1.

SCM
Multi Echelon Inventory EOQ
Economic order quantity (EOQ) is the order quantity that
minimizes total inventory holding costs and ordering costs. It is one of
the oldest classical production scheduling models. The model was
developed by Ford W. Harris in 1913, but R. H. Wilson, a consultant
who applied it extensively, is given credit for his in-depth analysis.
The framework used to determine this order quantity is also known as
Wilson EOQ Model or Wilson Formula. EOQ is the optimum
amount of material to order that has the lowest inventory cost. If
large quantities of material are ordered at any one time, rather than
small quantities, then the inventory ordering costs per unit and the
probability of stockout will be low. However, inventory carrying costs
will be high. Thus, there is an inventory cost component that tends to
decrease ordering costs and stockout costs when large quantities
are ordered and one other that tends to increase the carrying costs
when large quantities are held in stock. The total inventory cost is
the sum of the carrying costs, stockout costs and ordering costs and
the economic ordering cost is when this total cost has a minimum
value.

2.

In multi echelon inventory, the quantities to be stocked at each

inventory echelon or stage in the supply chain and final customer,
will depend not on the local inventory but it will depend on the
inventory that is available at the previous and next stages too and

3.

will help in minimizing the safety inventories for the individual stages.
The scope of inventory management concerns the fine lines between
replenishment

lead

time,

carrying

costs

of

inventory,

asset
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management, inventory forecasting, inventory valuation, inventory

visibility, future inventory price forecasting, physical inventory,
available

physical

space

for

inventory,

quality

management,

replenishment, returns and defective goods, and demand forecasting.

Balancing these competing requirements leads to optimal inventory
levels and EOQs for each inventory stage or echelon, which is an ongoing process as the business needs shift and react to the wider
4.

environment.
It is important for stages in a supply chain to interact with each other
regarding their inventory levels and consider the echelon inventory
and not local inventory for calculating EOQs.
Lead time

Multi Echelon Approach

Lead time

Lead time

5.

When an enterprise with multiple tiers of locations uses a true multiechelon approach to calculate EOQ, the primary objective is to
minimize the total inventory in all echelons (various distribution
centres) while meeting service commitments to end customers. Even
though inventory is the main focus, transportation and warehouse
operations expenses also are kept in line, because their cost factors
are

part

of

the

optimization.

Both

the

sequential

and

the

deterministic approaches treat each echelon as a separate problem

without considering the inventory impact one echelon may exert on
another. Calculating EOQ in such a way will result in inactive stocks at
each stage and increased storage costs. With a multi-echelon
approach, demand forecasting and inventory replenishment decisions
are made at the enterprise level in a single optimization exercise
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rather than in a sequence of sub-exercises for each echelon.

Specifically, a true multi-echelon approach should:a.
Avoid multiple independent forecast updates in each echelon.
The primary customer demand signal and other information at
the distribution centres drive the forecasts in all echelons. A true
multi-echelon approach eliminates the reliance on demands from
b.

the immediate downstream customer.

Account for all lead times and lead time variations. In each
echelon,

the

replenishment decisions account for lead times and lead time

variations of all upstream suppliers, not just the immediate
c.

suppliers.
Monitor and

manage

measures

the

bullwhip
the

effect.

The

enterprise
demand

distortion and determines the root causes for possible corrective

d.

actions.
Enable visibility up and down the demand chain. Each echelon
takes
advantage of visibility into the other echelons inventory
positionswhat

is

on hand, on order, committed and back ordered. At the

distribution centres, this negates any need for shortage gaming.
At the regional or central distribution centres, visibility into local
distribution centres inventories improves projections of demand
e.

requirements.
Synchronize order strategies. Synchronizing the ordering cycles
at the local distribution centres with central or regional
distribution centre operations reduces lead times and lead time
variation between them. Multi-echelon models can evaluate the

f.

impact on both echelons of different synchronization strategies.

Offer differentiated service levels. The central or regional
distribution centre can provide different service levels (for the
same product) to different local distribution centres. A multiechelon approach makes this possible, because the enterprise

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controls how and when a product enters and leaves the central
g.

or regional distribution centre.

Correctly model the interactive

effects

of

alternative

replenishment
strategies of one echelon on another. Alternative strategies
include
different

replenishment

review

frequencies,

strategies,

order

supply
service

level goals and stock keeping unit stratifications.

6. A multi-echelon distribution network presents many opportunities for

inventory
optimization that the enterprise must pursue to offset potential
increases

in

transportation, warehouse and occupancy costs. The key to achieving

those
savings is to use a true multi-echelon strategy to arrive at EOQ. It is
not

simple task to pursue such a strategy because of the multiplicities of

inventory
drivers and the complexities in modelling the interactions of the
drivers

between

echelons. Nevertheless, the benefits are worth the effort. Taking the
right
approach can yield rewards on both sides of the inventory equation
better
customer service with less inventory. Using a true multi-echelon
approach

is

the

ultimate win-win strategy for inventory management.

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