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Economic
Lot Size (ELS) was first developed about 1913. It
balances the costs of inventory against the costs of setup over a
range of batch quantities. In this model, the Economic Lot Size (ELS)
is where Total Cost is minimum.
Economic
Lot Size (ELS) is dead according to some advocates of Lean
Manufacturing and Theory of Constraints. They contend
that every operation should manufacture what the downstream customer
needs immediately in "batches" of one unit.
This
may be correct in an ideal world. Most factories are less than
ideal. Where significant setup costs exist,
batch quantity is still an issue and Economic Lot Size provides
important insights for rational decisions.
The
figure depicts a typical ELS model. This model calculates the total
production cost per unit over a range of batches. The batch quantity
having the lowest unit cost is the ideal or Economic Lot Size. This
Total Cost typically forms a "U" as shown in the figure.
The
model classifies total cost into three components: Setup Cost,
Direct Cost and Carrying Cost (Storage Cost). This facilitates
calculation and aids understanding.
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Direct
Cost
Direct
costs are directly proportional to the amount produced. Materials
and direct labor are the most common. Accounting systems usually
capture these costs accurately and make them readily available. In
the figure, direct cost per piece is a horizontal line for all batch
quantities.
Setup
Cost
Setup
costs include the labor and material to ready a machine for
production. They may include the processing of work orders or a
first-article inspection. We amortize these costs over the entire
batch to derive the Setup Cost per piece. This cost curve on the
figure is high when batches are small and rapidly decreases with
increasing batch quantity.
Carrying
Cost
Carrying
or Storage cost is the average cost associated with storing an
average production unit for the average time it will be in
inventory. These costs are more difficult to calculate and we will
not take up that procedure here. Storage costs
are significant and often represent 20%-60% of inventory value on an
annual basis.
Carrying
Cost per piece (in the simplest case) varies directly with batch
quantity. The larger the batch, the more units will be in inventory,
on average.
There
are problems with using ELS as the only determinate. The
next paper in this series explains how to make rational batching
decisions using ELS as one of several considerations.
Part
1 - Lot Sizing In Strategy
Part
2 - Economic Lot Sizing
Part
3 - Practical Guidlines
Part
4 - Setup Reduction Effects |
