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IJPPM 54,4

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Received July 2004 Revised November 2004 Accepted December 2004

Re-modelling EOQ and JIT purchasing for performance enhancement in the ready mixed concrete industries of Chongqing, China and Singapore
Wu Min and Low Sui Pheng
Department of Building, National University of Singapore, Singapore
Abstract
Purpose To develop just-in-time (JIT) purchasing threshold value (JPTV) models for ready mixed concrete (RMC) suppliers to decide whether or not to switch from an economic order quantity (EOQ) approach to a JIT purchasing approach for the purchase of their raw materials, when a price discount is offered. Design/methodology/approach The existing economic order quantity (EOQ) with a price discount versus the JIT purchasing cost comparative models neglect some important cost components under the inventory management systems, for example, the out-of-stock costs and the impact of inventory policy on product quality and production exibility. In addition, these models do not empirically study the capability of an inventory facility to hold the EOQ-JIT cost indifference points amount of inventory. These models suggest that the JIT purchasing approach is always preferred to the EOQ approach when the JIT purchasing approach can capitalize on physical plant space reduction. The JPTV models developed in this study overcome the two limitations of the existing EOQ and JIT purchasing cost comparative models. Findings By developing the JPTV models, this study suggests that the theoretical advantages of JIT purchasing may have been overstated. Originality/value The eld studies conducted in the RMC industries in Chongqing, China and Singapore supported the propositions in this study. The JPTV models, if adopted, would help to enhance performance in the RMC industries in other cities as well. Keywords Economic order quantities, Just in time, Purchasing, Concretes, China, Singapore Paper type Research paper

International Journal of Productivity and Performance Management Vol. 54 No. 4, 2005 pp. 256-277 q Emerald Group Publishing Limited 1741-0401 DOI 10.1108/17410400510593811

1. Introduction The economic order quantity (EOQ) approach can be regarded as the conventional method for purchasing materials. EOQ is the quantity of material within an order that minimizes the total costs that are required to order and hold inventory (Harris, 1915; Peterson and Silver, 1979; Fazel, 1997). This approach leads to placing of large-sized and infrequent orders (Schonberger, 1982). This approach was originally conceptualized by Harris (1915) in 1915. Fazel et al. (1998) suggested that Harris (1915) model can be modied to incorporate different price discount schemes to better reect the industry practice. The EOQ approach has been a fundamental technique for inventory management decisions and continues to be the starting point in the

development of many subsequent inventory purchasing models (Ray and Chaudhuri, 1997; Charabarty et al., 1998). Materials can also be purchased in a just-in-time (JIT) fashion (Low and Chan, 1997; Monden, 1998), which advocates smaller-sized and more frequent orders. This approach was originally explored by Kanzler as a method for reducing inventory levels at the Fordson Tractor Plant in the 1920s (Peterson, 2002). The JIT purchasing method is an important technique of the JIT philosophy, which is regarded as one of the most important productivity enhancement management innovations of the twentieth century in the manufacturing industry (Schonberger, 1982). The JIT approach provides the right materials, in the right quantities and quality, just in time for production (Vokurka and Davis, 1996). Although it was originally introduced in the manufacturing industry, the implementation of the JIT purchasing approach has been extended beyond that. Its successful implementation in many industries prompted many companies that are still using the EOQ approach to ponder whether they should switch to the JIT purchasing approach for managing their inventories. 1.1. Research problem Ready mixed concrete (RMC) is an important building material that is widely used today in the construction industry (Anson et al., 2002; Wang et al., 2001). RMC mixing is a prototypical example of JIT construction processes (Tommelein and Li, 1999). Inspired by the success achieved through the implementation of the JIT philosophy in the manufacturing industry, Wu and Low (2003) and Low and Wu (2005a, b) surveyed the implementation status of JIT purchasing in the RMC industries in Singapore and Chongqing, China. The surveys found that both the EOQ approach and the JIT purchasing approach were adopted by companies to manage the procurement of raw materials in the RMC industry. The JIT purchasing approach results in an advantage of maintaining relatively smaller inventories and thereby can reduce the plant space. Hence, the existing EOQ with a price discount versus JIT purchasing cost comparative models concluded that the JIT purchasing approach was always preferred to the EOQ approach, provided that the JIT purchasing approach could experience and capitalize on this physical plant space reduction (Schniederjans and Cao, 2000). However, this conclusion was not consistent with the industry practice, leading to a need to re-examine the presently available EOQ versus JIT purchasing cost comparative models. In a closer examination of these models, it could be found that these models had two limitations. First, these models did not theoretically nor empirically ascertain the capability of an inventory facility to hold the EOQ-JIT cost indifference points amount of inventory. The EOQ-JIT cost indifference point is the level of demand at which the costs of the EOQ with a price discount system equal that of the JIT purchasing system. Inventory facility is dened as a physical plant space where raw materials, goods or merchandise are stored. In the RMC industry, an inventory facility can be a storehouse, a warehouse, an aggregates depot, a sand yard or a cement terminal. Second, these models also ignored some important cost components of the inventory purchasing systems. These costs included, but not limited to, the impact of the inventory purchasing policy on product quality, production exibility and organizational competitiveness (Zhu et al., 1994; Cheng and Podolsky, 1996) and out-of-stock costs (Johnson and Stice, 1993; Low

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and Chong, 2001; Singh, 2003;). Because of these two limitations, these models cannot clearly explain the inventory purchasing approaches adopted in the RMC industry. 1.2. Research aim and objectives Based on the above background, the aim of this study is to develop JIT purchasing threshold value (JPTV) models for a RMC supplier. These JPTV models envisage overcoming the two limitations of the presently available EOQ with a price discount versus JIT purchasing cost comparative models. The JPTV models help the RMC supplier to decide whether the company should switch to the JIT purchasing approach if the RMC supplier is still adopting the EOQ approach to manage the procurement of his raw materials. In the process, this would help to enhance the overall performance of the RMC industry worldwide. 1.3. Research hypothesis The research hypothesis for this study is that the EOQ approach is preferred to the JIT purchasing approach in managing materials procurement when the additional costs resulting from JIT purchasing approach is high and when the annual demand is extremely low or high. This is evident even when the JIT operation can experience and capitalize on physical plant space reduction. 1.4. Research strategy and assumptions in this study The research strategy of this study is to expand on only one of the assumptions of the platform created earlier by Fazel et al. (1998) and Schniederjans and Cao (2000) to develop the JPTV models for the RMC industry. It should be noted that the paper is based on a study by Harris (1915), as the models of Schniederjans and Cao (2000) were developed based on the models of Fazel et al. (1998), which were, in turn, developed from the work of Harris (1915). It should also be noted that the assumptions made by Fazel et al. (1998) and Schniederjans and Cao (2000) were also presented in Fazel (1997) and Schniederjans and Cao (2001). This is because the rst two studies were largely similar to the later two studies, except for the consideration of the price discount factor. This study is based on nine assumptions as shown in Table I. The rst eight assumptions were made by the previous researchers. Assumption No. 9 was made by the authors. It assumes that the inventory physical storage costs under the EOQ approach, for example, rental, utilities and personnel salaries are linearly related to the average inventory level. Assumption No. 9 was expanded from assumption No. 3. This is to expand the total carrying costs in the classical EOQ model to include the inventory physical storage costs. This assumption is possible when selecting an inventory purchasing approach either for a new entrant for for an existing company. The rationale for this assumption is presented later. 2. Revised EOQ with a price discount model for the RMC industry While comparing the cost difference between the EOQ with a price discount versus JIT purchasing approach, Fazel et al. (1998) developed their EOQ-JIT cost indifference point models which suggested that JIT purchasing was economical only when the annual demand was low (Schniederjans and Cao, 2000). Arguing that the inventory physical storage cost reduction resulting from JIT purchasing was ignored in the models of Fazel et al. (1998), Schniederjans and Cao (2000) developed their own

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Assumptions made by previous researchers 1 Ordering cost under the EOQ system is xed per order (Harris, 1915) 2 Carrying cost under the EOQ system for the inventory item is constant on a per unit basis (Harris, 1915) 3 Total carrying costs (excluding the inventory physical storage costs) under the EOQ system are linearly related to the average quantity held in inventory (Harris, 1915) 4 Annual demand for the item is known and constant (Harris, 1915) 5 The unit price per item under the EOQ or JIT purchasing system remain constant (Fazel et al., 1998) 6 Orders under the EOQ system are arranged in such a way that the succeeding delivery arrives at the time that the quantity from the previous delivery has just been depleted (Harris, 1915); or safety stock costs required in an EOQ model are balanced out by other costs incurred in the use of a JIT model(Schniederjans and Cao, 2001, p. 112). Hence, safety stocks under the inventory systems are not considered 7 The order under the EOQ system are raised at the optimal economic order quantity (Fazel et al., 1998) 8 The materials suppliers of the JIT companies produce and store their products in large batches and respond to the JIT challenge by delivering them in small qauntities. The carrying and ordering costs (e.g. storage, inspection, transportation, preparation of purchasing orders for each delivery, etc.) of the JIT company were mainly transferred to the material suppliers and solely reected in the unit price to the JIT company. Therefore, the unit price under the JIT purchasing system, which includes the portion of carrying and ordering costs that are passed onto the the buyer, is higher than the unit price under the EOQ system (Fazel et al., 1998) Assumptions made by the authors 9 The inventory physical storage costs under the EOQ system, for example, rental, utilities and personnel salaries are linearly related to the average inventory level

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Table I. Assumptions made in the study

EOQ-JIT cost indifference point models. Both Schniederjans and Caos (2000) and Fazel et al.s (1998) EOQ-JIT cost indifference point models were based on the classical EOQ model and a price discount scheme proposed by Fazel et al. (1998). To develop the JPTV model for the RMC industry, the total annual cost under the classical EOQ model and the price discount scheme proposed by the previous researchers are discussed below. 2.1. The total annual costs under the EOQ model The total annual costs under the classical EOQ model. Based on assumptions No. 1 to No. 6 in Table I, the total annual cost of using an EOQ system for inventory ordering (TC E ) is the sum of the inventory ordering cost, inventory carrying cost, and the cost of the actual purchased units, and is given by: TC E kD Qh PE D Q 2 1

where Q is the xed order quantity, h is the annual cost of carrying one unit of inventory in stock, k is the cost of placing an order, D is the annual demand for the

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item, P E is the purchase price per unit, D=Q is the annual ordering frequency, Q=2 is the annual average inventory level in the inventory facility. The rst ratio is the inventory ordering cost item. The second ratio is the inventory carrying cost item. The last item is the annual purchasing cost component. It should be noted that based on assumption No. 6 in Table I, which was agreed by Fazel et al. (1998) and Schniederjans and Cao (2000), the costs of not having stock are not considered in Equation (1). Although the risk of no stock or late delivery and the cost associated with it can vary from place to place and between industries, this still needs to be recognized and will be considered later. It should also be noted that although Fazel et al. (1998) and Schniederjans and Cao (2000) used the term the total annual cost of an inventory item under an EOQ system to refer to TC E in Equation (1), the so called xed cost, for example, rental, utilities, and personnel salary, were excluded from the inventory carrying cost item. This was an important assumption agreed by Fazel et al. (1998), and Schniederjans and Cao (2000). This is assumption No. 3 in Table I. This assumption was expanded to become assumption No. 9 in Table I, that is to say, to expand the total carrying costs in the classical EOQ model to include the inventory physical storage cost. The extension of assumption No. 3 to assumption No. 9 is feasible when selecting an inventory purchasing approach either for a new entrant or for an existing company which is considering switching from the EOQ approach to the JIT purchasing approach. For a new entrant, the amount of inventory facility, utilities and the number of logistics staff can be easily adjusted based the average inventory level, because the inventory facilities have not been built yet. For an existing EOQ company, the excess inventory facility can be rented out if this company switches to a JIT purchasing approach as observed by Schniederjans and Cao (2000). The logistics staff may be reallocated to other posts. It should be noted that the inventory physical storage cost under the EOQ system is not necessarily a linear function with the average inventory level (this is assumption No. 9). For instance, let us put ourselves in the position of a warehouse man storing cubic boxes. All the boxes are identical. The area of each surface of each box is 1m2. Let us look at a simple scenario of three boxes and then extend it to a more complicated scenario of n boxes. For three boxes, the total oor area occupied may be 1m2, 2m2 or 3m2. This is shown in Figure 1. For n boxes, the total oor area occupied may be 1m2, 2m2, 3m2 . . . n 2 1m2, or nm 2 . This is shown in Figure 2. Hence, the total oor area taken up by n boxes does not have to be nm2, which is the logical extension of assumption No. 9. Figures 1 and 2 show that this assumption is biased against the high inventory level EOQ system if the annual cost of holding one unit of inventory under the high inventory

Figure 1. Floor area occupied by three cubic boxes

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Figure 2. Floor area occupied by n cubic boxes

level EOQ system is assumed to be the same as that under the low inventory level EOQ system, as the n boxes may be stored in a oor area that is smaller than nm2. Indeed, a higher and more compact inventory facility is usually built to save oor area and reduce the inventory physical storage costs in the RMC industry when the average inventory level increases. This is because the inventory physical storage costs per unt in a higher and more compact inventory facilty are usually lower than that in the smaller sized inventory facility, provided that the other conditions, such as rental rate, utility rate and labor rate remain unchanged. Hence, the assumption made by the authors (assumption No. 9) tended to be quite conservative for the high inventory level EOQ system when compared with a JIT purchasing system, provided that the annual cost of holding one unit of inventory in stock in the high inventory level EOQ system is determined based on the average value of inventory facilities or that of a low inventory level EOQ system. This study shows that it is still possible for the EOQ system to be more cost effective than the JIT purchasing system even when the JIT operation can experience physical plant space reduction; and an unfavourable assumption is made against the EOQ system. Denitely, Gaither (1996) also suggested that the inventory physical storage costs should be included as a component of the total carrying costs. The extension of assumption No. 3 in Table I to assumption No. 9 suggests that there are reasons to include all components of inventory carrying costs into h, when comparing an EOQ system with a JIT purchasing system to select the inventory purchasing policy. Nevertheless, it is essential to note that the amount of inventory facility and the number of logistics staff are usually xed during the operation stage under the EOQ system. Hence, the extension of h may not be possible during the operation stage. Therefore, the models developed in this study are suitable only for selecting an inventory purchasing approach. The total annual costs under the revised EOQ model. For the purpose of comparing this study with that of Fazel et al.s (1998) and Schniederjans and Caos (2000) models, the same terminology the total annual cost using an EOQ system for inventory ordering is still used in this study to refer to TC E . The expanded annual cost of carrying one unit of inventory under the revised EOQ model is symbolized as H in the later discussion. When h is expanded to become H , the total costs under the revised EOQ model (TC Er ) are given by:

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TC Er

kD HQ PE D Q 2

Since H in Equation (2) is greater than h in Equation (1), TC Er is also greater than TC E in Equation (1) in the classical EOQ model.

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2.2. Price discount scheme Existing price discount models. The cost incurred by suppliers is usually a decreasing function of the size of the delivery lot; the delivery price of an inventory is thus usually a decreasing function of the order quantity (Fazel et al., 1998). Goyal and Gupta (1989) concluded that there were three basic types of price discount models, namely: (1) two-part tariff; (2) two-block tariff; and (3) all unit quantity discount. In the two-part tariff price discount model, the buyer is required to pay a xed charge and a uniform price p for all units purchased. Although the buyer pays the same marginal unit price for all quantities, the average price paid is a monotonically decreasing function of quantity purchased (Goyal and Gupta, 1989, p. 263). In the two-block tariff price discount model, the price of a unit, p1 , is maintained up to a quantity x, the per unit price p2 is charged for all units in excess of quantity (p1 f p2 ) (Goyal and Gupta, 1989, p. 263). In the all unit quantity discount model, when a buyer buys less than a quantity x, the price of all units is decreased (Goyal and Gupta, 1989, p. 263). Britney et al. (1983a, b), Dolan (1987) and Wilcox et al. (1987) suggested several variations within each of the three basic types of price quantity discount models. Fazel et al.s (1998) price discount scheme. The price discount scheme proposed by Fazel et al. (1998) had two assumptions: (1) For quantities below a certain level (Qmax ) the delivery price was a decreasing, continuous and linear function of the order quantity. (2) Beyond Qmax , however, the price stayed at its minimum (P min ), which was the E lowest price the supplier would charge, no matter how large the order quantity was. The discount functions are mathematically dened as: P 0 ::::::::::::::::::::::::::::::::::::::::::::::::::::Q 0 E
0 dP E P E P E 2 pE Q:::::or::::::: dQ 2pE :::::::Q # Qmax

P min :::::::::::::::::::::::::::::::::::::::::::::::::QfQmax E whereP 0 is the purchase price per unit when the order quantity equals zero, pE is a E constant representing the quantity discount rate. This price discount scheme was one variation of the all unit quantity discount model, as the buyer paid the same unit price for every unit purchased (Fazel et al., 1998). It seems that this price discount scheme may not t well into the reality in the RMC industry on at least two counts. First, the initial condition for the rst-order differential equation:

dP E 2pE dQ in the price discount model (P 0 ), may not even be a feasible price, as there may be a E minimum order size so that an innitesimally small order size is not possible in the RMC industry. The lowest order quantity (Qmin ) which one can order must be one with an unit price of P 1 , if the inventory is not divisible, for example, one truck of bulk E Portland cement. Second, the intensive site studies carried out by the authors and the in-depth discussions with the general manager of a RMC supplier in Chongqing, China and the production manger of a RMC supplier in Singapore suggested that a greater price discount can usually be offered by the raw materials suppliers, if the order quantity was to be increased. There is no such things as P min . Nevertheless, there was a E maximum order quantity limit for an individual RMC supplier. The maximum order quantity limit for each individual RMC suppliers was usually governed by either the inventory carrying capacity of the inventory facility in the RMC batching plant or the production capacity of the raw material supplier, whichever was the lesser. The general manager of the RMC supplier in Chongqing and the production manger of the RMC supplier in Singapore made their suggestions based on their working experience in the RMC industry. A price discount scheme for the RMC industry. Based on the above background, to better reect the realities in the RMC industries, a new price discount scheme is suggested. This price discount scheme is revised from that of Fazel et al.s (1998) model and is given below. It assumes that the delivery price per unit starts from P Qmin , where E Qmin is the lowest order quantity that can be placed. The delivery price is then a decreasing, continuous, and linear function of the order quantity for the rest of the order quantities that are below a certain level (Qmax ). Qmax is determined by the inventory carrying capacity of the RMC supplier and the production capacity of the raw material supplier, whichever is the lesser. This discount scheme is graphically shown in Figure 3. The discount function can be mathematically presented as: P E P Qmin 2 pE Q 2 Qmin for Qmin # Q # Qmax E where pE is a constant. 2.3. Revised EOQ with a price discount model for the RMC industry The revised EOQ with a price discount model for the RMC industry is developed by incorporating the price discount scheme given in Equation (4) into the revised EOQ model. The total annual costs of the revised EOQ with a price discount model for the RMC industry is thus given by: TC Er  kD QH  Qmin P E pE Qmin 2 pE Q D for Qmin # Q # Qmax Q 2 5 4

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The optimum order quantity which minimizes the total cost under the revised EOQ with a price discount system (Q* ) can be derived by taking the rst order derivative r with respect to Q of Equation (5) and setting it to zero, and is given by:

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Figure 3. The EOQ price discount scheme proposed for the RMC industry

s 2kD Q* for Qmin # Q # Qmax r H 2 2pE D

Equation (6) results in the total annual optimal cost under the revised EOQ with a price discount system as: s r H 2 2pE D H 2kD TC Er kD 2kD 2 H 2 2pE D " P Qmin E s# 2kD pE Qmin 2 pE D for Qmin H 2 2pE D 7

# Q # Qmax

Equation (7) is valid only when the inventory is ordered at its optimal economic order quantity. 3. JPTV models 3.1. EOQ-JIT cost difference function under the revised EOQ model Based on assumption No. 8 in Table I, Fazel et al. (1998) suggested that the total annual cost under the JIT purchasing system (TC J ) was the product of the unit price under the JIT purchasing system (P J ) and the annual demand (D), and was given by: TC J P J D 8

As suggested earlier, this proposition did not consider the additional costs and benets resulting from JIT purchasing. Hence, the total annual cost under the JIT purchasing system for the JPTV models (TC Jr ) is proposed to be the product of the unit price under

the JIT purchasing system (P J ) and the annual demand (D) plus the additional costs and benets resulting from JIT purchasing, and is given by: TC Jr P J D j 9

EOQ and JIT purchasing

where j is the sum of the additional costs and benets resulting from the JIT purchasing approach. The additional costs are mainly the increased out-of-stock costs when inventory is purchased in a JIT fashion. The additional costs of JIT purchasing contribute positively to j. The additional benets are mainly improved quality, exibility of production, reduced waste and increased organizational competitiveness under the JIT purchasing system. The additional benets of JIT purchasing contribute negatively to j. It is essential to note that the cost of the inventory physical plant space reduction in the JIT purchasing system has been assumed to take its maximum value and is considered in the total annual optimal cost under the revised EOQ system. This is because the maximum value of the inventory physical plant space reduction under the JIT purchasing system is the inventory physical plant space under the EOQ system; and the inventory physical plant space under the EOQ system has been considered as a component of inventory carrying costs and included in H in Equation (2). The inventory physical plant space reduction was highlighted by Schniederjans and Cao (2000). The total annual optimal cost under the revised EOQ with a price discount model (TC Er ) has been given in Equation (7). Hence, the difference between the total annual optimal cost under the revised EOQ with a price discount system and the total annual cost under the JIT purchasing system in Equation (9) (Z r ) is: s r H 2 2pE D H 2kD Z r kD 2kD 2 H 2 2pE D s# " 2kD P Qmin pE Qmin 2 pE D 2 P J D 2 j for Qmin E H 2 2pE D # Q # Qmax Setting Z r to zero, the roots of Z r D 0 are the revised EOQ-JIT cost indifference points (Dindr1 and Dindr2 ), given by:
  r   kH 2 j P J 2 P Qmin 2 pE Qmin 2 k 2 H 2 2 2kH j P J 2 P Qmin 2 pE Qmin 2 4pE kj 2 E E (11)  2 11 Qmin P J 2 P E 2 pE Qmin 4pE k for Qmin # Q # Qmax

265

10

Dindr1

where Dindr1 is the lower EOQ-JIT cost indifference point under the revised EOQ with a price discount system for the RMC industry.

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Dindr2

  r   kH 2 j P J 2 P Qmin 2 pE Qmin k 2 H 2 2 2kH j P J 2 P Qmin 2 pE Qmin 2 4pE kj 2 E E (12)  2 12 P J 2 P Qmin 2 pE Qmin 4pE k E for Qmin # Q # Qmax

266

where Dindr2 is the upper EOQ-JIT cost indifference point under the revised EOQ with a price discount system for the RMC industry. The models in Equation (11) and Equation (12) are the JPTV models developed for the rst time in this study.

4. Discussion Equation (11) and Equation (12) indicate that the sum of the additional costs and benets resulting from JIT purchasing (j) is an important factor that affects the lower and upper EOQ-JIT cost indifference points. It should be noted that j varies from industry to industry and it may not be a constant even when the annual demand remains unchanged for the same manufacturers. However, there can be three scenarios for j. (1) j is equal to zero; (2) j is greater than zero; and (3) j is less than zero. Hence, the discussion on the lower and upper EOQ-JIT cost indifference points is presented below for the three scenarios.

4.1. j is equal to zero When j equals zero, Equation (11) suggests that Dindr1 equals zero and Equation (12) suggests Dindr2 is positive. Furthermore, when j equals zero and when the price discount rate (pE ) is insignicant, it can be proved that the EOQ system is more cost effective than the JIT purchasing system, provided that the annual demand is greater than the upper EOQ-JIT cost indifference point (Dindr2 ). pE can be small, for instance, the price discount rate given in the hypothetical examples by Fazel et al. (1998) and Schniederjans and Cao (2000) was 4x1024 only. When j equals zero, Dindr2 can be simplied as:  2kH PJ 2 P Qmin E 2 pE Qmin 2

4pE k

If Qmin is also equal to zero, Dindr2 can be further simplied as:  2kH 2 P J 2 P O 4pE k E

where: P 0 P Qmin pE Qmin E E Let Dindr represent  2kH 2 P J 2 P O 4pE k E

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The cases in which both j and Qmin are equal to zero was the scenario that had been studied by Fazel et al. (1998) and Schniederjans and Cao (2000). Hence, it is essential to compare the present study with Fazel et al.s (1998) and Schniederjans and Caos (2000) models. A comparison of the present study with that of Fazel et al.s (1998) model  is similar to  2kh DindF 2 O P J 2 P E 4pE k 2kH 2 P J 2 P O 4pE k E

the EOQ-JIT cost indifference point proposed by Fazel et al. (1998). DindF can be derived by substituting P E in Equation (1) with the second equation in Equation (3) and setting TC E in Equation (1) to equal TC J in Equation (8). Since H is signicantly greater than h, the revised EOQ-JIT cost indifference point (Dindr2 ) is thus signicantly greater than the EOQ-JIT cost indifference point proposed by Fazel et al. (1998) (DindF ), assuming that the values of the other parameters, namely, k, P J , P 0 and pE remain unchanged. E This is because some inventory physical storage costs were not accounted for in DindF (Schniederjans and Cao, 2000). This nding suggests that the JIT purchasing system can still be cost effective even at a high level of annual demand, thus invalidating Fazel et al.s (1998) conclusion that JIT purchasing was cost effective only at lower levels of annual demand. A comparison of the present study with that of Schniederjans and Caos (2000) model. The concept of the carrying capacity of an inventory facility can assist to compare the present study with Schniederjans and Caos (2000) model. The carrying capacity of an inventory facility is dened as the amount of inventory that can be held by the inventory facility at a specic time assuming each unit of inventory item takes up a xed amount of inventory facility (am2). Mathematically, it is the ratio between the oor area of an inventory facility (N E ) and the area occupied by a unit of inventory (a), and can be presented as: Qh NE a 13

where Qh is the carrying capacity of an inventory facility. In practice, to allow for exibility, the size of the inventory facility is usually designed to be greater than the

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size needed to hold the exact amount of optimal economic order quantity of inventory. Based on assumption No. 9 in Table I, it is reasonable to assume that the size of the inventory facility is b times the size which holds the optimal economic order quantity amount of inventory, which can be presented as: Qh bQ* r 14

268

where b is the stock exibility parameter and is greater than or equal to 1. It is important to note that the lower out-of-stock cost is the major issue in keeping rms on EOQ! Hence, b is often greater than 1. Substituting Qh in Equation (14) into Equation (13), would result in: N E abQ* r 15

Equation (15) is the formula of the oor area of an inventory facility determined by the inventory optimal economic order quantity. Substituting Dindr into Equation (6), Q* rind the optimal economic order quantity at the revised EOQ-JIT cost indifference point (Dindr ) can be derived as: Q* rind 2k PJ 2 P0 E 16

Substituting Q* for Q* in Equation (15), would result in the minimum area of the r rind inventory facility under the revised EOQ with a price discount system that can house the EOQ-JIT cost indifference points amount of inventory (N Edind ) as: N Edind 2abk PJ 2 P0 E 17

Hence, the total cost under the revised EOQ with a price discount system will be equal to the total cost under the JIT purchasing system, provided that the oor area reaches 2abk PJ 2 P0 E and the annual demand reaches  2kH ; 2 P J 2 P 0 4pE k E ;

and the order quantity is below Qmax . Meanwhile, the physical inventory plant space under the revised EOQ with a price discount system can accommodate the EOQ-JIT cost indifference points amount of inventory. For example, if F represents the annual cost to own and maintain a square meter of physical inventory plant space, 2abF is then a component of H . The above analysis suggests that Schniederjans and Cao (2000) seem to have overlooked that it was possible for an inventory facility to hold the EOQ-JIT cost indifference points amount of inventory when the oor area of an inventory facility

reach N Eind . Hence, another expression of this nding is that an EOQ based system can be more cost effective than a JIT purchasing system when the size of the inventory facility is above N Eind , and the magnitude of the annual demand is above the EOQ-JIT cost indifference point Dindr , and the optimal economic order quantity is less than Qmax . As suggested earlier, N Eind is the minimum area of the inventory facility that can accommodate the EOQ-JIT cost indifference points amount of inventory under the revised EOQ with a price discount system. 4.2. j is greater than zero When the additional costs of JIT purchasing are greater than the benets of JIT purchasing, Equations (11) and (12) have three implications. The rst is that the JIT purchasing approach may not be cost effective when the annual demand is low. This is suggested by Equation (11). The second is that the upper EOQ-JIT cost indifference point (Dindr2 ) shifts to a lower value that is less than:  2kH : 2 P J 2 P 0 4pE k E

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This is suggested by Equation (12). The third is that the EOQ approach can always be preferred to the JIT purchasing approach if the additional costs of JIT purchasing are substantially high. The analysis of the third implication is presented below. Comparing Equation (11) with Equation (12), it can be found that the condition for the lower cost indifference point (Dindr1 ) and the upper cost indifference point (Dindr2 ) are real is that the additional costs and benets resulting from JIT purchasing (j) is below a specic value jlimit , or:

j # jlimit r  
k 2 H 2 P J 2 P Qmin 2 pE Qmin E
2

  4pE k 3 H 2 2 kH P J 2 P Qmin 2 pE Qmin E 4pE k 18

When j is greater than jlimit , Dindr1 and Dindr2 are not feasible cost indifference points. In such a scenario, an EOQ system is always preferred to a JIT purchasing system.

4.3. j is less than zero Setting Z r in Equation (10) to zero, Equation (10) can be rewritten as: r   H 2 2pE D Qmin P J 2 P E 2 pE Qmin D j kD 2kD s H 2 2pE D 2kD for Qmin 2 H 2 2pE D # Q # Qmax

19

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When the additional benets resulting from JIT purchasing, such as increased product quality and production exibility, are considered, it is possible for j to be less than zero. When j is less than zero and the price discount rate pE is insignicant, Dindr1 is not a feasible cost indifference point. This is because, in such a scenario, it can be proved that the left hand side of Equation (19) is less than zero and the right hand side of Equation (19) is greater than zero if the annual demand is equal to Dindr1 (Equation (11)). However, Dindr2 is still a feasible EOQ-JIT cost indifference point. Furthermore, it can be proved that when j is less than zero, Dindr2 is greater than:  2kH : 2 P J 2 P 0 4pE k E

This further suggests that JIT purchasing can probably be adopted in a much wider range than that stipulated by the EOQ-JIT cost indifference point suggested by Fazel et al. (1998), provided that the benets reaped from JIT purchasing, such as improvements in quality and exibility in production are greater than the increased out-of-stock costs. 4.4. Three implications derived from the JPTV models The JPTV models suggest that the EOQ and JIT purchasing approach are preferred depending on the market conditions available in the locality. The JPTV models can have three implications. First, when the additional costs of JIT purchasing cannot be ignored and the annual demand is low, JIT purchasing may be an expensive alternative. Second, when the additional costs of JIT purchasing are substantially high, the EOQ purchasing approach may always be more cost effective than the JIT purchasing approach. Third, when the sum of the additional costs and benets resulting from JIT purchasing are insignicant, the JIT purchasing approach can be widely adopted. However, it is still possible for the EOQ approach to be more cost effective than the JIT purchasing approach, provided that the annual demand is substantially high. The components of the additional costs and benets of JIT purchasing have been explained earlier. The development of the JPTV models theoretically suggests that the research hypothesis can be supported. 5. Case study Temponi (1995) and Tommelein and Li (1999) observed that small companies usually have difculties in implementing JIT purchasing. There were two possible reasons for this. The rst is that the material supplier may not have an interest to act in a JIT fashion when the annual demand was low. This is because the low annual demand of the buyer might mean insignicant prot reaped by the material supplier. The second is that the material supplier might have difculties in delivering the material to the small buyer in a JIT fashion, as his facilities have to be arranged to serve the larger buyer, leading to high out-of-stock costs faced by the small buyer. Through surveys, Low and Wu (2005a, b) conrmed that because of the high out-of-stock risk resulting from JIT purchasing, none of the 20 registered RMC suppliers of the Chongqing Concrete Association procured their sand and aggregates in a JIT fashion. While the rst and second implications of the JPTV models were supported by the studies of Temponi (1995), Tommelein and Li (1999) and Low and Wu (2005a, b); the third

implications of the JPTV models can be veried by a case study with information from the RMC industry in Singapore. 5.1. Background This case study pertained to cement purchasing by the cement division of a RMC supplier in Singapore. The group of the company, in which this RMC supplier was a subsidiary, was incorporated in April 1973 and gained a listing in the Singapore Stock Exchange in 1979. The business scope of the group included the sale of RMC, dry mix mortar products and cement. The cement division of this RMC supplier built two huge silos on Pulau Damar Laut Island and adopted an EOQ system to procure its cement from Japan. The designed carrying capacity of each of the silos was approximately 25,000 tons. The average area occupied by one silo was about 2,800m2. The sum of the carrying capacities of the two silos was approximately 40,000 tons (where safety and exibility factor had been considered. Stock exibility parameter was b 1.25). Cement imported by the cement division of this RMC supplier was mainly transported using 40,000-ton cement carriers. This company placed an order approximately once a month for about 40,000 tons of cement. The annual demand (D) was 520,000 tons in 2003. The annual cost of carrying one ton of cement (H ) was S$ 344/ton. The carrying cost could be split into cement check-in cost (hcheckin ), cement storage costs (hstorage1 , hstorage2 and hstorage3 ) and cement check-out cost (hcheckout ). The cement check-in cost was the depreciation and operating cost of the facilities to unload cement from a cement carrier to a silo and hcheckin S$199 /year per ton. The cement storage costs were hstorage1 S$8/ year per ton, hstorage2 S$ 14/year per ton, and hstorage3 S$ 23/year per ton. The cement storage costs hstorage1 include insurance, cement spoilage cost and opportunity cost of the working capital tied up with the cement purchased. The average interest rate of government bonds in Singapore in the year 2003 was used to compute the opportunity cost of the working capital tied up with the cement purchased. The cement storage costs hstorage2 include the depreciation cost of the silo facilities, utilities, personnel salary and property tax. The cement storage costs hstorage3 include the land rental (2abF). The cement check-out cost was the depreciation cost and operating cost of the facilities, mainly cement trucks, to deliver cement from the silo to a RMC batching plant and hcheckout S$ 100/year per ton. The cost of placing an order from Japan for the 40,000 cement carrier was k S$ 432,000 for transportation alone. Each ton of cement took up a 0.112m2 of the inventory facility space. The annual cost to rent a square meter of inventory facility was F S$ 84. If cement was purchased under a JIT system in Singapore, the cost was P J S$ 69/ton. The additional costs and benets resulting from JIT purchasing (j) was estimated to be zero. There were two reasons for this. The rst is that the transportation infrastructure system in Singapore was well developed. Hence, the additional out-of-stock cost resulting from JIT purchasing of cement from the local market was insignicant. The second is that although JIT purchasing might increase production exibility and reduce waste, the stockpile of large amounts of cement in the EOQ system might help the cement division of the RMC supplier to control the local market. The order was often raised one or two months before the departure of a cement carrier from Japan. The Japanese cement manufacturers offered a few alternative pricing strategies. One pricing strategy was suitable for the EOQ with a price discount system. Under this pricing strategy, the

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lowest order quantity was Qmin 20,000 tons. The delivery price started at P Qmin S$ E 43.5/ton. For every additional ton ordered, the price would decrease by pE S$7:5 x1025 for the entire order lot. The discount was valid for order quantities up to Qmax 50,000 tons, which was the maximum carrying capacity of the cement division of this RMC supplier. It is essential to note that the information for this case study was collected through interviews with the overseas investment manager, the nancial manager, the production manager and the customer service supervisor of the cement division of this supplier in November 2003. It is also important to note that although the cement division of this RMC supplier ordered its cement in an EOQ fashion, the accounting system adopted by them did not exactly follow the EOQ approach. However, it was suggested that the cost information could be structured as above to t the EOQ model. In addition, the value of each parameter was the estimated average value. At this point, it should be noted that the examples given by Fazel et al. (1998, p. 107), and Schniederjans and Cao (2000, p. 291) were hypothetical. 5.2. EOQ-JIT cost indifference points derived from the JPTV models To compare the present study with the study of previous researchers and to make the problem simple, demand variability and safety stock were not considered in this case study. In addition, it was found that each ton of cement took up approximately 0.115m2 of the 100-ton silo and approximately 0.109m2 of the 25,000-ton silo. The annual cost of holding one ton of cement in a 100-ton silo was slightly higher than S$344 and the annual cost of holding one ton of cement in a 25,000-ton silo was slightly lower than S$344/year per ton. This shows that the annual cost of holding one ton of cement in silos can roughly be assumed to be a constant. Assumption No. 9 can roughly be met. Each order of cement was delivered by the 40,000 ton cement carrier. Hence, the ordering cost under the EOQ system can be assumed to be xed per order. The routine order quantity of cement in the cement division of this RMC supplier was 40,000 tons/order. This gure was between the minimum order quantity (20,000 tons/order) and the maximum order quantity (50,000 tons/order) under the revised EOQ with a price discount model. Equation (6) was, therefore, suitable for computing the optimal economic order quantity. According to Equation (6), the optimal economic order quantity was Q* 41,097 tons/order. The optimal economic order quantity was close rd to the routine order quantity. Hence, Equations (11) and (12) can be employed to derive EOQ-JIT cost indifference points. The lower EOQ-JIT cost indifference point (Dindr1 ) computed from Equation (11) was zero, as j was equal to zero. The upper EOQ-JIT cost indifference point (Dindr2 ) computed from Equation (12) was 421,224 tons. It should be noted that the EOQ-JIT cost indifference point could be shifted to a value that was lower than 421,224 tons/year, provided that j was greater than zero (for example, the additional costs resulting from JIT purchasing cannot be ignored); or it might be shifted to a value that was higher than 421,224 tons/year, provided that j was less than zero (for example, the improved product quality and production exibility resulting from JIT purchasing are counted). Since the annual cement demand of the cement division of the RMC supplier I S (520,000 tons) was greater than the EOQ-JIT cost indifference point (421,224 tons), the cement needs to be ordered in the EOQ fashion at a lower price, rather than in the JIT fashion but at a higher price.

A survey covering all the 15 registered members of the Ready-Mixed Concrete Association of Singapore showed that ve of the large companies purchased their cement by using the EOQ approach (Wu and Low, 2003). Besides the supply of cement to their own RMC batching plants, these companies also sold cement to the local construction market. The other ten RMC suppliers with a relatively smaller annual demand purchased their cement in a JIT fashion. 5.3. A comparison of the EOQ-JIT cost indifference points If the annual cost of holding one unit of cement (H ) in Equation (12) was replaced by the cement storage costs (hstorage1 ); and the additional costs and benets resulting from JIT purchasing was set to zero, and let P 0 P Qmin 2 pE Qmin , then Equation (12) was E E converted to be the formula for computing the EOQ-JIT cost indifference point as proposed by Fazel et al. (1998, p. 106). According to Fazel et al.s (1998, p. 106) formula, the EOQ-JIT cost indifference point for cement purchasing was 9,796 ton/year. Each ton of cement occupied at least 0.1m2 of the silo. Hence, JIT purchasing of cement can take advantage of inventory physical plant space reduction. Based on their own models, Schniederjans and Cao (2000) argued that when JIT operations could capitalize on inventory physical plant space reduction, a JIT ordering system is preferable to an EOQ system at any level of annual demand and with almost any cost structure (Schniederjans and Cao, 2000, p. 294). Hence, the EOQ-JIT cost indifference point would be 1. The EOQ-JIT cost indifference points worked out from the models proposed by Fazel et al. (1998), Schniederjans and Cao (2000) and the analysis from this paper are shown in Table II. The batching capacity of the widely used batching plant was 90m3/hr in Singapore. Based on the estimation of the production manager of the RMC supplier in the case study, the average demand for cement of the 90m3/hr batching plant was approximately 40,500 ton/year in 2003. Each RMC supplier had at least one RMC batching plant. Hence, the annual demand for cement of each of the RMC supplier surveyed was at least 40,500 ton/year. This gure was signicantly greater than the EOQ-JIT cost indifference point worked out from the models proposed by Fazel et al. (1998). Hence, the EOQ-JIT cost indifference point derived from the model of Fazel et al. (1998) suggests that all the RMC suppliers should operate in an EOQ fashion. However, as observed by Wu and Low (2003), ten RMC suppliers were purchasing their cement in a JIT fashion. These RMC suppliers used a number of 100-ton silos to store their buffer stock, as shown in Plate 1. The 100-ton silos were lled on a daily basis. Hence, the EOQ-JIT cost indifference point derived from the model of Fazel et al. (1998) was not supported by the cement purchasing process in the RMC industry in Singapore. In the meantime, the EOQ-JIT cost indifference point model proposed by Schniederjans and Cao (2000) suggested that all the RMC suppliers should operate in a JIT fashion, as cement purchasing can take advantage of physical plant space reduction. However, as
Fazel et al.s (1998) EOQ-JIT cost indifference point Fazel et al.s (1998) model Schniederjans and Cao (2000) s model

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Authors model

9,796 (ton/year)

1(ton/year)

421,224 (ton/year)

Table II. A comparison of the EOQ-JIT cost indifference points for cement purchasing in the RMC industry in Singapore

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Plate 1. 100-ton cement silos

suggested earlier, the cement divisions of ve big RMC suppliers were purchasing their cement in an EOQ fashion. To reap economies of scale, the cement division of these RMC suppliers built a number of huge multi-cells silos on the Pulau Damar Laut island, as shown in Plate 2. Hence, the EOQ-JIT cost indifference point derived from the model of Schniederjans and Cao (2000) was not supported by the cement purchasing process in the RMC industry in Singapore either. The EOQ-JIT cost indifference point proposed in this paper was supported by the case study. This case study suggested that when the sum of the additional costs and benets of JIT purchasing were insignicant, the JIT purchasing approach could be widely adopted. However, it was possible for the EOQ approach to be more cost effective than the JIT purchasing approach, provided that the annual demand was substantially high. This is the third implication of the JPTV models. 6. Conclusion and limitation of the study The research hypothesis formulated in this study is that the JIT purchasing approach is not always preferred to the EOQ approach in managing materials procurement, even when the JIT operation can experience and capitalize on physical plant space reduction. This is the opposite of the prevailing understanding, established by previous studies. The hypothesis has been developed from both theoretical and empirical grounds. The development of the JPTV models established the theoretical framework, while the case studies in the RMC industries in Singapore provided the empirical ground to test the hypothesis. The verication of the hypothesis suggests that the theoretical

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Plate 2. 25,000-ton cement silos

advantages of JIT purchasing may have been overstated in the currently available literature, especially when the rms are purchasing to meet high and consistent levels of demand and the JIT operation can take advantage of inventory physical plant space reduction. The JPTV models developed in this study can be helpful to RMC suppliers to select the purchasing approaches for their raw materials. The technologies of concrete admixtures are often beyond the control of a RMC supplier (Grace Construction Product, 2003). Hence, the focus of the JPTV models is on the purchase of cement, sand and aggregates in the RMC industry. Although the observations were made from Chongqing, China and Singapore, the general approach in this paper could be adopted in other countries. The models might be modied, as there can be differences in other RMC markets, due to climate, social, economic and political conditions. The JPTV models developed for the RMC industry can also have implications on the procurement of materials in other industries in which the conditions of the JPTV models can roughly be met, for example, the purchase of liqueed petrochemical gas (LPG) by underground LPG terminal projects, and the order of spare parts in helicopter companies and off-shore oil rigs. The JPTV models can also explicitly explain the difculty in implementing JIT purchasing in small companies whose annual demands are low (Temponi, 1995; Tommelein and Li, 1999) or in the developing countries where transportation infrastructures are under developed and the additional out-of stock costs cannot be neglected (Tanvir, 1986; Low and Wu, 2005a, b). It is hoped that the models presented in this study would help to further enhance the performance of the RMC industry, as well as other industries, where materials procurement is concerned.

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