Procurement Management
By Alison Cole
Procurement management can be defined as the independent monitoring or tracking of manufacturing processes to purchase order requirements. An implicit assumption of Economic Order Quantity (EOQ) analysis is that the purchase price per unit is constant. In an inflationary period, this assumption is not valid. If the rate of inflation is predictable the EOQ formula can be applied.
The standard EOQ model assumes that materials can be procured instantaneously, and hence implies that the firm may place an order for replenishment when the inventory level drops to zero. In the real world, however, time is required for the procurement of materials, and hence the order level must be such that inventory at the time of ordering suffices to meet the needs of production during the procurement period.
If the usage rate of materials and the lead time for procurement are known with certainty then the ordering level would simply be lead time in days for procurement, multiplied by the average daily usage. When the usage rate and lead time are likely to vary, the reorder level should be higher than the normal consumption period requirement during the procurement period, to provide a measure of safety in face of variability of usage and lead time. Put differently, the reorder level should be equal to normal consumption, added by the safety stock.
When both the lead time and usage rate vary, which is often the case, and the range of variation is wide, complete protection against stock out may require an excessively large safety stock. Since inventory-carrying costs are proportional to the level of inventories carried, it rarely makes sense to seek total protection against stock out. In view of the trade-off between stock out cost and inventory carrying cost, the optimal level of safety stock is usually much less than the level of safety stock required to achieve total protection against stock out.
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