This chapter presents an example on how the designed framework could assist a decision maker with the amount of material to buy and where to get the material from. The general idea for the case has been adopted from the preliminary exam questions given by Dr. Ralph Badinelli and Dr. Julio Martinez. The name of the company used in the example is fictitious.
9.1 Example Case Study
JPR Construction, Inc. is a medium sized electrical contractor that specializes in commercial construction. The company specializes in two particular types of projects: data centers and computer labs. On average, 60% of the company’s contracts are for computer labs and 40% of the contracts are for data centers. Assume that the time between contracts is exponentially distributed with a mean of 5 weeks. Assume a total of ten projects for the year and that the average duration of a project is five weeks.
The management of the company believes that materials management is a very important aspect for successful project completion; therefore they focus greatly in material issues for cost control. Typically, the project personnel are in charge of buying the material needed. The foremen for each project are responsible for preparing the list of materials to be requested from the suppliers. The material requisition is sent to the PM who in turn, sends it to the purchasing department. This requisition specifies the type of material to buy, how much material to buy and where to deliver this material.
The type of material to buy is usually specified in the material schedule prepared in the pre-planning stage. Usually, the type of material to request, by the site personnel, is miscellaneous since major material is requested early due to the long lead times that it requires. The type of commodities to buy depends on the type of work expected to be done in the particular period. For example, the contractor needs to decide which type of
An item that is used in every project is 1” electrical conduit. The company has three options for obtaining the conduit required for their projects. The three options are buying from a supplier in Mexico, buying from a supplier in DC, or using a Vendor Managed Inventory (VMI) System. Purchasing a batch of conduit requires negotiating price with the supplier. For our case it is assumed that the supplier is already known and that the prices are already negotiated and fixed. The typical material requisition process starts on the construction side. The construction team fills a material requisition form specifying the material needed, quantities and dates when the material is needed. This form is sent to the project manager, who verifies the material requested and then forwards the form to the purchasing department. The purchasing department procures the material from the supplier and specifies type of material, quantities and delivery dates. Field personnel are responsible for inspecting the material upon receipt, rejecting any damaged material or wrong deliveries and forwarding the packing slip to the purchasing department for payment purposes. Once the requested material is received, the purchasing department is then responsible for processing invoices, and paying certain fixed freight costs.
If the material is purchased from a supplier, either D.C. or Mexico, there are costs associated with the procurement activities. These costs vary depending on the supplying source. The ordering of material is not an issue when dealing with the VMI system since it is the vendor’s responsibility to have the material available at the construction site. “Assume that at the end of the construction cycle any remaining material can be returned without incurring any additional costs due to restocking”. When ordering from Mexico or D.C., purchasing quantities are typically quite large and require a period of time from the moment that an order is placed to delivery to the specified location. Company policy dictates that the batch sizes are fixed depending on the supplying source. The company needs to place an order once the inventory reaches a certain level. This inventory level is known as the reorder point. The reorder point is set by another decision model that answers the question of when-to-buy. The how-much-to-buy decision and the when-to- buy decision are entangled. The conventional practice to solve these two problems separately was used, with the answer to the “how-much-to-buy” decision affecting the answer to the when-to-buy decision. Typically, materials managers determine how much
to buy first. At this point in the decision process, the assumption that the reorder points are set in such a way that their impact on inventory holding cost and stockouts are within prescribed limits was made. The reorder points assumed for this problem could be changed by making an analysis of the when-to-buy decision.
Weather plays a factor for the delivery of the material and in certain instances it could delay deliveries. There is an additional cost associated with late deliveries. The majority of the times the material is delivered as ordered, however in minimal occasions the material needs to be rejected. This rejection creates an additional cost to compensate for delays in performance and reordering. Once the material is delivered, it is stored in the jobsite until needed. There is a cost associated with material being stored that is known as holding cost. The holding cost usually includes the lost investment income caused by having the asset tied up in inventory. This is not a real cash flow, but it is an important component of the cost of inventory.
If a Vendor Managed Inventory system is used, the distributor places a truck on site with the needed materials and equipment and maintains the inventory in the trailer throughout the project. The distributor charges the contractor for materials and equipment used at predetermined prices. The vendor visits the project at predetermined intervals. Every time he/she visits the project, parts are stored in the trailer and are available for future use. Table 9.1 depicts the data for the three options for material sourcing. The current batch sizes presented are based on the material requisition list prepared in the pre-construction planning phase. This batch size is set based on the anticipated productivity and work to be performed. The current service level is set up at 98% for all the options.
The construction firm uses the conduit on every project. This causes demand for the conduit to be fairly stationary. Recent time series analysis reveals that over all of the data center business that JPR, Inc. does, the average usage of conduit is 4800 pieces per week with a standard deviation of 900 pieces. For the computer lab business that JPR, Inc. does, the weekly usage of the conduit averages 3500 pieces per week with a standard deviation of 400 pieces.
Source Mexico D.C. VMI Procurement Cost ($/shipment) $1280 $1025 - Lead Time (weeks) 2 1 - Unavailability Penalty ($/occurrence) $250 $225 $300 Price ($/ 1” x 10’piece) $1.59 $1.67 $1.80 Material Delivered as Ordered 95% 98% 95% Rejection Cost ($/occurrence) $250 $225 $200 Current Batch Size
(# pieces/delivery) 30,000 20,000 10,000 Annual Holding Cost Rate
(% of the average dollar value of inventory)
20 % 20% -
Table 9.1: Data for the Three Options for Material Sourcing