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Joshua Zloof's Blog

How Google Shopping Proves Inventory Theory

Joshua Zloof

Photo: Google

Photo: Google

A couple friends convinced me to try out Google Shopping Express last weekend.  Within 2 days, I was hooked.  Not only did I place 3 additional orders within the first 2 days - Google Shopping has changed my behavior - I found that by the end of the weekend, I was ordering items more frequently without thinking.  It made me remember an equation from my Inventory Theory class in college: Economic Order Quantity.  I first heard about this theory almost 10 years ago.  I've applied it in many large scale inventory situations.  Over the weekend, I learned that it applies even for my individualized behavior.

Economic Order Quantity (EOQ)

The purpose

If you're managing inventory for something - whether it's for a factory, retail store, distribution center, etc - you face a pretty regular decision...when you run out of something, how much should you order?

Not surprisingly, with a little work, you can find the 'optimal' answer.  The Economic Order Quantity is the optimal amount of an item that you should order when replenishing inventory.

The formula

The formula for EOQ is relatively simple:

EOQ Formula

EOQ Formula

Variable  Description
 Q  Economic order quantity  The optimal quantity of an item to order
 D  Demand  The yearly demand of a particular item
 K  Fixed ordering cost  The amount of time or money required to place an order for an item.  Examples:
  • Fixed shipping cost of a pallet
  • Labor to unload a truck
  • Labor to call a vendor and place an order
 h  Holding cost  The cost to hold excess inventory.  Examples:
  • Rent for physical space to store items
  • Opportunity cost (i.e. interest) on cash tied up in excess inventory
  • Cost to upkeep inventory (e.g. freezer space for perishables)

The gist of it...

Skipping all the math, EOQ makes a simple point - the optimal amount of inventory to order is based on the tradeoff between how hard/ expensive it is to place an order versus how much I pay to hold extra inventory.

If its really expensive to place an order, I'm going to do it infrequently, place large orders, and just hold a bunch of inventory.  On the other hand, if its easy to place an order, but it's really expensive to hold on to the item, I'm going to order tiny batches and place lots of orders.

Some examples

High holding cost / Low order cost - Microprocessors

Microprocessors are extremely small and light, but they are expensive and they become obsolete very quickly.  This makes them really easy to order - they are easy to ship, move around, and track.  However, they tie up a lot of capital - a few thousand chips could tie up millions of dollars.  If you manufacture computers, you probably want to order many frequent and small batches of microprocessors.  Many manufacturers will receive daily shipments of chips from their suppliers with only enough for one day of inventory.

Low holding cost / High order cost - Toilet Paper

Toilet paper is big and bulky but really cheap.  It's a huge pain to transport a large box of toilet paper, but you don't think twice about buying it.  Most people buy toilet paper in bulk.  It's pretty common to have a closet full of toilet paper in your home or office.

Google Shopping Express

Now that I gave some context around EOQ, here's why Google Shopping Express is interesting...

Before Google Shopping Express - Monthly Batches

My typical buying process for most of my consumables (e.g. toothpaste, detergent, toilet paper) was standard.  I would go about my day and if I realized I needed something, I would add it to a shopping list.  Once a month, I'd make 1 trip to Walgreens, go down my list, and buy a large 'batch' of things.  Using the EOQ framework, if you breakdown my behavior, you can see that my monthly batches are highly impacted by the effort it takes to go to Walgreens.  If I lived in a larger house, I'd probably buy even larger quantities to make trips even more infrequent.

Fixed ordering cost

  • Travel time to and from Walgreens (include parking if you drive)
  • Time in store searching
  • Labor to carry back items

Holding cost

  • Value of storage space in my apartment
  • Time to keep extra stuff neat (I'm a messy person)
  • Cash tied up (this is minimal)

After Google Shopping Express - Hourly Batches

The first time I used Google Shopping Express, I felt like I had to go through the same behavior - write down a list of things and then place a large batch order.  However, I quickly realized it's actually really easy to order individual items.  There is no fixed delivery fee, so I pay just as much if I order 1 item or 10.  The interface seems more optimized for smaller orders.  Instead of writing down a shopping list, as soon as I needed something, I immediately placed an order.  On my second day, I placed 3 separate orders, each with 1 item, staggered 3 hours apart.  Again using the EOQ framework, you can see that my ordering cost has gone down dramatically.  Without me realizing it, this economic tradeoff altered my behavior in favor of smaller batches.

Fixed ordering cost

  • $0 delivery fee
  • No travel time
  • In-app search
  • App UI can place order in 3 taps
  • Labor to carry items up stairs

Holding cost

  • Unchanged from above

Capturing even more orders (a flaw in EOQ)

Interestingly, in addition to changing my frequency of orders, Google Shopping has increased my overall demand for goods.  According to EOQ, this shouldn't happen, but the model is slightly flawed.  EOQ (like most economic formulas) assumes a perfect system.  The demand is fixed.  In other words, whatever items I purchase, I'd eventually have to buy to satisfy some sort of demand - it's just a matter of when.  This works well for most cases - in a factory, you cannot avoid buying your raw materials.  However, for me as an individual, there are plenty of items that I never ended up buying because they just slipped my mind.  The root cause is the shopping list.  The shopping list is a 'lossy' tool, its easy to forget to add something to it.  By eliminating the shopping list, Google changes an impulse thought - "You know, I really should buy coasters for my table" into an immediate purchase - "Coasters? Let me order that right now."

This final point is why I think this platform is so powerful - by getting me used to placing frequent small orders, Google has also increased my overall consumption of goods.  Changing my behavior has unlocked additional demand.

Additional Reading

What about Amazon Prime?

I've told this story to a few people in the last week.  A couple people said "This isn't new, Amazon Prime has been around for years".  However, after using Amazon Prime a few times, I felt like it didn't change my behavior in quite the same way.  For me, the reason is pretty simple - packaging.  Amazon Prime overpacks every item I order in large bulky boxes.  I can't just throw them out, I have to break them down and squeeze them into my recycling bin (we have a small recycling bin in my apartment).  This seemingly small amount of effort was enough to deter me from placing frequent orders with Amazon.