MATERIALS MANAGEMENT

Unit 1 - INTRODUCTION
Operating Environment
Operations management works in a complex environment affected by many factors. Among the most
important are government regulation, the economy, competition, customer expectations, and quality.

Government
Regulation of business by the various levels of government is extensive. Regulation applies
to such areas as the environment, safety, product liability, and taxation. Government, or the
lack of it, affects the way business is conducted.
Economy
General economic conditions influence the demand for a company’s products or services and
the availability of inputs. During economic recession the demand for many products
decreases while others may increase. Materials and labor shortages or surpluses influence the
decisions management makes. Shifts in the age of the population, needs of ethnic groups, low
population growth, freer trade between countries, and increased global competition all
contribute to changes in the marketplace.
Competition
Competition is severe today.
• Manufacturing companies face competition from throughout the world. They find
foreign competitors selling in their markets even though they themselves may not be
selling in foreign markets. Companies also are resorting more to worldwide sourcing.
• Transportation and the movement of materials are relatively less costly than they used
to be.
• Worldwide communications are fast, effective, and cheap. Information and data can
be moved almost instantly halfway around the globe. The Internet allows buyers to
search out new sources of supply from anywhere in the world as easily as they can
from local sources.
Customers
Both consumers and industrial customers have become much more demanding, and suppliers
have responded by improving the range of characteristics they offer. Some of the
characteristics and selection customers expect in the products and services they buy are:
• A fair price
• Higher-(right) quality products and services
• Delivery lead time
• Better presale and after-sale service
• Product and volume flexibility
Quality
Since competition is international and aggressive, successful companies provide quality that
not only meets customers’ high expectations but exceeds them. Chapter 16 discusses quality
in detail.
Aggregate Planning
Aggregate planning is a method for developing an overall manufacturing plan that ensures
uninterrupted production at a facility.
Aggregate planning covers all production activities at a facility (or for large enterprises,
across several facilities), not just individual production runs or the manufacture of individual
products.
Because of this, aggregate production planning helps manufactures optimize resource
utilization despite significant variation in demand for individual products, which arise from
changes in customer orders, supply chain dynamics and other elements.
Aggregate Planning Strategies
The aggregate planning strategies include-
1. Level strategy

2. Chase strategy

3. Hybrid strategy for an aggregate planning

1. Level strategy
This type of aggregate planning deals with producing goods of similar quantities over equal
duration. This is done to handle a peak in market demand by filling out back orders or by
sending the extra products to inventory. The level strategy is considered a traditional aggregate
planning method that maintains a steady production rate as well as the level of the workforce
by continuing consistent human resources and production in the organization.

It is best suited where the inventory carrying costs are not high and are adopted by mainly
manufacturing companies. The advantages of using level strategy are well-trained workforce
as their changes are not so frequent, experienced workers and a low rate of absenteeism and
employee turnover. An essential disadvantage of level strategy is building up inventory costs
during the lean period when the demand is low.

2. Chase strategy
The chase strategy of aggregate planning puts its onus on reducing inventory. It keeps pace
with demand fluctuations by varying either actual level of output or the workforce number. It
is considered not as rigid as a level strategy as it allows room for some deviation from the
conventional approach. This methodology helps to minimize waste by receiving goods when
needed. It often leads to stressed employees.

This strategy is popular in several industries like hospitals, hospitality business and educational
centers like schools. The advantage of chase strategy is high flexibility to meet the fluctuations
in demand and the disadvantages related to the strategy include high costs associated with
hiring as well as training the workforce.
3. Hybrid strategy for an aggregate planning
As the name indicates, the Hybrid strategy is an integration of both level and chase strategies
to get a better result. It maintains a sufficient balance between stock level, recruiting,
termination and production rate. In the hybrid strategy of aggregate planning, the organizations
build up inventory before rising demands. It uses backorders to level with high peak periods.

It can easily cover short-term peaks by hiring workers temporarily or by subcontracting

production. Hiring, lay-off and reassigning workers is a normal part of the hybrid strategy.

Costs Techniques

Following are the main costs techniques

1. ABC Analysis

2. Determination of stock levels

3. Economic Order Quantity (EOQ) Analysis

4. Perpetual Inventory System

5. Periodic Annual Inventory Control System

6. VED Analysis.

1. ABC Analysis:
The concept of ABC Analysis was coined by Pareto, an Indian philosopher in the nineteenth
century. It is a value based system of material control. In this technique materials are
analysed according to their value so that costly and more valuable materials are given greater
attention and care.
All items of materials are classified according to their value—high, medium and low values,
which are known as A, B and C items respectively. ABC technique is some time called as
“Always better control” method.

‘A’ Items:
These are high value items which may consist of only a small percentage of the total items
handled. On account of their high cost, these materials should be under the tightest control
and the responsibility of the most experienced personnel.
‘B’ Items:
These are medium value materials which should be under the normal control procedures.

‘C’ Items:
These are low value materials which may represent a very large number of items. These
materials should be under the simple and economic methods of control.

The ABC technique is a selective control which aims at concentrating efforts on those materials
where attention is needed most. This is so because it is unwise to give equal attention to all
items in stock. The items are listed and ranked in the order of their descending importance
showing quantity and value of each item.

2. Determination of Stock Levels:

In order to guard against under-stocking and over-stocking, most of the large companies
adopt a scientific approach of fixing stock levels.
These levels are:
(i) Maximum level
(ii) Minimum level
(iii) Re-order/ ordering level
(iv) Danger level, etc.

These levels are not permanent and must be changed to suit changing circumstances. Thus,
change will take place if consumption of materials is increased or decreased or if in the light
of a review of capital available, it is decided that the overall inventory must be increased or
decreased.

i. Maximum Stock Level:

This is that level above which stocks should not normally be allowed to rise. The maximum
level may however, be exceeded in certain cases, e.g., when usually favourable purchasing
condition arise.
It is computed by the following formula:
Maximum Stock Level = Re-order level + Re-order Quantity – (Mini. Consumption × Mini
Re-order Period)

ii. Minimum Stock Level:

It is that level below which stock should not normally be allowed to fall. This is essentially a
safety stock and is not normally touched. In case of stock falling below this level, there is a
risk of stoppage in production and thus top priority should be given to the acquisition of fresh
supplies.
It is computed by the following formula:
Minimum Stock Level = Reorder level – (Normal Consumption x Normal reorder period)

iii. Re-Order Level or Ordering Level:

This is that level of material at which purchase requisition is initiated for fresh supplies. This
level is fixed somewhere above minimum level. This is fixed in such a way that by re-
ordering when materials fall to this level, then in the normal course of events, new supplies
will be received just before the minimum level is reached.
It is calculated with the help of following formula:
Re-order level = (Max. Consumption × Max. Re-order Period)

iv. Danger Level:

This is a level at which normal issues of materials are stopped and materials are issued for
important jobs only. This level is generally fixed somewhat below the minimum level. When
stock reaches danger level, urgent action is needed for the replenishment of stock so that
stoppage in production can be avoided. Purchasing materials on an urgent basis results in
higher purchasing cost.
It is calculated with the help of following formula:
Danger Level = (Normal Consumption x Maximum re-order period under emergency
condition)

3. Economic Order Quantity (E.O.Q.) Analysis:

Economic order Quantity is also termed as Re-order Quantity. Economic Order Quantity is
that size of the order which gives maximum economy in purchasing any material and
ultimately contributes towards maintaining the material at the optimum level and at minimum
cost.

EOQ can be computed with the help of following formula:

Where,
EOQ = Economic Order Quantity
2 = It is a constant figure
A = Annual consumption of materials in units or rupees
S = Cost of placing an order
I = Annual carrying cost of storing one unit.

4. Perpetual Inventory System:

This is a system of stock control in which continuous record of receipt and issue of materials
is maintained by the stores department. It shows the physical movement of stocks and their
current balance.
A perpetual inventory system is usually supported by a programme of continuous stock-
taking. In other words, perpetual inventory system means the system of records, whereas
continuous stock-taking means the physical checking of actual stock with the records.
Strictly speaking the perpetual inventory system means maintenance of such records (stock
control cards, bin cards and the stores ledger) that will show the receipts, issue and balance of
all items in stock at all times.
But to ensure accuracy, the system must be supplemented by a system of continuous stock
checking which ensures that physical stock agrees with the book figures. The system is
essential for planning production and to see that production is not interrupted due to want of
materials and stores.

5. Periodic/Annual Inventory Control System:

Under this system, stock-taking is undertaken at the end of the accounting year. As the stock
taking involves verifying the physical quantities of stores in hand, some firms temporarily
suspend plant operations when this is done. This is because it is rarely feasible to take stocks
when production is going on. Thus, the annual stock- taking should be organised well in
advance to minimise production holds up.

6. VED Analysis:
VED-vital, essential, desirable, analysis is used primarily for control of spare parts. The spare
parts can be divided into three categories-vital, essential and desirable, keeping in view the
criticality to production. The spares, the stocks out of which even for a short time will stop
production for quite some time and where the cost of stock out is very high, are known as
vital spares. The spares, the absence of which cannot be tolerated for more than a few hours
or a day and the cost of lost production is high and which are essential for the production to
continue, are known as essential spares.
The desirable spares are those spares which are needed but their absence for even a week or
so will not lead to stoppage of production. Some spares, through negligible in monetary
value, may be vital for the production to continue and require constant attention. Such spares
may not receive the attention they deserve, if they are maintained according to ABC analysis
because their value of consumption is small. So, in their cases, VED analysis is made to get
the effective results.

Master Scheduling

Master scheduling is the planning process that tracks manufacturing output.

Master scheduling is the detailed planning process that tracks manufacturing output and
matches this against customer orders that have been placed. The master schedule is the next
step in planning after the sales and operations planning (S&OP).

The figures from a sales and operations planning exercise, i.e. at a higher level, will flow
through to master scheduling where the planning is at a lower level and at the product group
level.

The master scheduling will determine when specific product groups will be made when
customer orders will be filled, and what manufacturing capacity is still available for new
customer demand.

The master schedule will be further planned in the Materials Requirement Planning (MRP)
system, which calculates the quantity and timing of purchase and production orders needed to
satisfy the master schedule.

Master Schedule Record

The master schedule record will vary based on your company’s planning systems and specific
products, but it will contain a number of required pieces of information. The record should
contain the forecasted demand, the number of booked orders, the projected inventory levels,
the production quantities, and the quantity available for promise.

The master schedule record is shown over a period of time which is called the planning horizon.
This can be a few days to a number of months, which will depend on the particular finished
item.

Complex finished goods such as aircraft and customized conveyor systems will have a lead
time in months, while products that can be manufactured and delivered in a few days will have
a planning horizon that is short.
Manufacturing Planning and Control (MPC) System

A production (or manufacturing) planning and control (MPC) system is concerned with
planning and controlling all aspects of manufacturing, including materials, scheduling
machines and people, and coordinating suppliers and customers. An effective MPC system is
critical to the success of any company.
An MPC system’s design is not a one-off undertaking; it should be adaptive to respond to
changes in the competitive arena, customer requirements, strategy, supply chain and other
possible problems.
There are 5 levels in the manufacturing planning and control (MPC) system:
– Strategic business plan,
– Production plan (sales and operations plan),
– Master production schedule,
– Materiel requirements plan,
– Purchasing and production activity control.

Each level varies in purpose, time span and level of detail. Since each level is for different
time span and purposes, each differs in the following:

– Purpose of the plan,

– Planning horizon: the time span from now to some time in future for which plan is created,
– Level of detail: the detail about products require for the plan,
– Planning cycle: the frequency with which the plan is reviewed.

B E N E F I T S O F MANUFACTURING P L A N N I N G A N D C O N T R O L

The benefits of manufacturing planning and control include:

• Improved organization for regular and timely delivery

• Better supplier communication for raw materials procurement

• Reduced investment in inventory

• Reduced production cost by increasing efficiency

• Smooth flow of all production processes

• Reduced waste of resources

• Production cost savings that improve the bottom line

O B J E C T I V E S O F MANUFACTURING P L A N N I N G A N D C O N T R O L

The objectives of production planning and control can vary from one business to another, but
some general objectives include the following:

• Regulation of inventory management

• Optimum utilization of production process and resources

• Organization of the production schedules, typically with the help of dynamic

production scheduling software

• To make sure the right quality and quantity of equipment, raw materials and more
are available during production times

• To ensure capacity utilization is aligned with forecast demand

Manufacturing Resource Planning

Because of the large amount of data and the number of calculations needed, the manufacturing
planning and control system will probably have to be computer based. If a computer is not
used, the time and labor required to make calculations manually is extensive and forces a
company into compromises. Instead of scheduling requirements through the planning system,
the company may have to extend lead times and build inventory to compensate for the inability
to schedule quickly what is needed and when. The system is intended to be a fully integrated
planning and control system that works from the top down and has feedback from the bottom
up. Strategic business planning integrates the plans and activities of marketing, finance, and
production to create plans intended to achieve the overall goals of the company. In turn, master
production scheduling, material requirements planning, production activity control, and
purchasing are directed toward achieving the goals of the production and strategic business
plans and, ultimately, the company. If priority plans have to be adjusted at any of the planning
levels because of capacity problems, those changes should be reflected in the levels above.
Thus, there must be feedback throughout the system. The strategic business plan incorporates
the plans of marketing, finance, and production. Marketing must agree that its plans are realistic
and attainable. Finance must agree that the plans are desirable from a financial point of view,
and production must agree that it can meet the required demand. The manufacturing planning
and control system, as described here, is a master game plan for all departments in the company.
This fully integrated planning and control system is called a manufacturing resource planning,
or MRP II. system. The term MRP II is used to distinguish the “manufacturing resource plan”
(MRP II) from the “materials requirement plan” (MRP). MRP II provides coordination between
marketing and production. Marketing, finance, and production agree on a total workable plan
expressed in the production plan. Marketing and production must work together on a weekly
and daily basis to adjust the plan as changes occur. Order sizes may need to be changed, orders
canceled, and delivery dates adjusted. This kind of change is made through the master
production schedule. Marketing managers and production managers may change master
production schedules to meet changes in forecast demand. Senior management may adjust the
production plan to reflect overall changes in demand or resources. However, they all work
through the MRP II system. It provides the mechanism for coordinating the efforts of
marketing, finance, production, and other departments in the company. MRP II is a method for
the effective planning of all resources of a manufacturing company.

Figure shows a diagram of an MRP II system.

Manufacturing resource planning (MRP II)

Enterprise Resource Planning (ERP)

As MRP systems evolved, they tended to take advantage of two changing conditions:

1. Computers and information technologies (IT) becoming significantly faster, more reliable,
and more powerful. People in most companies had become at least comfortable, but often
very familiar, with the advantages in speed, accuracy, and capability of integrated computer-
based management systems.

2. Movement toward integration of knowledge and decision making in all aspects of direct
and indirect functions and areas that impact materials flow and materials management. This
integration not only included internal functions such as marketing, engineering, human
resources, accounting, and finance but also included the “upstream” activities in supplier
information and the “downstream” activities of distribution and delivery. That movement of
integration is what is now recognized as supply chain management.

As the needs of the organization grew in the direction of a truly integrated approach toward
materials management, the development of IT systems matched that need. As these systems
became both larger in scope and integration when compared to the existing MRP and MRP II
systems, they were given a new name— enterprise resource planning, or ERP.

ERP is similar to the MRP II system except it does not dwell on manufacturing. The whole
enterprise is taken into account. The eleventh edition of the American Production and
Inventory Control Society (APICS) APICS Dictionary defines ERP as “Framework for
organizing, defining, and standardizing the business processes necessary to effectively plan
and control an organization so the organization can use its internal knowledge to seek
external advantage.” To fully operate there must be applications for planning, scheduling,
costing, and so forth, to all layers in an organization, work centers, sites, divisions, and
corporate. Essentially, ERP encompasses the total company and MRP II is manufacturing.

The larger scope of ERP systems allows the tracking of orders and other important planning
and control information throughout the entire company from procurement to ultimate
customer delivery. In addition, many ERP systems are capable of allowing managers to share
data between firms, meaning that these managers can potentially have visibility across the
complete span of the supply chain.

Although the power and capability of these highly integrated ERP systems is extremely high,
there are also some large costs involved. Many of the best systems are expensive to buy, and
the large data requirements (for both quantity and accuracy) tend to make the systems
expensive, time consuming, and generally difficult to implement for many firms.

Making the Production Plan

We have looked briefly at the purpose, planning horizon, and level of detail found in a
production plan. This section discusses some details involved in making production plans.
Based on the market plan and available resources, the production plan sets the limits or levels
of manufacturing activity for some time in the future. It integrates the capabilities and
capacity of the factory with the market and financial plans to achieve the overall business
goals of the company.
The production plan sets the general levels of production and inventories over the planning
horizon. Its prime purpose is to establish production rates that will accomplish the objectives
of the strategic business plan. These include inventory levels, backlogs (unfilled customer
orders), market demand, customer service, low-cost plant operation, labor relations, and so
on. The plan must extend far enough in the future to plan for the labor, equipment, facilities,
and material needed to accomplish it. Typically, this is a period of six to eighteen months and
is done in monthly and sometimes weekly periods.

The planning process at this level ignores such details as individual products, colors, styles,
or options. With the time spans involved and the uncertainty of demand over long periods,
the detail would not be accurate or useful, and the plan would be expensive to create. For
planning purposes, a common unit or small number of product groups is what is needed.
Unit 2 – Materials Planning

Materials Requirements Plan

Material requirements planning (MRP) is a computer-based inventory management system
designed to improve productivity for businesses.

Companies use material requirements-planning systems to estimate quantities of raw

materials and schedule their deliveries.

• Material requirements planning (MRP) is the earliest computer-based inventory

management system.
• Businesses use MRP to improve their productivity.
• MRP works backward from a production plan for finished goods to develop
inventory requirements for components and raw materials.
• Advantages of the MRP process include the assurance that materials and components
will be available when needed, minimized inventory levels, reduced customer lead
times, optimized inventory management, and improved overall customer satisfaction.
• Disadvantages to the MRP process include a heavy reliance on input data accuracy
(garbage in, garbage out), the high cost to implement, and a lack of flexibility when
it comes to the production schedule.

How Material Requirements Planning (MRP) Works

MRP is designed to answer three questions:

1. What is needed?
2. How much is needed?
3. When is it needed?

Steps of Material Requirements Planning (MRP)

The MRP process can be broken down into four basic steps:

1. Estimating demand and the materials required to meet it

The initial step of the MRP process is determining customer demand and the
requirements to meet it. Utilizing the bill of materials—which is simply a list of raw
materials, assemblies, and components needed to manufacture an end product—MRP
breaks down demand into specific raw materials and components.

2. Check demand against inventory and allocate resources

This step involves checking demand against what you already have in inventory. The
MRP then distributes resources accordingly. In other words, the MRP allocates
inventory into the exact areas it is needed.
 3. Production scheduling

The next step in the process is simply to calculate the amount of time and labor
required to complete manufacturing. A deadline is also provided.

4. Monitor the process

The final step of the process is simply to monitor it for any issues. The MRP can
automatically alert managers for any delays and even suggest contingency plans in
order to meet build deadlines.

Bill of Materials

A bill of materials (BoM) is a detailed source of data used in the manufacturing of a product. It
provides the material required to make an item along with directions to assemble the product most
proficiently. Bill of materials is an essential step in manufacturing. It is an extensive list of
components, raw materials and instructions required to manufacture, construct or repair service or
product. The first step to building a product is creating a BoM.

The importance of bill of materials

BoMs define products as they are designed (CAD or engineering bill of materials), as they
are ordered (sales bill of materials), as they are built (manufacturing bill of materials), and as
they are maintained (service bill of materials).

They incorporate product information from design and engineering, document control,
operations, manufacturing, purchasing, contract manufacturers, and more.

Bill of materials influence inventory levels, material purchases, shop floor assemblies, and so
much more.

In fact, departments often rely on BOM records to get the job done right.

Whether you realize it or not, your BoMs drive and affect your businesses’ operational
success.

This is why it is so important that your organization creates and manages well-organized,
correct and up-to-date bill of materials.
Resource Requirements Planning

Once the preliminary production plan is established, it must be compared to the existing
resources of the company. This step is called resource requirements planning or resource
planning. Two questions must be answered:

1. Are the resources available to meet the production plan?

2. If not, how will the difference be reconciled?

If enough capacity to meet the production plan cannot be made available, the plan must be
changed.

A tool often used is the resource bill. This shows the quantity of critical resources (materials,
labor, and “bottleneck” operations) needed to make one average unit of the product group.
Figure shows an example of a resource bill for a company that makes tables, chairs, and
stools as a three-product family.

If the firm planned to make 500 tables, 300 chairs, and 1500 stools in a particular period, they
could calculate the quantity of wood and labor that will be needed. For example, the amount
of wood needed is:

Tables: 500 * 20 = 10,000 board feet

Chairs: 300 * 10 = 3000 board feet

Stools: 1500 * 5 = 7500 board feet

Total wood required = 20,500 board feet

The amount of labor needed is:

Tables: 500 * 1.31 = 655 standard hours

Chairs: 300 * 0.85 = 255 standard hours

Stools: 1500 * 0.55 = 825 standard hours

Total labor required = 1735 standard hours

Product Wood (board feet) Labor (standard

hours)

Tables 20 1.31

Chairs 10 0.85
 Stools 5 0.55

Figure

Manufacturing Resource Planning

Because of the large amount of data and the number of calculations needed, the manufacturing
planning and control system will probably have to be computer based. If a computer is not
used, the time and labor required to make calculations manually is extensive and forces a
company into compromises. Instead of scheduling requirements through the planning system,
the company may have to extend lead times and build inventory to compensate for the inability
to schedule quickly what is needed and when. The system is intended to be a fully integrated
planning and control system that works from the top down and has feedback from the bottom
up. Strategic business planning integrates the plans and activities of marketing, finance, and
production to create plans intended to achieve the overall goals of the company. In turn, master
production scheduling, material requirements planning, production activity control, and
purchasing are directed toward achieving the goals of the production and strategic business
plans and, ultimately, the company. If priority plans have to be adjusted at any of the planning
levels because of capacity problems, those changes should be reflected in the levels above.
Thus, there must be feedback throughout the system. The strategic business plan incorporates
the plans of marketing, finance, and production. Marketing must agree that its plans are realistic
and attainable. Finance must agree that the plans are desirable from a financial point of view,
and production must agree that it can meet the required demand. The manufacturing planning
and control system, as described here, is a master game plan for all departments in the company.
This fully integrated planning and control system is called a manufacturing resource planning,
or MRP II. system. The term MRP II is used to distinguish the “manufacturing resource plan”
(MRP II) from the “materials requirement plan” (MRP). MRP II provides coordination between
marketing and production. Marketing, finance, and production agree on a total workable plan
expressed in the production plan. Marketing and production must work together on a weekly
and daily basis to adjust the plan as changes occur. Order sizes may need to be changed, orders
canceled, and delivery dates adjusted. This kind of change is made through the master
production schedule. Marketing managers and production managers may change master
production schedules to meet changes in forecast demand. Senior management may adjust the
production plan to reflect overall changes in demand or resources. However, they all work
through the MRP II system. It provides the mechanism for coordinating the efforts of
marketing, finance, production, and other departments in the company. MRP II is a method for
the effective planning of all resources of a manufacturing company.

Capacity Management

Capacity is the amount of work that can be done in a specified time period. In the eleventh
edition of the APICS Dictionary, capacity is defined as “the capability of a worker, machine,
work center, plant, or organization to produce output per time period.” Capacity is a rate of
doing work, not the quantity of work done.

Two kinds of capacity are important: capacity available and capacity required.
Capacity available is the capacity of a system or resource to produce a quantity of output in a
given time period.

Capacity required is the capacity of a system or resource needed to produce a desired output in
a given time period. A term closely related to capacity required is load. This is the amount of
released and planned work assigned to a facility for a particular time period. It is the sum of all
the required capacities.

Capacity available is the rate at which work can be withdrawn from the system. Load is the
amount of work in the system.

Capacity management is responsible for determining the capacity needed to achieve the priority
plans as well as providing, monitoring, and controlling that capacity so the priority plan can be
met. The eleventh edition of the APICS Dictionary defines capacity management as “the
function of establishing, measuring, monitoring, and adjusting limits or levels of capacity in
order to execute all manufacturing schedules.” As with all management processes, it consists
of planning and control functions.

Capacity planning is the process of determining the resources required to meet the priority plan
and the methods needed to make that capacity available. It takes place at each level of the
priority planning process. Production planning, master production scheduling, and material
requirements planning determine priorities: what is wanted and when. These priority plans
cannot be implemented, however, unless the firm has sufficient capacity to fulfill the demand.
Capacity planning, thus, links the various production priority schedules to manufacturing
resources.

Capacity control is the process of monitoring production output, comparing it with capacity
plans, and taking corrective action when needed.

Scheduling Orders

So far we have assumed that we know when an order should be run on one work center. Most
orders are processed across a number of work centers, and it is necessary to calculate when
orders must be started and completed on each work center so the final due date can be met.
This process is called scheduling. In the eleventh edition of the APICS Dictionary, a schedule
is defined as “a timetable for planned occurrences.”

Back scheduling. The usual process is to start with the due date and, using the lead times, to
work back to find the start date for each operation. This process is called back scheduling. To
schedule, we need to know for each order:

• Quantity and due date

• Sequence of operations and work centers needed

• Setup and run times for each operation

• Queue, wait, and move times

• Work center capacity available (rated or demonstrated)

 The information needed is obtained from the following:

• Order file. Quantities and due dates.

• Route file. Sequence of operations, work centers needed, setup time, and run time.

• Work center file. Queue, move, and wait times and work center capacity

The process is as follows:

1. For each work order, calculate the capacity required (time) at each work center.

2. Starting with the due date, schedule back to get the completion and start dates for each
operation

Production Activity Control

Production activity control concentrates on planning the flow of work and making sure that
the right material is fed to the line as stated in the planned schedule. Since work flows from
one workstation to another automatically, implementation and control are relatively simple.

Production activity control in intermittent manufacturing is complex. Because of the number

of products made, the variety of routings, and scheduling problems, PAC is a major activity
in this type of manufacturing. Planning and control are typically exercised using shop orders
for each batch being produced.

Production activity control (PAC) is responsible for executing the master production schedule
and the material requirements plan. At the same time, it must make good use of labor and
machines, minimize work-in-process inventory, and maintain customer service.

The material requirements plan authorizes PAC: to release work orders to the shop for
manufacturing, to take control of work orders and make sure they are completed on time, to
be responsible for the immediate detailed planning of the flow of orders through
manufacturing, and to manage day-to-day activity and provide the necessary support. The
activities of the PAC system can be classified into planning, implementation, and control
functions.

The flow of work through each work center must be planned. PAC must ensure that the
required resources are available to manufacture the components as needed and develop a load
profile for each work center to ensure the timely completion of orders by the scheduled date.

Next we implement the plan. PAC will gather the information needed by the shop floor to
make the product and release orders to the shop floor as authorized by the material
requirements plan (dispatching).

Monitor the process and determine the necessary corrective action. PAC will rank the shop
orders in desired priority sequence by work center and establish a dispatch list, track actual
performance to plan and take corrective action by replanning, rescheduling, or adjusting
capacity to meet delivery.
Understand the characteristics and differences between flow, intermittent and project
manufacturing .

With the help of the Production Activity Control, one can easily meet the timely completion
of the various orders by starting the various operations in time as per the plan. Effective
Production Activity Control is also responsible for meeting the delivery commitments.
Production Activity Control acts as the modules of the MRP/ERP systems, and involves
mainly four procedures – releasing, scheduling, monitoring, updating.

Functions of the Production Activity Control

• Helps in the planning.

• Helps in the execution of the plan.
• Ensures availability of the resources.
• Releases the shop orders.
• Schedules start and completion dates of the jobs.
• Collects required information for the shop order.
• Helps in controlling the operations.
• Establishes order priority.
• Maintains order priority.
• Checks actual performance.
• Monitors and controls WIP, lead times.
• Reports work center performance.

Role of the Production Activity Control

• Manages the shop floor production task.

• Controls the production work flow.
• Aims achievement of the production plans.
• Prepares the schedules.

Codification

Codification of materials can also be termed as the identification of materials. This deals with
uniquely identifying each item in the inventory. It is useful in requisitioning items or the
operational departments, in placing of orders by the purchase department, in receiving and
expediting the items on receipt from the supplier, in having a unique record of each of the
items in stores and in work-in-process or in warehouse so as to facilitate the control over the
inventory levels, and also in having a good control over the loss, deterioration, obsolescence,
non-movement, or pilferage of the items in the inventory. Unique identification of the
materials – whether they are raw materials, work-in-process or finished goods – is the first
step towards a good materials management system. Without it, the control over inventory by
rigorous exercises such as inventory techniques is not very effective. Without it, confusion
might prevail in the operational departments. Moreover for a good quality control system a
unique identification is a pre-requisite. There are many other advantages such as variety
reduction and standardization etc.

It is amazing to find that in many of our large public and private sector corporations, a
considerable amount of inventory lies in the stores or elsewhere because of a confused
nomenclature and a lack of proper identification system. Many items in inventory such as
pipes, rods, angles, electrical switches, cables, valves, similar equipments, spare parts and
even nuts, bolts and such items in inventory are available under different names and codes
thereby reducing the actual availability of the item for operational needs. An item may be
called a ‘nut and bolt’ by one section of the organization, whereas another may call it a
‘fastener’ and because of this there are two separate requisitions made, two separate purchase
orders sent out, and two separate inventory levels of the items built into the system. One
section might call an item a ‘pipe’ whereas another might call it a ‘conduit’ in fact both
sections using the same item. This increases the inventory level unnecessarily Prevention of
duplication is one of the important benefits of a good materials coding system.

Needless to say, for proper stock taking a good identification is of immense help. Many cases
have been observed in large corporations where the concerned people do not even know what
materials have been lying in the inventory for a large duration of time. These materials could
easily be eliminated from the list, salvage value recovered and the storage space freed. It is
also not uncommon to observe that although a material is available with the stores in reality
due to duplication of the identity it is often quoted as ‘not available’ and thus, many
production programs suffer with consequent loss to the organization as a whole Proper
identification of inventory items helps in simplification of all the processes such as storing,
receiving, procuring, manufacturing, warehousing and this results in a multiplicity of benefits
to the company. It is a simple concept. If followed it might produce results of proportions
equivalent to that of a rigorous application of the inventory control principles with, perhaps
much less effort.

Codification by Group Classification:

What do we mean by coding? By this, we give a unique number to a particular item in the
inventory. For instance, 010237 might mean a specific item in inventory such as a particular
kind of gasket, of a certain material, of a certain shape, and of certain dimensions. Of course,
each of these numbers or groups of numbers (within the total identification number) should
convey some unique information. For instance, the following numbers might be used to
describe the first classification of materials in an inventory:

01 – Raw materials
02 – Purchased components
03 – Spare parts
04 – Tools
05 – Fixtures and Patterns
06 – Other supplies
07 – Work-in-process material
08 – Finished goods
09 – Capital Equipment
Unit 3 – Inventory Management

Policy Decisions

Policy

The process of policy formation starts with identifying the problem and coming up with a
solution. So efforts to curb pollution, increase employment, promote education, abolish child
labor, boost our national defense, the creation of any new state, etc. are all results of policy
formation.

There can be various types of policies:

Regulatory Policy:

These are concerned with the regulation of our economy, i.e. regulation of trade, business, etc.
It also covers policies of safety guidelines and safety measures etc. Such policies are generally
formulated by advisory boards and committees working for the government.

Distributive Policy:

These policies are for the benefit of certain sections of society. Like education for the girl
child, health services for the poor, justice for women, etc.

Decisions

As we saw, policies are a collection of ideas. Decisions, on the other hand, initiates the actions to
be taken to implement the policy. So a policy will emanate from a decision.

Objectives of Policy Decision Making

1. Identifying goals
2. Efficient utilization of resources
3. Proper communication
4. Selecting best alternative
5. Business growth
6. Promotes innovation

1. Identifying Goals

The Decision-making process focuses on identifying the goals that an organization

aims to achieve. Proper analysis of the aims and objectives provides the basis for
effective decisions. Decisions are unproductive and aimless unless goals are clearly
recognized.

2. Efficient Utilization of Resources

It aims at fuller utilization of resources by taking proper decisions regarding their

usage within organization. All decisions are framed and implemented after thorough
analysis which ensures maximum productivity with minimum wastage.
 3. Proper Communication

Efficient decision making aims at developing the right communication network for
communicating all required information at different levels. Proper flow of information
regarding decisions within the organization avoids any confusion and conflict.
Employees are too motivated to participate in decision making and come up with new
ideas and facts.

4. Selecting Best Alternative

It performs a proper analysis of different alternatives available to come up with the

best possible one. Decision-maker selects the best course of action for performing a
task which yields maximum results. He employs various analysis tools of finance,
statistics and accounting for finding out the appropriate action.

5. Business Growth

Proper decision making plays an important role in enhancing the overall growth of
business enterprise. It helps in efficient utilization of resources by properly allocating
them within the organization. Business are easily able to face the problems and
challenges of market through quick and rational decisions. This will boost up the
probability of business and eventually contribute towards its growth.

6. Promotes innovation

Adopting the changes and innovation as per the market requirements is must for every
organization to ensure its survival. Decision-making process brings in large amount of
information within organization by performing different types of analysis. All this
information informs management of new ideas and market changes which facilitates
innovation by taking decisions accordingly.

Retail Discounting Model

Retail discounting is used to decrease the price of specific products for a set amount of time.
In some cases retailers offer a store-wide discount to move excess inventory and create space
for new collections.

Retailers usually run discounts to attract new customers, increase sales, and clear out old
inventory.

Large retailers have an easier time selling low-priced merchandise in high volumes, but this
strategy doesn’t always work for small to mid-sized retail boutiques.

With discounting, it’s important to keep an eye on your profit margins and break-even point,
avoid conditioning customers to wait for a sale, and understand exactly why and when you
want to discount products.
Newsvendor Model

The newsvendor (or newsboy or single-period or perishable) model is a mathematical model

in operations management and applied economics used to determine optimal inventory levels.
It is (typically) characterized by fixed prices and uncertain demand for a perishable product.
If the inventory level is q, each unit of demand above q is lost in potential sales. This model
is also known as the Newsvendor Problem or Newsboy Problem by analogy with the situation
faced by a newspaper vendor who must decide how many copies of the day’s paper to stock
in the face of uncertain demand and knowing that unsold copies will be worthless at the end
of the day.

These are called Newsvendor Problems because they mimic the dilemma faced by the
manager of a newsstand stocking newspapers each morning. They are quite prevalent in the
stocking of perishable goods, such as milk and baked goods, which must be discarded after
their expiration dates. They also apply to seasonal products, such as Christmas lights and
Easter eggs, which tend to be salvaged at the end of the season. Fashion goods, such as
designer clothes, also exhibit Newsvendor economics

The newsvendor problem is a one-time business decision that occurs in many different
business contexts such as:

• Buying seasonal goods for a retailer – Retailers have to buy seasonal goods
(sometimes called style goods) once per season. (A “season” can be a day, week, year,
etc.) For example, most swimsuits can only be purchased seasonally. If a buyer orders
too few swimsuits, the retailer will have lost sales and dissatisfied customers. If the
buyer orders too many swimsuits, the retailer will have to sell them at a clearance
price or even throw some away.
• Making the last buy or last production run decision – Manufacturers have to make a
last buy (or last production run) for a product (or component) that is near the end of
its life cycle. If the order size is too small, the firm will have stockouts and
disappointed customers. If the order size is too large, the firm will only be able to sell
the items for their salvage value.
• Setting safety stock levels – A distributor has to set the safety stock level for an item.
If the safety stock is too low, stockouts will occur. If safety stock is too high, the firm
has too much carrying cost. Nearly all safety stock models are newsvendor problems
with the selling season being one order cycle or one review period.
• Setting target inventory levels – A salesperson carries inventor y in the trunk of a
vehicle. The inventory is controlled by a target inventory level. If the target is too low,
stockouts will occur. If the target is too high, the salesperson will have too much
carrying cost.
• Selecting the right capacity for a facility or machine – If the capacity of a factory or a
machine over the planning horizon is set too low, stockouts will occur. If capacity is
set too high, the capital costs will be too high.
• Overbooking customers – If an airline overbooks too many passengers, it incurs the
cost of giving away free tickets to inconvenienced passengers. If the airline does not
overbook enough seats, it incurs an opportunity cost of lost revenue from flying with
empty seats.

All of these newsvendor problem contexts share a common mathematical structure with the
following four elements:
 • A decision variable ( Q) – The newsvendor problem is to find the optimal Q for a one-
time decision, where Q is the decision quantity (order quantity, safety stock level,
overbooking level, etc.). Q* denotes the optimal (best) value for Q.
• Uncertain demand (D) – Demand is a random variable defined by the demand
distribution (e.g., normal distribution, Poisson distribution, etc.) and estimates of the
distribution parameters (e.g., mean, standard deviation). Demand may be either
discrete (integer) or continuous. This paper develops the newsvendor models for both
cases.
• Unit overage cost (co) – This is the cost of buying one un it more than the demand
during the one-period selling season. In the standard retail context, the overage cost is
the unit cost ( c ) less the unit salvage value ( s ), i.e., co = c – s . The salvage value is
the salvage revenue less the salvage cost required to dispose of the unsold product.
• Unit underage cost (cu) – This is the cost of buying one unit less than the demand
during the one-period selling season. This is also known as the stockout (or shortage)
cost. In the retail context, the underage cost is computed as the lost contribution to
profit, which is the unit price ( p) less the unit cost ( c ), i.e., cu = p – c . The lost
customer goodwill ( g) associated with a lost sale can also be included (i.e., cu = p – c
+ g). However, it is difficult to estimate the g parameter because it is the net present
value of all future lost profit from this customer and all other customers affected by
this customer’s negative reports (negative “word of mouth”).

Economic Order Quantity (EOQ) Model

The Economic Order Quantity (EOQ) model can be defined as a traditional economic model
which is used to determine the economic or the most optimal order quantity. This quantity of
products or materials should be purchased or produced by the company according to the
definite period of time which is fixed.

The EOQ model is developed to minimize the company’s total costs in relation to the order,
including the complex of inventory holding costs and the ordering or setup costs (Collier &
Evans, 2011, p. 241). It is necessary to pay attention to the key assumptions in relation to
which the EOQ model is developed. These assumptions are the constant ordering cost, the
constant lead time, the impossibility to provide stock outs, and the focus on only one product
at a time (Collier & Evans, 2011, p. 243).

Role: The EOQ model is actively used by economists within companies to plan the
operations because this quantitative model allows the significant decrease of costs. Moreover,
the model is based on the constant or regular pattern, and the total costs can be successfully
predicted (Collier & Evans, 2011, p. 243). The quantitative model is important to determine
the optimal order quantity to purchase or produce that is why its usage contributes to
minimizing the possible inventory costs.
However, it is necessary to refer to the lead time, the fixed demand rate, and annual demand
to develop the model and determine the costs. Furthermore, depending only on the order
quantity, the EOQ model rejects the importance of fixed ordering or inventory holding costs.
As a result, it is important to concentrate only on variable ordering and inventory holding
costs while using the EOQ model (Collier & Evans, 2011, p. 244).

Applicability: The EOQ model can be successfully used with references to any sphere in
which the company realizes definite operations connected with purchasing and producing
goods and materials.

Variations of the EOQ Model

There are several modifications that can be made to the basic EOQ model to fit particular
circumstances. Two that are often used are the monetary unit lot-size model and the
noninstantaneous receipt model.

Monetary Unit Lot Size

The EOQ can be calculated in monetary units rather than physical units. The same EOQ
formula given in the preceding section can be used, but the annual usage changes from units
to dollars.

AD = annual usage in dollars

S = ordering costs in dollars

i = carrying cost rate as a decimal or a percent

Because the annual usage is expressed in dollars, the unit cost is not needed in the modified
EOQ equation. The EOQ in dollars is:

EOQ = root of A 2 ADS by i

Economic Batch Quantity (EBQ)

Economic Batch Quantity (EBQ), also known as the optimum production quantity (EPQ), is
the order size of a production batch that minimizes the total cost.

Batch production is a technique which is commonly used today for distributing the total
production in a series of small batches rather than mass producing in one go.

Sometimes the production of goods in batches is necessary because, for example, certain
equipment used in manufacturing (e.g. dyes) may wear out and need replacement before the
production can run again.

Batch production may be desirable in other cases as well. For example, where the objects
being produced are perishable, the entire production requirement for say a year can’t be
manufactured in a week as it might cause the goods to expire after some time. Batch
production also reduces the risk of obsolescence as any minor changes required in the
specification of goods (e.g. size, color, etc.) can be made in future batches according to the
feedback received from customers or retailers instead of producing everything in one go and
hoping for the best.

Whereas EOQ is suitable for determining the order size when the parts, materials or finished
goods are ready to be delivered by external suppliers when the order is placed, EBQ is used
to determine the size of a production run (i.e. batch size) when the manufacturing takes
place internally and any raw materials or parts required for production are either acquired
internally or are supplied incrementally by other companies according to the production
requirement.

Formula

Economic Batch Quantity = √ ( (2 x Cs x D ) / (Ch(1 – D/P)) )

Where:

• Cs is the setup cost of a batch

• D is the annual demand
• P is the annual production capacity
• Ch is the annual cost of holding one unit of finished inventory

The formula for calculating EBQ is very similar to EOQ with one notable difference in the
denominator. The cost of holding in EBQ formula is decreased by the amount of inventory
that will be produced and sold on the same day therefore not contributing to the annual cost
of holding the inventory.
Quantity Discount Model

Quantity discount is a reduction in price offered by seller on orders of large quantities.

Quantity discounts exist in different forms and in certain scenarios they may not be obvious.
The well-known buy-1-get-1-free sale is actually a 50% quantity discount since you
effectively purchase a unit at half the normal price.

Different forms of quantity discounts provide different purchase incentives to buyers. For
example, the one discussed above has a tentency to compel the buyer to purchase more than
they need at the moment i.e. the seller will not allow you to purchase just one unit at 50% of
the full price. Another form of quantity discount which is based on the cumulative quantity
purchased during a specific time period actually induces the buyer to continue purchasing
from the current supplier and restricts switching to other suppliers.

Probabilistic Inventory Models

Inventory is classified as idle possessions that possess economic value but still it is very
essential to maintain inventory for different kind of manufacturing units, retailers, factories
and enterprises. Generally, it is a vital constituent of the investment collection of any
generative organization. Approximately up to 60% of the yearly production budget is used up
on material and other inventories. It cannot be overstressed that better inventory management
would constantly develop organizational productivity, decrease costs, and contribute to
responsible use of scarce capital.

The classic inventory model is generally used either to forecast optimum inventory or to
evaluate two or more inventory systems. Two fundamental techniques are generally
employed by industries to develop inventory reserve estimates and they are the deterministic
and probabilistic methods. The deterministic method concedes a single best estimation of
inventory reserves grounded on recognized engineering, geological, and economic
information. The probabilistic method employs the known economic, geologica,l and
engineering data to produce a collection of approximate stock reserve quantities and their
related probabilities. Each inventory reserve categorization gives a signal of the prospect of
revival.

The advantage of a probabilistic approach lies in the fact that by using values lying within a
bandwidth and modeled by a defined distribution density, the reality can be modeled better
than by using deterministic figures.

Deterministic models of inventory control are used to determine the optimal inventory of a
single item when demand is mostly largely obscure. Under this model inventory is built up at
a constant rate to meet a determined, or accepted, demand.
Unit 4 – Purchasing Management

Purchasing is the “process of buying.” Many assume purchasing is solely the responsibility of
the purchasing department. However, the function is much broader and, if it is carried out
effectively, all departments in the company are involved. Obtaining the right material, in the
right quantities, with the right delivery (time and place), from the right source, and at the
right price are all purchasing functions.

Choosing the right material requires input from the marketing, engineering, manufacturing,
and purchasing departments. Quantities and delivery of finished goods are established by the
needs of the marketplace. However, manufacturing planning and control (MPC) must decide
when to order which raw materials so that marketplace demands can be satisfied. Purchasing
is then responsible for placing the orders and for ensuring that the goods arrive on time.

The purchasing department has the major responsibility for locating suitable sources of
supply and for negotiating prices. Input from other departments is required in finding and
evaluating sources of supply and to help the purchasing department in price negotiation.
Purchasing, in its broad sense, is everyone’s business.

Establishing Specifications

The first concern of purchasing—what to buy—is not necessarily a simple decision. For
example, someone deciding to buy a car should consider how the car will be used, how often,
how much one is willing to pay, and so on. Only then can an individual specify the type of
car needed to make the “best buy.” This section looks at the problems that organizations face
when developing specifications of products and the types of specifications that may be used.

In purchasing an item or a service from a supplier, several factors are included in the package
bought. These must be considered when specifications are being developed and can be
divided into three broad categories:

• Quantity requirements.

• Price requirements.

• Functional requirements.

1.Quantity Requirements

Market demand first determines the quantity needed. The quantity is important because it will
be a factor in the way the product is designed, specified, and manufactured. For example, if
the demand was for only one item, it would be designed to be made at least cost, or a suitable
standard item would be selected. However, if the demand were for several thousand, the item
would be designed to take advantage of economies of scale, thus satisfying the functional
needs at a better price.

2.Price Requirements

The price specification represents the economic value that the buyer puts on the item— the
amount the individual is willing to pay. If the item is to be sold at a low price, the
manufacturer will not want to pay a high price for a component part. The economic value
placed on the item must relate to the use of the item and its anticipated selling price.
3.Functional Requirements

Functional specifications are concerned with the end use of the item and what the item is
expected to do. By their very nature, functional specifications are the most important of all
categories and govern the others.

In a sense, functional specifications are the most difficult to define. To be successful, they
must satisfy the real need or purpose of an item. In many cases, the real need has both
practical and aesthetic elements to it. A coat is meant to keep one warm, but under what
circumstances does it do so and what other functions is it expected to perform? How cold
must it get before one needs a coat? On what occasions will it be worn? Is it for working or
dress wear? What color and style should it be? What emotional needs is it expected to fill? In
the same way, we can ask what practical and aesthetic needs a door handle or side-view
mirror on a car is expected to satisfy.

Functional specifications and quality

Functional specifications are intimately tied to the quality of a product or service. Everyone
knows, or thinks he or she knows, what quality is, but there are several misconceptions about
what it is and what it is not. Ask someone what is meant by quality, and you will get replies
such as “The best there is,” “Perfection,” “Degree of excellence,” and “Very good.” All
sound great but do not mean very much.

There are many definitions of quality, but they all center on the idea of user satisfaction. On
this basis, it can be said that an item has the required quality if it satisfies the needs of the
user.

There are four phases to providing user satisfaction:

1. Quality and product planning.

2. Quality and product design.

3. Quality and manufacturing.

4. Quality and use.

Product planning is involved with decisions about which products and services a company is
to market. It must decide the market segment to be served, the product features and quality
level expected by that market, the price, and the expected sales volume. The basic quality
level is thus specified by senior managers according to their understanding of the needs and
wants of the marketplace. The success of the product depends on how well they do this.

The result of the firm’s market studies is a general specification of the product outlining the
expected performance, appearance, price, and sales volume of the product. It is then the job
of the product designer to build into the design of the product the quality level described in
the general specification. If this is not properly done, the product may not be successful in the
marketplace.
For manufactured products, it is the responsibility of manufacturing, at a minimum, to meet
the specifications laid down by the product designer. If the item is bought, it is purchasing’s
responsibility to make sure the supplier can provide the required quality level. For purchasing
and manufacturing, quality means conforming to specifications or requirements.

To the final user, quality is related to his or her expectation of how the product should
perform. Customers do not care why a product or service is defective. They expect
satisfaction. If the product is what the customer wants, well designed, well made, and well
serviced, the quality is satisfactory.

Functional specifications should define the quality level needed. They should describe all
those characteristics of a product determined by its final use.

Function, quantity, service, and price are interrelated. It is difficult to specify one without
consideration of the others. Indeed, the final specification is a compromise of them all, and
the successful specification is the best combination of the lot. However, functional
specifications ultimately are the ones that drive the others. If the product does not perform
adequately for the price, it will not sell.

Value analysis

Value analysis as defined by the eleventh edition of the APICS Dictionary is “the systematic
use of techniques that identify a required function, establish a value for that function, and
finally provide that function at the lowest overall cost.” Teams of engineers, users, production
personnel and suppliers analyze parts to challenge current specifications and identify
redundant or unnecessary features. This can reduce the cost and, more importantly, improve
the overall functionality of the part. A good example of value analysis is the evolution of the
milk bottle as it went from a heavy glass bottle to a plastic jug. The result is a much cheaper
package with improvements in sterility, transportation, and breakage.

Selecting Suppliers

The objective of purchasing is to get all the right things together: quality, quantity, delivery,
and price. Once the decision is made about what to buy, the selection of the right supplier is
the next most important purchasing decision. A good supplier is one that has the technology to
make the product to the required quality, has the capacity to make the quantities needed, and
can run the business well enough to make a profit and still sell a product competitively.

Sourcing
There are three types of sourcing: sole, multiple, and single.

1. Sole sourcing implies that only one supplier is available because of patents,
technical specifications, raw material, location, and so forth.

2. Multiple sourcing is the use of more than one supplier for an item. The potential
advantages of multiple sourcing are that competition will result in lower price
and better service and that there will be a continuity of supply. In practice there
is a tendency toward an adversarial relationship between supplier and customer.
 3. Single sourcing is a planned decision by the organization to select one supplier
for an item when several sources are available. It is intended to produce a long-
term partnership.

Factors in Selecting Suppliers

The previous section discussed the importance of function, quantity, service, and price
specifications. These are what the supplier is expected to provide and are the basis for selection
and evaluation. Considering this, there are several factors in selecting a supplier.

1. Technical ability
Does the supplier have the technical ability to make or supply the product wanted? Does
the supplier have a program of product development and improvement? Can the
supplier assist in improving the products? These questions are important since, often,
the buyer will depend upon the supplier to provide product improvements that will
enhance or reduce the cost of the buyer’s products. Sometimes the supplier can suggest
changes in product specification that will improve the product and reduce cost.

2. Manufacturing capability
Manufacturing must be able to meet the specifications for the product consistently
while producing as few defects as possible. This means that the supplier’s
manufacturing facilities must be able to supply the quality and quantity of the products
wanted. The supplier must have a good quality assurance program, competent and
capable manufacturing personnel, and good manufacturing planning and control
systems to ensure timely delivery. These are important in ensuring that the supplier can
supply the quality and quantity wanted.

3. After-sales Service.
If the product is of a technical nature or likely to need replacement parts or technical
support, the supplier must have a good after-sales service. This should include a good
service organization and inventory of service parts.

4. Supplier location
Sometimes it is desirable that the supplier be located near the buyer, or at least maintain
an inventory locally. A close location helps shorten delivery times and means
emergency shortages can be delivered quickly.

5. JIT capabilities
Companies competing in a just-in-time (JIT) environment depend on suppliers to
quickly deliver small quantities of product. Modern companies operate with very little
inventory of raw materials and require accurate, on-time deliveries from their suppliers.
JIT suppliers who simply keep extra inventory to meet these demands will soon have
increased costs and pressures to increase their prices. Buyers in a JIT environment need
suppliers who value their new relationship, working in partnership to remove waste
from the system. As a result, JIT suppliers need to have in place information and
 delivery systems that allow them to quickly ship exactly what the customer needs
without increased cost or effort.

6. Other considerations
Sometimes other factors such as credit terms, reciprocal business, and willingness of
the supplier to hold inventory for the buyer should be considered.

Identifying Suppliers

One major responsibility of the purchasing department is to continue to research all available
sources of supply. Some aids for identifying sources of supply follow:

• Salespersons of the supplier company.

• Internet.

• Catalogues.

• Trade magazines.

• Trade directories.

• Information obtained by the salespeople of the buyer firm.

Final Selection of Supplier

Some factors in evaluating potential suppliers are quantitative, and a dollar value can be put on
them. Price is the obvious example. Other factors are qualitative and demand some judgment
to determine them. These are usually set out in a descriptive fashion. The supplier’s technical
competence might be an example.

The challenge is finding some method of combining these two major factors that will enable a
buyer to pick the best supplier. One method is the ranking method, described next.

1. Select those factors that must be considered in evaluating potential suppliers. 2. Assign a
weight to each factor. This weight determines the importance of the factor in relation to the
other factors. Usually a scale of 1 to 10 is used. If one factor is assigned a weight of 5 and
another factor a weight of 10, the second factor is considered twice as important as the first.
When developing the factors and their weights, the buyer can use input from the people who
will be affected by the supplier selection. This will help the buyer in making a more informed
decision and will improve the acceptance of the new supplier by the users.

3. Rate the suppliers for each factor. This rating is not associated with the weight. Rather,
suppliers are rated on their ability to meet the requirements of each factor. Again, usually a
scale of 1 to 10 is used.

4. Rank the suppliers. For each supplier, the weight of each factor is multiplied by the supplier
rating for that factor. For example, if a factor had a weight of 8 and a supplier was rated 3 for
that factor, the ranking value for that factor would be 24. The supplier rankings are then added
to produce a total ranking. The suppliers can then be listed by total ranking and the supplier
with the highest ranking chosen.

Price Determination

Price is not the only factor in making purchasing decisions. However, all other things being
equal, it is the most important. In the average manufacturing company, purchases account for
about 50% of the cost of goods sold, and any savings made in purchase cost has a direct
influence on profits.

However, remember that “you only get what you pay for.” The trick is to know what you want
and not pay more than necessary. When a purchase is made, the buyer receives a package of
function, quantity, service, and price characteristics that are suited to the individual’s needs.
The idea of “best buy” is the mixture that serves the purpose best.

Basis for Pricing

The term fair price is sometimes used to describe what should be paid for an item. But what is
a fair price? One answer is that it is the lowest price at which the item can be bought. However,
there are other considerations, especially for repeat purchases where the buyer and seller want
to establish a good working relationship. One definition of a fair price is one that is competitive,
gives the seller a profit, and allows the buyer ultimately to sell at a profit. Sellers who charge
too little to cover their costs will not stay in business. To survive, they may attempt to cut costs
by reducing quality and service. In the end, both the buyer and seller must be satisfied.

Since we want to pay a fair price and no more, it is good to develop some basis for establishing
what is a fair price.

Prices have an upper and a lower limit. The market decides the upper limit. What buyers are
willing to pay is based on their perception of demand, supply, and their needs. The seller sets
the lower limit. It is determined by the costs of manufacturing and selling the product and profit
expectation. If buyers are to arrive at a fair price, they must develop an understanding of market
demand and supply, competitive prices, and the methods of arriving at a cost.

One widely used method of analyzing costs is to break them down into fixed and variable costs.
Fixed costs are costs incurred no matter the volume of sales. Examples are equipment
depreciation, taxes, insurance, and administrative overhead. Variable costs are those directly
associated with the amount produced or sold. Examples are direct labor, direct material, and
commissions of the sales force.

Total cost = fixed cost + (variable cost per unit) (number of units)

Unit (average) cost = total cost / number of units

= fixed cost / number of units + variable cost per unit

The preceding formula shows that as the number of units produced increases, the unit cost
decreases. This is an important factor when determining price. Buyers can lower the unit price
paid by increasing the volume per order using longer-term contracts or through the
standardization of parts. Sellers will offer quantity discounts to encourage larger orders, also
taking advantage of this reduction in unit cost.

Forward buying

Forward buying is a process related to retail inventories, financial instruments, assets etc.
wherein they are purchased in quantity excess to demand to counter future price rise. This is
practised by retailer when they find manufacturers selling the product at a discounted price and
purchase the items bulk. Now when the price of the product is set to original price by the
manufacturer, retailer can make profit by selling the item purchased at low price earlier.

This is used when manufactures are overstocked and they want to clear the inventory. They
give the discounts to the retailer and retailer also get benefited by getting better profit margins.

Forward buying in the simplest form is buying more goods than needed. The best example is
retailer, who buys higher amount of commodity in order to store it and sell in further time.
Forward buying is usually associated with price and non-price competition. Producers try to
compete with each other by means of lowering prices for established period of time. It is good
occasion for cheap purchase, what is used by another company's supply chain management.
Also every of us - maybe not aware of it - is part of this scheme, e.g. buying more food on
supermarket's promotions.

Disadvantages

1. Forward buying is criticised for generating needless costs. Sometimes it is compared to be

addictive like a drug. Manufacturers want to quickly boost their revenue, so they decrease
prices and flood the market with their goods. Afterwards they discover, that together with
returning normal prices their gains disappear. Downstream supply chain is clogged up with
inventory. When market stabilizes, producers are keen to make another low-price period in
order to undo their losses. This causes arising of cycles, what leads to long-term debilitating
effects for production and distribution branches.

2. Forward buying increments company's costs. Manufacturers which want to offer low price
sale must gather wares. This generates expenditures on warehouses. Distributors, who want to
take advantage of discounts have to pay for storing commodity excess. In fact they increase
revenue because of small purchase expense, but this is only short-term profit. In some cases
keeping fixed prices whole time would be more profitable for producers as well as a distributors
because of avoiding inventory spendings. A lot of storehouses exist only as buffer essential for
forward buying phenomenon.

Mixed Buying Strategy

Purpose of Purchasing Strategies

Companies implement purchasing strategies in order to:

1. Make cost effective purchasing decisions from a group of efficient vendors who will.

2. Deliver quality goods

3. On time and at

4. Mutually agreeable terms.

Price Forecasting

Purchasing deals with prices every day for diverse categories like Raw Materials, Logistics,
MRO, Capital, Packaging, Labor, and other products and services. Some categories already
have price forecasts done by well-respected companies like ICIS (for petrochemicals, energy,
and fertilizer), IHS Global Insight (for country and industry forecasts), and many others in
specific fields.
Many collect opinions from hundreds of experts to understand the trends and cost drivers to
publish their forecasted prices. Others have developed mathematical models to predict future
prices. To be sure, both methods incur inaccurate predictions. However, if trends are
identified, Purchasing can take a reasoned position about buying more or less, according to
their perceived needs.
Cost aspects are useful when dealing with the supplier on a one-to-one basis. However there
are very many situations, particularly regarding raw materials, where the material is subject
to a multitude of economic factors which influence the price of the material. It becomes
necessary on the part of the purchasing executive to take cognizance of and understand the
price movements. Price forecasting, based upon the time series methods of computing trends,
business cycles and seasonality’s or based upon the understanding of the influence of various
economic/business parameters should be of some interest to the purchasing executive who
would like to keep the costs low. The objective is to keep the cots of purchases reasonably
low, and if the prices of the materials do ‘run away’, then to ensure the availability of supply
of the material for the current and near future requirements.

Make or Buy:

The purchase function would be incomplete if we do not make a mention of make/buy

analysis. To put it briefly, a company should buy a component instead of making it:

1. If it costs less to buy rather than to manufacture the component internally

2. If the return on the necessary investment to be made to manufacture the component is not
attractive enough.

3. If the company does not have the requisite skilled manpower to make the components

4. If it feels that manufacturing internally will mean additional labor problem

5. If adequate managerial manpower is not available to take charge of this extra work of
manufacture.

6. if the component to be manufactured shows much seasonal demand or upswings and

downswings of demand resulting in a considerable risk of maintaining inventories; also if the
raw materials for the component faces much seasonal fluctuations which makes the
manufacture of the product more risky for buying company.

7. There is no difficulty in transporting the component from the supplier to the buying
company.

8. If the process of making the product is confidential or is patented.

9. If the same component is not needed year-in and year-out and there is much risk of
technological obsolescence discouraging investment in capital equipment to manufacturer the
component internally.

Make or buy is a strategic decision, and therefore much short term as well as long term
thinking about various costs and other aspects needs to be done.

Purchasing Under Uncertainty

Safety stock is intended to protect against uncertainty in supply and demand. Uncertainty
may occur in two ways: quantity uncertainty and timing uncertainty. Quantity uncertainty
occurs when the amount of supply or demand varies; for example, if the demand is greater or
less than expected in a given period. Timing uncertainty occurs when the time of receipt of
supply or demand differs from that expected. A customer or a supplier may change a delivery
date, for instance.
There are two ways to protect against uncertainty: carry extra stock, called safety stock, or
order early, called safety lead time. Safety stock is a calculated extra amount of stock carried
and is generally used to protect against quantity uncertainty.
Safety lead time is used to protect against timing uncertainty by planning order releases and
order receipts earlier than required. Safety stock and safety lead time both result in extra
inventory, but the methods of calculation are different.
Safety stock is the most common way of buffering against uncertainty and is the method
described in this text. The safety stock required depends on the following:
• Variability of demand during the lead time.
• Frequency of reorder.
• Service level desired.
• Length of the lead time. The longer the lead time, the more safety stock has to be carried to
provide a specified service level. This is one reason it is important to reduce lead times as
much as possible.
Demand Management

The prime purpose of an organization is to serve the customer. Marketing focuses on meeting
customer needs, but operations, through materials management, must provide the resources.
The coordination of plans by these two parties is demand management.

Demand management is the function of recognizing and managing all demands for products.
It occurs in the short, medium, and long term. In the long term, demand projections are needed
for strategic business planning of such things as facilities. In the medium term, the purpose of
demand management is to project aggregate demand for production planning. In the short run,
demand management is needed for items and is associated with master production scheduling.
We are most concerned with the latter.

If material and capacity resources are to be planned effectively, all sources of demand must be
identified. These include domestic and foreign customers, other plants in the same corporation,
branch warehouses, service parts and requirements, promotions, distribution inventory, and
consigned inventory in customers’ locations.

Demand management includes four major activities:

• Forecasting.

• Order processing.

• Making delivery promises.

• Interfacing between manufacturing planning and control and the marketplace.

Figure shows this relationship graphically.

In each of these cases, production (supply) is being planned to react to anticipated demand as
shown by the forecast.

Order processing

Order processing occurs when a customer’s order is received. The product may be delivered
from finished goods inventory or it may be made or assembled to order. If goods are sold from
inventory, a sales order is produced authorizing the goods to be shipped from inventory. If the
product is made or assembled to order, the sales department must write up a sales order
specifying the product. This may be rel atively simple if the product is assembled from
standard components but can be a lengthy, complex process if the product requires extensive
engineering. A copy of the sales order stating the terms and conditions of acceptance of the
order is sent to the customer. Another copy, sent to the master planner, is authorization to go
ahead and plan for manufacture. The master planner must know what to produce, how much,
and when to deliver. The sales order must be written in language that makes this information
clear.
Demand management and the manufacturing planning and control system.

Production Planning

Marketplace Demand
Management

nfmf

Master Production
Schedule

Purchasing of Capital Equipment

Capital equipment purchasing involves buying assets intended for use exceeding one year.
There are several categories of capital equipment purchases. The first includes standard
general equipment that involves no special design requirements. Examples include general-
purpose material-handling equipment, computer systems, and furniture. A second category
includes capital equipment designed specifically to meet the requirements of the purchaser.
Examples include specialized production machinery, new manufacturing plants, specialized
machine tools, and power-generating equipment. The purchase of these latter items requires
close technical involvement between the buyer and seller.

Several features separate capital equipment purchases from other purchases. First, capital
equipment purchases do not occur with regular frequency. A production machine, for
example, may remain in use for 10 to 20 years. A new plant or power substation may remain
in operation over 30 years. Even office furniture may last over 10 years. A second feature is
that capital equipment investment requires large sums of money. This can range from several
thousand dollars to hundreds of millions of dollars. Highdollar contracts will require finance
and executive approvals. For accounting purposes, most capital equipment is depreciable
over the life of the item. Finally, capital equipment purchasing is highly sensitive to general
economic conditions.

Buyers can rarely switch suppliers in the middle of a large-scale project or dispose of capital
equipment after delivery because of dissatisfaction. Furthermore, the relationship between the
buyer and supplier may last many years, so the buyer should also consider the supplier’s
ability to service the equipment. The consequences of selecting a poorly qualified supplier of
capital equipment can last for many years. The reverse is also true. The benefit of selecting a
highly qualified capital equipment provider can last many years.
The purchase of capital equipment differs substantially from the purchase of production
materials and supplies. Such items as power generating equipments, machine tools,
specialised production machinery pumps, chemical processing equipment, conveyors and
materials handling trucks, and office furniture are typical examples of capital equipment. For
accounting purposes, most firms classify these items as noncurrent assets, which are
capitalised and depreciated over the course of their economic lives.
For accounting purpose, purchasing of capital equipment is considered as a fixed asset, to be
capitalised and depreciated over the period of economic life of the equipment. The purchase
of capital equipment is usually differentiated both in procedures and policies from the
purchase of consumption materials mainly because of the nature of large investment over a
long duration.

International Purchasing
Purchasing refers to the activities related with the acquisition of goods, raw materials or
services necessary for firms to accomplish their business goals. This is referred as
international purchasing when those purchasing activities are carried out in international
markets to support the firm’s operations and ensure a reliable source of supply. With the
economic globalization process one can experience that domestic and international
purchasing activities are becoming blurred and are converging in a single function within
firms. The main reasons for firms to purchase internationally are the following ones:
insufficient domestic capacity; changes in the business environment; lower prices, better
quality, better delivery and access better technology.
Purchasing involves all the activities needed for the acquisition of raw materials, goods or
services need for companies to reach their business goals. When such purchasing is done
outside the local market in other to support the company’s operation and ensure a quality
source of supply, then the process is regarded as international purchasing. With the current
surge for economic globalization, international buying activities are becoming more
pronounced. Businesses are looking to global markets for the goods and services needed for
the smooth running of their companies.
International purchasing often comes with a very critical factor which is the reduced cost, the
cost of getting raw materials and services from the global market is cheaper when compares
with the local market.
These days many organizations are looking for the best way to respond to customers’
demands, and the competing needs and international purchasing has become an increasingly
attractive option.
International Purchasing Process
The first step in the international purchasing process involves the proper selection of the
products needed by the organization. The essential products are those that are critical for the
adequate functioning of the company.
After locating the need of your company, you will need to decide the time and the number of
products and services you want to be delivered. There is also a critical need to research
suppliers; there are numerous suppliers in the international market that will call for your
attention but making proper research will do your business a lot of good.
At Pointon International we recognize how difficult it might be for start-ups and for business
to make use of international purchase, so we help you to handle the stress and provide you
with the best international purchasing solutions for businesses.
Unit 5 – Warehouse Management
Warehouse Management
As with other elements in a distribution system, the objective of a warehouse is to minimize
cost and maximize customer service. To do this, efficient warehouse operations perform the
following:
• Provide timely customer service.
• Keep track of items so they can be found readily and correctly.
• Minimize the total physical effort and thus the cost of moving goods into and out of storage.
• Provide communication links with customers.
The costs of operating a warehouse can be broken down into capital and operating costs.
Capital costs are those of space and materials handling equipment. The space needed depends
on the peak quantities that must be stored, the methods of storage, and the need for ancillary
space for aisles, docks, offices, and so on. The major operating cost is labor, and the measure
of labor productivity is the number of units (for example, pallets) that an operator can move
in a day. This depends on the type of material handling equipment used, the location and
accessibility of stock, warehouse layout, stock location system, and the order-picking system
used.
Warehouse Activities
Operating a warehouse involves several processing activities, and the efficient operation of
the warehouse depends upon how well these are performed. These activities are as follows:
1. Receive goods. The warehouse accepts goods from outside transportation or an
attached factory and accepts responsibility for them. This means the warehouse must:
a. Check the goods against an order and the bill of lading.
b. Check the quantities.
c. Check for damage and fill out damage reports if necessary. d. Inspect goods if
required.
2. Identify the goods. Items are identified with the appropriate stock-keeping unit (SKU)
number (part number) and the quantity received is recorded.
3. Dispatch goods to storage. Goods are sorted and put away.
4. Hold goods. Goods are kept in storage and under proper protection until needed.
5. Pick goods. Items required from stock must be selected from storage and brought to a
marshalling area.
6. Marshal the shipment. Goods making up a single order are brought together and checked
for omissions or errors. Order records are updated.
7. Dispatch the shipment. Orders are packaged, shipping documents prepared, and goods
loaded on the right vehicle.
8. Operate an information system. A record must be maintained for each item in stock
showing the quantity on hand, quantity received, quantity issued, and location in the
warehouse. The system can be very simple, depending on a minimum of written information
and human memory, or it may be a sophisticated computer-based system.

Functions of Warehousing:

1. Storage:
This is the basic function of warehousing. Surplus commodities which are not needed
immediately can be stored in warehouses. They can be supplied as and when needed by the
customers.
2. Price Stabilization:
Warehouses play an important role in the process of price stabilization. It is achieved by the
creation of time utility by warehousing. Fall in the prices of goods when their supply is in
abundance and rise in their prices during the slack season are avoided.
3. Risk bearing:
When the goods are stored in warehouses they are exposed to many risks in the form of theft,
deterioration, exploration, fire etc. Warehouses are constructed in such a way as to minimise
these risks. Contract of bailment operates when the goods are stored in wave-houses.
4. Financing:
Loans can be raised from the warehouse keeper against the goods stored by the owner. Goods
act as security for the warehouse keeper. Similarly, banks and other financial institutions also
advance loans against warehouse receipts. In this manner, warehousing acts as a source of
finance for the businessmen for meeting business operations.
5. Grading and Packing:
Warehouses nowadays provide the facilities of packing, processing and grading of goods.
Goods can be packed in convenient sizes as per the instructions of the owner.

Types of Warehousing
1. DISTRIBUTION CENTER

Many people confuse a warehouse with a distribution center and use the terms
interchangeably. Whereas a warehouse might hold items for a long period of time, a
distribution center holds products for a short period of time and sees a much higher
velocity of products coming in and going out.
Distribution centers are very customer-centric and are typically located close to where the
end user is, so they receive products quickly and in good shape. A distribution center may
also offer value added services, such as cross docking, pick and pack services, or simple
product mixing or packaging. Because a distribution center offers more services than a
warehouse, they are also equipped with much more advanced technology to facilitate the
processes happening within.

2. PICK, PACK, & SHIP WAREHOUSE

In a warehouse, pick, pack, and ship is the process that happens after an order is
received, either from an online store or a brick and mortar store. The warehouse
receives a pick list of products, and people or automated systems find the products
within the warehouse. Then, they are packed for shipping, labeled, and shipped to the
customer.

3. SMART WAREHOUSE
A smart warehouse uses automation systems and interconnected technologies to
receive products, put them away, pick them for orders, ship them, and keep an
accurate inventory count. Smart warehouses use technology to increase production,
decrease errors, and minimize the number of humans needed to run the warehouse.

4. COLD STORAGE
Cold storage does exactly what its name implies: it stores temperature sensitive items
at low temperatures. Cold storage warehouses allow medicine, perishable foods,
plants, cosmetics, artwork, and candles to have longer lives. Cold storage warehouses
also use refrigerated shipping for inbound and outbound shipping.

5. ON-DEMAND STORAGE
A growing trend in warehousing is on-demand storage. On-demand warehousing
connects businesses with a need for warehouse space (temporary, seasonal, or to
handle spikes in sales) with warehouses that have excess space.

6. BONDED WAREHOUSE
Also called “customs” warehouses, a bonded warehouse is a building in which
imported goods may be stored, manipulated, or undergo manufacturing operations
without payment of duty for five years from date of acceptance. The duty on imported
goods can be very high so the bonded warehouse allows the products to be sold first,
and then duty is paid from the proceeds of the sale.
 Stores Management

Store is an important component of material management since it is a place that keeps

the materials in a way by which the materials are well accounted for, are maintained
safe, and are available at the time of requirement. Storage is an essential and most
vital part of the economic cycle and store management is a specialized function,
which can contribute significantly to the overall efficiency and effectiveness of the
materials function. Literally store refers to the place where materials are kept under
custody.
Typically a store has a few processes and a space for storage. The main processes (Fig
1) of store are (i) to receive the incoming materials (receiving), (ii) to keep the
materials as long as they are required for use (keeping in custody), and (iii) to move
them out of store for use (issuing). The auxiliary process of store is the stock control
also known as inventory control. In a manufacturing organization, this process of
receiving, keeping in custody, and issuing forms a cyclic process which runs on a
continuous basis. The organizational set up of the store depends upon the
requirements of the organization and is to be tailor made to meet the specific needs of
the organization.

Store is to follow certain activities which are managed through use of various resources.
Store management is concerned with ensuring that all the activities involved in storekeeping
and stock control are carried out efficiently and economically by the store personnel. In many
cases this also encompasses the recruitment, selection, induction and the training of store
personnel, and much more.
The basic responsibilities of store are to act as custodian and controlling agent for the
materials to be stored, and to provide service to users of these materials. Proper management
of store systems provide flexibility to absorb the shock variation in demand, and enable
purchasing to plan ahead.
Since the materials have a cost , the organization is to manage the materials in store in such a
way so that the total cost of maintaining materials remains optimum.
Store needs a secured space for storage. It needs a proper layout along with handling and
material movement facilities such as cranes, forklifts etc, for safe and systematic handling as
well as stocking of the materials in the store with an easy traceability and access. It is to
maintain all documents of materials that are able to trace an item , show all its details and
preserve it up to its shelf life in the manner prescribed or till it is issued for use. Store is to
preserve the stored materials and carry out their conservation as needed to prevent
deterioration in their qualities. Also store is to ensure the safety of all items and materials
whilst in the store which means protecting them from pilferage, theft, damage, deterioration,
and fire.
Objectives of store management

An efficient stores management has normally the following main objectives.

• To ensure uninterrupted supply of materials without delay to various users of the
organization.
• To prevent overstocking and under stocking of the materials
• To ensure safe handling of materials and prevent their damage.
• To protect materials from pilferage, theft, fire and other risks
• To minimize the cost of storage
• To ensure proper and continuous control over the materials.
• To ensure most effective utilization of available storage space
• To optimize the efficiency of the personnel engaged in the store

Stores Systems and Procedures

The systems and procedures in stores can be broadly studied under four heads, viz.
identification system, receipt system, storage system and issue system. The overall system of
store functioning along with the major input-output documents at each state. A substantial
amount of information is required, at every stage, for checking, controlling and feedback
purposes. The stores systems have been discussed with reference to the physical system as
well as the recording or information system.

1. Identification System

The stores management is concerned with the design and control of the systems utilized in
conducting the. Store activities A large number of materials are being handled by typical
stores. Thus the development of an unambiguous and efficient identification system is the
first responsibility confronting a store’s manager so as to facilitate clear internal
communication.

The physical description of each item is usually lengthy and imprecise to be taken for the
purposes of identification in day-to-day operations. Moreover, it cannot be operated on
mechanical or electronic computing devices, the use of which is increasing every day in
automating the clerical operations of the stores. One kind of identification of the parts can be
done with the supplier’s part numbers. But each supplier has got his own codification system
and it will be cumbersome to operate on these numbers for the identification of different
parts.

Arbitrary approach: The inventory items are given an arbitrary number in the sequence in
which these are added in the stores account. Clearly, each item gets a discrete number but
there is no systematic relationship to the numbers assigned to related items.
The symbolic approach: This is a very systematic approach to the design of codification
system. The codes assigned to different parts may be numeric or mnemonic (alpha numeric).
A numerical system assigns a six to ten digit code number to each item to develop the
classification from broader to specific categories.

2. Receipt System

The stores department receives the stores both from outside suppliers and internal
divisions and accordingly there are separate receipt systems. The system of receipt
starts much before the physical receipt of the materials in the stores. It starts with the
placement of purchase order by the purchasing department, a copy of which is sent to
stores. This is maintained in chronological order, so as to give an idea at any time
about the volume of receipt, and helps in the planning of receipt, unloading,
unpacking and other related activities. Further, the supplies while dispatching
the Stores Management goods normally send an advice note to the stores. This
contains information regarding the date of dispatch, carrier details, description of the
consignment and value. Another document known as `consignment note’ is prepared
by the transport carrier and is sent to the stores concerned. These documents help the
store’s manager to organize and plan for expeditious clearance of materials to
minimize costly demurrages.
On actual Delivery the receiving department unpacks the goods received and checks
quantity and condition of goods using weighbridges, measuring devices, tapes, etc.,
and tallies it with that in previous documents. There is a packing slip inside each
package detailing the contents in package and usually it gives the purchase order
number.
3. Storage System

A Physical System: The design of proper shortage system is very important for easy
location, proper identification, and speedy issue to the consuming department. The
commonly followed systems for physically controlling stores materials are: closed
stores system, open stores system and random access stores system. A single firm can
follow a combination of these systems depending upon the nature of production
operation and the use of materials.
 Closed Stores System: In such a system all materials are physically stored in a closed
or controlled area, usually kept in physical control by locking. Only stores personnel
are permitted to enter the stores area. Entry and exit of the material from the area is
permissible only with the accompaniment of authorizing document. Maximum
physical security and tight accounting control of inventory material are ensured by
such a storage system.

Open Stores System: In this system no separate store room exists. The material is
stored as close to the point of use as is physically possible. Such a system finds
applicability in the highly repetitive, mass production type of systems exhibiting a
continuous and predictable demand, e.g. automobile assembly plant. The storage
facilities are arranged at each work station as per requirement and availability of
space. The storage facilities are open and worker has direct access to it; no
authorization document is needed.

4. Issue System

This is the last stage in the stores system. Issues can be of two kinds, i.e., issues to
consuming departments, and issues to outside supplies for processing. In both the
cases there are certain common requirements. The control of issues is regulated by
production programmers. Based on the programme and the bill of materials work
orders are prepared, listing for each material quantity to be issued and the
corresponding quantity of the component to be manufactured. Any material
requirement over and above indicated in the work order quantity means excessive
wastage and scrapping usually, the junior stores personnel are not authorized to issue
beyond the work order quantity which brings an inbuilt control.

Incoming Materials Control

Any organization, big or small, shall look for quality input (materials) from suppliers to have
the desired output or use. For this reason, it devises ways to control the incoming materials by
having a check system on quantity, quality and readiness for use. Control on incoming
materials is exercised through Inspection by the purchaser.

Need for Inspection

Inspection is an important aspect of Integrated Materials Management. It is an adjunct to the

purchase function to ensure that the incoming materials of right quality are procured for use.

The word quality has numerous meanings. The most appropriate meaning of quality in the
present context is “CONFORMANCE TO ORDERED SPECIFICATION & FITNESS FOR
USE”, whether for products or services. Depending upon the nature, criticality & value of
items, inspection is conducted either at supplier’s premises or at plant stores after receipt
there are several ways of carrying out inspection.

Pre Dispatch Inspection

This is inspection before dispatch of material. Usually specified in the Purchase Order (PO),
the inspection is carried out at supplier’s premises (works). Supplier gives an Inspection
Request (IR) to the inspection agency mentioned in the PO. On receipt of IR, the inspecting
officer visits the supplier’s premises along with documents necessary for inspecting such as
copy of PO, drawing, specification etc.

The following checks are conducted depending on the nature of item:

• Visual check
• Dimensional check
• Functional check
• Physical testing such as hardness, pressure test, load test etc
• Electrical and other on-bed testing such as High voltage test, Insulation resistance test
etc.

Final Inspection

For critical items, it is required to conduct stage inspection of semi-finished items (such as
castings, forgings etc) at suppliers premises. In such cases, the supplier gives an interim
Inspection Request to the inspection agency. During stage inspection, sample is collected by
the inspecting officer for Chemical analysis / Physical testing at either their own facility or at
3rd party locations. On receipt of test results, conformance to specification is verified &
clearance is given to the supplier for further processing of the item. After readiness of the
material in all respect & internal checking, the supplier gives the final Inspection Request to
the inspection agency. In some critical cases, joint inspection by Indenter & Inspection is
carried out at supplier’s premises.

Document Inspection

Sometimes and usually for very standard ,off the shelf items, inspection can be carried out
through the verification of supplier given certificates such as Material Test Certificate
(MTC), Manufacturing Certificate (Mfg. TC), Guarantee Certificate (GC) etc. After ensuring
conformance of materials to the ordered specification in all respect, Inspection Certificate
(IC) is issued by the inspecting officer to the supplier.

Receipt Inspection

Majority of items are inspected through this route. Materials are received in the receiving
bays of Stores. Such items are usually accepted based on visual examination & verification of
documents. Materials in the receiving bay are segregated into several categories, based on
their quality control status and destination. Procedures in receiving provide for storage and
transport of material in each category.

The major categories are:

• Awaiting inspection – This category consists of material that has been received and is
awaiting inspection before being moved into stock.
• Acceptance upon certification – This category consists of material that may be
accepted pending certification.
• Rework – In this category are materials that are defective and must be reworked.
• Return – This category contains materials that are defective and will be returned to the
supplier for credit or replacement.
Materials to be tested – This category consist of materials which have been received and are
awaiting delivery to the using/testing department.

Party Inspection

In case of specialized items, which require special proficiency for inspection, help of third
party inspection agencies is taken.

Statutory Compliances (IBR, EXPLOSIVE):

In case of items, which require approval of statutory authority such as IBR (Indian Boiler
Regulation), CCE (Chief Controller of Explosives) etc, verification & correlation of
documents with the materials is done by the inspection agency before acceptance.

Quality Complaint Redressal

If materials after issue to the user department are found to be having defects such as
dimensional deviation, fitness problem etc, the supplier is asked to supply free replacement
against such defects. If there is a pre-mature failure of the material, joint investigation is
carried out by the indenter & inspection agency. If it is established that, the pre-mature failure
has occurred due to use of wrong material or faulty workmanship, the supplier is asked to
either rectify the defects (if feasible) or supply free replacement.

Stores Accounting and Verification Systems

Stores Accounting Systems

Stores accounting is important from the point of view of estimating the cost of the product for
pricing decisions. The costing of material has to be done both for the materials consumed in
the production and estimating the value of materials held in stock.

For the purpose of costing the receipt of materials, the factors that should be included are
material price, freight charges, insurance, duties, taxes, packaging charges etc. The prices
quoted and accepted in purchase order may often be stated in various ways such as net prices,
prices with discount terms, free on board, cost, insurance, freight, etc. All these factors should
be appropriately accounted while costing for the incoming materials.

Another important accounting is to be done for the issue to production and of the stocks held
at the end of accounting period. Let us discuss some of the important and frequently used
system for this purpose:

FIFO System: This system known as First in First Out System is based on the assumption
that the oldest stock is depleted first. Therefore, at the time of issue the rate pertaining to that
will be applied. There is no `profit’ or `loss’ in the pricing arrangements. The value of the
stocks held on hand is the money that has been paid for that amount of stock at latest price
levels. In case of too many changes in price levels the FIFO System becomes unwieldy.
Another limitation of this system is that it fails to provide a satisfactory answer to costing-
returns from stores.
LIFO System: This system known as `Last in First Out’ System is based on the assumption
that the most recent receipts are issued first. As the latest prices are charged in this system, it
leads to lower reported profits in the periods of rising prices and this offers savings in taxes.
In case of wide fluctuations in prices this system tends to immunize unrealized gains or losses
in inventory. It has almost the same limitations as that of FIFO System.

Average Cost System: This is based on the assumption that issues to production department
are equally made from different shipments in stock, i.e. an average cost of shipment in stores
is charged. It stabilizes the cost figures. The average is to be calculated by dividing the total
cost with the number of items and is to be updated with every new purchase.

Market Value System: This is also known as replacement rate costing, in which the
materials issued are charged the prevailing market rates. This system underestimates the
stock on hand in the case of price increase, whereas it overestimates the stock on hand in the
case of price decrease. This may in turn lead to writing off huge amount to make it realistic.
Moreover, a continuous monitoring of the market rates for all materials makes the system
cumbersome.

Standard Cost System: In this system a detailed analysis of market price and trends is
carried out to determine a standard rate for a fixed period, say six months or so. This standard
rate is charged to materials issued during this period irrespective of the actual rate. After the
period is over the standard rate is reviewed and updated.

This system reflects the efficient use of materials as the fluctuation in rates is not considered
in accounting. Moreover, it adds to clerical efficiency as the fresh rates are not to be obtained
every time. However, similar to Market Value Approach, this also leads to underestimating or
overestimating stocks on hand in case of rising and falling prices respectively.

System of Costing the Closing Stock: The general guideline for this purpose is to use
market price or stock at cost, whichever is less.: The cost of closing stock is governed mainly
by price units, obsolescence and deterioration. In rare cases the stock may appreciate with
time. Appropriate formulae to account for these factors should be developed keeping in view
the past experience.

Stock Verification Systems

Some discrepancies between the actual and the book balances of inventories are bound to
occur despite the diligent store keeping. The process of stock verification is carried out for
following purposes:
• To reconcile the store records and documents for their accuracy and usefulness,
• Identification of areas deserving tighter document control,
• To back-up the balance sheet stock figures, and
 • To minimize the pilferage and fraudulent practices
Most companies keep an “inventory short and over” account to absorb such discrepancies,
which is eventually closed into the manufacturing overheads account. Some of the systems of
physical stock taking are as follows:

Annual or Periodic Physical Verification: In this system the entire inventory is physically
verified at the end of a period, usually the accounting period. That is, normally at the end of
fiscal year. Stocks are closed for a few days. This may necessitate the shutdown of
production operations;.’ the activities such as repair and overhaul of equipment and
machinery are resorted to. A special crew of store inspectors and stores verifying officers,
usually from the material audit, physically check each item and compare the entries on bin
card and stores ledger. This leads to the formation of a list of surplus or short items. Damaged
and obsolete items are traced and recorded. This needs to develop a detailed programme and
schedule to complete the verifications, store wise and item wise. Top management’s sanction
can then be sought for writing off deficiencies or valuing surplus.
As all the items are checked at one time there can be no confusion about any item being left
unchecked.

Obsolete, Surplus and Scrap Analysis

Obsolete items are good in all respect but have no useful role in the company due to changes
that have occurred in the course of time. They have economic worth in the market. Surplus
items are those that have accumulated due to faulty planning, forecasting and purchasing.
Hence a usage value is associated with these items. Scrap is wastage generated due to
processes like turning, boring drilling etc. and also due to bad manufacturing. it is said that in
India nearly Rs. 2500 crores are tied up as obsolete, surplus and scrap items.
Causes for their generation
Changes in product design – obsoletion
• Rationalization – initiative for variety reduction leads to surplus or obsolete items
• Cannibalization – parts of one idle machine are fitted on another machine needed urgently
during maintenance, results into obsoletion of parts and at times even scrap
• Faulty planning and forecasting – leads to excess procurement, surplus generation.
• Faulty purchase practices – sub-optimization in buying to utilize available discounts and
transportation economy, surplus and obsolete stocks are generated.
• Other causes – parts kept aside for insurance claims, bad storage system, bad material
handling, bad manufacturing and badly maintained machines are other causes for spoilage
and scrap.
Material Handling

Material handling is an activity that involves movement of material or products within an

organization from one place to another place or the flow of material or products to vehicles or
from vehicles. The activities are usually confined within the boundaries of an organization. The
movement of material from one organization to another is categorized as transportation work,
which is not part of material handling activities.

It is not only about the movement of material. It also involves storage, protection, and control
of material while it moves in different departments like a warehouse, production, and
manufacturing departments. It is one of the essential tasks for organizations. A poorly handled
material become waste before it can be used for production purpose or before it is sent to retail
stores.

In the old times, it was mostly done manually because of the lack of technology. Because of
that, the number of accidents during handling work was quite high. In present times, with the
introduction of technology, almost all of the work is done using automation or semi-
automation. The introduction of technology not only reduced the cases of accidents occurred
but also made the work fast.

Objectives of Materials Handling

Material handling is one of the most critical activities taking place in an organization. Material
handling makes a large portion of the total business expense of a company.

Therefore, achieving the lowest cost and maximum production can be considered as the main
objectives of the material handling process.

1. Reduced cost using a material handling

The first and foremost objective of material handling is lowering the cost of production.
Because a large portion of the total production cost is spent on material procurement, storage,
and movement. Material is crucial for the production process.

The process of production will halt if the material is not provided in sufficient quantity and on
time. Therefore, material handling is given the utmost importance. Companies always look for
methods that can be used for the optimized use of material.

By the use of sophisticated methods, the cost of production can be reduced to a significant
amount.

2. Reduced waste of material

Another significant concern of an organization is to minimize material waste. Sometimes, the

material gets wasted because of poor storage, or sometimes it gets wasted while moving it from
one place to another.
An appropriate material handling not only concerns about the movement of material but also
takes care of placing orders of the right amount, making the use of the material at the right
time, keeping the right amount of inventory, and moving material using better techniques and
with caution.

3. Improved work condition

Before the inclusion of technology, all movement and storage works were done manually.
Some labors were responsible for performing these tasks. They were responsible for all the
loading and unloading work.

Poor results in frequent accidents on-site because of poor work conditions. A proper and well-
thought material handling also takes care of people performing the work.

4. Enhanced distribution

Distribution means the delivery of final goods to the retailers and wholesalers. A lot of material
gets damaged during transportation because of poor packing and poor storage.

It helps in the reduction of damage to products during shipping and handling. In addition to
this, it also concerns the storage location of the material. A proper storage location reduced the
chances of material gets damaged in the storage house.

5. Optimized warehouse capacity

Warehouse cost also adds to the price of the final product. Warehouse capacity means the
ability for storing goods. It is essential to take care of the layout of the warehouse, flooring of
the warehouse, and aisle space in the warehouse to have optimized warehouse capacity.

6. Improved flow of material

A smooth flow of material is when material enters the company in raw material form at the
time when it is required and exits the organization in the form of final goods. The flow of
material gets disturbed when the material is not available when it is needed for the production
or gets damaged rather than being used for the production process.

It concerns with the smooth flow of material in the organization. It improves the circulation of
material in the organization as a result of which material stays for less time in the warehouse
and is used for production at earliest.

7. Full equipment utilization

Expensive machinery and equipment are used for the production process. These equipment
fails to perform at their maximum capacity because of poor material handling.
Because the performance of these equipment depends mainly on the speed at which the
material is supplied and received. Therefore, material handling also helps in the full utilization
of the capacity of the equipment.

8. Workers’ safety

The last but not least objective is the safety of workers. Poor material handling can result in
accidents in the factory, which are very risky for workers working there.

Transportation and Traffic Management

The important aspects in traffic and transportation management are choice of mode of
transport, route selection, rate verification and auditing, management of claims as well as
application of linear programming minimise transportation costs. Let us consider the various
transport avenues that are open to the materials managers viz., Shipping, Rail, Road and
others.

Transport by Shipping:
This is generally resorted to in case of imports. At times method is used for movement of
materials from one part to another within the country. Shipping transport is used for carrying
such vital commodities as food grains, oil, etc.

The increased use of shipping calls for more birthing facilities at our ports viz., Ports of
Mumbai, Kolkata and Chennai. The materials handling facilities at ports also require
improvement as at present unloading process is slow due to inferior handling device and
labour problems at ports.

Rail Transport:
The Railway network is Asia’s largest and the world’s fourth largest system. There has been
a continuous modernising of the track locomotives, signalling equipment and other devices
for monitoring and control. However, over the years the percentage of freight traffic handled
by road has steadily increased.

Railways are ideally suited for long distance over 800 kilometer freight transportation with in
the country. Quick Transport Service has been introduced to overcome the consumers’
apprehension about undue delay in the transport of goods by introducing a guaranteed Quick
Transit Service on payment of a small surcharge which is refundable in case of consignments
do not reach destination within the target time.
In order to compete with the door-to-door service of road transport, the Railways introduced
a scheme of road-cum-rail transport in containers of five tonnes capacity ensuring door to
door delivery as catered for by road transport.

Road Transport:
This is an important mode of transportation of material. There are a large number of transport
organisations in the country having a fleet of trucks. They are suited for transporting freight
of the order of 5 to 10 tonnes usually over distances of 300 to 500 kms. There are many
constraints to the movement of freight through road. Some of them are octroi, interstate per-
mits, check posts.

There are other areas of movement of materials viz., through inland waterways, pipelines and
air etc. Shippers of bulky relatively inexpensive raw materials try to ship by water or pipeline
whenever possible in order to keep transportation, costs at a minimum.

Routing and Delays:

Once the carrier is selected, the traffic manager’s job would seem to be complete but it rarely
is. The carrier does not necessarily carry out its part of the bargain. Trucking companies do
not always have trucks immediately available and, if they are busy, do not maintain their
committed schedules.

Tracing:
The supplier’s traffic department may trace shipments for its customers. The buyers follow
up with the supplier’s sales department. The sales department may give the appropriate bill of
lading or way bill number to the buyer so that his own traffic department could trace the ship-
ment or it might do the tracing for the customer.

Operational Efficiency

Operational efficiency is the practice of being able to deliver services and products (outputs)
as cost effectively as possible (by minimising inputs). This is doable through the streamlining
of processes and elimination of waste, whether the waste be in the form of resources or time.

To calculate operational efficiency, you may measure profits earned as a function of

operating costs. With higher operational efficiency comes higher profits because outputs are
maximised as inputs are being minimised.

In the pursuit of measuring efficiency, it’s important to note that productivity and efficiency
are not synonymous. Productivity is a measurement of output (i.e. units per hour). Efficiency
is the cost per unit of production. This is how businesses can achieve economies of scale (the
ability to decrease costs per unit as the quantity of outputs increases).
3 Steps to Achieve Operational Efficiency

Any organisation with the goal of being operationally efficient can do so by keeping in mind
the following to-do’s, or actionable steps.

Take a look:

• Benchmarking:

Start by creating a benchmark of your team or organisation’s performance. You can

do so by comparing your team or organisation against competitors within your
industry or your own past performance by way of reviewing key performance
indicators (KPIs).

• Eliminate waste:

In order to know where your organisation has room for improvement, model your
processes. This can be done through the creation of flowcharts, either with software or
by hand. Once you have a clear view of the way your processes run, you can spot
bottlenecks and waste. Through the implementation of automation software, you can
create and streamline processes to maximise efficiency.

• Manage performance:

Keep track of performance by monitoring progress and processes with dashboards and
reports. Automation software can collect, process and translate all data into easily
understandable reports that aid in better decision-making.

Factors of Operational Efficiency

Applying an operational efficiency strategy can be done by categorising and reviewing

operations.

The following four aspects are the most critical for businesses to properly manage if they
hope to achieve operational efficiency.

Resource utilisation:

Organisations rely on both human resources and material inputs to create their services and/or
products. By allocating resources optimally, you can eliminate waste and maximise revenue.

To illustrate, finance teams often use the input of data to create the output of financial
statements and/or information that’s needed for decision-making. Without automation,
finance processes are generally time-consuming, error-prone and have high opportunity
costs.

By utilising financial automation tools, businesses can optimise their resource allocation,
freeing up employees’ time to focus on high level task and achieve operational efficiency.
Production:

Importantly, any business that operates in manufacturing will need to focus on production to
accomplish operational efficiency. With the money and time you invest in creating an output,
you’ll look to optimise processes and equipment.

A surefire way to make this happen is by automating processes. Even if you work in an
industry that is not manufacturing, you’re likely carrying out time-consuming processes. By
automating processes, you can free up employees’ time, expedite production and reduce
costs.

Inventory management:

Inventory is considered to be an asset on a balance sheet, but it can end up becoming an

operational liability (i.e. there’s risk associated with holding onto inventory). Inventory costs
money to hold onto and move.

For operational efficiency to occur, there must be proper management and balance to have
enough inventory to meet consumer demand, but not too much to misallocate capital. One
way to better manage inventory is to utilise predictive analysis and forecast future demand
based on historical data.

Distribution:

Software analysis can be used to boost efficiency in distribution channels. Consider applying
operations research to find the quickest/most cost effective way to move goods from point A
to point B and deploying creative solutions to reach levels of efficiency.

Productivity and Cost Analysis

Productivity and costs refer to an economic data set that measures future inflationary trends
with two indicators. Productivity is the indicator that measures labor efficiency in producing
goods and services in the U.S. economy. Costs is the indicator that measures the unit labor
costs of producing each unit of output in the U.S. economy. Together, productivity and costs
monitor inflationary trends in wages, which usually affect trends of inflation in other areas.

The entire production process begins with the supply of factors of production or inputs used
towards the production of a final good we all consume in the final good market. Some
examples of these factors of production are the labor you will supply when you graduate,
machines, raw materials such as pulp, power ( such as gas, electricity), machines, factory
complex, research laboratory etc. We will begin by assuming that the prices of factors of
production are constant first. The reason for this initial simplification is that we want to
understand first how and why firms choose a particular way of producing given those prices.
Objectives:

1. Differentiate between economic and accounting profit.

2. Distinguish between long and short run production.

3. Understand what is diminishing marginal productivity.

4. How to calculate the various cost measures, and concepts.

5. Distinguish between various cost curves, and describe their interrelationship, and
individual shapes.

6. Understand the firm’s choice using the cost curves.

Performance Measurement

To determine how well an organization is performing, its progress must be measured.

Performance measures can be used to:

• Discover which process needs improvement.

• Evaluate alternative processes.

• Compare actual performance with targets so corrective action can be taken.

• Evaluate employee performance.

• Show trends

It is really not a question of whether performance measures are necessary but of selecting
appropriate measures. There is no point in measuring something that does not give valid and
useful feedback on the process being measured. There are many basic characteristics that can
be used to measure the performance of a particular process or activity, such as the following:

• Quantity. For example, how many units a process produces in a period of time. Time
standards measure this dimension.

• Cost. The amount of resources needed to produce a given output.

• Time/delivery. Measurements of the ability to deliver a service or product on time.

• Quality. There are three dimensions to quality measurements:

1. Function. Does the product perform as specified?

2. Aesthetics. Does the product or service appeal to customers? For example, the percentages
of people who like certain features of a product.

3. Accuracy. This measures the number of nonconformances produced. For example, the
number of defects or rejects.
Performance measures should be simple, easy for users to understand, relevant to the user,
visible to the user, preferably developed by the user, designed to promote improvement, and
few in number.
Measurement is needed for all types of processes. Some of the areas and possible
measurements are as follows:
• Customer. Number of complaints, on-time delivery, dealer or customer satisfaction.
• Production. Inventory turns, scrap or rework, process yield, cost per unit, time to perform
operations.
• Suppliers. On-time delivery, rating, quality performance, billing accuracy.
• Sales. Sales expense to revenue, new customers, gained or lost accounts, sales per square
foot.