Supplier Evaluation and Relevant Costs of Quality and Timely Deliveries

Companies that implement JIT purchasing choose their suppliers carefully and develop long-term supplier relationships. Some suppliers are better positioned than others to support JIT purchasing. For example, the corporate strategy of Frito-Lay, a supplier of potato chips and other snack foods, emphasizes service, consistency, freshness, and the quality of the products the company delivers. As a result, Frito-Lay makes deliveries to retail outlets more frequently than many of its competitors.

What are the relevant total costs when choosing suppliers? Consider again the UX1 units purchased by Glare Shade. Denton Corporation, another supplier of UX1 sunglasses, offers to supply all the units that Glare Shade needs. Glare Shade requires the supplier to deliver 100 units 130 times per year (5 times every 2 weeks). Glare Shade will establish an online purchase-order link with whichever supplier it chooses, trigger a purchase order for UX1 units by a single computer entry, and make payments electronically for batches of deliveries, rather than for each individual delivery. As discussed earlier, the company’s ordering costs will be only $2 per purchase order. The following table provides information about Denton versus Rytek. Rytek charges a higher price than Denton but also supplies higher-quality UX1s. The information about Rytek is the same as that presented earlier under JIT purchasing in Exhibit 21-5.

Description of ItemPurchasing Terms From RytekPurchasing Terms From Denton
Purchasing costs$14.02 per unit$13.80 per unit
Inspection of UX1sGlare Shade has bought UX1s from Rytek in the past and knows that it will deliver quality UX1s on time. UX1s supplied by Rytek require no inspection.Denton does not enjoy a sterling reputation for quality, so Glare Shade plans to inspect UX1s at a cost of $0.05 per UX1.
Required rate of return on investment15%15%
Relevant carrying cost of insurance, materials handling, storage, etc.$3.00 per unit per year$2.90 per unit per year because of lower purchasing costs
Customer return costsGlare Shade estimates $10 for shipping and processing a UX1 unit returned by a customer. Fortunately, the high quality of units supplied by Rytek will result in no units being returned by customers.Glare Shade estimates $10 for shipping and processing a UX1 unit returned by a customer and product returns of 2.5% of all units sold.
Stockout costsGlare Shade expects to incur stockout costs on 150 UX1 units each time, resulting in a rush-order at a cost of $4 per unit.Denton has less control over its processes, so Glare Shade expects to incur stockout costs on 360 UX1 units each time, initiating rush orders at a cost of $4 per unit.

Exhibit 21-6 shows the relevant total costs of purchasing from Rytek and Denton. Even though Denton is offering a lower price per unit, there is a net cost savings of $1,873 per year by purchasing UX1s from Rytek because of lower inspection, customer returns, and stockout costs. The benefit of purchasing from Rytek could be even greater if purchasing high-quality UX1s from Rytek enhances Glare Shade’s reputation and increases customer goodwill, leading to higher sales and profitability in the future.

Exhibit 21-6

Annual Relevant Costs of JIT Purchasing for UX1 Sunglasses From Rytek and Denton

Spreadsheet screenshot shows annual relevant costs of JIT purchasing for UX1 sunglasses from Rytek and Denton.

Details are as follows:

Rytek

1. Purchasing costs

2. Relevant Cost per Unit: $14.02

3. Quantity per Year: 13000

4. Total Costs (product of above 2 and 3): $182260

1. Ordering costs:

2. Relevant Cost per order: @2.00

3. Quantity per Year: 130

4. Total Costs (product of above 2 and 3): 260

1. Inspection costs:

2. Relevant Cost per unit: n/a

3. Quantity per Year: n/a

4. Total Costs (product of above 2 and 3): n/a

1. Opportunity carrying costs:

2. Relevant Cost per unit of average inventory per year: $2.10 (product of Purchasing cost per unit and 0.15 per year)

3. Quantity per Year:50 (Order quantity divide by 2 = 100 divide by 2 = 50 units)

4. Total Costs (product of above 2 and 3): 105

1. Other carrying costs (insurance, materials handling, etc.)

2. Relevant Cost per unit of average inventory per year: $3.00

3. Quantity per Year: 50 (Order quantity divide by 2 = 100 divide by 2 = 50 units)

4. Total Costs (product of above 2 and 3): 150

1. Customer return costs:

2. Relevant Cost per unit returned: $10.00

3. Quantity per Year: 0

4. Total Costs (product of above 2 and 3): 0

1. Stockout costs:

2. Relevant Cost per unit: $4.00

3. Quantity per Year: 150

4. Total Costs (product of above 2 and 3): 600

Denton

1. Purchasing costs:

5. Relevant Cost per Unit: $13.80

6. Quantity per Year: 13000

7. Total Costs (product of above 5 and 7): $179400

1. Ordering costs:

5. Relevant Cost per order: $2.00

6. Quantity per Year: 130

7. Total Costs (product of above 5 and 6): 260

1. Inspection costs:

5. Relevant Cost per order: $0.05

6. Quantity per Year: 13000

7. Total Costs (product of above 5 and 6): 650

1. Opportunity carrying costs:

5. Relevant Cost per unit of average inventory per year: $2.07 (product of Purchasing cost per unit and 0.15 per year)

6. Quantity per Year: 50 (Order quantity divide by 2 = 100 divide by 2 = 50 units)

7. Total Costs (product of above 5 and 6): 103

1. Other carrying costs (insurance, materials handling, etc.)

5. Relevant Cost per unit of average inventory per year: $2.90

6. Quantity per Year: 50 (Order quantity divide by 2 = 100 divide by 2 = 50 units)

7. Total Costs (product of above 5 and 6): 145

1. Customer return costs:

5. Relevant Cost per unit returned: $10.00

6. Quantity per Year: 325 (product of 2.5% of units returned and 13,000 units)

7. Total Costs (product of above 5 and 6): 3250

1. Stockout costs:

5. Relevant Cost per unit: $4.00

6. Quantity per Year: 360

7. Total Costs (product of above 5 and 6): 1440

Total annual relevant costs of Rytek: $183375

Total annual relevant costs of Denton: $185248

Annual difference in favor of Rytek: $1873.

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