By Zeeshan Hasan
(First published in the November 2011 issue of CIO magazine, Bangladesh edition)
It
is easy to manage purchases in a small company. The management can
easily see what sales orders are coming in, whether enough stock is
present to deliver those sales orders, and take steps to purchase
whatever goods are short. However, once a company becomes larger than
a single production location, it becomes more difficult to do the
above. With physical separation of purchase, production and sales
activities, the communication of sales orders, inventories and
shortages that are required for efficient purchase becomes a problem.
Any communication gap is likely to result in too much stock being
wastefully purchased, or in a raw materials shortage which causes
production delays and lost customers. This is the point at which ERP
(Enterprise Resource Planning) software becomes a necessity. ERP
software is an integrated business software designed to bring all the
above departments together and help them to work in a coordinated
way. In this article I will use the term ERP mainly with reference to
the features of the Adempiere community-supported open-source ERP
system, since that is what is used at my company (Kazi Farms,
Bangladesh's largest poultry producer).
There
is a simple logical method which ERP systems use to ensure efficient
purchase. The initial requirement of raw materials is justified in
any ERP system by a link to a sales order for finished product. The
link between finished products to be sold and raw materials to be
purchased is integral to the system; each finished product which
needs to be delivered is defined as a list of component raw
materials, referred to in the system as a Bill Of Materials (BOM).
Thus, by ordering sales orders by delivery date and then calculating the associated raw materials required from the BOM, an ERP
system can estimate raw materials requirements at any moment in time.
Since inventories in all locations are also in the system, purchase
orders can also be generated from the system to meet the requirements
of sales. All of this, in fact, is not even ERP but MRP
(Manufacturing Resource Planning), which was developed in the 1960's
and 70's as a means of coordinating purchases, inventories,
manufacturing and sales. MRP software evolved into modern integrated
ERP by the addition of accounting and budgeting features into the
basic sales, production and purchase cycle.
From
the above, it is apparent that ERP is particularly useful to an
organization which is trying to systematize its operations through
Sales and Operations Planning (often referred to as SOP). The idea is
that sales orders should justify and drive purchases, thus ensuring
that unnecessary purchases are minimized. Indeed, SOP is one of the
“best practices” built into ERP software; this is why ERP is
usually implemented in a large company at the instigation of a
management consultant, since it is usually a management consultant
who is pushing for implementing a practice such as SOP. The benefits
from ERP implementation usually come from aligning often-disorganized
company business procedures along logical and established best practices such as SOP.
The
above is the standard Sales and Operations Planning story which often forms
the justification of ERP implementation; but it is in fact not
applicable to all industries and businesses. For example, Kazi Farms
is in the livestock business; and it is almost impossible to implement
any kind of meaningful SOP in the livestock business. This is because
the production process is a live animal with a natural live-cycle
that limits how quickly any change in production can happen. Even if
sales orders increase or decrease, livestock production is fixed in
the short term as flocks which are in production will continue to
produce until age reduces their productivity, regardless of any fall
in demand. Likewise, immature flocks cannot be matured more quickly and be made
productive ahead of schedule regardless of excess demand. So what benefit was there in
implementing ERP in Kazi Farms?
As
it turns out, even without Sales and Operations Planning there are
many benefits to ERP. Any properly configured ERP software helps to
bring management control and transparency to an organization
regardless of whether or not SOP is implemented alongside the ERP.
For example, in any purchase department a logical sequence of
activity becomes essential to ensure that the right items are
purchased at the right time without wasting money on excess
inventory. At the same time, there should be appropriate checks and
balances built in to the purchasing system to ensure that management
has approved purchases where required. Transparency of operations is
helped immensely by the fact that ERP forces all departments to use
the same system; no department, purchase or otherwise, can “hide”
information from other interested parties, particularly accounts,
audit and top management.
The
truth is that in a growing organization that has rapidly increased in size
from one or two persons to many, there are often practices in the purchase cycle which can be improved. For example, a basic problem
which Kazi Farms had in the pre-ERP days was that storekeepers in
many locations were continuously requisitioning items to be bought by
the centralized purchase department. The problem was that, without a
networked, multi-location inventory system, there was no way for the
purchase department to verify whether the requisition could be
fulfilled by transferring excess existing stock from another
location. This is true for most organizations which have no ERP;
inventory in different locations is only known a few times a year
when a physical inventory is done. The rest of the time, the purchase
department doesn’t have enough information at its disposal to avoid
unnecessary purchases. This result is that purchase managers have no
choice but to purchase whatever is requisitioned, and lose the
opportunity to save money by transferring and reducing excess stocks.
Once
an ERP is implemented, the purchase department continuously gets to
see a live figure for all inventories at all locations. This allows
management to implement many policies which would otherwise be
difficult, for example setting high levels and low levels for each
inventory item in each location. A high level could raise a flag
telling the purchase department that they should try to move the
excess item to a different location where it is more likely to be
utilized; a low level alerts the purchase department to plan a
purchase quickly, and possibly pro-actively reminding the location
manager that their stock is low. Once the basics of multi-location
live inventory are enabled by ERP, companies can actually try to
implement further cost-cutting initiatives like Lean
manufacturing / Toyota Production System / kanban, all of which
focus on reducing waste and unnecessary stock.
Of significance to many Bangladeshi companies is that ERP can also help to reduce corruption by enforcing discipline in the purchase
cycle; this arises because the ERP automatically maintains a paper
trail for audit purposes. Once the purchase department receives a
requisition, there is a series of steps it has to go through; first,
it has to create a Request for Quotations document, which ensures that all suppliers get the same specifications
against which to quote prices. The suppliers have to give bids, which
can be stored in the system. The system can even be configured to
automatically issue purchase orders to the lowest-bidding supplier
once the bidding is completed. All of these steps are required to be followed if a
purchase department is to function in accordance with best practices and be easily audited; however, without an ERP it is often
difficult in a large organization to check if all the above are being
followed for every purchase. Once the ERP system is in place, the
system itself can alert the purchase manager and the audit department
if (for example) there is only one bid stored against the Request for
Quotations, alerting everyone that there may be a problem with that
purchase.
ERP
allows many further refinements of the purchasing process; for
example, what is the approval process for large purchases? Usually
there is a requirement for higher level approval than just the
location management. ERP systems allow for customizable “work-flows”,
meaning that different users can be assigned permissions to approve
particular requisitions; without the approval, the item cannot be
purchased. Furthermore, the date of the requisition being raised in
the location, the date of the higher authority approval and the date
of the final purchase by the purchase department are all stored; this
allows for identification of where delays are occurring and
rectifying them.
The
basic rule in any organization is that you can only improve what you
can measure; by recording minute details of the purchase procedure,
ERP give organizations unprecedented scope for improving it. Since
purchase is the basic generator in cost for manufacturing
organizations, this can translate to significant savings and higher
profits.
