JIT or EOQ?

The research article on JIT and EOQ makes the case that there is no clear cut preferred option between EOQ and JIT systems. In fact, the determination of which system to use is entirely related to the specific situation.

According to the article, there are a variety of factors that influence which system is best. JIT relies on the reduction of ordering costs as well as holding costs to be more profitable. While the EOQ system relies on minimizing and balancing ordering and holding costs to achieve the most profitable system. As stated in the article, in a comparison of JIT and EOQ, Johnson and Stice (1993) conclude that “traditional inventory management techniques may underemphasize the costs of maintaining large inventories. JIT may under-emphasize the costs of not maintaining inventories, particularly since such costs are often difficult to identify and measure”.

As stated in the article, Under the JIT system, much of the holding costs and some components of the ordering costs can be significantly reduced or eliminated. Other costs such as transportation and inspection costs can be reduced by having the suppliers locate near the buyer’s plant or by improving the quality at the suppliers’ facilities.

However, The remaining costs associated with holding or ordering items (e.g. storage, inspection, or transportation costs that have not been eliminated) are transferred to suppliers and are in turn charged indirectly to the buyer as a part of the purchase price. The purchase price change is a problem with the JIT system, because if the purchase price increases as a result of the new system, it might very well cost you more than the savings you will make as a result of using JIT.

The manufacturer will be holding less inventory, but as the article states the suppliers usually begin to hold larger inventories and just ship smaller amounts to handle the JIT system. This results in more inventory costs for the supplier which eventually are passed on to the manufacturer in the form of increased prices as described previously.

This means demand becomes a critical part of the equation, as demand increases you are going to be losing more money to the purchase price increase factor. So at some breakeven amount of demand, EOQ will become the more profitable system. However, if the use of JIT allows the supplier to deliver at a cheaper cost than they would using EOQ, then JIT is definitely the preferred system.

There are also the other two factors of holding and ordering costs that can change the profitability of the systems. If either holding or ordering costs are particularly high then JIT becomes the correct choice as it will reduce alot of your costs as inventory is usually reduced in some amount as well as ordering costs going down due to closer suppliers and less transportation costs. Since the costs were high originally, these gains should be large enough to insure less costs than EOQ.

The article goes on to describe a mathematical model that can be used to determine the profitability of one system over the other based on ordering cost, demand, holding cost, and purchasing cost. You can solve for a breakeven demand at which EOQ becomes more profitable than JIT and at what demand amount JIT is most profitable.


Mark Brislin