Academic journal article Journal of Purchasing & Materials Management

The Cost of Ordering

Academic journal article Journal of Purchasing & Materials Management

The Cost of Ordering

Article excerpt

The Cost of Ordering

The utilization of traditional purchasing management methods and techniques should be reviewed on a timely basis to ensure that necessary changes are made as time and circumstances dictate. In this article, the authors report the results of a study to evaluate current uses of cost of ordering figures, the actual dollar values used for the cost of ordering, and how these values are determined. The results indicate that for most firms studied, there has been little, if any, change in the use and determination of the order cost value since the development of the classical EOQ model in 1913.

INTRODUCTION

This article reports the results of a study that was conducted to analyze both the cost of ordering and the current use of this cost figure in U.S. industry. The analysis also considers the internal costs incurred in process setup work. At the outset, the authors believed intuitively that many quantitative input values used in purchasing and operations management decision making are assumed to have been determined correctly years ago--and hence are given only minimal attention. For this reason, it was thought that many day-to-day operating decisions may well be based on incorrect values and assumptions.

Clearly, better operating decisions can lead to increased productivity. And the basis for better decisions is better input information. Too often, however, managers are not provided relevant and timely information with which to make decisions.[1] For example, an earlier study determined that while decision makers understand the concepts of inventory carrying cost, almost all of them actually use arbitrary values based on experimental work done during the World War I era.[2] The authors believe that the same situation prevails with the value used for both external and internal ordering costs. That is, if an order cost is part of an equation used in determining lot size or order size, this cost figure probably is determined by some rather informal process, and will only by chance represent the true cost of ordering.

The focus of current research appears to be on the newer, more glamorous, purchasing and operations management tools carrying acronyms, such as JIT, OPT, TQC, and SPC. On the surface, it appears that many academicians and practitioners alike have embraced these managerial tools as likely answers to a myriad of purchasing and production management problems. Yet, the empirical evidence to date casts some doubt on this view. For example, one recent study concludes that "to date no American company has adopted the JIT purchasing concept for application to every production part used in its operation."[3] Although Hewlett-Packard is not one of the companies included in the present study, it is a highly visible user of JIT. Yet, as researchers Ansari and Heckel further note, Hewlett-Packard's purchasing program uses JIT for only about 25 out of 4,000 purchased items. Thus, it would seem that a high percentage of the purchasing and operations decisions in many U.S. firms are still made using the old familiar techniques.

An extensive literature search found very little information pertaining to the determination of order cost in various types of operating situations. Further, no particular values were recommended for use as accurate approximations for the cost of ordering, except the illustrative values used in lot sizing equations found in textbooks and other theoretical examples.

As a result of the existence of these anomalies, the primary purpose of this research was to determine the range of values being used in U.S. industry for the cost of ordering--and to determine the rationale for the use of these cost figures. Secondary goals were to identify the decisions affected by order cost, and to determine how order cost is used in these decisions--and finally to ascertain the magnitude of the decisions.

RESEARCH METHODOLOGY

As part of a graduate class project, a survey of manufacturing firms was conducted in the heavily industrialized southern Wisconsin-northern Illinois area. …

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