Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 1 Purchasing, Quality Control, and Vendor Analysis

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 2 Supply Chain Management A key determinant of a company’s ability to compete A key determinant of a company’s ability to compete Shaving 2% from a company’s CGS can increase net income by as much as 28% Shaving 2% from a company’s CGS can increase net income by as much as 28% Requires a sound purchasing plan Requires a sound purchasing plan

Components of a purchasing plan Right Quality Right Vendor Right Time Right Quantity Right Price The Purchasing Plan

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 4 The Purchasing Plan Quality Quality  Total Quality Management  Deming’s 14 Points Quantity Quantity  Economic Order Quantity Analysis (EOQ)  Economic Order Quantity with Usage Price Price  Purchase Discounts

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 5 Time Time  Reorder Point Analysis Vendor Vendor  Sources of Supply  Vendor Rating Scale (Continued) The Purchasing Plan

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 6 Quality “Higher quality is less expensive to produce than lower quality.” -- W. Edwards Deming “Higher quality is less expensive to produce than lower quality.” -- W. Edwards Deming The endless pursuit of quality produces lower costs, higher productivity, greater market share, and more satisfied customers. The endless pursuit of quality produces lower costs, higher productivity, greater market share, and more satisfied customers. Experts estimate that the cost of “bad quality” ranges from 20% to 30% of sales. Experts estimate that the cost of “bad quality” ranges from 20% to 30% of sales. Quality

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 7 Total Quality Management (TQM) is a philosophy that strives for getting everything a company does for a customer right the first time. Total Quality Management (TQM) is a philosophy that strives for getting everything a company does for a customer right the first time. TQM involves a life-long process of continuous improvement; a successful TQM process requires a company to change everything it does. TQM involves a life-long process of continuous improvement; a successful TQM process requires a company to change everything it does. Quality Quality

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 8 Implementing TQM 1. Use benchmarking to discover the best practices that will produce quality results. 2. Shift from a management-driven culture to a participative, team-based one. 3. Modify the reward system to encourage teamwork and innovation. Success requires following 11 principles:

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 9 4. Train workers constantly to give them the tools they need to produce quality and to upgrade the company’s knowledge base. 5. Train employees to measure quality with the tools of statistical process control (SPC). 6. Use Pareto’s Law to focus TQM efforts. 7. Share information with everyone in the organization. Implementing TQM Success requires following 11 principles:

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company Focus quality improvements on astonishing the customer. 9. Don’t rely on inspection to produce quality products and services. 10. Avoid using TQM to place blame on those who make mistakes. 11. Strive for continuous improvement in processes as well as in products and services. Implementing TQM Success requires following 11 principles:

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 11 Deming’s 14 Points 1. Constantly strive to improve products and services. 2. Adopt a total quality philosophy. 3. Correct defects as they happen rather than rely on mass inspection of end products. 4. Don’t award business on price alone.

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company Constantly improve the system of production and service. 6. Institute training. 7. Institute leadership. 8. Drive out fear. Deming’s 14 Points

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company Break down barriers among staff areas. 10. Eliminate superficial slogans and goals. 11. Eliminate standard quotas. Deming’s 14 Points

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company Remove barriers to pride in workmanship. 13. Institute vigorous education and retraining. 14. Take demonstrated management action to achieve transformation. Deming’s 14 Points

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 15 Economic Order Quantity Cost of units = D x C Cost of units = D x C Holding (Carrying) costs = Q/2 x H Holding (Carrying) costs = Q/2 x H Setup (Ordering) costs = D/Q x S Setup (Ordering) costs = D/Q x S... seeks to minimize total inventory costs. Three major inventory costs to consider:

EOQ and Carrying Costs If Q is... Q/2, Average Inventory Q/2 x H, Carrying Costs ,0002,0003,0004,0005,0006,0007,0008,0009,00010, ,0001,5002,0002,5003,0003,5004,0004,5005,000$ ,2501,8752,5003,1253,7504,3755,0005,6256,250

EOQ and Ordering Costs If Q is... D/Q, # Orders per Year D/Q x S, Ordering Cost ,0002,0003,0004,0005,0006,0007,0008,0009,00010, $7,200 3,600 3,600 1,800 1,800 1,206 1,

Solving for EOQ where D = Annual demand for product S = Setup (ordering) cost for a single run (order) H = Holding (carrying) cost per unit per year

EOQ and Total Costs If Q is... Q/2 x H Total Costs ,0002,0002,4003,0004,0005,0006,0007,0008,0009,00010,000$7,200 3,600 3,600 1,800 1,800 1,500 1,5001, $620, , ,000 D x C $ ,2501,5001,8752,5003,1253,7504,3755,0005,6256,250 D/Q x S $627, , , , ,050623,000623,075623,400623,845624,350624,889625,450626,025626,610

Calculating Total Cost Total Cost Total Cost = Cost of Units + Carrying Cost + Ordering Cost

EOQ and Total Costs

EOQ with Usage where D = Annual demand for product S = Setup (ordering) cost for a single run (order) H = Holding (carrying) cost per unit per year U = Usage rate P = Production rate

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 23 Discounts Trade discounts - established on a graduated scale and depend on a company’s position in the channel of distribution. Trade discounts - established on a graduated scale and depend on a company’s position in the channel of distribution.

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 24 Trade Discount Structure Manufacturer sells for $80. Wholesaler buys at $80; sells at $100. Retailer buys at $100; sells at $175. Customer buys at $175.

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 25 Quantity discounts - offer price breaks on large-volume purchases. Quantity discounts - offer price breaks on large-volume purchases. Cash discounts - offered as incentives to pay early. (e.g. “2/10, net 30”) Cash discounts - offered as incentives to pay early. (e.g. “2/10, net 30”) Discounts Trade discounts - established on a graduated scale and depend on a company’s position in the channel of distribution. Trade discounts - established on a graduated scale and depend on a company’s position in the channel of distribution.

The Cost of Foregoing a Cash Discount $1,000 invoice 2/10, net 30 Day Amount $1,000$ days $20 R = I P x T = $20 $980 x 20/360 = %

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 27 Simple Reorder Point Model Reorder Point = (L x U) + S L = Lead time for an order (days) U = Usage rate for the item (units per day) S = Safety stock (units) where

Simple Reorder Point Model

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 29 Reorder Point Model (assuming normally distributed demand) Reorder Point = D L + (SLF x SD L ) D L = Average demand during lead time for an order (units) SLF = Service level factor (the appropriate Z score) SD L = Standard deviation during lead time (units) where

Reorder Point without Safety Stock

Reorder Point with Safety Stock

The Shift from No Safety Stock to Safety Stock

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 33 Vendor Certification 1. Determine important criteria in selecting a vendor. 2. Assign “weights” to each criterion to reflect its relative importance. 3. Develop a grading scale for each criterion. 4. Compute a weighted score for each vendor: Weighted Score = Weight x Grade 5. Choose the vendor with the highest weighted score.

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 34 Supply Chain Management (SCM) Goals Goals  Reduce inventory  Get products to market faster  Improve customer satisfaction Web-based SCM Web-based SCM  Share production plans, shipment schedules, inventory levels, sales forecasts, and actual sales real-time with vendors

Chapter 17 Purchasing & Quality Copyright 2006 Prentice Hall Publishing Company 35 Legal Issues in Purchasing The concept of title, the right to ownership of goods, has been replaced by: Identification - Goods must be in existence and identifiable from all other similar goods. Identification - Goods must be in existence and identifiable from all other similar goods. Risk of loss - determines which party incurs the financial risk if the goods are damaged, destroyed, or lost before they are transferred. Risk of loss - determines which party incurs the financial risk if the goods are damaged, destroyed, or lost before they are transferred. Insurable interest - gives the right to either party to a sales contract to obtain insurance to protect against lost, damaged, or destroyed merchandise as long as he has a “sufficient interest” in them. Insurable interest - gives the right to either party to a sales contract to obtain insurance to protect against lost, damaged, or destroyed merchandise as long as he has a “sufficient interest” in them.