Page 161 - DMGT523_LOGISTICS_AND_SUPPLY_CHAIN_MANAGEMENT

Logistics and Supply Chain Management

Notes Three typical adjustments are volume adjustment, Quantity discounts, other adjustments, volume
transportation rates.
In the EOQ formulation, no consideration was given to the impact of transportation cost on
order quantity. When products are purchased on a delivered basis and the seller pays
transportation cost from origin to the inventory destination, such neglect may be justified. The
seller is responsible for the shipment until it arrives at the customer’s place of business. However,
when product ownership is transferred at origin, the impact of transportation rates on total cost
must be considered when determining order quantity.
As a general rule, the greater the weight of an order, the lower will be the cost per pound of
transportation from any origin to destination. A freight-rate discount for larger-size shipments
is common for both truck and rail and is found in most transportation rate structures. Thus, all
other things being equal, an enterprise naturally wants to purchase in quantities that maximize
transportation economies. Such quantities may be larger than the purchase quantity determined
using the EOQ method.

Notes Increasing order size has a two-fold impact on inventory cost.

Rates

In the EOQ formulation, no consideration was given to the impact of transportation cost on
order quantity. When products are purchased on a delivered basis and the seller pays
transportation cost from origin to the inventory destination, such neglect may be justified. The
seller is responsible for the shipment until it arrives at the customer’s place of business. However,
when product ownership is transferred at origin, the impact of transportation rates on total cost
must be considered when determining order quantity.
As a general rule, the greater the weight of an order, the lower will be the cost per pound of
transportation from any origin to destination. A freight-rate discount for larger-size shipments
is common for both truck and rail and is found in most transportation rate structures. Thus, all
other things being equal, an enterprise naturally wants to purchase in quantities that maximize
transportation economies. Such quantities may be larger than the purchase quantity determined
using the EOQ method. Increasing order size has a twofold impact on inventory cost.
The second impact is a decrease in the number of orders required. The decreased number of
orders increases the shipment size, which provides better transportation economies.

To complete the analysis, it is necessary to formulate the total cost with and without transportation
savings. While this calculation can be directly made by modification of the EOQ formulation,
comparison provides a more insightful answer. The only additional data required are the
applicable freight rates for ordering in quantities to complete the analysis.
The impact of volume transportation rates on total cost of procurement cannot be neglected.
Thus, any EOQ must be tested for transportation cost sensitivity across a range of weight breaks
if transportation expenses are the buyer’s responsibility. Finally, two factors regarding inventory
cost under conditions of origin purchase are noteworthy. (Origin purchase means that the buyer
is responsible for freight cost and product risk when the product is in transit.) First, the buyer
assumes full risk on inventory at time of shipment. Depending on time of required payment,
this could mean that transit inventory is part of the enterprise’s average inventory and therefore
subjected to an appropriate charge. It follows that any change in weight break leading to a
shipment method with a different in-transit time should be assessed the added cost or savings as
appropriate in a total-cost analysis.

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