08 procurement and inventory management

Arif Rahman – The Production Systems 1
Slide 8
Material Procurement and
Inventory Management
Arif Rahman, ST MT

Arif Rahman – The Production Systems
Material Procurement and Inventory
in Logistic Management
2

The word logistic has originated from Greek
word ‘logistikos’ and the Latin word ‘logisticus’
which means science of computing and
calculating.
Logistic management is an integrative process
of Planning, implementing and controlling the
physical flow of material, supplies and products
from point of origin to point of use to meet
customer’s need at a profit.
Logistics Management
3

An effective logistics management should
concerns with demand management.
It controls the flow of material that its
volume is estimated by demand
management.
The activities include material
procurement and material inventory.
Logistics Management
4

Demand management is an activity in
support of a firm’s products in their
marketplace, such as stimulating the
demand, estimating its volume and planning
the production accordingly, including
arranging supplies purchasing, planning its
capacity and eradicating waste.
Demand Management
5

Demand management is driven by two
reasonings :
¤ Demand forecasting. The unknown future
demand is predicted based on historical sales
and/or other judgments.
¤ Order receiving. The actual demand is
determined according to customer’s specific
order
Some producers use the hybrids that
combine both reasonings.
Demand Management
6

Demand management defines the volume
of overall customer order. It helps material
inventory and procurement management:
¤ Material inventory management maintains the
optimum stock level of material inventory to
provide uninterrupted production.
¤ Material procurement management plans and
controls the replenishment to prevent material
shortage and overstock
Demand Management
7

Push system: the production system for
moving work where output is pushed to the next
station as it is completed. The material and
supplies are purchased based on the volume
estimation and their allowances.
Pull system: the production system for
moving work where a workstation pulls output
from the preceding station as needed. The
material and supplies are just purchased with
specific volume when the related station
releases the order.
The Push/Pull System
8

Material Procurement and Inventory
Challenges
9

Unreliable suppliers
Poor quality of materials
Perishable or fragile materials
Improper facilities and infrastructures
Unstandardized operation
Uncertain fluctuating demand
The Challenges
10

The equipments for transportation,
material handling, warehousing
Operating costs consist of setup cost,
purchasing cost, handling cost, holding
cost, shortage cost, insurance, etc.
The number of suppliers and their location
Manufacturing processes efficiency
Damage, diminishing, lost and stolen risk
Family or item priority.
Decision Factors
11

the right material
the right quantities
the right price
the right time
the right source
Objectives
12

Inventory turnover
Stock level
Inventory value
Holding time in storage
Probability shortage
Rate of defect or expired item
Total operational cost
Performance Measures
13

Make or Buy Analysis
14

15

The use of outsourcing has quickly
become a competitive weapon for an
increasing number of businesses.
It is no easy task for management to
decide to make lease or buy component
parts and services.
The decision to outsource has led to a
need for strategic partnerships.
16

In most cases, businesses are not proficient at
identifying their core capabilities . Buyers usually
rationalize in-house decisions based on capacity
capabilities.
Buying organizations wait too late to assess the
value of consultants or strategic partners.
Buyers do not recognize that the product or
service is approaching maturity.
There are always new competitors with new
technology attacking the market.
Mistakes in Make or Buy Analysis
17

Perform a realistic assessment of the
capabilities and expertise of each member of the
in-house team. If the core competencies exist,
what happens if a key member leaves the team.
Evaluate alternative strategic partnership
arrangements and select the appropriate
partner.
Share information with all functional areas and
request their input.
Success Factors of Make or Buy Analysis
18

Purchasing System
19

Petty Cash System
Blanket Order System
Rate Contract System
Tender System
Subcontracting System
Stockless Purchase System
e-Purchasing / e-Procurement System
Types of Purchasing System
20

A small fund of cash is kept in hand for
purchases or reimbursements which are too
small to be worth submitting to the more
rigorous purchase and reimbursement
procedures of a company or institution.
Petty cash funds must be safeguarded and
documented to ensure that thefts do not occur.
The most common way of accounting for petty
cash expenditures is to use the imprest system.
Petty Cash System
21

Petty Cash System
ADVANTAGES
Easy
Time saving
DISADVANTAGES
Embezzlement of Funds
Cuts down on
accountability
Accounting Errors
Lot of Paper Work
22

The firm purchase many small items on day to
day basis. It becomes difficult to have inventory
for all.
It is most popular method for purchasing items
which are used regularly.
There are two methods:
¤ Agreement is made to supply a Fixed Quantity of the
product at a Fixed Price for a Specific Period.
¤ Agreement is made to supply for a Specific Period but
the Quantity is unknown.
23

ADVANTAGES
Flexible
Avoid negotiation
Avoid placement of new
order again and again
Advantage to supplier to
plan the work at his place
Reduces clerical activities
Protections against higher
pricing in future
DISADVANTAGES
Petty frauds
It requires flexible internal
control
Poor vendor
performances
Difficult to determine and
forecast the quantity
24

A Rate Contract or a Rate Agreement (RC in
short) is a procurement cost reduction strategy
aimed at standardizing procurement prices for
commonly procured, homogenous and price
varying inputs.
The basic idea behind a rate contract is to aid a
company in establishing parameters for the
purchase of goods and services necessary for
the continued operation of the business.
25

ADVANTAGES
Increased Efficiency
Protections against higher
pricing in future
Predictability simplifies
budgeting
DISADVANTAGES
It requires market analysis
of economic price
It could afford cost more
than the price
Poor vendor
performances
26

The firm invites suppliers to give their
quotations.
The supplier with the lowest quotation wins the
contract.
It is a kind of contract mostly followed by large
organizations and governments when purchases
are of large value
Types of tender :
¤ Open tender
¤ Restricted tender
¤ Negotiated tender
Tender System
27

Tender System
ADVANTAGES
Competitive
Lower Cost
Transparent Process
DISADVANTAGES
Low Price usually
Detriment of Quality
Time consuming
28

Subcontracting refers to the process of entering
a contractual agreement with an outside person
or company to perform a certain amount of work.
The outside person or company in this
arrangement is known as a subcontractor.
Many small businesses hire subcontractors to
assist with a wide variety of functions.
29

ADVANTAGES
Cost Saving
Increased Efficiency
Continuity & Risk
Management
DISADVANTAGES
Loss of Managerial
Control
Quality Problems
Hidden Costs
30

Stockless purchase system can be defined as
arrangement in which a supplier holds the items
ordered in its own warehouse, and releases
them as and when required by the buyer.
It is also known as just-in-time purchasing.
In this system the supplier has a clear idea of
the requirements of the buyer and holds the
stock in convenient location.
The seller has the financial responsibility of
holding the stock.
31

ADVANTAGES
Reduced warehouse
space
Eliminate the cost of
storing, maintaining and
distributing
supplies
Increased inventory
turnover
Less manpower
DISADVANTAGES
High cost
Need of complex
technology
32

e-Procurement is the business-to-business or
business-to consumer or business-to-
government purchase and sale of supplies,
work, and services through the Internet.
e-Procurement helps to achieve benefits such
as increased efficiency and cost reduction.
33

ADVANTAGES
Reducing Cost
Visibility of spend
Productivity
Control
Quicker processing times
Better communication
DISADVANTAGES
High Learning curve
Human or system errors
in orders
No hardcopies
Training costs
System failure
34

Procurement Procedure
35

1. Consumption requisition. Material
requisition from any various department to
warehouse or from demand management.
2. Purchase requisition. If stock level is less
than reorder point or it is ordering period,
warehouse sends purchase requisition to
purchasing department
3. Vendor inquiry. Initial inquiry about
suppliers offerings, visit to the web-site, catalog
request
36

4. Sales quotation. Choose some suppliers
and request budgetary or availability quotation
for specific order configuration.
5. Vendor evaluation. Evaluate qualifications
and bids to select best supplier.
6. Order booking. The formal order placement
or closing of the deal (issuing a Purchase Order
)
37

7. Order Acknowledgment /
Confirmation. Confirmation or notification
that the order is booked and/or received.
8. Order Processing. Vendor executes the
order to produce the supplies.
9. Shipment. Transportation of the supplies.
10.Track and Trace. Follow and expedite the
shipment.
38

11.Delivery and Receive. Storage receives
the supplies delivery.
12.Invoicing / Billing. The commercial
invoice / bill from supplier
13.Settlement. The payment of the charges for
supplies delivery
14.Returns. In case the material are
unacceptable / rejected
39

Supplier Relationship
Management
40

Strategic suppliers are most important to
the buying firm. They supply the buying firm with
essential materials and capabilities that are not
easily replaced.
Preferred suppliers are important to the
buying firm, but alternative suppliers could be
found with some effort.
Transactional suppliers can be easily
replaced in a short time.
Categories of Suppliers
41

There is a trend toward specialization away from
manufacturing an entire product and to more
contract manufacturing and purchasing.
In some market segments, it is estimated that 80
percent or more of total product revenue often
passes directly to suppliers as payment for
labor, materials, and equipment.
This significant transfer of value downstream
emphasizes the importance and significance of
supplier relationship management.
Supplier Relationship Management Reasons
42

For any buying organization to stay competitive
in today’s aggressive market sectors, it is
essential that they maintain strong relationships
with their best contract manufacturers and
suppliers.
Buying firms experience a great deal of pressure
from customers and competitors to keep their
edge and stay in business by reducing costs,
improving product, improving service quality and
enacting continuous improvement.
43

With the decreasing number of suppliers used
by buying firms, it is more important than ever to
maintain strong buyer-supplier relationships.
For each strategic supplier, a key contact within
the buying firm must be established to ensure
that the relationship is being properly managed.
Relationships with strategic suppliers need to be
closely managed. One way to keep up on
supplier relationships is for a buying
organization is to compile supplier profiles for
each strategic supplier.
44

Counterproductive (lose-lose) relationships
are those in which each organization (buying
and supplying) is so focused on getting what is
best for it that each puts the other at a
disadvantage.
This type of relationship is undesirable because:
¤ it does not promote a positive rapport between buying
and supplying firms involved and
¤ neither organization achieves its goals.
Counterproductive buyer-supplier relationships
are not recommended.
Dimension of Supplier Relationship Management
45

Competitive (win-lose) or transactional
relationships are those relationships in which
both buying and supplying firms strive to get the
very best arrangement possible in their
negotiations and fail to see the benefits of both
organizations obtaining their goals and
objectives.
In transactional relationships, the buying and
supplying firms will stop at nothing to make sure
that they come out on top and do not care about
the other organization’s well-being.
46

A competitive relationship is almost required with
transactional/tier-three suppliers and assumes
that the buying firm can lower prices to help
keep its competitive edge in the market.
It does not matter if the relationship is not strong
enough to last because by definition,
transactional suppliers can be easily replaced at
any time.
47

Cooperative (win-win) relationships recognize
the potential value of both organizations getting
what they want and maximize the potential of
having a long-term relationship.
Although it is a strong relationship, a cooperative
alliance lacks the teamwork that is needed
between the various buying and supplying firms
in order to optimize the benefits for all of the
members of the supply chain.
48

Cooperative relationships are commonly found
within a buying organization’s preferred/tier-two
service providers and suppliers list.
49

Collaborative (win-win) relationships, usually
found with the buying firm’s strategic/tier-one
suppliers, include the team component that is
missing in a cooperative relationship.
In collaboration, the two organizations truly
realize the benefits of working together to
optimize outcomes for both organizations.
The two firms work together to develop a
strategy to deliver a high-quality product or
service on time and under budget.
50

Single-source policy. Only one supplier
is used to supply a particular part.
Multiple-sources policy. This involves
the use of two or more suppliers.
Decision to Determine the Number of Suppliers
51

The major arguments in favor of single sourcing
are that with the certainty of large volumes that
the supplier can enjoy lower costs per unit and
increased cooperation and communication to
produce win-win relationships between buyer
and seller.
Naming a certain supplier as the single source
and providing it with a long-term contract (three
to five years) greatly reduces the uncertainty that
the supplier will lose business to another
competitor.
Advantages of Single Sourcing
52

With this contract guarantee, the supplier is
more willing to invest in new equipment, or
change its business/operating methods to
accommodate the buyer.
Single sources should be able to provide lower
costs per unit compared to multiple sources by
reducing the duplication of operations in areas
such as setup.
Spreading fixed costs across a larger volume
should also result in an accelerated learning
curve.
Advantages of Single Sourcing
53

The main arguments for multiple sourcing are
competition and assured supply.
¤ It is commonly believed that competition between suppliers for a similar
part will drive costs lower as suppliers compete against each other for
more of the OEM’s business.
This sense of competition is the basis for
capitalism and is the backbone of Western
economic theory.
Multiple sources also can guarantee an
undisrupted supply of parts.
¤ If something should go wrong with one supplier, such as a strike or a
major breakdown or natural disaster, the other supplier (s) can pick up
the slack to deliver all the needed parts without a disruption.
Advantages of Multiple Sourcing
54

Contract
55

A contract is a mutually binding agreement that
obligates the seller to provide the specified
products or services and obligates the buyer to
pay for them
Contracts can clarify responsibilities and
sharpen focus on key deliverables of a project
Because contracts are legally binding, there is
more accountability for delivering the work as
stated in the contract
Contract
56

Different types of contracts can be used in
different situations:
¤ Fixed price or lump sum contracts
¤ Cost reimbursable contracts
¤ Time and material or unit price contracts
A single contract can actually include all four of
these categories, if it makes sense for that
particular procurement
Types of Contracts
57

Fixed price or lump sum contracts involve a fixed total
price for a well-defined product or service. These
contracts are particularly suited where supplies or
services can be clearly specified before tenders are
invited. The buyer incurs little risk in this situation.
Fixed price contracts may also include incentives for
meeting or exceeding project objectives. They may also
include safeguards in the form of penalty clauses,
however these may be difficult to apply before the
consequences of delay are felt.
Fixed Price or Lump Sum Contract
58

59

60

Firm Fixed Price (FFP)
Commonly used
Fee is fixed for the product or service
No incentives
Change increases the costs to the buyer
61

Firm Fixed Incentive Fee (FFIP)
Incentives and Bonus to the sellers based
on performance targets
Motive sellers for better performance
It is Firm Fixed Price contract with
incentive attached
62

Fixed Price with Economic Price Adjustment
(FP-EPA)
Price can be adjusted based on some
agreed parameters like : inflation rate,
currency rate, oil index, gold index, and
other metal index
Best suited for projects where period
spans for number of years.
63

Cost reimbursable or cost-plus contracts involve
payment to the supplier for direct and indirect
actual costs.
The actual cost incurred plus profit. Profit could
be fixed or percentage of actual cost.
These contracts are often used for projects that
include the provision of goods and services
associated with new technologies.
The buyer absorbs more risk with the type of
contract. When scope is uncertain, it could not
estimate total cost at start of the project.
Cost Reimbursable Contracts
64

65

66

Cost reimbursable with ceiling:
The buyer pays the supplier for all
allowable cost, but will not be paid over the
Ceiling Price
The supplier assumes the risk when
actual cost exceeds the agreed upon Ceiling
Price.
67

Cost saving sharing:
The buyer pays the supplier for allowable
performance costs plus a predetermined
percentage based on saving sharing
provision as incentive
68

Cost plus fixed fee (CPFF):
performance costs plus a fixed fee payment
usually based on a percentage of estimated
costs
69

Cost plus incentive fee (CPIF)
performance costs plus a predetermined fee
and an incentive bonus
70

Cost plus percentage of costs (CPPC)
performance costs plus a predetermined
percentage based on total costs
A fee rises as the supplier cost rise.
Because it provides no incentive for
supplier.
71

Cost plus award fee (CPAF)
The buyer pays the supplier a fee based
upon the supplier performance.
In some contracts, the fee is determined
subjectively by an awards fee board
whereas in others the fee is based upon
objective performance metrics.
72

Time and material or unit price contracts require
the buyer to pay the supplier a predetermined
amount per unit of service.
The total value of the contract is a function of the
quantities needed to complete the work.
This type of contract is often used for services
that are needed when the work cannot be clearly
specified and total costs cannot be estimated in
a contract. Many contract programmers and
consultants prefer to use unit price contracts.
Time And Material or Unit Price Contract
73

Time And Material or Unit Price Contract
74

Risks of Contracts
75

International Commercial Terms (INCOTERMS)
76

77

78

79

80

87

Inventory management is an integrated activity
employed in maintaining the optimum number or
amount of each inventory item.
The objective of inventory management is to
provide uninterrupted production, sales, and/or
customer-service levels at the minimum cost.
Since for many companies inventory is the
largest item in the current assets category,
inventory problems contribute to losses or even
business failures.
88

Inventory planning is the process of determining
the optimal quantity and timing of inventory for
the purpose of aligning it with sales and
production capacity.
Inventory control is the process of making sure
that the right amount of goods, parts, and
materials are available to use, process or sell
without excessive oversupply or loss.
89

Material inventories : raw - materials, parts and
components bought from supplier which enter into the product.
Direct during the production process and generally form part of the
product.
In-process inventories: Semi-finished parts, work-in-
process and partly finished products formed at various stages of
production.
M.R.O. Inventories: Maintenance, repairs and operating
supplies which are consumed during the production process and
generally do not form part of the product itself
Finished goods inventories: Complete finished products
ready for sale.
Types of Inventory
90

Independent Demand : Common product,
Interchangable part, Raw material, MRO
supplies
Dependent Demand : Tailored product,
Special subassembly / component / part /
material of differentiated product.
Demand Dependency of Material
91

EOQ (Economic Order Quantity)
EPQ (Economic Production Quantity)
PR (Periodic Review)
MRP (Material Requirement Planning)
Kanban System
Inventory Management Methods
92

ABC (Always Better Control) or XYZ analysis
FSN (Fast moving – Slow moving – Non moving)
analysis
HML (High – Medium – Low) analysis.
SDE (Scarce – Difficult – Easy to acquire)
analysis
SOS (Seasonal – Off Seasonal) analysis
VED (Vital – Essential – Desirable) analysis
GOLF (Government – Open market – Local –
Foreign source) analysis
93

First In First Out (FIFO)
Last In First Out (LIFO)
Priority Queueing
Random
94

Lead Time
Safety Stock
Space and capacity
Inventory value and turnover
Probability shortage and service level
Holding time in storage and perishable attribute
Replenishment, warehousing and stockout costs
Inventory Management Factors
95

Average stock level is computed by adding safety
stock by a half of average replenishment size.
Where :
SL : Average stock level
SS : Safety stock
Qi : Replenishment size
n : Number of replenishment
Average Stock Level
96












⋅+=
∑=
n
Q
SS
n
i
i
SL
1
2
1

Inventory turnover ratio is computed by dividing
the cost of material consumed by the average
stock level
Where :
STO : Inventory turnover ratio
Da : Annually demand
Cp : Price or purchasing cost per unit material
Inventory Turnover Ratio
97
L
pa
TO
S
CD
S
⋅
=

Inventory service level is complement of probability
of shortage
Where :
S : Service Level
P(shortage) : Probability of shortage
Inventory Service Level
98
)(1 shortagePS −=

Total Inventory Cost is summary of all operational
cost including procurement cost, warehousing cost
and stockout cost.
Where :
TIC : Average stock level
n : Number of replenishment
Da : Annually demand
E(shortage) : Expectation of shortage
Cs : Setup / ordering cost per order
Cp : Purchasing cost per unit material
Ch : Annually holding cost per unit on-hand material
Cb : Backorder cost per unit material shortage
Total Inventory Cost
99
( ) )(.... shortageECSCDCnCTIC bLhaps +++=

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08 procurement and inventory management

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