Purchasing and Supply Scheduling Decisions

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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
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Purchasing in Inventory Strategy
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A Typical Scheduling Diagram
Build schedule
Forecast
Orders
Bill of materials
Inventory
Shortages
Purchase order releases
The point Supply is to inventory or to
requirements
To vendors
Production release
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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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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 (Contd)
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

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Supply to Requirements (Contd)

• 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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MRP Example (Contd)
Safety stock Uncertainties in the master schedule
and in the lead times are sometimes handled by
requiring a minimum quantity on hand to be
maintained. Suppose a safety stock of 100
units is to be maintained with a 500-unit
order-size minimum.
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Supply to Requirements (Contd)
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

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Kanban (Contd)

• 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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KANBAN vs. Supply to Inventory
Factors
KANBAN/JIT Scheduling
Supply to Inventory
Inventory
A liability. Every effort must
An asset. It protects against forecast
be expended to do away with
errors, machine problems, late vendor
it.
deliveries. More inventory is "safer."
Lot Sizes
Size for immediate needs only.
Formulas are used. Optimum lot
A minimum replenishment
sizes frequently revised based on the
quantity is desired for both
tradeoff between the cost of
manufactured and purchased
inventories and the cost of set up.
goods.
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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.
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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.
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KANBAN vs. Supply to Inventory
Factors
KANBAN/JIT Scheduling
Supply to Inventory
Workers
Management by consensus. Changes
Management by edict. New
are not made until consensus is
systems are installed in spite of
reached, whether or not a bit of arm
the workers. The concentration
twisting is involved. The vital
is on measurements to determine
ingredient of "ownership" is achieved.
whether or not they're doing it.
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Supply Chain Dynamics Bullwhip Effect
Supply channel
Customer Customer
Firm A
Firm C
Demand
Firm B
Firm A
Firm C
Demand on upstream firms varies greatly with
small changes in downstream demand
Time
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Bullwhip Effect (Contd)

• Reasons for the effect
• Internal
• Demand shifts
• Product/service changes
• Late deliveries
• Incomplete shipments

• External
• Supply shortages
• Engineering changes
• New product/service introductions
• 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
  customers 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 firms
  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 (Contd)
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 (Contd)
Importance of purchasing management

• Decisions impact on 40 to 60 of sales dollar
• Decisions are highly leveraged

• Sets terms of sale
• Evaluates the value received
• Measures inbound quality if not a responsibility
  of quality control
• Predicts price, service, and sometimes demand
  changes
• Specifies form in which goods are to be received

Activities of purchasing

• Selects and qualifies suppliers
• Rates supplier performance
• Negotiates contracts
• Compares price, quality, and service
• Sources goods
• Times purchases

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Importance of Purchasing
Leverage principle?costs
A company with 100 million in sales wishes to
double profits. How to do it?
Current Sales 17 Price 5 Labor and Salaries -50 Overhead -20 Purchases 8
Sales 100 117 105 100 100 100
Purchased goods and services 60 70 60 60 60 55
Labor and salaries 10 12 10 5 10 10
Overhead 25 25 25 25 20 25
Profit 5 10 10 10 10 10
Conclusion Reducing purchase prices requires the
least change
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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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Supplier Selection (Contd)
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

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Supplier Selection (Contd)
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

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Supplier Selection (Contd)
Criteria for selecting suppliers (Contd)

• 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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Supplier Rating
Example of weighted checklist method for supplier
evaluation
Weight
Factor
Formula
50
Quality
100 - rejects
25
Service
100 - 7 for each failure
25
Price
Lowest price offered

Price actually paid
Scoring actual performance
Factor
Weight
Performance
Evaluation
Quality
50
5 rejects
50x(1-.05) 47.50
Service
25
3 failures
25x1-(.07x3) 19.75
Price
25
100
25x(90/100)
22.50

Overall
89.75
Compare to best score of 100 and to scores for
other suppliers.
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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
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Allocation (Contd)
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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Allocation (Contd)
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 (Contd)
Purchase price plus transport
Allocate using linear programming
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
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Allocation (Contd)
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.
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Allocation (Contd)
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
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Allocation (Contd)
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
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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

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Timing of Purchases (Contd)
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
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Timing of Purchases (Contd)
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
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Inclusive Price Breaks (Contd)
Price break curves
Curve for Qlt500
Total cost

Feasible curve
Curve for Q?500
Q2 Q1
500
Order quantity, Q
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Quantity Discounts (Contd)
Noninclusive price breaks
Price discount only applies to the items beyond
the price break quantity. Average price
continues to drop with increasing purchase
quantities.
Example Suppose the previous 5 discount applies
only to purchases gt 500 units. That is, the
first 500 units are priced at 5 per unit, but
all units over 500 are priced at 0.95 x 5
4.75. Because of the declining average cost,
the optimum Q is found by trial and error. We
can develop a table for the total cost equation.
Q is about 1,000 units.
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Quantity Discounts (Contd)
Price break curve-noninclusive discounts
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