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OPs, Up-Tos, and EOQs.. OH My!

Many businesses purchase an ERP system with the goal of automating their purchasing process. Instead of making manual buying decisions, the goal is to use the power of your ERP system to automatically generate purchase orders for the buyer to review and edit as necessary. This frees up the buyers time for more productive tasks like negotiating with vendors, analyzing new product lines, and expediting existing purchase orders. But the problem for many buyers is that the formulas and settings can seem intimidating.

When I first started back in 1993 (wow that's a long time ago) we had expert on Inventory Control and Purchasing in our Support/Development department who told me to start by focusing on 2 important considerations in purchasing:

  1. When to buy
  2. How to buy.

When to Buy
To me the starting point for purchasing an item is determining when to buy an item. Buyers can be as simple or complex as they like. When to buy can be when you run out of an item or it can be when you run low on an item. Many people refer to this point as an item minimum or order point; it's the minimum stocking level of an item.

Sometimes item minimums are arbitrarily set. When the item was first set up, the minimum was set to five. Why was it set to five? Well because five seemed like a good number at the time. In many cases, buyers have their own logic or math to come up with a minimum. For instance, last year I worked with a buyer who set the average usage over the last 3 months as a minimum. That worked for him, but he was manually updating the item minimum on a recurring basis from an Excel based report.

When to buy can also be an order point. Order Point is a mathematical calculation of when to buy an item. Instead of thinking of it as a quantity, I like to think of it as a point in time. That helps me understand the formula.

The formula for Order Point can consider multiple factors including:

  • Lead time: The time it takes from when a purchase is generated to when item is received
  • Safety Stock: The level of extra stock that is maintained to manage the risk of stocks due to variation in demand and vendor lead time
  • Average Daily Usage: The average quantity of an item sold each day or a future forecast

Using these variables, and some additional settings, purchasing systems can calculate an order point that is dynamic, meaning it changes as the variable change. If lead time goes up, order point goes up. If lead time goes down, order point goes down. Essentially when to buy an item is automatically updated.

How much to Buy
Once you determine when to buy, the next question is how much to buy - or what many people call purchase quantity. Buyers can be as simple or complex as they like with purchase quantity. To start, the purchase quantity should factor in the vendor package quantity. But once you know to buy a box of 12 versus one at a time, where do you go from there?

That's where Order-Up-To and EOQ (Economic Order Quantity) come in. Let's start with EOQ.

EOQ or Economic Order Quantity is purchase quantity designed to maintain item levels at the lowest total cost, balancing inventory carrying cost against cost to purchase. Most systems will allow the buyer to enter the cost to carry and the cost to purchase. Industry standards for inventory carrying cost are between 20% to 30% and $4.00 to $6.00 per purchase order line for purchasing cost. The calculations react to changes in demand, but the math can be difficult to understand, as it involves a square root.

Using a simpler mathematical formula, order-up-to is designed to bring an item up to a given level. For instance, the buyer could configure the system to replenish the item “up to” three months of supply. Like EOQ, the calculations react to changes in item demand. But unlike EOQ, the calculations are easy to understand, and the supply levels can be used to approximate economic order quantities.

If your goal is automated purchasing, you can get there, but you'll need a thorough understanding of how your system works and how to pull the right switches and push the right buttons.

Tony Corley, Senior Product Marketing Manager at Epicor Software


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