Adding Value by Defining the right quantity
By Haytham Etemad
Managing director (ArcBlue Egypt Office)
In these series of articles, we are discussing how procurement department adds value to its organisation, we discussed in earlier articles the overall objective of procurement department, also we discussed adding value by achieving the right quantity, in today’s articles we will discuss how to add value by achieving the right quantity.
What is the right quantity in a procurement transaction? Basically the answer to this question will be the quantity requested in a purchase requisition for example if production manager requested 10 tonnes of raw materials the right quantity will be 10 tonnes but warehouse manager notified you earlier that there is no place to store this 10 tonnes so you need to work closely with production managers and warehouse manager to sort this issue and define the optimum quantity to purchase in this situation.
There are some factors that determine the right quantity according to Lyson and Farrington and these factors are as the following:
- What is the demand for final product? (Dependant Demand) which means that you are buying the components of final product so based on the number of final products that you wish to produce you will buy their components for example you are producing laptops and you wish to produce 100 laptops so you will buy 100 keyboards, 100 hard disks and 100 screens.
- What is the demand of finished products? Such as office equipment office furniture and maintenance services for the office, and this will be based on average consumption and replacement rate.
- What is the inventory policy of the organisation? As according to inventory policy either to have buffer stock available in case of emergency or eliminating stock to avoid cost and risk associated with holding stock.
- What is the service level required? Either the organisation needs to achieve 100% availability of all items or 100% for critical items and 90% for routine items
- What are the market conditions and supply side factors? Sometimes market conditions inforce companies to increase their stock to avoid future shortage or make use of lower prices opportunity in case of bulk order, on the other hand companies may avoid stockpiling due to high certainty of supply which enables companies to avoid costs and risks of holding stock.
These factors lead to another important question how much stock should I hold?
There are good reasons for you to hold stock, specially when the company wants to avoid any stock outs which may cause loss of production or Idle machinery time that increase the overheads costs. Some of these good reasons are
- Stocks reduce the risks of disruption to production from long delivery lead times or unforeseen events.
- Stocks allow rapid replenishment of goods such as maintenance and office supplies that are in constant use and demand.
- Buyers can take advantage of lower prices of bulk orders, or reduced transaction costs by placing larger orders.
- Stocks protect against anticipated price increases, or exchange rate fluctuations.
- Stocks of finished or almost finished goods may be prepared during periods of slow demand ready for unexpected peaks in customer demand which are beyond the organisation’s production capacity
On the other hand, there are good reasons too for not holding stocks as there are costs for stock holding such as the capital tied up in the stock; the ‘opportunity cost’ of having capital tied up in stock that could be used in other investment or at least earn interest; the costs of storing inventory such as (warehouse rent, materials handling machinery, and the wages of warehouse or stores staff); and the cost of losses through, deterioration, damage and obsolescence of stored good.
In addition to that there are also acquiring costs such as the cost of purchasing procedures from preparing purchase requisitions, to, receiving and inspecting incoming deliveries; and processing payment.
Based on the above it is a difficult decision to either stock or not to stock so the ability to forecast demand to define the right quantity and using the economic order quantity to balance between holding costs and acquiring costs is very crucial in adding value through right quantity
Demand forecasting and economic order quantity will be the main topic for next article in order to have better understanding about defining the right quantity.