Operations Management

MBA II Sem

UNIT: IV
Dr. A. Subrahmanyam

GITAM Institute of Management

GITAM Deemed to be University
 Topics

• Aggregate Production Planning (APP) - Strategies, Master

Production Scheduling – Linkages with APP. Evolution of ERP –
Developing MRP Logic - Bill of Materials (BoM), Lot Sizing
Rules, Inventory Management.

Reference Books:
• B. Mahadevan, “Operations Management”, Third Edition,
Pearson Publishers.
 Production planning

• Production planning is a pre-production activity.

• It is the pre-determination of manufacturing requirements
such as manpower, materials, machines and manufacturing
process.
• “Production planning is the determination, acquisition and
arrangement of all facilities necessary for future production
of products.”
 Production control
• In spite of planning to the minute details, most of the time it is not
possible to achieve production 100 per cent as per the plan.
• There may be innumerable factors which affect the production
system and because of which there is a deviation from the actual
plan.
• Some of the factors that affect are:
1. Non-availability of materials (due to shortage, etc.);
2. Plant, equipment and machine breakdown;
3. Changes in demand and rush orders;
4. Absenteeism of workers; and
5. Lack of coordination and communication between various
functional areas of business
Phases in Production Planning and control
The Planning Process
Aggregate Planning Process (APP)
 Aggregate Production Planning
Why is it necessary?
• Demand fluctuations
• Capacity fluctuations
• Difficulty level in altering production rates
– Production systems are complex and varying the rate of
production requires prior planning and co-ordination with
supplier and distributor
• Benefits of multi-period planning

Aggregate Production Planning is done in an organisation to match

the demand with the supply on a period-by-period basis in a cost
effective manner
 Business Planning and Aggregate Planning

• Business plan is strategic in nature and addresses the following

questions:
– Should we meet the projected demand entirely or a portion of the
projected demand?
– What are the implications of this decision on the overall competitive
scenario and the firm’s standing in the market?
– How is this likely to affect the operating system and planning in
other functional areas of the business such as marketing and
finance?
– What resources should we commit to meet the chosen demand
during the planning horizon?
• Aggregate production planning seeks to translate business plans to
operational decisions
 Planning Hierarchies in Operations

Business Plan

Marketing Plan Financial Plan

Production Plan
(rough cut capacity)
Level 1 1-5 years

Level 2 3-12 Months

Aggregate Production Schedule

Master Production Schedule

Materials Capacity
Requirement Plan Requirement Plan

Level 3 1-3 Months

Detailed Scheduling

Shop Floor Control

The Aggregate Planning Process cont..
 Aggregate Production Planning Framework

Forecasting
Alternatives for
Modifying demand

Arriving at effective
Targeted Demand
Period-by-period
to be fulfilled
Demand to be met

Arriving at
Actual period-by-period
Period-by-Period
-
Supply Schedules
Supply Schedules

Alternatives for
Modifying supply
 Aggregate Production Planning

• Aggregate planning typically focuses on manipulating several

aspects of operations-aggregate production, inventory and
personnel levels -to minimize costs over some planning
horizon while satisfying demand and policy requirements.
• Intermediate term planning is normally performed in terms
of aggregate production units and resources rather than
for individual products.
• This approach takes the demand pattern as given (using
forecasts) and focuses on minimizing costs.
 Aggregate Production Plan

Months January February

Aggregate Plan 1,500 1,200
(Shows the total
quantity of amplifiers)
Weeks 1 2 3 4 5 6 7 8
Master Production Schedule
(Shows the specific type and
quantity of amplifier to be
produced)
240-watt amplifier 100 100 100 100
150-watt amplifier 500 500 450 450
75-watt amplifier 300 100
 Simple planning Strategies
• During periods of low demand the company’s normal production capacity
exceeds demand,
• During periods of high demand capacity is less than demand.
• Two simple strategies are obvious
1. The chase demand strategy
2. The level workforce strategy
 The aggregate planning process

 Determine demand for each period.

 Determine capacity for each period

 Identify company, departmental, or union policies that are pertinent.

 Determine unit costs for units produced.

 Develop alternative plans and compute the cost for each.

 If satisfactory plans emerge, select the one that best satisfies objectives.
 Aggregate Production Planning
Decision Variables: An illustration
• The decisions involve
– Amount of resources (productive capacity and labour hours) to be
committed
– Rate at which goods and services needs to be produced during a
period
– Inventory to be carried forward from one period to the next
• An example from Garment Manufacturing
– Produce at the rate of 9000 metres of cloth everyday during the months of
January to March
– Increase it to 11,000 metres during April to August
– Change the production rate to 10,000 metres during September to
December
– Carry 10% of monthly production as inventory during the first 9 months of
production.
– Work on a one-shift basis throughout the year with 20% over time during
July to October
 Aggregate Production Planning: Alternatives

Description of the alternative Costs

Reservation of capacity Planning and Scheduling costs
Influencing Demand
Alternatives for • Special Tariffs
managing demand • Differential Discount Structures Marketing oriented costs
• Limited period al offers

Inventory based alternatives

Stock out, Backordering/Backlogging
(a) Build Inventory Inventory Carrying/holding costs
Capacity Adjustment Alternatives
(a) Varying Working Hours : Over
Time/Under Time OT premium, Lost productivity
Alternatives for
managing supply (b) Vary no. of shifts Shift change costs
(c) Hire/Lay-off workers Training/Hiring costs, Morale issues
Capacity augmentation alternatives
(a) Sub-contract/Outsource Transaction costs for sub-contract
(b) De-bottleneck Annualised de-bottlenecking cost
(c) Add new capacity Annualised cost of new capacity
 Resource Requirements Planning (RRP)

Three important techniques for disaggregating aggregate plans into

executable operations plans:
 Master production scheduling (MPS)
 Materials requirements planning (MRP)
 Capacity requirements planning (CRP)

Aggregate
Aggregate
Planning
Planning

Master Production
Master Production
Scheduling (MPS)
Scheduling (MPS)
Resource
Requirements Material Requirements
Material Requirements
Planning Planning (MRP)
Planning (MRP)

Capacity Requirements
Planning (CRP)
 Aggregate Planning, MPS and MRP
• Aggregate Planning aims at an overall plan without distinguishing
products.

• But, master production plan/schedule (MPS) aims to prepare a

product wise schedule for manufacturing products which is consistent
with the aggregate planning.

• This process of generating a feasible master production schedule is

known as disaggregation planning.

• MPS provides the top-level input requirements to MRP (Material

Requirement Planning) system.

• MRP is a technique for determining the quantity and timing for the
acquisition of dependent items needed to satisfy the MPS.
 Master Production Schedule (MPS)

▶ A master production schedule (MPS) is a statement of how

many finished items are to be produced and when they are
to be produced.

▶ Must be in accordance with the aggregate production plan

▶ MPS is established in terms of specific products, it

disaggregates the aggregate plan

▶ As the process moves from planning to execution, each

step must be tested for feasibility

▶ The MPS is a statement of what is to be produced, not a

forecast of demand

▶ Main input to materials requirements planning

Master Production Scheduling Linkages with
APP & Forecasting

Aggregate
Order
Inflow Production Forecasting
Planning
Market

Master
Capacity Plan Production Materials Plan
Scheduling

Labour & Actual

Vendors
Resources Production
Resource Material
availability Inflow
 Master Production Schedule (MPS)

Can be expressed in any of the following terms:

1. A customer order in a job shop (make-to-order) company

2. Modules in a repetitive (assemble-to-order or forecast)

company

3. An end item in a continuous (stock-to-forecast) company

 Master production plan/schedule (MPS)
• Statement of the volume and timing of the end-products to be
made.

• Chase master production schedule record

• Level master production schedules

The process of Material Requirement Planning
 Material Requirements Planning (MRP)

• Material Requirements Planning (MRP)

– Is a computerized information system that aids in the planning of materials
in organization
– MRP systems exploit certain unique characteristics of the production items
– Utilize information on lead time, inventory status and master production
schedule to make material available exactly at the time of requirement
– The output of an MRP system is a schedule for obtaining raw materials and
purchased parts, a detailed schedule for manufacturing and controlling
inventories, and financial information that drives cash flow, budget, and
financial needs.
• The logic applied to plan materials could be extended to other
resources required in any operations system.
• Therefore, these planning methodologies can be broadly defined as
resources planning
 Material Requirements Planning (MRP)

• The logic that ties production functions together from a material

planning and control view
• A logical, easily understood approach to the problem of
managing the parts, components, and materials needed to
produce end items
– How much of each part to obtain?
– When to order or produce the parts?
• Dependent demand drives the MRP system
 MRP Structure

Data Files Output Reports

MRP by
BOM Master period report
production schedule
MRP by
date report

Lead times
(Item master file) Planned order
report

Inventory data
Purchase advice
Material
requirement
planning
programs Exception reports
Purchasing data (computer and
software) Order early or late
or not needed

Order quantity too

small or too large
 Planning for Materials
Two types of inventories

• Two types of inventories exist in any operations system

– Operating Inventory:
• Denotes all the resources (broadly of material and capacity) that
are available for the operating system to consume in the
production process
– Example: Number of steering wheels required for a day’s production
of 5,000 cars in Maruti Plant
• Exhibit Dependant demand attributes
– Distribution Inventory:
• Meant for market consumption
• Exhibit Independent demand attributes
– Example: Number of Alto’s to be stocked to meet a day’s demand
• They differ in their demand attributes & therefore require
alternative planning methodologies
 Types of inventories
Demand Attributes
Attribute Dependant Demand
Nature of Demand No uncertainty; Dependant;
Parent - Child relationships
cause dependency
Goal Make availability meet
requirements exactly
Service Level 100% a necessity, Feasible to 100% is not feasible
achieve
Demand Occurrence Often lumpy
Estimation of demand By Production Planning
How much to order? Known with certainty
(Quantity)
When to order? (Timing) Very critical, can be
estimated
Independent Demand
Considerable Uncertainty,
Independent
Make availability meet
estimated demand for a
targeted service level
Often continuous
By Forecasting
Estimated based on past
consumption
Can not be answered directly
 17-31

Independent vs. Dependent Demand

Independent Demand (Demand for the final end-

product or demand not related to other items)

Finished
product
Dependent
Demand
(Derived demand
items for
E(1 component
) parts,
subassemblies,
Component parts raw materials,
etc)
 Developing MRP Logic
Basic Building Blocks
1. Existence of multiple levels of dependency - Explosion
2. Product Structure – Bill of Materials (BOM)
3. Time phasing the requirement
4. Determining Lot Size
 MRP Logic - terminologies

1. The iterative process of computing all requirements at a level and then

moving down the level is known as explosion in MRP

1. The requirements for end items are retrieved from the master schedule.
These are referred to as “gross requirements” by the MRP program.
2. On-hand balance and schedule of orders are used to calculate the “net
requirement.”
3. Net requirements data are used to calculate when orders should be
received to meet these requirements.
4. Planned order releases are generated by offsetting to allow for lead time.
5. Specify the quantity and time an order is to be received.
6. Repeat for all items in bill of materials.
 MRP Logic - terminologies
2. Product Structure and Bill of Material (BOM)
• Product Structure graphically depicts the dependency relationships among
various items that make up the final product
• A Bill of Material (BOM) is a list of all materials needed to assemble or put
together one unit of the final product
• BOM is an alternative representation of a product structure.
• The data set also includes a short description and the unit of measure for each
part.
• BOM exists in various formats
– Single level BOM
– Indented BOM
– Modular BOM
 Product structure

The product structure of a typical fountain pen

Material Requirement Planning
 Product structure

The Product structure of the Treasure Hunt game

Material Requirement Planning
 Product structure

The product structure of a of a telephone

Material Requirement Planning
 Material Requirement Planning
3. Time Phasing the Requirement
• The computing of the requirement of items is based on simple arithmetic.
• Let us consider a two-month period as the planning horizon. Let us use the
following notations:
 Gross requirement for an item during the period: A
 Inventory of the item available for the period: B
 Net requirement of an item during the period: C
C = A- B

Lead Times for Components

The time required to purchase, produce, or assemble an item
For production – the sum of the move, setup, and assembly or run times
For purchased items – the time between the recognition of a need and when
it's available for production
 Material Requirement Planning
Time Phasing the Requirement
For Instance: Using these equations, we find that:
• B: On hand = 350
• A: Gross requirement = 470 (200 + 120 + 150)
• C: Net requirement = 120
 Material Requirement Planning
4. Determining Lot Size
• Lot sizing is the process of determining the size of the order quantities for
each component in a product.
• The lot-sizing decision also affects the lead time required and involve
balancing the carrying and ordering costs.

1. Lot-for-lot (LFL)
 Material Requirement Planning
4. Determining Lot Size
2. Fixed order quantity (FOQ)

3. Periodic order quantity (POQ)

 Inventory Status Records

Basic information
describing the item

Information about
part availability

Additional
information that
may be useful
 Inventory Status Records

An MRP record consists of the following:

• Gross requirements (GR) are the total demand for an item derived from all of
its parents. Scheduled or planned receipts (S/PR) are orders that are due or
planned to be delivered.

• Planned order receipt (PORec) specifies the quantity and time an order is to
be received.

• Planned order release (PORel) specifies the planned quantity and time an
order is to be released to the factory or a supplier.

• Projected on-hand inventory (POH) is the expected amount of inventory on-

hand at the beginning of the time period considering on-hand inventory from the
previous period plus scheduled receipts or planned order receipts minus the gross
requirements.
 Material Requirement Planning
Example-1
Developing a Product Structure and Gross requirements.
• Speaker Kits, Inc., packages high-fidelity components for mail order. Components for the top-of-
the-line speaker kit, “Awesome” (A), include 2 Bs and 3 Cs.
• Each B consists of 2 Ds and 2 Es. Each of the Cs has 2 Fs and 2 Es. Each F includes 2 Ds and 1 G. It
is an awesome sound system. (Most purchasers require hearing aids within 3 years, and at least
one court case is pending because of structural damage to a men’s dormitory.) As we can see, the
demand for B, C, D, E, F, and G is completely dependent on the master production schedule for
A—the Awesome speaker kits.
• Given the preceding information, construct a product structure and “explode” the requirements.
Table-1 Lead Times for Awesome
Speaker Kits (As)
COMPONENT LEAD TIME
A 1 week
B 2 weeks Using this information, from example – 1 and table – 1,
C 1 week construct the Gross Material Requirements plan
D 1 week with a production schedule that will satisfy the
E 2 weeks demand of 50 units of A by week 8.
F 3 weeks
G 2 weeks
Material Requirement Planning

Time-Phased Product Structure

 Material Requirement Planning

Gross Requirements Plan

Gross Material Requirements Plan for 50 Awesome Speaker Kits (As)
TABLE 2
with Order Release Dates Also Shown
WEEK LEAD
1 2 3 4 5 6 7 8 TIME
A. Required date 50
Order release date 50 1 week
B. Required date 100
Order release date 100 2 weeks
C. Required date 150
Order release date 150 1 week
E. Required date 200 300
Order release date 200 300 2 weeks
F. Required date 300
Order release date 300 3 weeks
D. Required date 600 200
Order release date 600 200 1 week
G. Required date 300
Order release date 300 2 weeks
 Material Requirement Planning
Example-1
▶ Given the following on-hand inventory, speaker kits, Inc., now wants to
construct a net requirements plan.
▶ The gross requirement remains 50 units in week 8, and components
are shown in the product structure in example 1.
ITEM ON HAND

A 10

B 15

C 20

D 10

E 10

F 5

G 0
 ITEM ON HAND ITEM ON HAND

Net Requirements A 10 E 10
B 15 F 5
Plan C 20 G 0
D 10

2 × number of As = 80

3 × number of As = 120
Net Requirements Plan

2 × number of Bs = 130
2 × number of Cs = 200

2 × number of Cs = 200

2 × number of Bs = 130
2 × number of Fs = 390

1 × number of Fs = 195
 M R P, Core Processes, and Supply Chain Linkages

• The MRP system interacts with the four core processes of an

organization

Figure :MRP Related Information Flows in the Supply Chain

MRP Logic
 CAPACITY REQUIREMENTS PLANNING (CRP)

• CRP is a technique that applies the MRP logic to address the

capacity issues in an organization.
MPS, MRP & CRP
 Material Requirements Planning-II (MRP-II)
• MRP II is an extended version of MRP.
• The MRPII is an integrated information system that co-ordinates sales,
purchasing, manufacturing, finance and engineering by adopting a focal
production plan and by using one unified database to plan and update the
activities in all the system.
• A typical MRP II system will consist of the following modules:
• Business planning
• Purchasing
• Forecasting/demand management
• Inventory control
• Order entry and management
• Shop-floor control
• Master production scheduling (MPS)
• Distribution requirements planning (DRP)
• Material requirements planning (MRP)
• Service requirements planning (SRP)
• Capacity requirements planning (CRP)
• Accounting
 Enterprise Resources Planning (ERP):

Enterprise resource planning is an organization-wide

planning system that utilizes some common software and an
integrated database for planning and control purposes.
 ENTERPRISE RESOURCES PLANNING (ERP)

EVOLUTION OF ERP
• The history of ERP can be traced back to the 1960’s, when the
focus of systems was mainly towards inventory control.
• Most of the systems software was designed to handle
inventory based in traditional inventory concepts.
• The 1970’s witnessed a shift of focus towards MRP (Material
Requirement Planning).
• Then, in 1980’s came the concept of MRP-II i.e., the
Manufacturing Resource Planning which involved optimizing
the entire plant production process.
• This gave birth to ERP (Enterprise Resource Planning) which
covered the cross-functional coordination and integration in
support of the production process.
 ENTERPRISE RESOURCES PLANNING (ERP)
• Difficulty in getting accurate data, timely information and improper interface
of the complex natured business functions have been identified as the
hurdles in the growth of any business.
• One or the other applications and planning systems have been introduced
into the business world for crossing these hurdles and for achieving the
required growth. They are:
• Management Information Systems (MIS)
• Integrated Information Systems (IIS)
• Executive Information Systems (EIS)
• Corporate Information Systems (CIS)
• Enterprise Wide Systems (EWS)
• Material Resource Planning (MRP)
• Manufacturing Resource Planning (MRP II)
• Money Resource Planning (MRP III)
The latest planning tool added to the above list is Enterprise Resource Planning
(ERP).
 ENTERPRISE RESOURCES PLANNING (ERP)

• An Enterprise is a group of people with a common goal, which

has certain resources at its disposal to achieve that goal. The group
has some key functions to perform in order to achieve its goal.

• Resources included are money, manpower, materials, and all the

other things that are required to run the enterprise.

• Planning is done to ensure that nothing goes wrong. Planning is

necessary functions in place and more importantly, putting them
together.

• Therefore, Enterprise Resource Planning or ERP is a method of

effective planning of all the resources in an organization.
 Enterprise Resource Planning (ERP)

▶ ERP modules include

▶ Basic MRP

▶ Finance

▶ Human resources

▶ Supply-chain management (SCM)

▶ Customer relationship management (CRM)

▶ Sustainability
ERP and MRP
 Enterprise Resource Planning (ERP)

▶ ERP systems have the potential to

▶ Reduce transaction costs

▶ Increase the speed and accuracy of information

▶ Facilitates a strategic emphasis on JIT systems

and supply chain integration
▶ Can be expensive and time-consuming to install
 ERP in the Service Sector

▶ ERP systems have been developed for health care,

government, retail stores, hotels, and financial services
▶ Also called efficient consumer response (ECR)
systems in the grocery industry
▶ Objective is to tie sales to buying, inventory, logistics,
and production
SAP's ERP Modules
 Inventory Management

• Inventory is the stock of any item or resource used in an

organization and can include:
– Raw materials, finished products, component parts, supplies, and
work-in-process
• It refers to any idle resource that can be put to some future
use.
▶ One of the most expensive assets of many companies
representing as much as 50% of total invested capital.
▶ Less inventory lowers costs but increases chances of running
out.
▶ More inventory raises costs but always keeps customers
happy.
 Inventory Management

• Functions of Inventory
1. To provide a selection of goods for anticipated demand and
to separate the firm from fluctuations in demand
2. To decouple or separate various parts of the production
process
3. To take advantage of quantity discounts
4. To hedge against inflation
 Inventory Planning
Independent demand items

• Finished goods and spare parts typically belong to independent

demand items in manufacturing organisations
• Two attributes characterise and distinguish independent demand
items:
– Timing of demand: Independent demand items have a continuous
demand
– Uncertainty of demand: There is considerable element of
uncertainty in the demand in the case of independent demand
items
• Inventory planning of independent demand items must address the
following two key questions:
– How much?
– When?
 Types of Inventory

 Decoupling Inventory:
 Seasonal Inventory:
 Cyclic Inventory:
 Pipeline Inventory:
 Safety Stock:
 Raw material: Cyclic inventory, pipeline inventory, and safety stock

 Work-in-process (WIP):
 Maintenance/repair/operating (MRO):
 Finished goods:
 Inventory

Example
• A manufacturer of transformers requires copper (both in plate and wire form) as a
key ingredient. The average weekly requirement of copper is 200 tonnes. The lead
time for the supply of copper is two weeks. If the manufacturer places monthly
orders of copper, analyze the various types of inventory in the system.

SOLUTION:
• Order Quantity Q= 1 month (4 weeks) requirement=800 tonnes
• Cyclic inventory in the system Q/2=800/2=400 tonnes
• Lead time (L) = 2 weeks
• Average weekly demand (µ) =200 tonnes
• Pipeline inventory =L×µ=200×2=400 tonnes
 Inventory cost

• Carrying cost Computation of Carrying Cost: An Illustration

• Ordering costs
• Shortage Cost
 Inventory management & control

• Inventory management involves the: “Development

and administration of policies systems and
procedures, which will minimize total cost related to
inventory decisions and related functions such as
production scheduling, purchasing and traffic”
 Day-to-day inventory decisions

• In managing the system, operations managers are involved in three

major types of decision:
• How much to order. Every time a replenishment order is placed,
how big should it be (sometimes called the volume decision)?

• When to order. At what point in time, or at what level of stock,

should the replenishment order be placed (sometimes called the
timing decision)?

• How to control the system.

• What procedures and routines should be installed to help make
these decisions?
• Should different priorities be allocated to different stock items?
• How should stock information be stored?
 Inventory profiles

Inventory profiles chart the variation in inventory level

 Inventory profiles

Two alternative inventory plans with different order quantities (Q)

 Inventory control Techniques

• EOQ Technique:
• Economic order quantity is one of the techniques of inventory
control which minimizes total holding and ordering costs for
the year.
• The economic order quantity is the technique which solves
the problem of the materials manager
• Economic Order Quantity (EOQ) is the level of inventory
order of which inventory cost is minimum.
• EOQ is the order size at which the total cost, comprising
ordering cost and plus carrying cost is the least.
The economic order quantity (EOQ) formula
 Economic Order Quantity (EOQ)
Higher Balancing Carrying against Ordering Costs

Minimum
Total Annual
Annual Cost ($)

Costs

Total Annual
Costs
Annual
Carrying Costs
Lower

Annual
Ordering Costs
Smaller EOQ Larger
Order Quantity
 Economic Order Quantity
• Assumptions of the EOQ Model
1. Demand is known and constant
2. Lead time is known and constant
3. Receipt of inventory is instantaneous
4. Quantity discounts are not available
5. Variable costs are limited to: ordering cost and carrying (or
holding) cost
6. If orders are placed at the right time, stockouts can be
avoided
 Finding the Optimal Order Quantity
Parameters:
Q* = Optimal order quantity (the EOQ)
D = Annual demand
Co = Ordering cost per order
Cc = Carrying (or holding) cost per unit per yr
P = Purchase cost per unit

Finding Q*
Recall that at the optimal order quantity (Q*):
Carry cost = Ordering cost
(D/Q*) x Co = (Q*/2) x Cc
Rearranging to solve for Q*:
Q* =
(2DCo / Cc)
 EOQ Example: Sumco Pump Co.
Buys pump housing from a manufacturer and sells to retailers
D = 1000 pumps annually
Co = $10 per order
Cc = $0.50 per pump per year
Q* = ? and N (No. of Orders)?
------------------------------------------------------------------------------------------------------
Solution: Q* = (2DC / C ) o c

Q* = (2 *1000 *10 / 0.5) = 200 pumps

No. of Orders = D/ Q* = 1000/200 = 5 Orders

Total Cost = (D/Q*) x Co + (Q*/2) x Cc

= (5 X 10) + (100 X 0.50) = Rs. 100 /-
 Purchase Model
In this model of inventory,
• orders of equal size are placed at periodical intervals.
• The items against an order are replenished instantaneously
and the items are consumed at a constant rate.
• The purchase price per unit is the same irrespective of order
size. Then, the corresponding model is shown in below figure
 Purchase Model Cont..

Let, Therefore,
• D be the annual demand in units
Cost of ordering/year = (D/Q) Co
• Co be the ordering cost/order
Cost of carrying/year = (Q/2) Cc
• Cc be the Carrying cost/unit/year
Purchase cost/year = D * P
• P be the purchase price per unit

• Q be the order size.

The total inventory cost (TC)/year = [(D/Q) Co] + [(Q/2) Cc] + (D * P)

EOQ (Q*) = 2CoD / Cc

The number of orders/year= D/Q*
Average inventory = Q*/2
Time between orders = Q*/ D
 Purchase Model Cont..

Example: Alpha industry estimates that it will sell 12,000 units of its product
for the forthcoming year. The ordering cost is Rs.100 per order and the carrying
cost per unit per year is 20% of the purchase price per unit. The purchase price
per unit is Rs.50.

Find

(a) Economic order quantity (EOQ)

(b) No. of orders per year

(c) Time between successive orders

 Manufacturing Model

• If a company manufactures its component which is

required for its main product, then the corresponding model
of inventory is called “Manufacturing model”.
• This model will be with shortages or without shortages.
• The rate of consumption of items is uniform throughout the
year.
• The cost of production per unit is same irrespective of
production lot size.
 Manufacturing Model Cont..

• During the period t1 , the item is produced at the rate of k units per period
and simultaneously it is consumed at the rate of r units per period.
• So, during this period, the inventory is built at the rate of k-r units per
period.
• During the period t2, the production of the item is discontinued but
the consumption of that item is continued. Hence, the inventory is
decreased at the rate of r units per period during this period.
 Manufacturing Model Cont..

Let,
• r be the annual demand of an item
• k No. of units produced per year
• Co be the cost per set up
• Cc be the carrying cost per unit per period
• p be the cost of production per unit
• EBQ be Economic Batch quantity
 Manufacturing Model Cont..

Example 2 : If a product is to be manufactured within the

company, the details are as follows:

• r =24,000 units/year
• k =48,000 units/year
• Co =Rs.200 per set-up
• Cc =Rs.20/unit/year
• Find the EBQ and cycle time.
 Implementation of Purchase Inventory Model
Can be classified into
1. Fixed Order Quantity System (Q System)
2. Fixed Period Quantity System (P System)

Fixed Order Quantity System (Q System)

1. In this system of inventory, whenever the stock level touches the reorder
level, an order is placed for a fixed quantity which is equal to EOQ.
2. Lead time is the time to complete all activities associated with placing, filling
and receiving the order.
3. The average demand during the lead time (average lead time) is known as
the demand during lead time (DLT).
4. The variation in demand during lead time (average lead time) is known as
Safety Stock.
5. The average demand during delivery delays is called Reserve Stock.
6. The Reorder level is computed as the sum of the above 3, 4 and 5 stocks.
Fixed Order Quantity System (Q System)
 Implementation of Purchase Inventory Model
Fixed Period Quantity System (P System)

1. In this system of inventory, the stock position is reviewed once in a

fixed period and an order is placed depending on the stock position,
unlike a fixed quantity in the Q system of inventory.

2. The review period is approximately equal to EOQ/D

3. The desired Maximum Inventory Level is fixed as the sum of the

average demand during average lead time plus review period,
variation in demand during average lead time plus review period,
and the average demand during delays in supply.
Implementation of Purchase Inventory Model
ABC Analysis
 ABC Analysis
• ABC analysis (Always Better Control) is a technique which is used to
classify the items in store based on the demand of the stock.
• It will be very difficult to continuously monitor the stock level of
each item and place order.
• Hence, it is highly essential to classify the items of the stores into
different categories.
• ABC analysis is one such technique which classifies the items into A, B
and C class items. It is also known as Selective Inventory Control
• The ABC analysis provides a mechanism for identifying items
that will have a significant impact on overall inventory cost,
• while also providing a mechanism for identifying different
categories of stock that will require different management and
controls.
 ABC Analysis

ABC classification of inventories

From below figure,

A Items: 10% of the items accounts for 70% of the annual consumption value
of the items. (very tight control and accurate records)
B Items: 20% of the items accounts for 20% of the annual consumption value
of the items. (less tightly controlled and good records)
C Items: 70% of the items accounts for 10% of the annual consumption value
of the items. (simplest controls possible and minimal records.).
 Procedure for ABC Analysis
The steps of ABC analysis are presented below.
Step-1: Input the following.
• Total number of items.
• Item code, Annual consumption in terms of units and unit price for
each of the items.
Step-2: for each item, compute annual consumption value in terms of
rupees by multiplying,
its annual consumption units with its unit price.
Step-3: Arrange the items and their details in descending order of
the annual consumption values computed in Step-2.
Step-4: Compute cumulative values of the annual consumption values.
Step-5: group the items into A,B and C classes by dividing the items into
70%,20% and 10% of the annual consumption values, respectively from
top to bottom in the sorted list of Step3.
 Procedure for ABC Analysis
Sample Data for ABC Classification
End of UNIT-IV