Purchasing and Supply

Scheduling Decisions
Press On
Nothing in the world can take the place of persistence.
Talent will not. Nothing is more common than
unsuccessful men with talent. Genius will not.
Unrewarded genius is almost a proverb. Education will
not. The world is full of educated derelicts. Persistence
and determination alone are omnipotent.

Chapter 10
CR (2004) Prentice Hall, Inc.
10-1
 Purchasing in Inventory
Strategy
Inventory Strategy
• Forecasting Transport Strategy
• Inventory decisions • Transport fundamentals

CONTROLLING
ORGANIZING
• Purchasing and supply • Transport decisions
Customer

PLANNING
scheduling decisions
• Storage fundamentals service goals
• Storage decisions • The product
• Logistics service
• Ord. proc. & info. sys.

Location Strategy
• Location decisions
• The network planning process

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10-2
 A Typical Scheduling Diagram

Forecast Build Orders

schedule
Bill of
materials
Inventory Shortages

Purchase
order The point: Supply
releases is to inventory or
to requirements

Production To vendors
release
CR (2004) Prentice Hall, Inc. 10-3
 Supply to Requirements
Methods of scheduling
•Just-in-time concept
•Requirements planning
•KANBAN
Just-in-time
A philosophy of scheduling where the entire supply
channel is synchronized to respond, in as short a time
as possible, to the requirements of operations.

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10-4
 Supply to Requirements
The characteristics are:
•Close relationship with a few suppliers and
transport carriers
•Information is shared between buyers and
suppliers
•Frequent production/purchase and transport of
goods in small quantities
•Minimum inventory levels
•Uncertainties are to be eliminated wherever
possible throughout the supply channel

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 Supply to Requirements (Cont’d)
Requirements planning

Definition A formal, mechanical method of scheduling

whereby the timing of purchases or supplies is determined
by offsetting the requirements in the master production
schedule.

•Why requirements become lumpy for the materials

manager
•Setting the master schedule
-through derived demand patterns and bill of
materials explosion
-forecasting
-orders on hand
CR (2004) Prentice Hall, Inc. 10-6
 Supply to Requirements (Cont’d)
(a) Field inventory (Finished product in warehouse)

Level
Why demand becomes lumpy

Order
point
Order
placement
0 Time
(b) Factory inventory (Finished product at plant)
Level

Production order
Order release
point

0 10-7
CR (2004) Prentice Hall, Inc. Time
 Supply to Requirements (Cont’d)

(c) Component inventory (Supply stocks at plant)

Level

Purchase order
release
Order
point
0
Time

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10-8
 Supply to Requirements (Cont’d)

•The mechanics of lot-for-lot scheduling given

certain requirements and lead times
•Determining lot sizes
-Trading purchase price for inventory carrying
cost
•Handling uncertainties in the master schedule
-Minimum inventory levels
-Part-period cost balancing
•Handling lead time uncertainties
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 Supply to Requirements (Cont’d)
KANBAN

Definition A method of scheduling using the order

point inventory control procedure, but with very low
setup costs and very short lead-times.

Characteristics of the scheduling method are:

•Models are repeated frequently in the master
schedule. A typical master schedule for economies
of scale might look like.
AAAAAABBBBBBAAAAAABBBBBB
but a KANBAN schedule would approach
ABABABABABABABABABABABAB 10-10
CR (2004) Prentice Hall, Inc.
 Kanban (Cont’d)

•Lead-times are predictable because they are short

and because suppliers are located near the site of
operations
•Order quantities are small because setup or
procurement costs are kept low
•Few vendors are used with high expectations of
vendors and high level of cooperation with them
•Classic reorder point inventory control is used to
determine reorder quantities and timing of
purchases

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10-11
 KANBAN vs. Supply to Inventory
Factors KANBAN/JIT Scheduling
Inventory A liability. Every effort must
be expended to do away with
it.
Lot Sizes Size for immediate needs only.
A minimum replenishment
quantity is desired for both
manufactured and purchased
goods.
CR (2004) Prentice Hall, Inc.
Supply to Inventory
An asset. It protects against forecast
errors, machine problems, late vendor
deliveries. More inventory is "safer."
Formulas are used. Optimum lot
sizes frequently revised based on the
tradeoff between the cost of
inventories and the cost of set up.
10-23
 KANBAN vs. Supply to Inventory
Factors KANBAN/JIT scheduling Supply to Inventory
Set Ups Make them insignificant. This Low priority. Maximum output is the usual
requires either extremely rapid goal. Rarely does similar thought and effort
changeover to minimize the go into achieving quick changeover.
impact on operations, or the
availability of extra machines
already set up. Fast changeover
permits small lot sizes to be
practical, and allows a wide
variety of parts to be made
frequently.
Queues Eliminate them. When Necessary investment. Queues permit
problems occur, identify the succeeding operations to continue in the
causes and correct them. The event of a problem with the feeding
correction process is aided operation. Also, by providing a selection of
when queues are small. If the jobs, the factory management has a greater
queues are small, it surfaces the opportunity to match up varying operator
need to identify and fix the skills and machine capabilities, combine set-
cause. ups and thus contribute to the efficiency of
the operation. 10-24
CR (2004) Prentice Hall, Inc.
 KANBAN vs. Supply to Inventory
Factors KANBAN/JIT Scheduling Supply to Inventory
Vendors Co-workers. They're part of the team. Adversaries. Multiple sources
Multiple deliveries for all active items are the rule, and it's typical to
are expected daily. The vendor takes play them against each other.
care of the needs of the customer, and
the customer treats the vendor as an
extension of his factory.
Quality Zero defects. If quality is not 100%, Tolerate some scrap. Scrap is
production is in jeopardy. tracked and formulas are
developed for predicting it.
Equipment Constant and effective. Machine As required. But not critical
mainten- breakdowns must be minimal. because of queues available.
ance
Lead times Keep them short. This simplifies the The longer the better. Most
job of marketing, purchasing, and foremen and purchasing agents
manufacturing as it reduces the need want more lead time, not less.
for expediting.

CR (2004) Prentice Hall, Inc. 10-25

 KANBAN vs. Supply to Inventory
Factors KANBAN/JIT Scheduling
Workers Management by consensus. Changes
are not made until consensus is
reached, whether or not a bit of arm
twisting is involved. The vital
ingredient of "ownership" is achieved.
CR (2004) Prentice Hall, Inc.
Supply to Inventory
Management by edict. New
systems are installed in spite of
the workers. The concentration
is on measurements to determine
whether or not they're doing it.
10-26
 Supply Chain Dynamics
“Bullwhip Effect”
Supply channel
Customer Customer

Firm A Firm C

Firm B Demand
Firm A

Firm C
Demand on upstream firms varies
greatly with small changes in
downstream demand
Time 10-27
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 Bullwhip Effect (Cont’d)
Reasons for the effect
Internal External
•Demand shifts •Supply shortages
•Product/service •Engineering changes
changes •New product/service
•Late deliveries introductions
•Incomplete shipments •Product/service promotions
•Information errors
Remedies
•Centralize demand forecasting
•Improve forecasting accuracy
•Reduce lead-time uncertainties throughout the channel
•Smooth response to change
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Vendor Managed Inventory
•The supplier usually owns the inventory at the
customer’s location
•The supplier manages the inventory by any means
appropriate and plans shipment sizes and delivery
frequency
•The buyer provides point of sale information to the
supplier
•The buyer pays for the merchandise at the time of sale
•The buyer dictates the level of stock availability
required
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 Purchasing
What is purchasing?

•Primarily a buying activity

•A decision area to be integrated with overall
materials management and logistics
•At times, an area to be used to the firm’s strategic
advantage
Mission Securing the products, raw materials, and
services needed by production, distribution, and
service organizations at the right time, the right price,
the right place, the right quality, and in the right
quantity.
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 Purchasing (Cont’d)
What is purchased?

•Price
-Cost of goods
-Terms of sale
-Discounts
•Quality
-Meeting specifications
-Conformance to quality standards
•Service
-On-time and damage-free delivery, order-filling
accuracy, product availability
-Product support
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 Purchasing (Cont’d)
Importance of purchasing management
•Decisions impact on 40 to 60% of sales dollar
•Decisions are highly leveraged
•Sets terms of sale
Activities of purchasing •Evaluates the value
received
•Selects and qualifies • Measures inbound quality if
suppliers not a responsibility of
•Rates supplier performance quality control
•Negotiates contracts • Predicts price, service, and
•Compares price, quality, and sometimes demand
service changes
•Sources goods • Specifies form in which
•Times purchases goods are to be received
CR (2004) Prentice Hall, Inc. 10-32
 Importance of Purchasing
Leverage principlecosts
A company with $100 million in sales wishes to double
profits. How to do it?
Labor and
Salaries
Sales Price -50% Overhead Purchases
Current +17% +5% -20% +8%
Sales $100 $117 $105 $100 $100 $100
Purchased 60 70 60 60 60 55
goods and
services
Labor and 10 12 10 5 10 10
salaries
Overhead 25 25 25 25 25 25
Profit $5 $10 $10 $10 $10 $10

Conclusion Reducing purchase prices requires the least change

CR (2004) Prentice Hall, Inc. 10-33
 Importance of Purchasing
Leverage principlereturn on assets
Sales
$10 million
Profit
Less $500,000 Profit
Total cost a ($750,000) Divided margin
$9.5 million by 5%
Sales
(9.25 million) b $10 million (7.5%)
Return
Multiplied on
by assets
Sales 10%
$10 million (15.3%)
Investment
Divided
turnover
c Total
by
2 times A 5% reduction
Inventory
$2 million assets (2.04) in purchase
($1.9 million)
$5 million price can lead to
($4.9 million) a 15% increase
a
Purchases are 50% of total sales.
bFigures in parentheses assume a 5% reduction in purchase prices.
cInventory is 40% of total assets.
in return on
CR (2004) Prentice Hall, Inc. assets 10-34
 Supplier Selection
Criteria for selecting suppliers
•Past or anticipated relations
-Honesty
-Financial viability
-Reciprocity
•Measured performance
-Price
-Responsiveness to change or requests
-On-time delivery
-Product or service backup
-Meeting quality goals
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10-24
 Supplier Selection (Cont’d)
Single vendors

•Allows for economies of scale

•Consistent with the just-in-time philosophy
•Builds loyalty and trust
•May be only source for unique product or service
Multiple vendors

•Encourages price competition

•Diffuses risk
•May disturb supplier relations, reduce loyalty, reduce
responsiveness, and cause variations in product
quality and service 10-25
CR (2004) Prentice Hall, Inc.
 Supplier Selection (Cont’d)
Finding suppliers

•Personal contacts
•Trade publications
•Web sites, catalogs, and directories
•Advertisements and solicitations
Qualifying suppliers

•Previous experiences and formal rating schemes

•Word of mouth
•Samples of product
•Reputation
•Site visits and demonstrations
CR (2004) Prentice Hall, Inc.
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 Supplier Selection (Cont’d)

Criteria for selecting suppliers (Cont’d)

•Operational compatibility
-Informational compatibility
-Physical compatibility
•Ethical and moral issues
-Minority vendors
-Lowest price bidding
-Patriotic purchasing
-Open bidding but a pre-selected vendor
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 Allocation to Suppliers
Allocation methods
•Company policy considering risk, fairness, ethics, etc.
•Definitive methods
Example of a definitive method
The Acme Company has received quotes for a component
(X-16) that is part of a larger assembly (industrial motors).
The prices are as follows:
Shipping
Supplier location FOB price
Philadelphia Tool Philadelphia $100 ea
Houston Tool & Die Houston 101
Chicago-Argo St Louis 99
LA Tool Works Los Angeles 96
10-40
CR (2004) Prentice Hall, Inc.
 Allocation (Cont’d)
The company has 3 plants to be supplied at Cleveland,
Atlanta, Kansas City. The transportation rates, plant
requirements (cwt.), and available supply limits (cwt.) are:

Shipping Kansas Avail-

point Cleveland Atlanta City ability
Philadelphia 2 3 5 5,000
Houston 6 4 3 15,000
St Louis 3 3 1 4,000
Los Angeles 8 9 7 15,000
Requirements 4,000 2,000 7,000

Each part weighs 100 lb. (1 cwt.) and rates are in $/cwt.

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10-41
 Allocation (Cont’d)
Current purchase: Buy from supplier with lowest price.
Thus, all purchases from LA Tool for a total cost of:

Purchase costs 13,000 x 96 = $1,248,000

Transport to CLE 4,000 x 8 = 32,000
Transport to ATL 2,000 x 9 = 18,000
Transport to KC 7,000 x 7 = 49,000
Total $1,347,000

Is buying based on lowest price a good strategy?

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 Allocation (Cont’d)
Allocate using linear programming Purchase price
plus transport

Shipping Avail-
point CLE ATL KC Dummy ability
Phila- 102 103 105 0
delphia 4,000 1,000 5,000
Houston 107 105 104 0
15,000 15,000
Saint 102 102 100 0
Louis 4,000 4,000
Los 104 105 103 0
Angeles 1,000 3,000 11,000 15,000
Require-
ments 4,000 2,000 7,000 26,000
CR (2004) Prentice Hall, Inc. 10-43
 Allocation (Cont’d)
Revised plan

PHI to CLE 102 x 4000 = $408,000

PHI to ATL 103 x 1000 = 103,000
STL to KC 100 x 4000 = 400,000
LAX to ATL 103 x 1000 = 103,000
LAX to KC 103 x 3000 = 309,000
Total $1,325,000

This allocation saves $22,000 per purchase

Now, asking “what if” questions can provide insight into

good allocation plans.
CR (2004) Prentice Hall, Inc. 10-44
 Allocation (Cont’d)
Problem
What if CLE and KC markets are increased by 20% and
ATL market is increased by 50%.
Solution
CLE ATL KC
PHI 4800 200
HOU
STL 2800 1200
LAX 7200

Total cost = $1,657,400

CR (2004) Prentice Hall, Inc. 10-45
 Allocation (Cont’d)
Problem
What if Philadelphia price is increased by 10%?
Solution

CLE ATL KC
PHI
HOU
STL 2000 2000
LAX 4000 5000

Total cost = $1,335,000

CR (2004) Prentice Hall, Inc. 10-46
 Allocation (Cont’d)
Problem
What if STL is no longer a supplier?
Solution

CLE ATL KC
PHI 4000 1000
HOU
STL
LAX 1000 7000
Total cost = $1,337,000
CR (2004) Prentice Hall, Inc. 10-47
 Allocation (Cont’d)
Problem
What if STL’s capacity is doubled?
Solution
Observations Houston is a
CLE ATL KC weak supplier. Perhaps some
PHI 4000 1000 price concessions can be
HOU negotiated? Philadelphia is
price sensitive and cannot
STL 1000 7000 withstand much of a price
LAX increase. St Louis is a valuable
supplier and more capacity
Total cost = $1,313,000 should be sought.

CR (2004) Prentice Hall, Inc. 10-48

 Timing of Purchases
Methods
•Through just-in-time planning
-Material requirements planning for continuous work
-Gantt charts and CPM/PERT for project work
•Through inventory management
-Push methods
-Pull methods
•According to market conditions
-Speculative buying
-Forward buying
-Hand-to-mouth buying, or buying to current
requirements 10-49
 Timing of Purchases (Cont’d)
Speculative buying
Buying more than the foreseeable requirements at
current prices in the hope of reselling later at higher
prices. Some of the purchased quantities may be used
in production and some simply resold. Generally a
financial activity, not a materials management one.

Forward buying
Buying in quantities exceeding current requirements,
but not beyond foreseeable needs.
- Takes advantage of favorable prices in an unstable
market, or takes advantage of volume transportation
rates
- Reduces risk of inadequate delivery
CR (2004) Prentice Hall, Inc. 10-50
 Timing of Purchases (Cont’d)
Hand-to-mouth buying
Buying to satisfy immediate needs such as those
generated through MRP.
- Advantageous when prices are dropping
- May improve cash flow by temporarily reducing
expenses of carrying inventory

CR (2004) Prentice Hall, Inc. 10-51

 Timing of Purchases (Cont’d)
Forward buying example--volume buying
A firm is able to forecast
the following price curve
over the next two years
with usage averaging
20,000 units per month

Note: The reason

to look at
forecasting methods

Objective To buy in larger volume when prices are

rising and to buy only to immediate needs when
prices are falling.
CR (2004) Prentice Hall, Inc. 10-52
 Timing of Purchases (Cont’d)
Strategy Try purchasing every four months while
prices are rising and hand-to-mouth purchasing when
they are falling.

Price upswing purchase cost

No of Cost Total
Date units per unit cost
Jan 80,000 $2.00 $160,000
May 80,000 2.35 188,000
Sep _______
80,000 2.75 ________
220,000
240,000 $568,000

Average cost per unit = 568,000/240,000 = $2.37 per unit

CR (2004) Prentice Hall, Inc. 10-53
 Timing of Purchases (Cont’d)
Price downswing purchase cost
No of Cost Total
Date units per unit cost
Jan 20,000 $2.86 $ 57,200
Feb 20,000 2.83 56,600
Mar 20,000 2.80 56,000
Apr 20,000 2.75 55,000
May 20,000 2.65 53,000 Note: This is the
Jun 20,000 2.55 51,000 same average price
Jul 20,000 2.45 49,000 as hand-to-mouth
Aug 20,000 2.35 47,000 buying on price
Sep 20,000 2.25 45,000 upswing.
Oct 20,000 2.15 43,000
Nov 20,000 2.05 41,000
Dec 20,000 2.00 40,000
240,000 $593,800
Average cost per unit = 593,000/240,000 = $2.47 per unit
CR (2004) Prentice Hall, Inc. 10-54
 Timing of Purchases (Cont’d)
Savings

Savings for one year out of two are:

Price reduction = 2.47 − 2.37 x100 = 4%

2.47
or $593,800 – 568,000 = $25,000

But trades with increased inventory

Buying in 80,000 lot quantities instead of 20,000 will
add to inventory.
This is the incremental
80,000 − 20,000 = 30,000 units inventory needed
2 for forward buying
CR (2004) Prentice Hall, Inc. compared with H-to-M 10-55
Timing of Purchases (Cont’d)

Suppose inventory carrying costs are 25% per year

on an approximate value of $2.37 per unit.
Incremental inventory costs would be:
CC = 0.25(2.37)(30,000) = $17,775
Net savings = 25,000 – 17,775 = $7,225 in favor of
forward buying. Now, try other lengths of forward
buying, such as once a year, to see if further
improvement can be made.

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10-44
 Timing of Purchases (Cont’d)
Forward buying exampledollar averaging
Spend the same amount on each purchase with the idea of
buying more when prices are low and less when they are
high. This is a good strategy when prices are expected to
rise over the long term and there is substantial uncertainty
as to the actual price level. Because under-supply may
occur, some level of inventory will need to be maintained.
Dollar averaging procedure
•Estimate the average price over the planning period
•Estimate the average usage for each purchase period
•Compute the dollars to be spent each time a
purchase is made
CR (2004) Prentice Hall, Inc. 10-57
Timing of Purchases (Cont’d)
Assumption Adequate inventory is available to handle
the needs of production.

Example Consider the first year of the data. The

average price is about $2.50 per unit. Suppose
purchases are to be made every 3 months at an
average usage rate of 20,000 units per month. Hence,
the dollar purchase should be 20,000 x 3 x 2.50 =
$150,000.

CR (2004) Prentice Hall, Inc.

10-46
Timing of Purchases (Cont’d)
Results

No of Cost Total
Date units per unit cost
Jan 75,000 2.00 $150,000
Apr 66,667 2.25 150,000
Jul 58,824 2.55 150,000
Oct _______
53,571 2.80 150,000
_______
254,062 600,000

Average price = 600,000/254,062 = $2.36

A purchase cost saving over hand-to-mouth buying of
[(2.47 – 2.36)/2.47] x 100 = 4.5%
CR (2004) Prentice Hall, Inc.
10-47
 Timing of Purchases (Cont’d)
And don’t forget the inventory effects!

The average purchase quantity is 254,062/4 = 63,516

so that the average inventory has increased from
hand-to-mouth buying by:

63,515 − 20,000 = 21,575 units

2

CC = 0.25(2.36)(21,575) = $12,729
So, the net savings are (2.47 – 2.36)x254,062 – 12,729
= $15,218 per year for this single item

CR (2004) Prentice Hall, Inc.

10-48