Question

In Base Stock Inventory Model

4. There is no setup cost associated with placing an order; and

5. There is no constraint on the number of orders that can be placed per year. 

Last two assumptions imply that there is no incentive to replenish stock in anything other than one-at-a-time fashion.

How we infer this? If there is no setup cost associated with placing an order Wouldn't we like to order more than one because orders setup costs are out of consideration.

Answer 1

Whenever we manage inventory there are two main costs associated with inventory management. One of them is the setup or ordering cost. This is the cost that is incurred every time an order is placed or a setup process is initiated. The other cost is the inventory holding cost. In the optimum model we usually attempt to balance the two cost so that our overall cost is minimum. However if there is no cost incurred for ordering or setting up then we can order or set up as many times as we want. This means we have a new opportunity of reducing the holding cost. We can choose not to hold any inventory. This will mean that we will order or set up whenever it is required. This also means that we can order 1 unit at a time.

Take an example of a service such as Pizza delivery that has a fixed delivery charge of $10 every time you place order. If you and your friends chose to order some pizza regularly, you will likely want to reduce this cost of delivery and club your orders together. However, if there is no delivery charge then you may place individual different orders without any hesitation. This is the same case when we consider the base stock inventory model without any set up cost or ordering cost.