas that allow us to take volume discounts into account such as for example
Where Z=Demand, H= Annual maintenance cost per unit, δ =quantity of delta inventory necessary to reach the reorder point and P= Purchase price per unit
In any event and leaving mathematical formulas to one side, at IKOR Group we take another approach to Aesop’s fable. Look at the graph again and look at the inventory maintenance costs and see how it affects the cost; you not only have to look at the purchase cost like the ant does, but it is equally important to calculate the inventory maintenance cost, as both factors affect profitability.