7.2.5 Quantity discounts
Suppliers often offer an extra discount for larger orders of goods and/or services, which larger orders, which reduces the total ordering cost. However, larger order quantities result in larger average inventories, which result in higher inventory holding costs. All these factors must be considered when deciding whether or not to place a quantity discount order.
Example
The Western Electric Wholesale Supply Co. sells 500 000 electric light switches a year. The company opens 6 days a week and expects this annual demand to be evenly distributed over 300 working days of the year. Each switch costs the company $2.50. The holding cost of inventory has been estimated to be 20% of the inventory value. The company can order the switch from either of two competing manufacturers.
- Manufacturer X delivers in 4 days and ordering costs would be $100 per order. Manufacturer Y takes 6 days to deliver and ordering costs would be $80 per order. Assume no safety stocks are carried.
- What is the EOQ for light switches for each manufacturer?
- How many orders per year would be placed if only Manufacturer X is used? How many orders if only Manufacturer Y is used?
- What would be the re-order points for each manufacturer?
- Which manufacturer would you select on the basis of total inventory costs (total relevant costs)? What would be these costs for each manufacturer?
- Assume that Manufacturer X offers Western Electric a 2% discount if it orders 50,000 units at a time. Will this affect the choice of manufacturer based on TRC? (Refer to the decision in Question 4 above.)
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