Procurement in Industrial Management
BPT3133
Chapter Outline
1. Order Processing


Ordering Process Flow
Document Involved
2. Order Quantities
3. Independent Demand Order System


Economic Order Quantity (EOQ)
Reorder Point System (ROP)
4. Computer Information System
Learning Objectives
 Identify methods of stock control and their application
 Examine positive and negative reasons for holding stock
and approaches to reducing inventories
 Explain the Economic Order Quantity (EOQ) concept
Order Processing
 Order processing is a key element of order fulfillment. Order
processing operations or facilities are commonly called "distribution
centers".
 Order processing is the term generally used to describe the process
or the work flow associated with the picking, packing and delivery of
the packed item(s) to a shipping carrier.
 The specific order fulfillment process or the operational procedures
of distribution centers are determined by many factors. Each
distribution center has its own unique requirements or priorities.
There is no "one size fits all" process that universally provides the
most efficient operation
Order Processing
Tactics and tools that can help manage the order
fulfillment processes involving material flows between the
firm and its external customers:
1. Inventory Placement
2. Vendor-managed inventories
3. Continuous replenishment program
4. Radio frequency identification
5. Distribution processes
Shop Floor Control System
Implemented by a combination of computer systems and human resources
Order Release
 Generates
the documents needed
production order through the factory
to
process
a
 The documents are sometimes called the shop packet,
which consists of:
 Route sheet
 Requisitions to obtain starting materials
 Job cards to report direct labor time
 Move tickets to transport parts
 Parts list for assembly jobs
Order Scheduling
 Assigns the production orders to work centers in the
factory
 A dispatch list is prepared indicating which orders should
be accomplished at each work center
 Also provides relative priorities for the jobs, e.g.: by
showing due dates for each job
 Dispatch list helps the department foreman assign work
and allocate resources to achieve the master schedule
Order Progress
 Monitors the status of the orders, work-in-process and
other parameters in the plant that indicate progress and
production performance
 Various techniques are available to collect data from
factory operations
 Called
the factory data collection system, the
techniques range from requiring workers to submit
paper forms that are later compiled, to fully automated
techniques with no human participation
Inventory
 Every
organization holds some things in stock
(inventory)
 Inventory is an important element in operational
effectiveness and often appears on the balance sheet
as the biggest of current assets
 Inventory is created when the receipt of materials, parts
or finished goods exceeds their disbursement
Types of Inventory
Different inventory control procedures are appropriate, according to which type is
managed
Functions of Inventory
 Provide a stock of goods to meet anticipated customer






demand and provide a “selection” of goods
Provision for fluctuations in sales or production
Mistakes in planning
Allow one to take advantage of quantity discounts
To provide a hedge against inflation
To protect against shortages due to delivery variation
To permit operations to continue smoothly with the use of
“work-in-process”
High Inventory – Hides Problems
Less Inventory – Exposes Problems
Identifying Critical Inventory
 Divides on-hand inventory into 3 classes

A class, B class, C class
 Basis is usually annual $ volume

$ volume = Annual demand x Unit cost
 Policies based on ABC analysis



Develop class A suppliers more
Give tighter physical control of A items
Forecast A items more carefully
ABC Analysis
Class
A
B
C
% Annual $ Usage
100
80
60
% $ Vol
80
15
5
% Items
15
30
55
A
40
B
20
C
0
0
50
100
% of Inventory Items
150
Inventory Control

Concerned with achieving a balance between two
competing objectives:
1. Minimizing the cost of maintaining inventory
2. Maximizing service to customers

Two different inventory control systems are required:
1. Order point systems – for independent demand
items
2. Material requirements planning – for dependent
demand items
Types of Demand
1. Independent Demand


Demand or consumption of the item is unrelated to demand
for other items
Eg.: end products and spare parts
2. Dependent Demand



Demand for the item is directly related to demand for
something else, usually because it is a component of a
product subject to independent demand
Eg.: automobile – it’s an end product, its demand is
independent
However, tires on new automobiles are examples of
dependent demand
Order Point Systems

Two related issues encountered when controlling
inventories of independent demand items:
1. How much to order - often decided by means of
economic order quantity (EOQ) formula
2. When to order - accomplished using reorder points
(ROP)
Model of inventory level over time in the typical make to stock situation
EOQ Assumptions
 Demand rate is constant
 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only relevant costs are set-up (ordering) and holding
 No constraints on lot size
 Decisions for items are independent from other items
EOQ Cost Model
Annual
cost ($)
Total Cost
Slope = 0
HQ
Holding Cost =
(Carrying)
Minimum
total cost
Set-up Cost =
(Ordering)
Optimal order
Qopt
2
SD
Q
Order Quantity, Q
Why Holding Costs Increase
 More units must be stored if more ordered
Purchase Order
Description Qty.
Microwave
1
Order
quantity
Purchase Order
Description Qty.
Microwave 1000
Order
quantity
Why Order Costs Decrease
 Cost is spread over more units
 Example: You need 1000 microwave ovens
1 Order (Postage $ 0.32)
1000 Orders (Postage $320)
Purchase Order
Description
Qty.
Microwave
1000
PurchaseOrder
Order
Purchase
PurchaseOrder
Order
Description
Qty.
Purchase
Description
Qty.
Description
Qty.1
Microwave
Description
Qty.
Microwave 11
Microwave
Microwave
1
Order
quantity
EOQ Cost Model
S - set-up (ordering) cost
H – holding (carrying) cost
D - annual demand
Q - order quantity
1. Total annual cycle-inventory cost = Holding Cost + Set-up Cost
TIC
HQ
=
+
SD
2
2. Economic (Optimal) Order Quantity, EOQ =
Q
2 × D ×S
H
3. Expected Number of Orders, N =
D
EOQ
4. Expected Time Between Orders, T =
Working Days / Year
N
EOQ Calculation Example
H = $0.75 per yard
Qopt =
Qopt =
2SD
H
2(150)(10,000)
(0.75)
Qopt = 2,000 yards
S = $150
D = 10,000 yards
SD
TIC =
+
Q
TIC =
HQ
2
(150)(10,000) (0.75)(2,000)
+
2,000
2
TIC = $750 + $750 = $1,500
No. of orders,N = D/Qopt
= 10,000/2,000
= 5 orders/year
Order Cycle Time,T = 311 days/ N
= 311/5
= 62.2 store days
Reorder Point System
 When the inventory level for a given stock item declines
to some point defined as the reorder point, this is the
signal to place an order to restock the item
 Reorder point is set at a high enough level so as to
minimize the probability that a stock out will occur during
the period between when the reorder point is reached
and a new batch is received
 Reorder point policies can be implemented using
computerized inventory control systems
Reorder Point System
Operation of a reorder point inventory system
d =
D
Working Days / Year
ROP = d × L
D = Demand per year ; d = Demand per day ; L = Lead time in days
EOQ and ROP
Material Requirements Planning
 Computational procedure to convert the master production schedule
for end products into a detailed schedule for raw materials and
components used in the end products
 The detailed schedule indicates the quantities of each item, when it
must be ordered and when it must be delivered to achieve the
master schedule
 Most appropriate for job shop and batch production of a variety of
products consisting of multiple components, each of which must be
purchased and/or fabricated
 It is the proper technique for determining quantities of dependent
demand items that is raw materials, purchased parts and WIP which
are used to manufacture independent demand products
Lead Times in MRP
 The lead time for a job is the time that must be allowed to
complete the job from start to finish
 Two kinds of lead times in MRP:
 Ordering lead time - time required from initiation of the
purchase requisition to receipt of the item from the
vendor
 Manufacturing lead time - time required to produce the
item in the company's own plant, from order release to
completion
MRP Example
Inputs to the MRP System
 For the MRP processor to function properly, it must
receive inputs from several files:
 Master production schedule
 Product design data as a bill of materials file
 Inventory records
 Capacity requirements planning
MRP Output Reports
 Order releases - authorize placement of orders planned





by MRP system
Planned order releases in future periods
Rescheduling notices - indicating changes in due dates
for open orders
Cancellation notices - indicate that certain orders are
canceled due to changes in the master schedule
Inventory status reports
Exception reports, showing deviations from schedule,
overdue orders, scrap, etc.
Benefits of MRP
 Inventory reductions
 Faster response to changes in demand
 Reduced setup and changeover costs
 Better machine utilization
 Improved ability to respond to changes in the master
schedule
 Helpful in developing the master schedule
E-Commerce or CIS
 Internet enables firms to reengineer their order placement process to
benefit both the customer and the firm itself. Advantages include:
1.
2.
3.
4.
Cost Reduction
 Allows greater participation by the customer
 Reduce the need for call centers – labor intensive
Revenue Flow Increase
 Reduces the time lags often associated with billing the customer
Global Access
 Accept orders 24 hours a day – reduce the time it takes to satisfy
customers
 A competitive advantage over brick and mortar firms
Pricing Flexibility
 Change prices as the needs arises – avoiding the cost and delay
publishing new catalogs
Summary
 The method of ordering used depends upon the industry,
the usage, the production technique and the cost of
ordering
 Stock is expensive to hold, therefore it is advantageous
to reduce levels
 EOQ technique works well for minor items used on a
variety of products but makes limiting assumptions that
price is stable and usage steady. It ignores lead time.