Practical Lot Sizing

Implications of the Total Cost Curve

Lot size examples in most textbooks show Total Cost curves that are sharp and narrow. Such curves indicate a clear optimum. Yet, most real curves are flat and broad as in the figure below. 

There is a theoretical optimum where (dx/dy)=0.00. But, often, on both sides of this optimum, large changes in lot size bring miniscule changes in cost. This indicates that there is a range of realistic lot sizes rather than a clear optimum.

The accuracy of the costs used in this analysis is usually questionable. Direct Costs are often accurate and easily obtained. Setup Costs are more variable but a reasonable estimate can usually be made. Storage Costs are often buried in overhead accounts. They must be found and allocated to production units. This makes the Storage Cost component very approximate.

The flatness of the curve and uncertainty of the input costs suggests that the ELS analysis should be a guide rather than an absolute decision tool. Nevertheless, it is quite a valuable guide.

Most manufacturers have never done an ELS analysis. They determine batches by instinct, tradition or guess. Thus, most batches are far too big. Occasionally, they are too small.

This initial analysis provides a range of lot sizes. Sometimes it is a very wide range. This raises the question "What other criteria can help select the lot size within the ELS Range?" Some general guidelines follow.

Lot Size Guidelines

• Mostly, lot sizes should be at the low end of the ELS range. This reduces capital requirements, smoothens production and makes scheduling more flexible.
• When a particular machine is a "bottleneck" and needs to operate at maximum capacity, set lot sizes at the upper end of the ELS range. This increases inventory buffers before and after the bottleneck operation but it allows more time for production and less time for setups.
• When a piece of equipment must be staffed and maintained even when idle, and if the equipment is not a bottleneck, set the lot sizes at or below the ELS range. This decreases inventory but does not increase setup cost. 

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  Given the fuzziness of the numbers, set lot sizes to a convenient unit such as "1-day of production," "two containers" or some round number.
• Bias your decisions towards the lowest reasonable lot size. The ELS does not capture intangible costs of larger lots such as quality and scheduling flexibility. In addition, most accounting systems under-estimate carrying costs. 

Practical Lot Size

ELS analysis requires considerable time and effort. With hundreds or thousands of items, an analysis of each one is impractical. Nor is it necessary. Analyze a few representative parts and use the results for all similar items. The sample may be just 3-4 parts.