A Portfolio Approach for Purchasing Systems: Impact of Switching Point

Abstract

In operations management different ordering policies, such as, economic order quantity, lot for lot and periodic ordering, are used in various combinations without deeper considerations for the likely consequences on cash flow and profitability. The success of these techniques is analyzed through inventory levels and/or total cost. In this paper, we present results of simulation which uses three different product groups with varying demand characteristics, changing product margins and also considers product quality failures (due to ordering, engineering change or customer requests). Based on our results, we suggest a portfolio approach where lot for lot policy may be useful in an early phase of the product life-cycle and later it may be an advantage to change over to economic order quantity (EOQ) based ordering. However, demand sustainability and failure rates create instances where orders in larger economical lots may reduce profitability. Therefore, manufacturing may benefit from a portfolio of different purchase order policies and may evaluate the successful balance of policies using cash flow as a parameter. Accuracy of demand forecasting is vital to switching point estimation. Further research on real-world applications of advanced forecasting tools is advocated as well as a framework to develop the portfolio for intelligent purchasing systems.