ering cost is expressed in terms of the number of orders per year multiplied by the cost of placing an order. The annual setup cost is expressed as the number of runs per year times the setup cost per run (Inman, 1994, p. 31).
Traditional inventory management uses reorder points and safety stock. Reorder points are those inventory order levels that prompt a new order based on lead time (the time an order is placed to the time that it is received), and the estimated quantity that will be used in the meantime. While reorder points signal when to place a new order, safety stock offers a buffer against the day-to-day fluctuations in demand and against production and delivery delays. The amount of safety stock is determined by balancing storage costs against estimated stockout costs (such as loss of customer goodwill, loss of profit, idle equipment time and work stoppage). The reorder point is at a higher quantity for those companies which use and maintain safety stock (Newman, 1993, p. 7).
The focus of traditional inventory management is on the reduction of the total costs associated with inventory within "given" constraints rather than on minimizing inventory. Ordering and setup costs are modeled as constraints and no consideration is given to reducing setup or lead times in the basic EOQ computations. However, such reductions would decrease the amount of inventory needed, causing investment in inventory to decrease and return on investment in inventory to increase.
Reduction of inventories is the main reason that companies have sought alternative inventory management methods. The use of smaller batches leads to the need for less inventory at any particular point in the production process. Cash flow is improved due to less capital investment in inventory. Less inventory on hand leads to savings in other areas as well, such as smaller space requirements, decreased materials handling costs, decreased record keeping costs, ...