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Our Company spends on an average of 1100 Crores per year for various capital works and maintenance works. Majority of these works requires different types of major and minor materials. Availability of the right material in required quantity at the right time is very much crucial. Non-availability of the materials not only delays planned works but also over burdens the existing network. On flip side, unplanned spending of such huge amounts directly impacts Company’s finances. Hence, proper material procurement planning is very much essential.

There are many techniques on which material procurement decisions can be taken. One such technique is consumption based procurement planning – where procurement decision of a material is taken based on its consumption history.

Different types of consumption based procurement techniques are as follows,
Procurement TypesOf all the above, most widely accepted method in consumption based procurement planning is the reorder point formula.

What is reorder point? Does it vary from material to material?
Reorder point is the stock level of a material below which procurement process for that material needs to be initiated in order to ensure availability of stock in future.

Reorder point of any material is a function of its consumption and time taken for its procurement (as can be observed from the below formula).  Different materials have different consumption rates and requires different amounts of time for their procurement, hence reorder point is different for different materials.

How is reorder point calculated?
Reorder point of a material whose consumption history is available, can be calculated using the formula,

Reorder Point = (A x B) + C

A  – Average daily consumption
Number of units (of material) consumed per day.
B – Procurement lead time
Time required for procurement of a material. It is the time gap between point of initiation of procurement process to receipt of ordered materials at stores.
C – Safety stock (equals to ‘average daily consumption x safety time’)   
Buffer stock to be maintained at stores in order to handle excess consumption during procurement lead time and or delivery delays.

Hence, in order to calculate reorder point of a material the above three (A, B & C) essential parameters are to known.

Consider the following example,
Let’s calculate the reorder point of “3-Phase 25KVA DTR” whose essential parameters are as follows…..

♦  In the last one year 3650 Nos of “3-Phase 25KVA DTR” were drawn
.  /consumed.

♦  Based on the previous procurement experience, on an average of 100 days
.   is required to procure it.
♦  Considering field emergencies (based on previous experience) and
.  delivery delays encountered during the previous procurement cycles,
.  a safety stock equal to 20 days consumption is required.

.  A – Average daily consumption   =   3650/365  =  10 Nos
.  B – Procurement lead time                            =  100 days
.  C – Safety stock                     =   10*20      =  200 Nos

   Reorder point   = (A x B) + C  =  10*100 + 200  =  1200 Nos

Hence, a reorder point of 1200 Nos is to be maintained for “3-Phase 25KVA DTR” and it can be graphically depicted as…..
Reorder 1
If the stock of “3-Phase 25KVA DTR” at stores falls below 1200 Nos, then procurement process is to be initiated in order to ensure availability of “3-Phase 25KVA DTR” in future.

Why Safety stock is to be maintained?
Safety stock for a material is maintained to handle the following….
Excess consumption during procurement lead time.
.  ♦  
Delivery delays by vendors.

In previous example a safety stock of 200 Nos is maintained for “3-Phase 25KVA DTR”. Hence, any excess consumption upto 200 Nos during the procurement lead time can be accommodated without running out of stock at stores and is as shown in the following figure….
Similarly, as a safety stock of 200 Nos (equivalent to 20 days consumption) is maintained delivery delays by vendors upto 20 days can be handled and is as shown in the following figure…

Sufficient care to be taken in arriving at reorder point of a material such that at any point of time optimal stock is available at stores without excess or less.

Please note that, reorder point only indicates when to initiate procurement but it does not tell the amount of material that is to be procured.

Advantages of reorder point based procurement…..
♦  Encourages discipline in procurement planning.
♦  Promotes market research before procurement.
♦  Allows early identification and resolution of procurement problems.
♦  Allows sufficient time to obtain mandatory approvals.
♦  Reduces procurement cost.
♦  Ensures availability of stock at all times.
♦  Storage and holding costs of inventory are minimized.
♦  Improves Company’s cash flow.

What our Company has done?
As our Company runs on SAP-ERP, reorder point of all the materials (procured by P&MM wing) were calculated taking last 365 days consumption and time required for procurement into consideration.  Calculated reorder point of all the materials were maintained in SAP. A reorder point report (TCode: Zmstore23) was developed. On every Monday, SAP system automatically sends reorder point report (for reorder triggered materials) via SAP express mail to all the concerned P&MM staff of Corporate Office indicating the need for initiation of procurement process.

Further, tracking of procurement process from the point of placing of tenders on e-procurement platform to receipt of materials at stores is also designed (Tcodes: Zmtender1, Zmtender2 & Zmtender3).

Expected outcome:
♦  Discipline in material procurement.
♦  Avoiding procurement of non-moving materials.
♦  Tracking procurement process for taking effective and appropriate decisions.
♦  Ensuring availability of materials at stores at all times.
♦  Optimizing inventory at stores – As on date (11th February, 2014) value of
.  inventory at stores is 228 Crores. Even a 10% reduction of inventory
.  (by effective planning) will save 2.28 Crores per annum (assuming
 . a 10% savings rate).

From 27th January, 2014 – reorder point based procurement and tracking of procurement process is being taken up by our Company.

By Er. B S Jaya Prakash Nayak
ADE/Tech to CMD and SAP-MM