What happens if the order quantity based on the EOQ decision model differs from the order quantity managers would choose to make their own performance look best? Consider, for example, opportunity costs. As we have seen, the EOQ model takes into account opportunity costs because these costs are relevant costs when calculating inventory carrying costs. However, managers evaluated on financial accounting numbers, which is often the case, will ignore opportunity costs. Why? Because financial accounting only records actual transactions, not the costs of opportunities forgone (see Chapter 12). Managers interested in making their own performance look best will only focus on measures used to evaluate their performance. Conflicts will then arise between the EOQ model’s optimal order quantity and the order quantity that managers regard as optimal.
As a result of ignoring some of the carrying costs (the opportunity costs), managers will be inclined to purchase larger lot sizes of materials than the lot sizes calculated according to the EOQ model, particularly if larger lot sizes result in lower purchase prices. As we discussed in the previous section, the cost of these suboptimal choices is small if the quantities purchased are close to the EOQ. However, if the lot sizes become much greater, the cost to the company can be quite large. Moreover, if we consider other costs, such as costs of quality and shrinkage of holding large inventories, the cost to the company of purchasing in large lot sizes is even greater. To achieve congruence between the EOQ decision model and managers’ performance evaluations, companies such as Walmart design performance-evaluation systems that charge managers responsible for managing inventory levels with carrying costs that include a required return on investment.