KEY WORDS: – (RC) Rate contract, (ERP) Enterprise Resource Planning, (ICE) Information Consolidation for Efficiency, (OEM) original equipment manufacturers, (EPC) executive purchase committee, (MM) materials management, (PR) Purchase Requisition, (PO) Purchase Order, (LOI) Letter of Intent, (EMD) Earnest Money Deposit, (BEC) Bid Evaluation Criteria, (NIT) Notice Inviting Tender,(TC) Tender Committee,( E&P) Exploration and Production, (MTOE) Million Metric Tons of Oil Equivalent, (PSU) Public Sector Unit, (SCADA) Supervisory Control and Data Acquisition, (RFQ) Request for Quotation, (T-code) Transaction code, (GR) Goods Receipt, (SRM) Supplier Relationship Management, (SAP) Systems, Applications and Products.
Abstract:-Rate Contracts have been initiated by Suppliers GROUP in Oil and Gas companies for Supply of Spares, Services and Overhauls. Executive Purchase Committee deliberated the proposals of Supplier and observed that, contrary to the benefits envisaged there has been an increase in the inventory of certain items and desired that a special study may be carried out on all the suppliers Rate Contracts. I was required to examine and review the Stock Levels of Materials vis-a-vis consumption where Rate Contracts were entered and to find its impact on inventory, lead time and price. It required an in depth analysis of all the purchases which were entered under rate contracts
From the study which I conducted, I found that there is a positive impact on the price of the material and the lead time where Rate Contracts have been entered by suppliers Group; there is a substantial decrease in the price and the lead time except in a few cases where there are delays in delivery of the Material. However there is no decrease in the stock levels of Material where Rate Contracts were entered, instead in many cases there is a considerable increase in the Stock Levels without any increase in the consumption of the Material.
Based on the study work performed it was found that 1. Purchase Orders are being placed even though sufficient quantity of Material was lying in the Stores. The total amount of Stock which was not utilized even once from the time it was bought is Rs. 88 Lakhs (as per
sample study of 70 items out of a total of 330 Material). 2. There was an increase in the Stock Levels.
3. In many case the Quantities purchased were more than the average consumption during the Last 5 Years.
Prioritizing all the defects which were found as the result of study on the basis of loss incurred due to that defect, the most vital problem is identified as “ procurement disparate to consumption “Various causes leading to this problem were analyzed and the root cause is identified as inadequate input and internal controls of SAP/ERP and recommendations were given on the basis of strengthening the input and internal controls of ERP. It is also recommended to organize regular training programs for employees to raise the level of user awareness in SAP/ERP.
Introduction:- Rate Contract: – Rate contracts (RC) is a procurement cost reduction strategy aimed at standardizing procurement prices for commonly procured, homogenous and price varying inputs.ate contracts are mutual agreements between the buyer and the seller to operate a set of chosen items, during a given period of time for a fixed price or price variation. Under this system the rates are fixed and at times even the quantity of the selected items. As and when the need arises the buyer issues purchase order directly on the basis of the rate chart available on the supplier who in terms supplies the items. Application of the rate contract helps organizations cut down the internal administrative lead time as individual work centers need not go through the central purchasing depart and can place order directly with the suppliers. It also helps in building buyer –supplier relationship as the contract period is usually 5yrs and then there is always a change of the same players doing the next contracts. The system work well normally in a situation where the selected items are routinely consumed items for which concluded will be specified and this list will be review and additions me every year depending upon the past consumptions or an anticipated consumption. Rate contracts will not be entered into, in the case it’s for which the market shows downward trend.
Types of Rate contracts:-
A) Items Rate contracts: – For this contract, contractors are required to quote rates for individual items of work on the basis of schedule of quantities furnished by the clients dept. B) Quantity Rate contracts:-For this contract, suppliers are bound to supply the items of specified quantity fixe in the contract. C) INDEG Rate contract:-the contract fixed with only Indian suppliers. D) DGS&D Rate contract: – The Director General of Suppliers and Disposals (DGS&D) constitutes the central purchasing organization of the Govt. of India. It is responsible for the procurement and purchase of suppliers required by the departments of Defense organization, Railways etc. It is used for purchase of materials, stores, equipment etc., with various Indian a foreign firms.
Objective of the study:-
1) Impact of RC on Inventory of the spares in absolute terms and as a ratio to the consumption level. 2) Impact of RC on system, equipment availability and lead time. 3) Impact of the suppliers RC on Cost of spares.
Scope of the study:-
1) Examine & review the stock levels of materials vis-avis on consumption where RC was entered. 2) Study the impact of RC on inventory of spares, lead time taken for delivery and price of the material. 3) Analyses the inefficiencies that were found during the study and to find the major causes leading to the negative of RC on inventory, Lead time price. 4) Highlighting and giving recommendations on process to eliminate the major causes.
Limitation of the study:-
1) This study is limited to purchases which are under only Rate contracts. 2) Time period is for 5 years.
3) This study is limited only one sector i.e. oil and gas companies. 4) This study is limited to one region in south Indian and cannot disclose the company name.
Methodology of the study:-
1) Identification of the problem:- The following procedures were used to achieve the study objectives: a) Collected the list of all the suppliers and materials for which RC were finalized from the material management dept. b) T-code ME2L was used to download all the purchase orders placed during last 5 yrs, from this list all the cases where the tender process is 10 filtered. Tender process 10 stands for RC. c) There are 330 numbers of materials which were purchased on RC during last 5 yrs out of this a sample of 70 numbers of materials was taken for analysis.
2) Adopted for selecting the sample: – the following procedures were adopted for selection the sample: a) Out of 330 materials, all cases where the net price of material was more than Rs. 50,000 were selected. b) After this cases where more than 100 unit of material were purchased during the last 5 yrs were selected. c) Subsequently all material which were purchased more than 4 times during the last 5 yrs were taken. d) T-code MB5B & MC.9 were used to check the consumption pattern of the material and stock levels. e) This study no materials was available in the store were taken.
3) Detailed study analysis with observations: – I examined the impact of suppliers Rc on the price of the material, lead time taken for delivery, consumption pattern of the materials, stock out situations, the impact on equipment availability and the impact on inventory level after the implementation of Rc. Based on the study performed, I found that there is a decrease in the prices of the Material and lead time, where Rate Contracts were entered. Based on the review I observed that there exists some inefficiency in managing the quantity of pares that need to be maintained, these need to be eliminated. The following are the main areas of concern,
A) There are a few cases where there is an increase in the lead time for delivery of the material. B) In some cases where there was no stock of spares for more than 6 months. C) There are cases where the materials were purchased repeatedly, even though there was no consumption of that material. There were no contract to prevent rising of requisitions where there is a sufficient quantity of the material in the stores. D) In many cases it was observed that there is increases in the stock of the materials even after the RC were finalized. Study Result:-
a) The following are the cases where there was increase in the Lead time. (Such cases constitute 7 % of the sample cases
Sl.no| Plant| Material cost| Lead time before RC| Lead time after RC| Price fixed RC (INR)| Cost at which material is brought (INR)| 1| 41D1| 210456485| 365| 575| 3,52,519.81| 4,37,124.56| 2| 41D1| 210456179| 300| 575| 7,00,887| 8,76,108.75| 3| 41D1| 215308679| 84| 112| 1,10,556| -|
4| 41D1| 215330888| 96| 112| 2,94,254| -|
5| 41D1| 210618660| 84| 112| 1,03,371.21| 1,28,180.300|
2. The following are the cases where there was increase in price.
Sl.no| Plant| Material cost| PR. no| PO. no| Qty| Amount| Rate before PO| Diff.| Vendor Code| 1| 41d1| 210456485| 1090002484| 4010039564| 1| 3,97270| 3,34268| -63,002| 100785| 2| 41d1| 215308679| 109000236| 4010036788| 38| 2,552| 2124| -428| 101233| 3| 41d1| 215330888| 1090002036| 4010036788| 93| 1,613| 1543| -70| 101233|
Out of 70 cases scrutinized, in 60 cases no prior purchase was observed in the system. Therefore only 10 cases were found where there was either increase or decrease in cost after RC. There is 10% decrease in the Cost of Spares after Suppliers Rate Contracts.
3. The following are the cases where there is no stock of Materials in the Stores. The column Date of Last issue is the date from which there was no
stock in the Warehouse.
Sl.no| Plant| Material Cost| PR .no| PO .no| GR .no| Qty| Current Stock| Date of last issue| Vendor code| 1| 41d1| 210456471| 1090002484| 4010039564| 12-08| 1| 0| 16/09| 100785| | ,,| | 1090003572| 4010045211| 31-07| 1| 0| 20/03| 100785| 2| 41a1| 210002209| 1090003399| 4010044730| Not Recd| 1| 0| 16/12| 101233| | ,,| | 1020023312| 4010049414| Not Recd| 1| 0| 20/03| 101233| 3| 41e1| 210019849| 1090002487| 4010039499| 12-09| 4| 0| 16/01| 101233| | ,,| | 1020024627| 4010049639| Not recd| 3| 0| 20/10| 101233| 4| 41e1| 215308652| 1090002561| 4010039513| 10-09| 2| 0| 09/06| 101233| 5| 41e1| 220012001| 1090002561| 4010039513| 10-09| 2| 0| 13/12| 101233| | ,,| 215308652| 1020024516| 4010039513| Not recd| 2| 0| 09/12| 101233| 6| 41e1| 215301843| 1090002561| 4010039513| 10-09| 2| 0| 28/06| 101233| 7| 41e1| 340408205| 1090002561| 4010039513| 12-09| 7| 0| 09/06| 101233| 8| 41e1| 220923090| 1090003078| 4010041448| 15-10| 1| 0| 20/12| 101233| | ,,| | 1020024516| 4010049848| Not recd| 2| 0| 25/03| 101233| 9| 41e1| 210019820| 1090002487| 4010039499| 12-09| 3| 0| 28/05| 101233| | ,,| | 1020024516| 4010049848| Not recd| 3| 0| 12/09| 101233| 10| 41e1| 215308764| 1090002561| 4010039513| 10-09| 5| 0| 05/12| 101233| | ,,| | 1020024516| 4010049848| Not recd| 3| 0| 12/06| 101233|
The spares belonging to Engineering Services (41E1) i.e., Workshop are required only when requisition takes place for overhauling of Cummins Engines. The order for these Spares is placed 6 months before the Overhauling. So there is no necessity in keeping the spares in inventory. The Spare related with Drilling mentioned at item No.1 (Material Code210456471 RESET RELIEF VALVE 3″) is also repairable type and all the connected spares are available in Stock. Therefore the equipment is available even though the stock is nil a) The spare related with asset mentioned at item No. 2 (Material Code 210002209) Supplier base is near to the asset, so that this item can be supplied just in time. So it is not desired to keep the item in stock as inventory.
Selection of problem
The 6 different cases of inefficiencies which were found in the study and the loss incurred due to this inefficiency are as follows: 1. Increase in lead time
No of cases observed: 5
Loss incurred due to this: 2, 26,635.59 INR
Because of late supply & urgency of the material, in 3 cases the material is bought from the OEM at much higher price and that extra price is calculated as loss, for which supplier is not liable as per the terms and conditions agreed in the contract.
2. Increase in price
No of cases observed: 3
Loss incurred due to this: 66,669 INR
The difference between the price before fixing the rate contract and price after fixing the rate contract is calculated as loss.
3. No stock of material in the store
No of cases observed: 10
Loss incurred due to this: negligible
4. No consumption, but material was purchased
No of cases observed: 22
Loss incurred due to this: 89, 08,166 INR
Based on average consumption of previous years, the excess stock in the inventory is identified and cost incurred in buying the excess materials comes as 71,26,533 RS and 25% of the value is considered as the inventory carrying cost i.e. 17,81,633 RS. The sum of these two costs is treated as loss which comes to 89, 08,166 Rs.
5. Increase in stock levels as purchase is not based on the past consumption
No of cases observed: 20
Loss incurred due to this: 16, 13,431.73 INR
The price of the material is calculated for the increased average stock of inventory and, inventory carrying cost is calculated for the extra stock in inventory.
6. Quantity purchased is more than average consumption
No of cases observed: 22
Loss incurred due to this: 70, 94,892 INR
The cost for the extra materials is taken and their inventory carrying cost is added up and considered as total loss. Graphical Representation of the losses incurred by these 6 problems:
• In order to find the relative importance of problems & the vital few problems in a simple, quickly interpreted, visual format. PARETO ANALYSIS is done for all the above cases in order to distinguish the critical problems from the less significant problems with respect to COST. It is based on the fact that 80 % of defects are caused by 20 % of causes.
Thus the major problems which constitutes 80 % of all the problems are : No consumption , but material was purchased
Quantity purchased is more than average consumption. As the 2 major problems states that as there is no consumption, but still material was purchased, in some cases the consumption is very less compared to the procurement and the quantity purchased is more than average consumption per annum. By considering all these statements I arrived to the major problem needs to be addressed in order to eliminate the 80 % of defects in the system.
The vital problem that needs to be addressed is “PROCUREMENT DESPARATE TO CONSUMPTION” Defining the problem
Problem statement: procurement is disparate to consumption for the items which were fixed in the Rate contracts. Impact: increase in inventory with excess purchases, thus the objective of introducing the Rate contract is not achieved Objective: to develop a solution for procuring the materials which were there in Rate contract as per the consumption, thus reducing the inventory. Goal: to reduce the loss incurred due to excess purchases for the items under Rate contract by around 75 %. Now I focused my efforts in analyzing this vital problem in order to identify the probable causes whose elimination leads to improvement.
Identification of causes
Analysis of the problem (fishbone diagram)
In order to identify many possible causes for the above defined problem I selected the tool FISHBONE DIAGRAM also called as ISHIKAWA DIAGRAM. The probable causes which drives the effect “procurement disparate to consumption” are identified by the brainstorming session and numerous interviews conducted by the personnel’s of MATERIALS MANAGEMENT DEPARTMENT, FINANCE DEPARTMENT, INTERNAL AUDIT DEPARTMENT, ENGINEERING DEPARTMENT and sorted into the categories of POLICIES, PROCEDURES, PEOPLE & PLANT ( INFRASTRUCTURE ) .
Cause & effect diagram
Causes due to inefficiencies in people
Causes due to inefficiencies in plant (sap/ erp)
Causes due to policies
Causes due to inefficiency in procedure
LIST OF ALL SUB CAUSES DUE TO PEOPLE, PLANT, POLICY & PROCEDURE leading to the problem “procurement disparate to consumption” 1. In sufficient knowledge in usage of ERP.
2. Complex interface of ERP.
3. Resistance to change ( employees )
4. Network problems.
5. Low level of confidence in the data provided by ERP. 6. Process of L1 bidding.
7. Deficiency in internal controls of ERP.
8. High lead time.
9. Unknown life expectancy
10. Commissioning problems
11. Inadequate operational skills required for new equipment. 12. Inadequate input controls of ERP.
13. More checks & inspections.
14. Equipment break down cannot be forecasted accurately.
Selecting the root causes (control- impact matrix)
Out of all the known possible root causes, it is not viable to attack all, so CONTROL- IMPACT MATRIX is applied in order to sort out the root causes on the basis of its controllability and its impact. Classification of all the causes in this matrix is arrived by discussions with personnel’s of various departments and supported with the data collected in some cases.
Control- impact matrix
The causes which fall under HIGH IMPACT & HIGH CONTROL are viable to address and they should be controlled first. All the causes whose impact is very high and controlling of these inefficiencies are in our hand have to be attacked.
The vital root causes which are leading to the negative impact of Rate contracts were identified. * In sufficient knowledge in usage of ERP.
* Complex interface of ERP.
* Network problems.
* Low level of confidence in the data provided by ERP. * Deficiency in internal controls of ERP.
* Inadequate input controls of ERP
CONCLUSION & RECOMENDATIONS
Conclusion:-Suppliers GROUP achieved most of its objectives by introducing Rate contracts. Based on the study I found that there is a positive impact on the price of the material and the lead time where Rate Contracts have been entered by Suppliers Group, there is a substantial decrease in the price and the lead time except in a few cases where there are delays in delivery of the Material. However there is no decrease in the stock levels of Material where Rate Contracts were entered, instead in many cases there is a considerable increase in the Stock Levels without any increase in the consumption of the Material.
Based on the study work performed I found: * Purchase Orders are being placed even though sufficient quantity of Material was lying in the Stores. The total amount of Stock which was not utilized even once from the time it was bought is Rs. 88 Lakhs (as per sample study of 70 items out of a total of 330 Material). * There was an increase in the Stock Levels.
The following table gives the stock of the Material of 330 items where Rate Contracts were entered.
Stock as on| Amount| % increase
Year on Year| Consumption for the Year|
31-Dec-09| 58,59,896| | 6,395,964|
31-Dec-10| 1,65,14,549| 181.82| 9,885,554| 31-Dec-11| 2,95,15,613| 78.72| 17,299,079| 28-Feb-12| 3,48,10,873| 17.94| 14,324,509
Taking the amount of loss incurred due to theses inefficiencies into consideration the vital problem is detected as “procurement is disparate to consumption”. Week input and internal controls of SAP/ ERP and insufficient knowledge in usage of ERP have been identified as potential root causes which are responsible for this vital problem. So management or the IMPETUS GROUP should focus on these identified causes and necessary steps have to be taken in order to achieve the objectives of introducing rate contracts. Some necessary steps that have to be implemented by the management for the above mentioned cause were recommended below.
* Strengthening input controls and internal control procedures to ensure accurate and timely capture of data. * Reorder level, maximum level and minimum level have to be fixed in the ERP system. * Controls have to be placed in such a way that system should not allow to generate PR if it shows stock is greater than reorder level. * Temporary material codes have to be effectively matched with their mother equipment or with the permanent material codes in SAP ERP, as indenters don’t have sufficient knowledge in identifying the material with temporary material codes. * Have to update the list of integrated suppliers who were fixed in the Rate contracts in the SRM module
* Numerous cases in almost all vendors were noticed where spares were purchased from RC vendor but the items concerned were not reflected in SRM module even after revised price lists became operational. This appears to suggest that there is inadequate system maintenance in SRM module which has to be improved. * One of the major objectives of Rate contracts is to reduce the time in tendering process so as to procure the spares just in time for its consumption. All vendors have specified the time lag between placement of order and its supply. This lead time period is not loaded in the SRM module and to the extent one of the main objectives of RC would be defeated.
(Lead time data being vital to reduce carrying costs of spares I would suggest that this data be loaded in SAP also, besides loading on SRM Module so that any material code report taken from SAP would provide the user with data on when the order has to placed )
* Accumulating information about RC purchases is difficult process presently, as there are multiple vendors. The problem gets aggravated due to mergers of the RC vendors and link in between the two vendors does not get reflected in system. The process of data accumulation could be simpler and more visible if a separate RC-PO series could be allotted in SAP for PO’s under RC.
* Better coordination of PROJECT IMPETUS with PROJECT ICE to ensure uniformity for maintenance & procurement. * The operations of Rate Contracts and the effect on inventory buildup may be monitored at an appropriate level. * Organizing regular training programmes to raise the level of user awareness and minimize errors of data input and making available updated operational documentation to the end users.