Supplychain Management Dadhich

Material and Store Management
Index
I. Content ...................................................................... II
II. List of Figures .........................................................VI
III. List of Tables ........................................................... VII
IV. Abbreviations .....................................................VIII
V. Case Study ............................................................. 116
VI. Bibliography ........................................................ 124
VII. Self Assessment Answers .................................. 127
Book at a Glance
Contents
Chapter I....................................................................................................................................................... 1
Material Management ................................................................................................................................. 1
Aim ................................................................................................................................................................ 1
Objectives ...................................................................................................................................................... 1
Learning outcome .......................................................................................................................................... 1
1.1 Introduction to Material Management ..................................................................................................... 2
1.2 Classification of Inventory ...................................................................................................................... 2
1.3 Meaning of Material Management ........................................................................................................... 3
1.4 Objectives of Material Management ........................................................................................................ 4
1.5 Motives of Material Management ............................................................................................................ 4
1.6 Scope of Material Management ............................................................................................................... 5
1.7 Material Planning..................................................................................................................................... 5
1.8 Technique of Planning Materials ............................................................................................................. 5
1.9 Process of Codification ............................................................................................................................ 6
1.10 Standardisation ...................................................................................................................................... 7
1.11 Scheduling ............................................................................................................................................. 8
1.12 Procurement ........................................................................................................................................... 8
1.13 Purchasing.............................................................................................................................................. 8
1.14 Inspection............................................................................................................................................... 9
1.15 Quality Control ...................................................................................................................................... 9
1.16 Packaging............................................................................................................................................... 9
1.17 Storage ................................................................................................................................................... 9
1.18 Inventory Control................................................................................................................................. 10
1.19 Distribution .......................................................................................................................................... 10
1.20 Disposal ............................................................................................................................................... 10
1.21 Functions of Material Manager ............................................................................................................ 10
1.22 Effects of Over Stocking and Under Stocking ..................................................................................... 10
Summary .................................................................................................................................................... 11
References................................................................................................................................................... 11
Recommended Reading ............................................................................................................................. 11
Self Assessment........................................................................................................................................... 12
Chapter II ................................................................................................................................................... 14
Material Cost Management ...................................................................................................................... 14
Aim .............................................................................................................................................................. 14
Objectives .................................................................................................................................................... 14
Learning outcome ........................................................................................................................................ 14
2.1 Introduction to Material Cost Management ........................................................................................... 15
2.2 Material Cost ......................................................................................................................................... 15
2.3 Economic Order Quantity (EOQ) Models ............................................................................................. 17
2.4 Determination of Various Inventory Levels ........................................................................................... 19
2.4.1 Maximum Level..................................................................................................................... 20
2.4.2 Minimum Level ..................................................................................................................... 20
2.4.3 Re-order Level ....................................................................................................................... 20
2.4.4 Danger Level ......................................................................................................................... 20
2.4.5 Calculation of Various Levels ................................................................................................ 20
2.5 ABC Analysis......................................................................................................................................... 23
2.6 XYZ Analysis ........................................................................................................................................ 25
Summary .................................................................................................................................................... 27
References................................................................................................................................................... 27
Self Assessment........................................................................................................................................... 28
IV/MITSDE
Chapter III .................................................................................................................................................. 30
Material Requirements Planning.............................................................................................................. 30
Aim .............................................................................................................................................................. 30
Objectives..................................................................................................................................................... 30
3.1 Introduction ............................................................................................................................................ 31
3.2 Definition of MRP.................................................................................................................................. 31
3.3 System Components ............................................................................................................................... 32
3.4 Demand Dependency ............................................................................................................................. 33
3.5 Objectives of MRP ................................................................................................................................. 33
3.6 Advantages of MRP ............................................................................................................................... 34
3.7 Limitations of MRP................................................................................................................................ 35
3.8 Evaluation of MRP................................................................................................................................. 35
3.9 Keeping MRP Current in a Changing Environment............................................................................... 35
3.10 Manufacturing Resource Planning (MRP II) ....................................................................................... 36
3.11 JIT ........................................................................................................................................................ 36
3.12 KANBAN............................................................................................................................................. 36
Summary ..................................................................................................................................................... 38
References ................................................................................................................................................... 38
Self Assessment ........................................................................................................................................... 39
Chapter IV .................................................................................................................................................. 41
Introduction to Enterprise Resource Planning (ERP) ............................................................................ 41
Aim .............................................................................................................................................................. 41
Objectives..................................................................................................................................................... 41
4.1 Introduction ............................................................................................................................................ 42
4.2 History and Evolution ............................................................................................................................ 42
4.3 Meaning ................................................................................................................................................. 43
4.4 Definition ............................................................................................................................................... 43
4.5 Concept .................................................................................................................................................. 43
4.6 Implementation of an ERP System ........................................................................................................ 44
4.7 Advantages of ERP ................................................................................................................................ 44
4.8 Disadvantages of ERP ............................................................................................................................ 45
4.9 Applicability of ERP .............................................................................................................................. 45
4.10 Reasons for the Growth of the ERP Market ......................................................................................... 46
4.11 Success of the ERP ............................................................................................................................... 46
Summary ..................................................................................................................................................... 47
References ................................................................................................................................................... 47
Self Assessment ........................................................................................................................................... 48
Chapter V .................................................................................................................................................... 50
Inventory Models ....................................................................................................................................... 50
Aim .............................................................................................................................................................. 50
Objectives..................................................................................................................................................... 50
5.1 Introduction to Inventory Models .......................................................................................................... 51
5.2 Models for Accepting/Rejecting Discounts on Purchases ...................................................................... 51
5.3 Fixed Order vs. Fixed Interval System................................................................................................... 55
5.3.1 Cyclical Ordering or Fixed Period System (Time Based) ...................................................... 55
5.4 Material Requirement Planning (MRP) ................................................................................................. 60
5.4.1 Applicability of the MRP System........................................................................................... 61
5.4.2 Inputs for MRP....................................................................................................................... 61
5.4.3 MRP Process .......................................................................................................................... 61
5.4.4 Outputs of MRP ..................................................................................................................... 61
5.4.5 Benefits of MRP .................................................................................................................... 62
5.5 Inventory Turnover ................................................................................................................................ 62
5.5.1 Interpretation of Inventory Turnover ..................................................................................... 63
Summary .................................................................................................................................................... 64
References................................................................................................................................................... 64
Self Assessment........................................................................................................................................... 65
Chapter VI .................................................................................................................................................. 67
Purchase Management .............................................................................................................................. 67
Aim .............................................................................................................................................................. 67
Objectives .................................................................................................................................................... 67
6.1 Introduction to Purchase Management .................................................................................................. 68
6.1.1 Objectives of Material Management...................................................................................... 68
6.2 Functions of Purchase Department ........................................................................................................ 68
6.2.1 Purchasing Function vs. Purchase Department ...................................................................... 69
6.2.2 Procurement vs. Purchasing ................................................................................................... 70
6.2.3 Objectives of Purchasing ....................................................................................................... 70
6.3 Purchase Requisition ............................................................................................................................. 70
6.3.1 Types of Purchase Requisitions ............................................................................................. 70
6.4 Purchase Procedure ................................................................................................................................ 71
6.5 Types of Purchasing ............................................................................................................................... 71
6.5.1 Forward Buying ..................................................................................................................... 71
6.5.2 Tender Buying........................................................................................................................ 72
6.5.3 Systems Contract ................................................................................................................... 73
6.5.4 Speculative Buying ................................................................................................................ 74
6.5.5 Rate Contracts........................................................................................................................ 74
6.5.6 Reciprocity in Buying ............................................................................................................ 74
6.5.7 Zero Stock Buying ................................................................................................................. 75
6.5.8 Blanket Orders ....................................................................................................................... 75
6.6 Vendor Management .............................................................................................................................. 75
6.7 Inspection of Materials .......................................................................................................................... 76
6.7.1 Pre Dispatch Inspection ......................................................................................................... 76
6.7.2 Stage Inspection/Final Inspection .......................................................................................... 77
6.7.3 Document Inspection ............................................................................................................. 77
6.7.4 Stores/Receipt Inspection ...................................................................................................... 77
6.7.5 Third Party Inspection ........................................................................................................... 77
Summary .................................................................................................................................................... 80
References................................................................................................................................................... 80
Self Assessment........................................................................................................................................... 82
Chapter VII ................................................................................................................................................ 84

Stores Management ................................................................................................................................... 84
Aim .............................................................................................................................................................. 84
Objectives .................................................................................................................................................... 84
7.1 Introduction to Stores Management....................................................................................................... 85
7.1.1 Motive to Hold Inventory ...................................................................................................... 85
7.2 Functions of Stores Department ............................................................................................................ 85
7.2.1 Receipt of Material ................................................................................................................ 85
7.2.2 Issue of Material .................................................................................................................... 86
7.2.3 Return of Material .................................................................................................................. 87
7.2.4 Transfer of Materials .............................................................................................................. 88
7.2.5 Proper Storage Function......................................................................................................... 88
7.3 Valuation of Material.............................................................................................................................. 90
7.4 Valuation of Receipts ............................................................................................................................. 90
7.5 Valuation of Issues ................................................................................................................................. 91
7.5.1 First In First Out (FIFO) Method ........................................................................................... 92
7.5.2 Last In First out (LIFO) Method ............................................................................................ 93
7.5.3 Highest In First Out (HIFO) Method ..................................................................................... 94
7.5.4 Average Rate Method ............................................................................................................. 95
7.5.4.1 Simple Average (SAR) Method ............................................................................... 95
7.5.4.2 Weighted Average Rate (WAR) Method .................................................................. 96
7.5.5 Market Rate ............................................................................................................................ 97
7.6 Valuation of Returns ............................................................................................................................... 98
Summary ................................................................................................................................................... 100
References ................................................................................................................................................. 100
Recommended Reading ........................................................................................................................... 100
Self Assessment ......................................................................................................................................... 101
Chapter VIII ............................................................................................................................................. 103

Quality Management ............................................................................................................................... 103
Aim ............................................................................................................................................................ 103
Objectives................................................................................................................................................... 103
Learning outcome ...................................................................................................................................... 103
8.1 Introduction .......................................................................................................................................... 104
8.2 Definition of Total Quality Management ............................................................................................. 104
8.2.1 Defining Quality .................................................................................................................. 104
8.3 Cost of Quality ..................................................................................................................................... 104
8.4 Continuous Improvement (Kaizen) ...................................................................................................... 106
8.4.1 Plan to Study Cycle .............................................................................................................. 106
8.4.2 Benchmarking ...................................................................................................................... 107
8.5 Employee Empowerment ..................................................................................................................... 107
8.5.1 Team Approach .................................................................................................................... 108
8.6 Tools of Quality Control....................................................................................................................... 108
8.6.1 Cause-and-Effect Diagrams ................................................................................................. 108
8.6.2 Flowcharts ............................................................................................................................ 109
8.6.3 Checklists ............................................................................................................................. 109
8.6.4 Control Charts ...................................................................................................................... 109
8.6.5 Scatter Diagrams .................................................................................................................. 109
8.6.6 Pareto Analysis ..................................................................................................................... 110
8.6.7 Histograms ........................................................................................................................... 110
8.7 Process Management............................................................................................................................ 111
8.8 Quality Standards ................................................................................................................................. 111
8.8.1 ISO 9000 Standards ............................................................................................................. 111
8.8.2 ISO 14000 Standards ........................................................................................................... 112
8.9 Reason for TQM Failure ...................................................................................................................... 112
Summary ................................................................................................................................................... 113
References ................................................................................................................................................. 113
Recommended Reading ........................................................................................................................... 113
Self Assessment ......................................................................................................................................... 114
List of Figures
Fig. 1.1 Inventory classification .................................................................................................................... 2
Fig. 2.1 Process from procurement to realisation of money ........................................................................ 17
Fig. 3.1 Computer architecture for MRP ..................................................................................................... 31
Fig. 3.2 Material requirements planning system .......................................................................................... 32
Fig. 8.1 Cost of defects .............................................................................................................................. 106
Fig. 8.2 PDSA cycle................................................................................................................................... 107
Fig. 8.3 Seven tools of quality control ....................................................................................................... 110
List of Tables
Table 1.1 List of classification of inventories ................................................................................................ 7
Table 4.1 Evolution of ERP from 1960s to 1990s ........................................................................................ 43
Table 5.1 Model developed for accepting/rejecting discounts on purchases in excel spread sheet ............. 52
Table 6.1 Purchasing function vs. purchase department .............................................................................. 69
Table 6.2 Matrix of price and quality of the tenders .................................................................................... 72
Table 8.1 Cost of quality ............................................................................................................................ 105
Abbreviations
BOM - Bill of Materials
DGS & D - Directorate General of Supply & Disposal
DIL - Desired Inventory Level
EDI - Electronic Data Interchange
EOQ - Economic Order Quantities
ERP - Enterprise Resource Planning
FIFO - First In First Out
GC - Guarantee Certificate
GRN - Goods Returned Note
GRR - Goods Received Report
HIFO - Highest In First Out
IR - Inspection Request
IRF - Inventory Record File
IT - Information Technology
LIFO - Last In First Out
LTE - Limited Tender Enquiry
MPS - Master Production Schedule
MRO - Maintenance, Repair and Operating Inventories
MRP - Materials Requirement Planning
MTC - Material Test Certificate
PO - Purchase Order
QA - Quality Assurance
ROI - Return on Investment
ROL - Re-Order Level
SAR - Simple Average Rate
STE - Single Tender Enquiry
VDC - Vendor Development Cell
WAR - Weighted Average Rate
Chapter I
Material Management
Aim
The aim of this chapter is to:
• introduce the students to material management
• explain the scope of material management
• elucidate the various motives of inventory
Objectives
The objectives of this chapter are to:
• define the classification of inventory
• explicate the key objectives of material management
• enlist the functions of material manager
Learning outcome
At the end of this chapter, you will be able to:
• understand the materials requirement planning technique (MRP)
• analyse about the process of purchasing
• identify the effects of overstocking and under stocking
1/MITSDE
1.1 Introduction to Material Management
Every organisation depends on materials and services from other organisations to varying extents. These materials
and services are obtained through exchange of money. Various materials are used as inputs such as raw materials,
consumables and spares. These are required to be purchased and made available to the shops/users as and when
needed to ensure uninterrupted production. Efficient management of input materials is of paramount importance
in a business organisation for maximising materials productivity, which ultimately adds to the profitability of the
organisation.
Material cost is probably the most important element of cost. In the case of certain industries like cement,
sugar, chemicals, iron and steel, etc., the materials cost forms a very significant portion of the overall cost of
production.
1.2 Classification of Inventory

The term material refers to all commodities which are consumed in the production process. The materials which
can be consumed in the production process can be basically classified as:
• Direct Materials
• Indirect Materials
Material is generally called raw material. Inventory is a name collectively given to raw material; work in process
and finished goods. Even though Material and Inventory are used as synonyms, material usually means raw material
and inventory means raw material along with work in process plus finished goods.
Raw Material Work in Progress Finished Goods
Fig. 1.1 Inventory classification
Raw Material is first subjected to a manufacturing process before it becomes finished goods. Raw material is also
present with work in process and finished goods. It is a continuous process.
Inventory classification
Inventory includes idle resources that have future economic value. It indicates that it may be available in different
forms depending upon the production cycle stage it is in. Classification of inventory is done on this basis and thus,
the different classifications of inventory are as follows:
• Raw materials: Raw materials are input goods intended for combination and/or conversion through the
manufacturing process into semi-finished or finished goods. They change their form and become part of the
finished product.
• Components and parts: Just as raw materials are converted to finished goods in a manufacturing operation,
components and parts are assembled into finished goods in an assembly operation.
• Maintenance, repair and operating inventories (MRO): These include parts, supplies and materials used in or
consumed by routine maintenance and repair of operating equipment, or in support of operations.
• Work-in-process goods: These include goods in the process of manufacturing and only partially completed.
They are usually measured for accounting purposes in between significant conversion phases. In-process
inventories provide the flexibility necessary to deal with variations in demand between different phases of
manufacturing.
• Finished goods: These represent the completed conversion of raw materials into the final product. They are
goods ready for sale and shipment.
2/MITSDE
• Resale goods: These are goods acquired for resale. Such goods may be purchased by a wholesaler for resale to
distributors, or by distributors for resale to consumers, etc.
• Capital goods: These are items (such as, equipment) that are not used or consumed during a single operating
period, but have extended useful lives and must be utilised over multiple operating periods. Tax laws require
that such an item be capitalised, and a predetermined percentage of its cost be recognised as an expense, each
operating period, over a predetermined time frame, according to equipment classes.
• Construction materials: These are raw materials and components for construction projects such as a building,
bridge, etc.
• Hard goods/soft goods: What one identifies as hard goods and soft goods will vary depending on the industry
involved. For example, in data processing, hard goods include apparatus such as, computers and terminals,
while soft goods include software, data storage media and the like.
• Fuel and lubricants: Fuel and lubricants are used for the oiling purpose for the equipment used in the process
which again varies with the type of industry.
• Stationery goods: It includes writing material like, paper, pen, ink, etc., which are used by the people involved
in the process.
• Primary packing material: Packing material like, plastic, paper, etc. are used to pack the finished goods for
sale.
1.3 Meaning of Material Management

Materials management can be defined as “an integrated management approach to planning, acquiring, processing and
distributing production materials from the raw material state to the finished product state”. Materials management
is a key business function that is responsible for the coordination of planning, sourcing, purchasing, moving,
storing and controlling materials in an optimum manner, so as to provide pre-determined service to the customer
at a minimum cost.
Materials management has such sub-fields as:

• inventory management
• value analysis
• receiving
• stores and management of the obsolete
• slow moving and non moving materials
Materials management is the branch of logistics that deals with tangible components of a supply chain. It covers the
acquisition of spare parts and replacements, quality control of purchasing and ordering such parts, and the standards
involved in ordering, shipping, and warehousing the said parts. The physical arrangement of materials/spare parts
is called materials management.
Planning and control of the functions supporting the complete cycle (flow) of materials, and the associated flow of
information is called materials management. Materials management is concerned with the control of materials in
such a manner which ensures maximum return on working capital. Materials management is concerned with the
location and purchase of materials needed, their storage and movement. It also arranges to keep an account of them.
It is also responsible for planning their movement through manufacturing processes, store rooms and distribution
channels.
Materials management provides an integrated systems approach to the coordination of the materials activities and the
control of total material costs. The materials management function ranges from receiving the material requisitions
from user department to placement of purchase orders and then, on the other hand, receiving the materials from
vendors and making it available to the users departments.
3/MITSDE
1.4 Objectives of Material Management
The fundamental objectives of the materials management function are acquisition of materials and services:
• of the right quality
• in the right quantity
• at the right time
• from the right source
The key objectives of material management are as follows:

• Buying at the lowest price, consistent with the desired quality and service
• Maintaining a high inventory turnover, by reducing excess storage, carrying costs and inventory losses occurring
due to deteriorations, obsolescence and pilferage
• Maintaining continuity of supply, preventing interruption of the flow of materials and services to users
• Maintaining the specified material quality level and a consistency of quality. This permits efficient and effective
operation
• Developing reliable alternate sources of supply to promote a competitive atmosphere in performance and
pricing
• Minimising the overall cost of acquisition by improving the efficiency of operations and procedures
• Hiring, developing, motivating and training personnel and providing a reservoir of talent
• Developing and maintaining good supplier relationships in order to create a supplier attitude and desire furnish
the organisation with new ideas, products, and better prices and service
• Achieving a high degree of cooperation and coordination with user departments
• Maintaining good records and controls that provides an audit trail and ensures efficiency and honesty
• Participating in 'Make or Buy' decisions
1.5 Motives of Material Management

A company may hold the inventory with the various motives as stated below:
Transaction motive
The company may be required to hold the inventories in order to facilitate the smooth and uninterrupted production
and sales operations. It may not be possible for the company to procure raw material whenever necessary. There
may be a time lag between the demand for the material and its supply. Hence, it is needed to hold the raw material
inventory. Similarly, it may not be possible to produce the goods immediately after they are demanded by the
customers. Hence, it is needed to hold the finished goods inventory. The need to hold work in progress may arise
due to production cycle.
Precautionary motive
In addition to the requirement to hold the inventories for routine transactions, the company may like to hold them
to guard against the risk of unpredictable changes in demand and supply forces. For example, the supply of raw
material may get delayed due to the factors like strike, transport, disruption, short supply, lengthy processes involved
in import of the raw materials, etc.
Hence the company should maintain sufficient level of inventories to take care of such situations. Similarly, the
demand for finished goods may suddenly increase (especially in case of seasonal types of products) and if the
company is unable to supply them, it may indicate gain for the competitions. Hence, the company will like to
maintain sufficient stock of finished goods.
Speculative motive
The company may like to purchase and stock the inventory in the quantity which is more than needed for production
and sales purpose. This may be with the intention to get the advantages in terms of quantity discounts connected
with bulk purchasing or anticipated price rise.
1.6 Scope of Material Management

The scope of material management includes the following aspects:
• Material planning
• Cataloguing or coding the materials
• Standardisation
• Scheduling
• Procurement
• Inspection
• Quality control
• Packaging
• Storage
• Inventory control
• Distribution
• Disposal
1.7 Material Planning

Material management involves the process of planning to get the materials. It is the starting point for the whole
material management function. Material planning is a scientific way of determining the requirements starting with
raw materials, consumables, spare parts and all other materials that are required to meet the given production plan
for a certain period. Material planning is derived from overall organisational planning and hence, it is always a sub-
plan of the broad organisational plan. What it does is forecast and initiate the procurement of materials.
Factors affecting material planning

The factors affecting material planning are:
• Macro factors: Global factors such as price trends, business cycles, government’s import and export policies
etc., are called macro factors. Credit policy of the government is a critical factor as banks follow these guidelines
only while extending financial support to a business entity.
• Micro factors: These are essentially the factors existing within the organisation such as corporate policy
on inventory holding, production plan, investments etc., For any organisation, factors such as lead time of
procurement, acceptable inventory levels, working capital, seasonality, delegation of power are micro factors
1.8 Technique of Planning Materials

Materials Requirement Planning (MRP) considers the annual production plan of the manufacturing concern. Once
a firm determines its annual production plan, the over all material requirement to meet the given production plan
is worked out. It is a detailed analysis encompassing the materials and quantities available for use, materials with
quantities not available and hence, needing procurement, the actual lead time of procurement, etc.
It is always possible to have a situation where some parts of an assembly are available and some others are not
available. The Bill of Materials (BOM) is prepared. It quantifies all the materials (components) needed for various
assemblies as per the production plan. BOM is thus a list displaying the code, nomenclature of an item, its unit
and quantity, location of use and also the estimated price of each component. An explosion chart is a series of bills
of materials grouped together in a matrix form so that combining the requirements for different components can
be made. Once the BOM is ready, the same is handed over to the Purchasing wing which initiates the purchasing
activities. MRP, thus, keeps in view the lead time also. Using computers, preparation of BOM through explosion
of lists is quite easy and smooth.
Materials required for any operation are based on the sales forecasts and production plans. Planning and control is
done for the materials taking into account the materials not available for the operation and those in hand or in the
pipe line. This involves estimating the individual requirements of parts, preparing materials budget, forecasting the
levels of inventories, scheduling the orders and monitoring the performance, in relation to production and sales.
Cataloguing or coding the materials

For easy procurement, storage, retrieval and the distribution of the inventories, it is essential to classify them into
different categories. This classification can be done through codification or cataloguing. Codification or cataloguing
is basically an identification system for each item of the inventory.
There are three broad approaches to developing a suitable identification system. These are:
• Arbitrary approach
• Symbolic approach
• Use of drawing numbers
Arbitrary approach
As and when an item is received by stores in its receiving bay, a running and unique serial number is assigned to it.
This number becomes the code of the item for subsequent use at different stages. It does not help in the scientific
management of inventory. Arbitrary approach is useful only where perhaps items are non-repetitive and the inventory
management need not be scientific.
Symbolic approach
It assigns code in such a manner that the same item number is not allotted to two different materials. The code is
designed such that it can be used to tell many things about an item of material.
The system uses either a numeric codification system or an alphanumeric system. Under the numeric system, a set of
numeric code (length pre-decided) is assigned to each item where different parts of the code describe different aspects
of an item: class, subclass, unique running number of that item, location of the storage suppliers’ code, etc.
Example:
2 145 098 344
Class Subclass Running number Location code
Thus, the code of this item shall be a 10 digit code, 2145098344 and it shall always remain so for this item. It
shall then be easy to communicate about this item among the concerned agencies. Similarly, there can be a code
using alpha numeric value like AA223B234 with different alpha and numerical value describing some pre-decided
meaning. It is also called mnemonic system. Since this code has certain logic, it is also called intelligent code and
this system is widely used everywhere.
Use of drawing numbers

Many firms use drawing numbers as codes to identify an item. Since the drawing number for a firm remains unique,
assigning a code on this basis assumes a unique code for that item and hence, confirms the requirement of a unique
identification for the item.
1.9 Process of Codification

The process of codification is listed below:
• Decide if the firm wants to go for arbitrary system, symbolic system or engineering drawing system
• List the inventory items
• Define the class of items
• Define the sub class under each class
• Depending upon the number of classes, their subclasses and probable number of items under each sub class
decide the length of codes which shall remain fixed for all the inventory items (10 digit, alphanumeric, etc.)
• Start assigning codes as per the detailed list of inventory
An illustrative list of classification of inventories:
Abrasives Bearings Belt and beltings

Bolts, nuts & washers Brooms & brushes Building materials
Cans & containers Chemicals & reagents Cloth, leather & rubber
Electrical Gases Glassware
Oil & lubricants Pipe & pipe fittings Raw materials
Rolls Refractory Stationery
Safety items Tools & tackles Photographic items
Table 1.1 List of classification of inventories
Codification is usually done by a team consisting of representatives drawn from stores, user department and industrial
engineering department. The major responsibility lies with the stores department. Codification identifies an item.
Also it acts as a communicating medium for an item among the different users of that item in whatever way such
as stores, user department, planning department, finance, purchasing, etc. As soon as the item is received in the
stores (if the item is a new one), it is codified. Once codified, the same code is used in the cycle of procurement,
throughout and for ever.
1.10 Standardisation
Standardisation means “formulation, publication and implementation of guidelines, rules and specifications for
common and repeated use, aimed at achieving optimum degree of order or uniformity in a given context, discipline,
or field”. Publication means communication of a message, statement, or text through any means such as audio, video,
print, electronically as an e-book or on the web. Specification means exact statement of the particular needs to be
satisfied or essential characteristics that a customer requires in goods, material, method, process, service, system,
or work and which a vendor must deliver. Specifications are written usually in a manner that enables both parties
(and/or an independent certifier) to measure the degree of conformity
Specifications are divided generally into two main categories:

• Performance specifications: Conform to known customer requirements such as keeping a room’s temperature
within a specified range.
• Technical specifications: Express the level of performance of the individual units, and are subdivided into the
following:
 Individual unit specifications which state boundaries (parameters) of the unit’s performance consisting of a
nominal (desired or mandated) value and tolerance (allowable departure from the nominal value)
 Acceptable quality level which states limits that are to be satisfied by most of the units, but a certain
percentage of the units is allowed to exceed those limits, and
 Distribution specifications which define an acceptable statistical distribution (in terms of mean deviation
and standard deviation) for each unit, and are used by a producer to monitor its production processes
1.11 Scheduling
Scheduling means “assigning an appropriate number of workers to the jobs during each day of work and determining
when an activity should start or end”. Schedule depends on the following:
• duration
• predecessor activity (or activities)
• predecessor relationships
• resource availability
• target completion date of the project
1.12 Procurement
Procurement means acquisition. It includes the complete process of obtaining goods and services from preparation
and processing of a requisition to receipt and approval of the invoice for payment. It is also called sourcing.
Procurement involves the following activities:

• purchase planning
• standards determination
• specifications development
• supplier research and selection
• value analysis
• financing
• price negotiation
• making the purchase
• supply contract administration
• inventory control and stores, and
• disposals and other related functions
1.13 Purchasing
Basically, the job of a materials manager is to provide to the user departments, right material at the right time in
right quantity of right quality at right price, from the right source. To meet these objectives, the activities undertaken
include selection of sources of supply, finalisation of the terms of purchase, placement of purchase orders, follow
up, maintenance of relations with vendors, approval of payments to vendors, evaluating, rating and developing
vendors.
Before deciding the quantity to be purchased, the following factors should be taken into consideration:
• Quantity already ordered
• Quantity reserved - It may happen that a particular quantity, though in hand, might have been reserved for a
particular job which is not available for other purposes. In such cases, this quantity is such, as if it is not in stock
• Funds availability - Amounts which are kept aside for drawing up purchase budget should be considered
Normally, the process of purchasing the materials involves the following stages:
• Requisitioning: At this stage, the purchasing officer should receive an accurate description of the goods or service
required. The requisition form by which a member of staff notifies purchasing officer of a need for goods or
services should be simple, but clear. The more accurate and detailed the requisition form is, the more are the
chances that the purchase will meet the expectations.
• Financial approval: Here, the purchasing officer must be given the approval from a responsible person. It should
be done before the purchasing commitment is made, and the purchasing system should ensure that this is done
at the right time and by the right person.
• Market assessment: The purchasing officer receives an approved requisition and starts market research in this
stage. He should check that the item is not already in stock, that there is a competitive market for the item, if
there is a list of “approved suppliers” for the item, if a lower price can be negotiated, and so on.
• Purchase decision: During purchase decision stage, after the purchasing officer completed the market assessment
and determined the method of purchase, he decides on the supplier or suppliers. To avoid internal customer
complaints or audit reproof, the decision must be well documented to provide clear reasons as to why a particular
supplier has been chosen.
• Ordering: At the ordering stage, the main instrument purchasing officer works with is an order form. The order
form is an official, numbered document which details the purchase requirements and authorises the supplier to
deliver the goods or services to the company. Also, it can fulfil other important functions.
• Delivery: At the delivery stage, the purchasing officer controls the method, terms and time of delivery established
while ordering. In case there is a competitive transport market, wise freighting decisions can lead to considerable
cost savings.
• Receipting and accounting: At this stage, the purchasing officer should check whether the quality and quantity
of delivered goods or services are relevant to ones in the purchase order. Usually, suppliers are not paid until
the goods are checked however, this procedure should be taken up without unnecessary delays to ensure that
payment terms are met.
• Payment: At the payment stage, the purchasing officer makes sure that the payments are made on the dates they
are due, because maintaining good supplier relations is very important. Also, he should control the terms of
payment in case, they include previously negotiated discounts, progress payments or postponement of payment
during warranty period.
1.14 Inspection
Inspection involves critical appraisal involving examination, measurement, testing, gauging, and comparison of
materials or items. An inspection determines if the material or item is in proper quantity and condition, and if it
conforms to the applicable or specified requirements.
Inspection is generally divided into three categories:

• Receiving inspection
• In-process inspection and
• Final inspection
1.15 Quality Control

A subset of the quality assurance (QA) process, it comprises of activities employed in detection and measurement of
the variability in the characteristics of output attributable to the production system, and includes corrective responses.
In quality control the role of inspection is to verify and validate the variance data.
1.16 Packaging
Packaging includes processes (such as cleaning, drying, and preserving) and materials (such as glass, metal, paper
or paperboard, plastic) employed to contain, handle, protect, and/or transport an article. The role of packaging is
expanding and may include functions such as to attract attention, assist in promotion, provide machine identification
(barcodes, etc.), impart essential or additional information, and help in utilisation.
1.17 Storage
Storage means non-transitory, semi-permanent containment, holding or placement of goods or materials, usually
with the intention of retrieving them at a later time. It does not include the interim accumulation of a limited amount
during processing, maintenance, or repair.
1.18 Inventory Control

Inventory control covers aspects such as setting inventory levels, doing various analyses such as ABC, XYZ, etc,
fixing economic order quantities (EOQ), setting safety stock levels, lead time analysis and reporting.
1.19 Distribution
Distribution means movement of goods and services from the source through the distribution channel, right up to
the final customer, consumer, or user.
1.20 Disposal
Disposal means final placement or riddance of wastes, excess, scrap, etc., under proper process and authority with
(unlike in storage) no intention to retrieve. Disposal may be accomplished by abandonment, destruction, internment,
incineration, donation, sale, etc.
1.21 Functions of Material Manager

The functions of a material manager are as under:
• materials planning and control
• purchasing
• management of stores
• inventory control
• use of information technology for efficient material management
1.22 Effects of Over Stocking and Under Stocking

The objective of material is to maintain optimum stock. The principle which should be kept in mind is that there
should not be any over stocking or under stocking of materials, as both these situations involve costs.
Overstocking will result into the following consequences:

• blocking of working capital, resulting in escalating cost of capital investment
• risk of deterioration of quality and obsolescence resulting in the material being unfit for use
• more storage facilities, resulting in higher rental cost
• additional insurance cost
• more material handling and up-keeping
• risk of breakage/pilferage, etc.
• price of raw material may go down in future
• in a nut-shell, carrying cost goes up
• however, ordering cost goes down
Understocking will result into the following consequences:

• production hold-ups, resulting into disturbed delivery schedules
• frantic eleventh hour purchases which may result in unfavourable prices and quality
• payment for idle time to workers
• increase in the number of orders which will result in more transportation cost
• in nut shell ordering cost goes up
• however carrying cost goes down
Overstocking or understocking of materials results in losses, hence a manufacturer should go for optimum stock.
10/JNU OLE
Summary
• The term material refers to all commodities which are consumed in the production process. The materials
which can be consumed in the production process can be basically classified as direct materials and indirect
materials.
• Material is generally called as raw material. Inventory is a name collectively given to raw material, work in
process and finished goods.
• Inventory includes idle resources that have future economic value. It indicates that it may be available in different
forms depending upon the production cycle stage it is in.
• Materials management can be defined as “an integrated management approach to planning, acquiring, processing
and distributing production materials from the raw material state to the finished product state”.
• The fundamental objectives of the materials management function are acquisition of materials and services: of
the right quality, in the right quantity, at the right time, from the right source, and at the right time.
• A company may hold the inventory with the various motives such as: transaction motive, precautionary motive,
and speculative motive.
• Material planning is a scientific way of determining the requirements starting with raw materials, consumables,
spare parts and all other materials that are required to meet the given production plan for a certain period.
• Materials requirement planning (MRP) considers the annual production plan of the manufacturing concern.
• Codification or cataloguing is basically an identification system for each item of the inventory. There are three
broad approaches to developing a suitable identification system: arbitrary, symbolic, and use of drawing numbers
approach.
• Standardisation means the formulation, publication, and implementation of guidelines, rules and specifications
for common and repeated use, aimed at achieving optimum degree of order or uniformity in a given context,
discipline, or field.
• Scheduling means assigning an appropriate number of workers to the jobs during each day of work and
determining when an activity should start or end.
References
• Aswathappa, K. & Bhat, K. S., 2010. Production and Operations Management, Introduction to operations
Management, 2nd ed., Himalaya Publishing House.
• Shim, J. K. & Siegel, J. G., 1999. Operations Management, Scope of Operations Management, 1st ed., Barrons
Education Series Inc.
• Introduction to Operations Management, [Pdf] Available at: <http://highered.mcgraw-hill.com/sites/dl/
free/0073377848/609567/stevenson_sample_chapter1.pdf> [Accessed 13 February 2013].
free/0073525251/886181/stevenson11_sample_ch01.pdf> [Accessed 13 February 2013].
• Dr. Sumukadas, N., 2013. [1.a] Introduction to Operations Management, [Video online] Available at: <http://
www.youtube.com/watch?v=Y28MsljBgvU> [Accessed 13 February 2013].
• Dr. Oke, A., 2012. Introduction to Operations Management 1, [Video online] Available at: <http://www.youtube.
com/watch?v=skg_lg-4m2o> [Accessed 13 February 2013].
Recommended Reading
• Krajewski, L., Ritzman, L. P., & Malhotra, M, K., 2009. Operations Management: Process and supply chain,
Operations Management, Prentice Hall Publication.
• Murthy, P. R., 2006. Production and Operations Management, Introduction to Operations Management,
2nd ed., New Age International Publishers.
• Gaither, N., & Fraizer, G., 2002. Operations Management-Overview, Thompson Learning, 9th ed.
Self Assessment
1. Which of the following is defined as “assigning an appropriate number of workers to the jobs during each day
of work and determining when an activity should start or end”?
a. Procurement
b. Scheduling
c. Planning
d. Disposal
2. provides an integrated systems approach to the coordination of the materials activities and
the control of total material costs.
a. Material management
b. Planning and control
c. Cost management
d. Scheduling
3. Inventory is a name collectively given to raw material; work in process and .

a. services
b. equipments
c. resources
d. finished goods
4. Which of the following statements is false?

a. Over stocking or under stocking of materials results in losses, hence a manufacturer should go for optimum
stock.
b. Specifications are written usually in a manner that enables both parties (and/ or an independent certifier) to
measure the degree of conformity.
c. Codification is usually done by a team consisting of representatives drawn from stores, user department and
industrial engineering department
d. The code is designed such that it can be used to tell one thing about an item of material.
5. In quality control, the role of inspection is to verify and validate the data.
a. system
b. optimum
c. variance
d. material
6. is first subjected to a manufacturing process before it becomes finished goods.

a. Procurement
b. Planning
c. Raw material
d. Purchasing
7. What do the idle resources have in an inventory?

a. Future economic value
b. Future purchasing value
c. Future profit value
d. Future manufacturing value
8. The materials which can be consumed in the production process can be basically classified as .
a. raw material and finished material
b. direct material and indirect material
c. minimum material and maximum material
d. spare material and optimum material
9. Which of the following statements is true?

a. In-process inventories provide the flexibility necessary to deal with variations in demand between different
phases of manufacturing.
b. What one identifies as hard goods and soft goods will remain same with every industry.
c. Materials management is the branch of statistics that deals with the tangible components of a supply
chain.
d. Material management is not concerned with the location and purchase of materials needed, their storage
and movement.
10. Which of the following are three broad approaches to developing a suitable identification system?
a. Arbitrary, symbolic and use of drawing numbers approach
b. Arbitrary, random and use of drawing numbers approach
c. Arbitrary, supply and use of drawing numbers approach
d. Arbitrary, symbolic and use of prime numbers approach
Chapter II
Material Cost Management
Aim
• introduce the concept of economic order quantity
• explain the material cost management
• elucidate the various inventory levels
Objectives
• define material cost
• explicate the drawbacks of Economic Order Quantity model (EOQ)
• enlist the ABC analysis
Learning outcome
• define the XYZ analysis
• recognise about AX control
• identify the advantages of ABC analysis

2.1 Introduction to Material Cost Management

The object of inventory control is to reduce the investment in the inventory without affecting the efficiency in the
area of production and sales. If a sufficient stock of raw material is not available, the production activity is likely
to be interrupted. If sufficient stock of finished goods is not available, it may not be possible for the organisation to
serve the customers properly and they may shift to the competitors. The objective of inventory control is to avoid the
situation of over stocking as well as under stocking. The level of inventories should be maintained at the optimum
level. Excess stock results in higher carrying cost and less stock results in excess ordering cost. In case of a typical
manufacturing type of operation, the activity may consist of conversion of raw material in the form of finished
goods with the help of labour and other services and selling the finished goods in the market to earn the profits.
Though inventory is an idle resource, it is almost essential to keep some inventory in order to promote smooth and
efficient running of business.
For example: Consider the case – an enterprise that does not have any inventory. Clearly, as soon as the enterprise
receives a sales order, it will have to order for raw materials to complete the order. This will keep the customers
waiting. It is quite possible that sales may be lost. Also the enterprise may have to pay high price for some other
reasons. On the other hand, inventory may promote sales by reducing customers waiting time.
It is essential to maintain the inventories in order to enhance the stability of production and employment levels.
Consider the case of seasonal items. Any fluctuation in demand can be met if possible, by either changing that part
of production or with inventories. If the fluctuation is not followed by changing the rate of production, one has to
take into account the following costs.
Cost of increasing production and employment level, involves the following:

• employment and training
• additional staff and service activities
• added shifts
• overtime costs
Cost of decreasing production and employment level, involves the following:

• employee compensation
• other employee costs
• staff, clerical and service activities
• total time costs
The functions of inventories are to:

• protect against unpredictable variations (fluctuations) in demand and supply
• take advantage of the price discounts by bulk purchases
• take the advantage of batches and longer production run
• provide flexibility to allow changes in production plans in view of change in demands, etc.
• facilitate intermittent production
2.2 Material Cost

Material cost is the cost of commodities and materials used by the organisation. It can be direct or indirect.
• Direct Material is indicative of material which can be identified with the individual product and which becomes
an integral part of the finished goods. It basically consists of all raw materials, either purchased from outside
or manufactured in-house.
• Indirect Material indicates that material which cannot be identified with the individual product. This material
assists the manufacturing process and does not become an integral part of finished goods. The examples of
indirect material may be consumable stores, cotton waste, oils and lubricants, stationery material, primary
packing material, etc.
Material cost is categorised as variable cost. The cost increases with the increase in the level of production activity
and vice versa. The heart of inventory analysis resides in the identification of relevant costs. Some of the important
costs that apply to inventory situation are as follows:
• Ordering or set up costs: These are the costs associated with ordering or manufacturing goods through purchasing
or manufacturing and are known as set up costs or cost of ordering. Set up costs are generally assumed to be
independent of the quantity ordered or produced.
• Purchase cost or production cost (Material cost): When large production runs are in process, these results in
reduction of production cost per unit. Often, discounts are offered for the purchase of large quantities. In other
words, often the unit cost of an item depends on the quantity procured or produced.
• Inventory holding cost or carrying cost: The cost associated with carrying or holding the goods in stock are
known as carrying or holding costs. These costs arise due to the storage costs, property taxes on the items in
inventory, interest on the invested capital (interest on value of the inventory items, spillage of the inventory
items, depreciation of the inventory items, transportation and handling of the items in inventory, etc).
• Shortage or stock out costs: The costs that are incurred as a result of running out of stock are known as stock out
or shortage costs. As a result of shortages, sales or goodwill may be lost. If the unfulfilled demand for the items
can be satisfied at a later date (back order case). In this case, the cost of back orders are assumed to vary directly
with the shortage quantity (in rupee value) and the delaying time. However, if the unfulfilled demand is lost
(lost-sales case), in this case, the cost of shortages are assumed to vary directly with the shortage quantity.
Example: For calculating material cost
The following is the information about a manufacturing unit, M/s Vishal Industries-
Elements of cost Amount per unit

Raw material 80
Direct labour 30
Overheads 60
Total cost 170
Profit 30
Selling Price 200
The following further particulars are available:

• Raw materials are in stock for one month
• Materials are in process for an average of half month
• Finished Goods are in stock for an average of one month
• Credit allowed to customers is two months
You are requested to prepare a statement showing the material cost needed to manufacture 1,20,000 units per
annum.
Solution:
Estimates of Raw Material Cost Rs.

Sr. No of Units for which working Amount of
Current Assets Period of holding
No. capital required material cost
1 Raw Material 1 Month 10,000 8,00,000
2 Work in Process 0.5 month 5,000 4,00,000
3 Finished Goods 1 Month 10,000 8,00,000

4 Debtors 2 Months 10,000 16,00,000
Total 36,00,000
Working notes
Sr. No of units for which Amount of

Category Period of holding
No. working capital required Material cost
1 Raw material 1 Month 10,000 8,00,000
2 Work in Process 0.5 Month 5,000 4,00,000
3 Finished Goods 1 Month 10,000 8,00,000

4 Debtors 2 Months 10,000 16,00,000
Total 36,00,000
Cash
Raw Material
Debtors
Work in
Process
Finished
Goods
Fig. 2.1 Process from procurement to realisation of money
Note: We have not considered the labour cost and other cost, since it is outside the purview of material cost. From
the above example, it is clear that the cost of raw material is present in raw material stage, work in process stage,
finished good stage and debtors. Raw material is like a life blood of the industry which flows through out the process
from procurement stage to realisation money from debtors.
2.3 Economic Order Quantity (EOQ) Models

Economic Order Quantity (EOQ) models are the most basic models of inventory management. EOQ model is
essentially a trade-off between various relevant costs and derive an order quantity and time for placing an order in
such a way that the total costs are minimised.
Economic lot size or economic order quantity model assumptions are:

• The rate of demand for the item is deterministic and is constant D units per annum, independent of time
• Production rate is infinite, i.e., production is instantaneous
• Shortages are not allowed
• Lead time is zero or constant independent of demand and the quantity ordered
• The entire quantity is delivered as a single package (or production in a single run)
Objective of the EOQ

The prime objective of EO is to minimise the average annual variable cost. Economic Order Quantity (EOQ) indicates
that quantity, which is fixed in such a way that the total variable cost of managing the inventory, can be minimised.
Such cost basically consists of two parts:
• First, ordering cost (which in turn consists of the costs associated with the administrative efforts connected with
preparation of purchase requisitions, purchase enquiries, transportation cost and handling of more number of
bills and receipts)
• Second, carrying cost i.e., the cost of carrying or holding the inventory (which in turn consists of the cost like
godown rent, handling and upkeep expenses, insurance, opportunity cost of capital blocked i.e., interest etc.)
There is a reverse relationship between these two types of costs i.e.,
If the purchase quantity increases, ordering cost may get reduced but the carrying cost increases and
vice versa.
A balance is to be struck between these two factors and it is possible at Economic Order Quantity (EOQ), where
the total variable cost of managing the inventory is the least.
The following is the formula for calculating Economic Order Quantity:

EOQ = √ (2 A O)/C
Where,
Q = Economic Order Quantity
A = Annual Requirement in Units
O = Cost of Placing an Order
C = Cost of Carrying One Unit per Year
Example
A manufacturer uses 4,000 units of a component every year and he buys them entirely from outside supplier. The
order placing and receiving cost is Rs.100 per order and annual carrying cost is Rs. 10%. Unit cost of raw material
is Rs 200/-. Calculate Economic Order Quantity.
Solution: EOQ = √ (2 A O)/C

= √ (2 x 4,000 x 100)/ 10% of 200
= √ (8, 00,000/20)
= √40,000
= 200 units
Annual Requirement: 4,000

Ordering cost per order: 100
Carrying Cost: 10%
Price per unit: 200
Lot size No. of orders Ordering cost Carrying cost Total cost
1 2 3 4 5
2=4000/col. 1 3=100xcol.2 4=col.1x100x0.10/2 5=3+4
50 80 8,000 500 8,500
100 40 4,000 1,000 5,000
150 27 2,667 1,500 4,167
200 20 2,000 2,00 4,000

250 16 1,600 2,500 4,100
500 8 800 5,000 5,800
1000 4 400 10,000 10,400
2000 2 200 20,000 20,200
Number of Orders = Annual Requirement/Size of the order

= 4,000/200
= 20
Ordering Cost = Number of Orders x Ordering Cost per order
= 20 x 100
= Rs. 2,000
Carrying Cost = Carrying Cost% x Size of the Order x Price per Unit /2
= 10/100 x 200 x 200/2
= Rs. 2,000
Total Cost = Ordering Cost + Carrying Cost
= Rs. 2,000 + Rs. 2,000
= Rs. 4,000
It can be observed from the above table that the order size of 200 units proves to be the most economic one, in
terms of minimum total cost. If the purchases are made in any other way, the same may not necessarily result in
minimial total cost. From the above table, we can find that for the order size of 200 units, the total cost is lowest i.e.
Rs. 4, 000/- . We can also observe that as the size of the order increases, the number of orders decreases and hence,
the ordering cost decreases but the carrying cost increases. Thus, the ordering cost is inversely proportion to the
size of the order and the carrying cost is directly proportion to the size of the order.
25,000
20,000
15,000 ordering cost

carrying cost
10,000
total cost
5,000
0
1 2 3 4 5 6 7 8
Drawback of EOQ model

In the above modal, various parameters are used such as demand, inventory carrying charges, ordering cost. These
parameters are estimated and though they are assumed to be known, in real life what we have is an estimated value
which may be different than real value for various reasons.
2.4 Determination of Various Inventory Levels

Fixation of various inventory levels facilitates the initiating of proper action in respect of the movement of various
materials in time so that the various materials may be controlled in a proper way. However, the following points
should be remembered.
• Only the fixation of inventory levels does not facilitate the inventory control. There has to be a constant watch
on the actual stock level of various kinds of materials so that proper action can be taken in time.
• The various levels fixed are not fixed on a permanent basis and are subject to revision regularly.
• The various levels which can be fixed are as below:
 Maximum Level
 Minimum Level
 Re-order Level
 Danger Level
2.4.1 Maximum Level

It indicates the level above which the actual stock should not exceed. If it exceeds, it may involve unnecessary
blocking of funds in inventory. While fixing this level, following factors are considered:
• maximum usage
• lead time
• storage facilities available, cost of storage, and insurance etc.
• prices for the material
• availability of funds
• nature of the material
• government regulations in respect of import of goods
• economic order quantity
2.4.2 Minimum Level

It indicates the level below which the actual stock should not reduce. If it reduces, it may involve the risk of non-
availability of material whenever it is required. While fixing this level, the following factors are considered:
• lead time
• rate of consumption
2.4.3 Re-order Level

It indicates that level of material stock at which it is necessarily to take the steps for procurement of further lots of
material. This is the level falling in between the two extremes of maximum level and minimum level and is fixed in
such a way that the requirements of production are met properly till the new lot of material is received.
2.4.4 Danger Level

This is the level fixed below minimum level. If the stock reaches this level, it indicates the need to take urgent
action in respect of getting supply. At this stage, the company may not be able to make the purchases in a systematic
manner, but may have to make rush purchases which may involve higher costs of purchases.
2.4.5 Calculation of Various Levels

The various levels can be decided by using the following mathematical expressions.
Re-order Level = Maximum Lead Time x Maximum Usage
Maximum Level = Reorder Level + Reorder Quantity - (Minimum Usage x Minimum Lead Time)
Minimum Level = Reorder Level - (Normal Usage x Normal Lead Time)
Average Level = (Maximum Level + Minimum Level)/2
Danger Level = Normal Usage x Lead-time for emergency purchases

Note: It should be noted that the expression of the reorder quantity in the calculation of maximum level indicates
economic order quantity.
Illustration 1
Normal usage 50 units per week
Minimum usage 20 units per week
Maximum usage 80 units per week
Reorder quality 500 units
Reorder period 5 to 7 weeks
Compute from the above:

1. Re-order level
2. Minimum level
3. Maximum level
4. Average stock level
Solution
Reorder Level = Maximum Lead time x Maximum Usage 7 weeks x 80 units
= 560 units
Minimum Level = Reorder Level – (Normal Usage x Normal Lead-time)
= 500 units – (50 units X 6 weeks)
= 200 units.
Maximum Level = Reorder Level+Reorder Quantity - (Minimum Usage x Minimum Lead time)
= 560 units + 500 units – (20 units x 5 weeks)
= 960 units.
Average Stock Level = (Minimum Level + Maximum Level)/2
= (200 units + 960 units)/2
= 580 units
Illustration 2
Swarupa Industries manufactures a special product ‘Vick’. The following particulars are collected for the year
1986.
• Monthly demand of 'Vick' - 1000 units
• Cost of placing an Order - Rs.100
• Annual carrying cost per unit - Rs.15
• Normal Usage 50 units per week
• Minimum Usage 25 units per week
• Maximum Usage 75 units per week
• Re-order period 4 to 6 weeks
Compute the following:

• Re-order Quantity
• Re-order Level
• Minimum Level
• Maximum Level
• Average Stock Level
Solution
Reorder Quantity;
EOQ = √(2 A O)/C
= √(2 X 12,000 X 100)/ 15
= √(24,00,000/15)
= √1,60,000
= 400 units
Reorder Level = Maximum Lead Time x Maximum Usage
= 6 weeks x 75 units
= 450 units
Minimum Level = Reorder Level - (Normal Usage x Normal Lead time)
= 450 units – (50 units x 5 weeks)
= 200 units
Maximum Level = Reorder Level + Reorder Quantity – (Minimum Usage x Minimum Lead-time)
= 450 units + 400 units – (25 units x 4 Weeks)
= 750 units.
Average Stock Level = (Minimum Level + Minimum Level)/2
= (200 units + 750 units)/2
= 475 units
There may be one more way in which the various inventory levels may be fixed and for this determination of the
safety stock (also called as minimum stock or buffer stock) is essential. Safety stock is that level of stock below
which the actual should not be allowed to fall. The safety stock may be calculated as;
(Maximum Usage x Maximum Lead-time) - (Normal Usage X Normal Lead-time)
According to this method, the various inventory levels as discussed above may be fixed as below.
• Minimum Level = Safety stock
• Maximum Level = Safety Stock + EOQ
• Reorder Level = Safety Stock + (Normal Usage x Normal Lead-time)
• Average Stock Level = (Minimum Level + Minimum Level)/2
= (Safety Stock + Safety stock + EOQ)/2
Illustration 3
Calculate the various levels from the information given hereunder:
1. Total cost of purchasing relating to the order Rs. 20
2. Number of units to be purchased during the year 5,000
3. Purchase price per unit including transportation costs Rs. 50
4. Annual cost of storage of one unit Rs. 5
• Lead time:
 Average ... 10 days
 Maximum... 15 days
 Minimum... 6 days
 Maximum for emergency purchases... 4 days
• Rate of consumption:
 Average... 15 units per day
 maximum... 20 units per day
Solution:
Working Notes:
• Calculation of Safety Stock
= (Maximum Usage x Maximum Lead-time) (Normal Usage x Normal Lead-time)
= (20 units x 15 days) – (15 days x 10 days)
= 300 units - 150 units = 150 units
• Calculation of EOQ
EOQ = √(2 A O)/C
= √(2 X 5,000 X 20)/ 5
= √40,000
= 200 units
Reordering Level
= Safety Stock + (Normal Usage x Normal Lead-time)
= 150 units + (15 units X 10 days)
= 150 units + 150 units
= 300 units.
Maximum Level = Safety Stock + EOQ

= 150 units + 200 units
= 350 units
Minimum Level = Safety Stock = 150 units
Danger Level = Normal Usage x Lead-time for emergency purchases

= 15 units x 4 days
= 60 units
Average Stock Level = (EOQ + Safety Stock + Safety Stock)/2

= (200 + 150 + 150)/2
= 250 units
2.5 ABC Analysis

The ABC classification process is “an analysis of a range of objects, such as finished products, items lying in inventory
or customers into three categories”. This method usually categorises inventory into three classes with each class
having a different management control associated.
• A - Outstandingly important
• B - of average importance
• C - Relatively unimportant as a basis for a control scheme
Each category can and sometimes should be handled in a different way, with more attention being devoted to category
A, less to B and still less to C.
Popularly known as the '80/20' rule, ABC concept is applied to inventory management as rule-of-thumb. It says that
“about 80% of the Rupee value, consumption wise, of an inventory remains in about 20% of the items”. This rule
is frequently used by inventory managers to put their efforts where the benefits are most, in terms of cost reduction
as well as maintaining a smooth availability of stock.
The ABC concept is derived from the Pareto’s 80/20 rule curve. It is also known as the 80-20 concept. Here, Rupee
value of each individual inventory item is calculated on annual consumption basis. It is a determination of the relative
ratios between the number of items and the value of the items consumed on a repetitive basis.
‘A’ class items are closely monitored because of the value involved (70-80%); High value (A), Low value (C) and
intermediary value (B). ABC Analysis is the basis for material management processes and helps define how stock
is managed. It can form the basis of various activity including leading plans on alternative stocking arrangements
(consignment stock), reorder calculations and can help determine at what intervals, inventory checks are carried out
(for example A class items may be required to be checked more frequently than C class stores. The ABC classification
system is grouping of items according to annual issue value, (in terms of money), in an attempt to identify the small
number of items that will account for most of the issue value and that are the most important ones to control for
effective inventory management. The emphasis is on putting effort where it will have the effect is most.
All the items of inventories are put in three categories, as mentioned below:
• A Items: These Items are seen to be of high consumption volume. ‘A’ items usually include 10-20% of all
inventory items, and account for 50-60% of the total Rupee consumption volume
• B Items: ‘B’ items are those that are 30-40% of all inventory items, and account for 30-40% of the total
Rupee consumption volume of the inventory. These are important, but not critical, and don’t pose sourcing
difficulties
• C Items: ‘C’ items account for 40-50% of all inventory items, but only 5-10% of the total
ABC classifications allow the inventory manager to assign priorities for inventory control. Strict control needs to
be kept on A and B items, with preferably low safety stock level. Taking a lenient view, the C class items can be
maintained with looser control and with high safety stock level.
The ABC concept puts emphasis on the fact that every item of inventory is critical and has the potential of affecting,
adversely, production, or sales to a customer or operations. The categorisation helps in better control on A and B
items. ABC classifications can be used to design cycle counting schemes. For example, A items may be counted 3
times per year, B items 1 to 2 times, and C items only once, or not at all.
Suggested policy guidelines for A , B & C classes of items are given below:
A items (High Cons. Val) B items (Moderate cons. Val.) C item (Low cons. Val)
• Very strict cons. Control • Moderate control • Loose control
• No or very less safety stock • Low safety stock • High safety stock
• Phased delivery (Weekly) • Once in three months • Once in 6 months
• Weekly control report • Monthly control report • Quarterly report
• Maximum follow up • Periodic follow up • Exceptional
• As many sources as possible • Two or more reliable • Two reliable
• Accurate forecasts • Estimates on past data • Rough estimate
• Central purchasing/storage • Combination on past data • Decentralised
• Max. efforts to control LT • Combination purchasing • Min. clerical efforts
• To be handled by Sr. officers • Moderate • Can be delegated
• Middle level
ABC analysis assumes the principle of “Vital Few Trivial Many” while considering the inventory structure of any
organisation and is popularly known as “Always Better Control”. It is an analytical method of inventory control
which aims at concentrating efforts in those areas where attention is required most. It is usually observed that only
a few numbers of items of inventory prove to be more important in terms of amount of investment in inventory or
value of consumption, where as a very large number of items of inventory account for a very meagre amount of
investment in inventory or value of consumption. ABC analysis classifies the various inventory items according to
their importance in terms of amount:
• ‘A’ class consists of only a small percentage of a total number of items handled, but is most important in terms
of amount
• ‘B’ Class items include relatively less important items.

• ‘C’ Class items consist of a very large number of items which are less important.
The importance of the various items may be decided on the basis of following factors:
• amount of investment in inventory
• value of material consumption
• critical nature of inventory items
An example of ABC Analysis is given below.
Category No of items Percentage to total number Value in Rs. Percentage to total value
A 150 1.29% 100000 76.92%
B 1500 12.88% 20000 15.38%
C 10000 85.84% 10000 7.69%
Total 11650 100.00% 130000 100.00%
From the above example we can find that the 'A' category items are less in number i.e. 1.29% to total numbers but,
the most important thing is value and they account for 76.92% of the total value. On the other hand, ‘C’ category
items are very high in number since they account for 85.84% to total numbers but, in terms of value they are least
important since they account for 7.69% of the total value. The Material Manager should concentrate on 'A' category
items.
Advantages of ABC Analysis are as under:

• A close and strict control is facilitated on the most important items which constitute major portion of overall
inventory valuation or overall material consumption and due to this the costs associated with inventions may
be reduced.
• The investment in inventory can be regulated in a proper manner and optimum utilisation of the available funds
can be assured.
• A strict control on inventory items in this manner helps in maintaining a high inventory turnover ratio. However,
it should be noted that the success of ABC analysis depends mainly upon correct categorisation of inventory
items and hence, should be handled by only experienced and trained personnel.
2.6 XYZ Analysis

XYZ analysis is one of the basic supply chain techniques, often used to determine the inventory valuation inside
a store. It’s also strategic as it intends to enable the Inventory manager in exercising maximum control over the
highest stocked item, in terms of stock value.
This method usually categorises inventory into three bands with each band having a different management control
associated. Although different criteria may be applied to each category the typical method of scoring an inventory
item is that of annual stock value of said item (Quantity in stock X Price per unit) with the result then ranked and
then scored (X, Y or Z).
Bandings may be specific to the industry but typically follow a 70%, 90%, 100% banding, in that X class items
represent 70% of the stock value (although they may account for 20% number wise), Y class items fall between 70%
and 90% of the annual stock value with Z class the remaining. In practical terms the complex high cost materials
typically fall into the X class items, with the consumable, low cost (and typically fast moving) classed as Z class.
Not all stock is equally valuable and therefore doesn’t require the same management focus. The results of the XYZ
analysis provide information that helps evaluate how each inventory part should be monitored and controlled. X
class items which are critically important and require close monitoring and tight control – while this may account
for large value these will typically comprise a small percentage of the overall inventory count. Y class is of lower
criticality requiring standard controls and periodic reviews of usage. Z class requires the least controls.
Classification of inventory in terms of XYZ is also quite strategic as it can form the basis of various activity
including leading plans on alternative stocking arrangements (consignment stock), reorder calculations and can help
determine at what intervals inventory checks are carried out. For example X class items may require to be checked
more frequently than Z class stores.
The main difference between the ABC Analysis and XYZ Analysis is that in case of ABC Analysis, the materials are
classified on the basis of value of materials consumed where as in case of XYZ Analysis; the materials are classified
on the basis of value of materials held in the stock.
Inventory plays an important role for any organisation as it blocks the working capital which otherwise would have
earned the organisation some money. While the need for having inventory can’t be denied for any running plant /
machinery, its availability in controlled measures too is highly desirable. Control techniques such as ABC and XYZ
analyses try to ensure the maximum control of materials.
AX control
One of the ways to have still better (tight) control over the inventory with still less commitment of resources is by
determining the AX category of items in a given inventory. Once ABC and XYZ analyses have been done and a
list of A and X classes of items is drawn then AX category is a combination of the two categories. Going by the
definition of A and X separately, AX category of items, normally, display a high consumption (A) as well as a high
stock value (X). Essentially, these items are high value, in terms of overall procurement cost.
Obviously, the measures that need to be taken to keep AX inventory under control is similar to that of A or X items
that are:
• stock less number at any given time
• have tight consumption control
• more sources so that supply doesn’t become a constraint when needed etc.
Based on the ABC and XYZ analysis there is another control mechanism, popularly known as AX control. Materials
falling under A category under ABC analysis and X category under XYZ analysis are included in AX category and
maximum control is exercised on these items.
The combination of ABC analysis and XYZ analysis will give the following alternatives.
X Y Z
A AX AY AZ
B BX BY BZ
C CX CY CZ
AX category the most important items of materials and CZ category the least important category.
Summary
• The object of inventory control is to reduce the investment in the inventory without affecting the efficiency in
the area of production and sales.
• It is essential to maintain the inventories in order to enhance stability of production and employment levels.
• Cost of increasing production and employment level, involves: employment and training, additional staff and
service activities, added shifts, and overtime costs.
• Cost of decreasing production and employment level, involves: employee compensation, other employee costs,
staff, clerical and service activities, and total time costs.
• Material Cost is the “cost of commodities and materials used by the organisation”. It can be direct or indirect.
• Direct Material indicates that material which can be identified with the individual product and which becomes
an integral part of the finished goods.
• Indirect Material indicates that material which cannot be identified with the individual product.
• Ordering or set up costs: These are the costs associated with ordering or manufacturing goods through purchasing
or manufacturing.
• Purchase cost or production cost (Material Cost): When large production runs are in process, these results in
reduction of production cost per unit.
• The cost associated with carrying or holding the goods in stock are known as carrying or holding costs.
• The costs that are incurred as a result of running out of stock are known as stock out or shortage costs.
• Economic Order Quantity (EOQ) models are the most basic models of inventory management. EOQ model is
essentially a trade-off between various relevant costs and derive an order quantity and time for placing an order
in such a way that the total costs are minimised.
• Formula for calculating Economic Order Quantity can be given as - EOQ = √ (2 A O)/C
• Various inventory levels are: maximum, minimum, re-order and danger level.
• The ABC classification process is “an analysis of a range of objects such as, finished products, items lying in
inventory or customers into three categories”.
• XYZ analysis is one of the basic supply chain techniques, often used to determine the inventory valuation
inside a store.
References
• Aswathappa, K., 2010. Production and Operations management- Manufacturing and Service operations,
Himalaya publishing House.
• Kumar, S.A., 2006. Production and operations management-Introduction to production and operations
management, New Age International.
• Introduction to Product and Operations Management, [Pdf] Available at: <http://www.newagepublishers.com/
samplechapter/001233.pdf> [Accessed 13 February 2013].
• Tutor2u, Introduction to POM, [Online] Available at: <http://tutor2u.net/business/production/pom_introduction.
html> [Accessed 13 February 2013].
com/watch?v=nT2b5CGuIvM> [Accessed 13 February 2013].
• 2010. Introduction to Product Management, [Video online] Available at: <http://www.youtube.com/
watch?v=ONrbwhPxJUc> [Accessed 13 February 2013].
Recommended Reading
• Arora, K. C., 2004. Production and Operations Management, Service Operations, Firewall Media.
• Kolli, S., Essentials of Production and Operations Management, Research and entertainment Association.
• Khanna, Production And Operations Management, PHI Learning Pvt. Ltd.
Self Assessment
1. material indicates that material which cannot be identified with the individual product.
a. Inventory
b. Direct
c. Indirect
d. Costly
2. The heart of analysis resides in the identification of relevant costs.

a. product
b. finished goods
c. raw material
d. inventory
3. The ABC concept is derived from which of the following?

a. Pareto’s 20/80 rule curve
b. Pareto’s 40/20 rule curve
c. Pareto’s 40/80 rule curve
d. Pareto’s 80/20 rule curve
4. What is material cost categorised into?

a. Variable Cost
b. Fixed cost
c. Explicit cost
d. Implicit cost

a. Inventory plays an important role for any organisation as it blocks the working capital which otherwise
would have earned the organisation some money.
b. All the stock is equally valuable and therefore doesn’t require the same management focus.
c. Safety stock is that level of stock below which the actual should not be allowed to fall.
d. The cost increases with the increase in the level of production activity and vice versa.

a. Inventory is an profitable resource, it is almost essential to keep some inventory in order to promote smooth
and efficient running of business.
b. The objective of inventory control is to avoid the situation of over stocking as well as under stocking.
c. It is not essential maintain the inventories in order to enhance stability of production and employment
levels.
d. The level of inventories should be maintained at the minimum level.
7. Analysis is the basis for material management processes and helps define how stock is managed.
a. Profit
b. ABC
c. XYZ
d. Inventory
8. costs are generally assumed to be independent of the quantity ordered or produced.

a. Ordering
b. Purchasing
c. Carrying
d. Set-up
9. Which of the following is that level of stock below which the actual should not be allowed to fall?
a. Safety
b. Optimum
c. Required
d. Purchase
10. Which of the following is the correct formula for calculating economic order quantity?
a. EOQ = √ (3 A O)/C
b. EOQ = √ (4 A O)/C
c. EOQ = √ (2 C O)/A
d. EOQ = √ (2 A O)/C
Chapter III
Material Requirements Planning
Aim
• explain the concept of Material Requirements Planning (MRP)
• elucidate objectives and advantages of MRP
• explain the limitations of MRP and analyse its system components
Objectives
• define MRP and determine its system components
• recognise the objectives, advantages and limitations of MRP
• describe the concept of demand dependency
Learning outcome
At the end of this chapter, you will be able to understand:
• describe MRP and its objectives, advantages and limitations
• understand system components of MRP
• identify MRP in changing environment

3.1 Introduction
In the recent times, Material Requirements Planning (MRP) systems have replaced conventional planning systems
which were reactive inventory systems in several organisations. The traditional reactive systems were simple to
manage but were having serious drawbacks such as high inventory costs and unreliable delivery performance.
However, the new system is more complex to manage but has several advantages. It reduces inventories and their
associated costs as it carries only those items and components that are actually needed. Through its forward planning
approach, it ensures that all the materials required are available whenever needed for production and aims at reducing
order-processing delays. By setting realistic job completion dates, jobs can be completed on time, order promises are
kept and production lead times are significantly reduced. Improved customer services, along with other advantages
are achieved in more ways making it economical and effective.
3.2 Definition of MRP

• Material requirements planning is a time phased priority-planning technique that calculates material requirements
and schedules supply to meet demand across all products and parts in one or more plants.
• It is a computer based system in which the given Master Production Schedule (MPS) is divided into the required
raw materials, parts and subassemblies needed to produce the end product in each time period, which may be
a week or month of the production horizon.
• MRP is an inventory control process carried out with the aid of the computer to determine time-phased requirement
of components that are used for manufacturing products on the assembly line principles.
• MRP aims at solving problems at inventory control such as, the supply of the components in right quantity
at the right time, to avoid stock pilling of heavy inventory and stock deficiencies, MRP is used for dependent
demand solutions. Computer architecture for MRP can be shown as follows:
Orders
Master
Schedule
Bill of MRP Inventory

materials Program status
Output
Fig. 3.1 Computer architecture for MRP

3.3 System Components

Material requirements planning system can be represented diagrammatically as follows:
Master
Production
Schedule (MPS)
Materials requirement
Inventory ststus file Planning (MRP) Bills of materals file
Processing logic
Order relaese Order rescheduling

Planned orders
requirments (orders to (expedite, deexpedite,
(future)
be released now) cancle, open orders)
Fig. 3.2 Material requirements planning system
Under the MRP system, three major sources of information are necessary, a Master Production Schedule (MPS), a
bill of materials file and an inventory status file. These components are discussed below.
Master Production Schedule (MPS)

• A Master Production Schedule (MPS) is a plan for production, staffing, inventory, and so on. MPS is developed
as the customer orders are received by the firm or from the forecasts of demand before the MRP system begins
to operate.
• The MPS is an input to the MRP system. It is designed to meet market demand by identifying the quantity of each
end product and when it is to be produced during each future period, during production planning horizon.
• Orders are placed for replacement components for customers and entered as end items in the MPS. Thus, MPS
provide the important information for the MRP system
Bills of Materials
• A Bill of Materials or BOM is a list of the raw materials, sub-assemblies, intermediate assemblies, components,
sub-components, parts and the quantities of each needed to manufacture the end product. This information is
obtained from product design documents, work flow analysis and other standard manufacturing and industrial
engineering documents.
• The MRP receives primary information from the BOM i.e. the product structure which shows various components
of the product. Each item in the product is given a unique identification number. Taking into consideration the
master schedule for the end items, MRP schedules the time phase for the orders for the correct components
items in the production structure.
Inventory status file

• The MRP system must retain an updated file of the inventory status of each item in the product structure. This file
provides accurate and up-to-date information about the availability of every controlled item by the MRP system,
which can then maintain an accurate accounting of all inventory transactions both actual and planned.
• The inventory status file contains the identification numbers, quantity on hand, safety stock level, quantity
allocated and procurement lead time of every item.
3.4 Demand Dependency

• The concept of demand dependency is important between the reactive and proactive (planning) systems. The
demand dependency is the degree to which the demand for the same product is associated with the demand for
another item.
• In case of “independent demand”, the demand is unrelated to the demand for other items. However, in case
of a “dependent demand” situation, if we know the demand for one item, we can deduce the demand for the
other related items. For example, If the demand for a product is known, we can calculate how many of its
subcomponents are needed as its demand is already known.
• In the past, industries used reactive control systems such as order quantity, reorder point system ignoring the
dependent and independent demand. Now, large safety stocks are not needed for dependent demand items
because it is possible to calculate the exact amounts required. It is also not necessary to stock up items that are
related to the dependent demand.
• According to A. K. Dutta, the order point techniques based on Economic Order Quantity (EOQ) are more suited
for items having independent demands because they use past usage of sales data to forecast future demands.
But for items which have dependent demands such as lower level components, sub-assemblies, etc., usage data
is unrelated to the past demands.
• Rather than planning for their requirements and timely availability, master production schedules, bills of
materials and inventory records act as starting points. The master production schedule shows the number of
finished goods and the major subassemblies.
• The bills of material prepared for each item define the precise requirements for materials and components. By
consumption, total requirements are arrived at on a need time basis.
• Depending on the nature of the industry, the production process and the item, demand for an inventory item
may be either discrete or continuous. Thus, variability of demand and the complexity of production process are
the determining in using an order point system or time phased materials planning system.
• In job lot or batch production demand discontinuity is pronounced. When production is discontinuous, a product
is broken down in many components, parts subassemblies and the materials planning system coordinates
the ordering, delivery schedule and the start off time variation, which automatically minimises the time of
inventory.
• As there is emphasis on timing rather than quantity, it reduces the probability of production stoppages arising out
of stock outs. At the same time it eliminates the need for maintaining large stocks, which reduces the carrying
cost of inventory further.
• In practice, discontinuous demand indicates necessity and importance of proper timing of delivery schedules
rather than control of inventory through quantity. The EOQ formula, which assumes constant demands subject
to certain random fluctuations at times, further, assumes need for the inventory at hand at all the time. The need
to replenish arises when inventory levels fall below the desirable level through constant depletion.
• It also assumes that this constant demand is predetermined. But the material planning logic assumes that material
is required only when they are actually manufacturing operations and that these would be available in time.
• Earlier it was not done because of huge data processing costs and the time taken for computation. Now, with
the availability of computer facilities at a cheaper rate, computation costs are declining and inventory coasts
are rising. Hence, it has become easier to justify time phased materials planning systems which ensure tight
operational control. It is rapid, flexible and responsive to changes in the requirements.
3.5 Objectives of MRP

Following are the objectives of MRP:
• Inventory reduction: MRP determines the number of components needed and the time when they are needed
to meet the master schedule. It enables the managers to procure the component as it is needed thus avoiding
costs of excessive inventory.
• Reduction in production and delivery lead time: MRP identifies quantities, timings, availabilities, procurement
and production action required of materials and components to meet delivery dead lines. By coordinating
inventories, procurement and production decisions MRP helps in avoiding delays in production. It helps in
arranging production activities in priorities by putting due dates on consumer job orders.
• Realistic commitments: Realistic delivery promises can enhance customer satisfaction and make him delighted.
By using MRP, production system can give information in time and likely delivery time to prospective customers.
The potential customer orders can be added to the system to show the manager how the revised total loading
can be handled with the existing capacity. This will result in more realistic delivery dates.
• Increase in efficiency: MRP provides close coordination amongst various work centres as production progresses
through them. Hence production can be processed with fewer indirect personnel and fewer material interruptions.
The information provided encourages production efficiencies.
• It reduces inventory cost by reducing inventory levels.
• It improves plant operating efficiency by making better use of productivity resources
• Thus, the MRP technique is used as:
 requirement calculator
 manufacturing and planning control system
 manufacturing resource planning system
3.6 Advantages of MRP

MRP is not only a method of calculating how much material to order and when, but it is also a new technique of
conducting manufacturing operations effectively under dynamic conditions. The main advantages of MRP are as
follows:
• Reduced levels of inventory: Helps in achieving better coordination among various orders for components and
production plans for parent items. As a result average inventory level tends to get reduced for dependent demand
items like raw materials and work in progress.
• Better utilisation of human and non human resources: Provides accurate prior information; it helps in improving
delivery systems, flow of work, avoiding intermittent delays and reducing manufacturing cycle times in jobs.
All these result in optimum utilisation of all available resources.
• Improved consumer service: Enables managers to fix delivery dates that are definitely achievable. It helps in
improving the company’s ability to react to changes in customer orders, improve service by providing quality
products at fair prices, meet assembly dates and reduce delivery time significantly.
• Efficient financial planning: Enables to plan effective cash flow requirements. It enables to identify bottleneck
work centres or capacity constraints thus helping the operations manager to take better investment decisions
• Better scheduling: Provides better knowledge about priorities hence better scheduling can be undertaken
easily.
• Improved vendor relations: Enables the purchase department to know the priorities and changes in due dates for
orders so that purchaser places the orders on vendors accordingly. This helps in improving vendor relations.
• Efficient planning: May suggest necessary changes in the Master Product Schedule (MPS) for evaluating an
alternative to it. It helps in projecting facility and equipment requirement, manpower planning, etc. so that the
organisation can survive and grow under competitive conditions.
• Promoting engineering efficiency: Helps in planning the time of design releases as well as design
modifications.
• Dynamic nature: MRP is a dynamic system which is an important advantage. It reacts effectively with changing
conditions. In fact it thrives on change. Changing conditions from the master schedule for several periods in
future can affect not only the end item but also thousands of components. As the product system is computerised
the management can make a new MRP computer run to revise production and procurement plans that react
quickly to changes in customer demands as reflected in the master schedule.
• Rational material decisions: In order to maintain planned production schedules, planned order releases for
necessary items have to be acted upon immediately. Thus, it enables the manager to take rational decisions.
3.7 Limitations of MRP

The limitations of MRP are given below:
• The limitations of MRP arise from the conditions that need to be met before it can be used. Thus, for implementing
MRP, computers are necessary, the product structure has to be assembly oriented, bills of material and inventory
status information need to be regularly collected and computerised and a valid master schedule must be
prepared.
• Limitations related to data integrity. Unreliable inventory and transaction data from the shop can ruin a well-
planned MRP system. Training personnel to keep accurate is not an easy task, but it is critical for the success
of MRP implementation. In general, the system must be accurate and directly useful or else it becomes an
expensive ornament that is bypassed in favour of ad hoc methods.
• Top management support and proper organisation of functions such as production planning and control, materials,
production, quantity, engineering and so on. Timeliness of generating information, effective communication
systems, proper motivation of people, efficient leadership are necessary things for the successful implementation
of MRP. Most of these can be lacking in many organisations.
3.8 Evaluation of MRP

The main advantages of the MRP system over conventional inventory planning approach and fixed order system are:
• improved customer services
• reduced inventory levels
• improved operating efficiency of the production departments
The MRP cannot be applied to all production systems. Conventionally, MRP is applied to production units producing
discrete products for which a bill of materials can be generated. It cannot be applied to service systems like petroleum
refineries or refilling systems, transportation companies and other non manufacturing systems.
MRP is more useful in process-focussed systems that have long process times and complex multistage production
steps. However, MRP is not a panacea to solve all types of inventory planning problems. It cannot function
effectively when there is an ineffective inventory status, BOM files are inaccurate and the MPS is unreliable. MRP
can be efficiently applied where production systems are not well managed and when a comprehensive production
and planning system is needed.
3.9 Keeping MRP Current in a Changing Environment

MRP is dynamic; it is responsive to new job orders from customers, current shop conditions and changes anticipated
in the future. So, the MRP system must be updated with current information. It must provide stability for production
operations in the face changing conditions. The four aspects of MRP are vital elements under dynamic environments.
These are as follows:
• Pegging: It is a process of tracing through the MRP records and levels in the product structure to identify how
changes in the records of the component will affect the records of other components. The pegging procedure
shows exactly which item plans must changed.
• Cycle counting: An accurate record is necessary for MRP, otherwise the production schedule cannot be
maintained, deliveries will be missed and labour and equipment will be inefficiently used. Cycle counting
ensures that on-hand inventories correspond to the quantities shown in the MRP records. The updated records
indicate the excesses or shortage of components and hence production schedules at various work centres need
adjustment.
• Updating: When new jobs arrive or other shop transactions take place, the MRP system must be updated.
• Time fence: MRP has to function under dynamic environments; hence, the changes may lead to unstable and
erratic shop operations or “system nervousness”. Stability can be gained by using time fences in the MRP
system. The time fence is incorporated into the MPS and the shortest lead-time from raw materials to finished
goods is determined .Within this time fence, the MPS is fixed.
3.10 Manufacturing Resource Planning (MRP II)

• Manufacturing Resource Planning (MRP II) evolved from early material requirements planning (MRP) systems
by including the integration of additional data, such as employee and financial needs.
• This system is designed to centralise, integrate and process information for effective decision making in
scheduling, design engineering, inventory management and cost control in manufacturing.
• MRP II is a computer-based system that can create detail production schedules using real-time data to coordinate
the arrival of component materials with machine and labour availability. MRP II is used widely by itself, but
also as a module of more extensive Enterprise Resource Planning (ERP) systems.
3.11 JIT
• Just in Time (JIT) production is a manufacturing philosophy which eliminates waste associated with time, labour,
and storage space. Basics of the concept are that the company produces only what is needed, when it is needed
and in the quantity that is needed.
• The company produces only what the customer requests, to actual orders, not to forecast. JIT can also be defined
as producing the necessary units, with the required quality, in the necessary quantities, at the last safe moment.
It means that company can manage with their own resources and allocate them very easily.
Benefits of JIT
• Reduced set up times in store: A company, in this case, can focus on other processes that might need
improvement.
• Improved flows of goods in/through/out warehouse: Employees will be able to process goods faster.
• Employees who possess multi-skills are utilised more efficiently: The company can use workers in situations
when they are needed, when there is a shortage of workers and a high demand for a particular product.
• Better consistency of scheduling and consistency of employee work hours: If there is no demand for a product
at the time, workers don’t have to be working. This can save the company money by not having to pay workers
for a job not completed or could have them focus on other jobs around the warehouse that would not necessarily
be done on a normal day.
• Supplies continue around the clock keeping workers productive and businesses focused on turnover. Employees
will work hard to meet the company goals.
To achieve the aims of JIT a disciplined approach is needed which incorporates three principles applied to the
organisation:
• Elimination of waste
• Total Quality Management(TQM)
• Total Employee Involvement
3.12 KANBAN
• Japanese are good at manufacturing products. Just ask any global producers of automobiles, copiers, or personal
electronics what happened in the 1980s. They will probably tell you how the Japanese captured a large share of
the global-market by creating world-class standards in design, materials, and management.
• What is often overlooked is the attempt to understand how the Japanese industry succeeds at the services that
support the manufacturing process within the production field, the Kanban process is the most significant of
these services.
• The concept of time-based management is nothing new for managers outside of Japan and has been in practice
for many years. However, the Kanban process involves more than just in time deliveries and inventory control.
Kanban process components are the most ‘exportable’ of Japanese techniques, but the complete process itself
has not yet been successfully adopted outside Japan.
• The Japanese refer to Kanban as a simple parts movement system that depends on cards and boxes/containers
to take parts from one work station to another on a production line.
• Kanban stands for Kan- card, Ban- signal. The essence of the Kanban concept is that a supplier or the warehouse
should only deliver components to the production line as and when they are needed, so that there is no storage
in the production area.
• Within this system, workstations located along production lines only produce/deliver desired components when
they receive a card and an empty container, indicating that more parts will be needed in production.
• Kanban limits the amount of inventory in the process by acting as an authorisation to produce more inventories.
Since Kanban is a chain process in which orders flow from one process to another, the production or delivery
of components is pulled to the production line, in contrast to the traditional forecast oriented method where
parts are pushed to the line.
The advantages of the Kanban process are as follows:

• simple and understandable process
• provides quick and precise information
• low costs associated with the transfer of information
• provides quick response to changes
• limitation over or limits over-capacity in processes
• avoids overproduction
• minimises waste
• control can be maintained
• delegates responsibility to line workers
Summary
• In the recent times MRP systems have replaced conventional planning systems which were reactive inventory
systems in several organisations offering several advantages over the conventional planning systems.
• Material Requirements Planning (MRP) is a material planning methodology which makes use of computer
technology.
• Under the MRP system there are three major sources of information are necessary, a Master Production Schedule
(MPS), an inventory status file and a bill of materials file.
• A Master Production schedule (MPS) is a plan for production, staffing, inventory, etc.
• A Bill of Materials or BOM is a list of the raw materials, sub-assemblies, intermediate assemblies, components,
sub-components, parts and the quantities of each needed to manufacture an end products.
• The Inventory status file provides accurate and up-to-date information about the availability of every controlled
item by the MRP system, which can then maintain an accurate accounting of all inventory transactions both
actual and planned.
• The key features of MRP are the creation of material requirements via exploding the bills of material and time-
phasing of requirements using posted average lead times.
• Main objectives of MRP are inventory reduction, realistic commitments, and increase in efficiency and reduction
in production and delivery lead time.
• The main advantages of the MRP system over conventional inventory planning approach and fixed order system
are improved customer services, reduced inventory levels, and improved operating efficiency of the production
departments.
• MRP cannot be applied to service systems like petroleum refineries or refilling systems, transportation companies
and other non manufacturing systems.
• JIT is producing the necessary units, with the required quality, in the necessary quantities, at the last safe moment.
It means that company can manage with their own resources and allocate them very easily.
• The Japanese refer to Kanban as a simple parts movement system that depends on cards and boxes/containers
to take parts from one work station to another on a production line. Kanban stands for Kan- card, Ban- signal.
References
• Arora, K. C., 2004. Production and Operations Management, Batch Production, Firewall Media.
• Kolli, S., Essentials of Production and Operations Managemen-Different Production Systems, Research and
entertainment Association.
• Birla Institute of Technology and Science, Production, Planning & Control, [Online] Available at: <http://
discovery.bits-pilani.ac.in/dlpd/courses/coursecontent/courseMaterial%5Cmmzg511%5CMOML18.pdf>
[Accessed 15 November 2010].
• Graves, S. C., Manufacturing Planning and Control, [Pdf] Available at: <http://web.mit.edu/sgraves/www/
ProdPlanCh.PDF> [Accessed 13 February 2013].
• Prof. Jain, P. K., Mod-1 Lec-1 Production Planning and Control, [Video online] Available at: <http://www.
youtube.com/watch?v=yYIVumq6sVM> [Accessed 13 February 2013].
• 2008. Production Plannning and Control, [Video online] Available at: <http://www.youtube.com/
watch?v=b143Y7dTfIA> [Accessed 13 February 2013].
Recommended Reading
• Adam, Everette, E. & Ebert, R. J., 2003. Production and Operations Management - Concepts Models and
Behaviour, New Delhi: Pearson Education.
• Buffa, E.S., 1988. Modern Production Management, New Delhi: Wily.
• Charantimath, P., 2003. Total Quality Management, Pearson Education, New Delhi.
Self Assessment
1. MRP is an control process carried out with the aid of the computer.
a. inventory
b. data
c. production
d. automated
2. The concept of demand dependency is important between the ____________ and proactive (planning)
systems.
a. informative
b. reactive
c. automatic
d. productive
3. determines the number of components needed and the time when they are needed to meet the master
schedule.
a. MPR
b. ERP
c. MRP
d. PRM
4. By using MRP, system can give information in time and likely delivery time to the prospective
customers.
a. development
b. manufacturing
c. managerial
d. production
5. The MRP system must retain an updated file of the status of each item in the product structure
a. inventory
b. record
c. index
d. data

a. MRP is used for dependent demand solutions.
b. MRP cannot be used for dependent demand solutions.
c. The MPS is an input to the MRP system.
d. The inventory status file contains the identification numbers, quantity on hand; safety stock level, quantity
allocated and procurement lead time of every item.

a. The MRP receives primary information from the bills of materials.
b. The MRP receives primary information from the inventory files.
c. The MRP receives primary information from the managers.
d. The MRP receives primary information from the workers.
8. Which of the following is not an objective of MRP?

a. Realistic commitments
b. Increase in efficiency
c. Inventory reduction
d. Conceptualisation
9. Which of the following is the advantage of MRP?

a. Reduced levels of inventory
b. Increased levels of inventory
c. Static nature
d. Increased lead time
10. Which of the following contains the identification numbers, quantity on hand; safety stock level, quantity
allocated and procurement lead time of every item?
a. Inventory status file
b. Database file
c. Register file
d. Index file
Chapter IV
Introduction to Enterprise Resource Planning (ERP)
Aim
• explain the students to understand the concept of ERP system
• introduce the ERP and its applications
• explore reasons for the growth of the ERP Market
Objectives
• explain the concept of ERP, its evolution and growth
• describe the advantages of ERP
• elucidate the difference between ERP system and ERP software
Learning outcome
At the end of this chapter, you will able to:
• understand evolution of ERP
• recognise the factors responsible for the growth of ERP market
• analyse the use of ERP

4.1 Introduction
Since last decade, information technology has made a drastic change in our life. As compared to earlier stage, when
computer was used just as a typewriter, nowadays users have become more intelligent and IT literate. Now the user
knows that a PC can do many more things rather then just typing a letter in a word processing software or making
balance sheets in excel. They expect more things out of their PC. During this phase of industry, every one of us must
have heard the word ERP i.e., Enterprise Resource Planning. In one sentence, ERP is a combination of management
practice and technology, where information technology integrates with your company’s core business processes to
enable the achievement of specific business objectives.
4.2 History and Evolution

• Enterprise Resource Planning is the evolution of Manufacturing Requirements Planning (MRP) II in 1980s,
which was mainly related to Manufacturing Industry and was designed to control manufacturing process and
planning the required production with efficient output.
• Where as, MRP is the evolution of Inventory Management and Control conceived in 1960s, which was mainly
designed for management of Stocks in any particular industry.
• ERP has expanded from co-ordination of manufacturing processes to the integration of enterprise-wide backend
processes like production planning and scheduling of delivery.
• In terms of technology, ERP has evolved from legacy implementation to more flexible tiered client-server
architecture.
From business perspective, ERP has expanded from coordination of manufacturing processes to the integration of
enterprise-wide backend processes. From technological aspect, ERP has evolved from legacy implementation to
more flexible tiered client-server architecture.
The following table summarises the evolution of ERP from 1960s to 1990s:
System Year Description
Inventory Management 1960’s • Inventory Management and control is the combination of information
and Control technology and business processes of maintaining the appropriate level
of stock in a warehouse
• The activities of inventory management include identifying inventory
requirements, setting targets, providing replenishment techniques and
options, monitoring item usages, reconciling the inventory balances,
and reporting inventory status
Materials Requirement 1970’s • Materials Requirement Planning (MRP) utilises software applications
Planning for scheduling production processes
(MRP) • MRP generates schedules for the operations and raw material purchases
based on the production requirements of finished goods, the structure
of the production system, the current inventories levels and the lot
sizing procedure for each operation
Manufacturing 1980’s • Manufacturing Requirements Planning or MRP utilises software
Requirement Planning-II applications for coordinating manufacturing processes, from
(MRP-II) product planning, parts purchasing, inventory control to product
distribution.
Enterprise Resource 1990’s • Enterprise Resource Planning or ERP uses multi-module application
Planning software for improving the performance of the internal business
processes.
• ERP systems often integrate business activities across functional
departments, from product planning, parts purchasing, inventory
control, product distribution and fulfillment, to order tracking.
• ERP software systems may include application modules for supporting
marketing, finance, accounting and human resources.
Table 4.1 Evolution of ERP from 1960s to 1990s
4.3 Meaning
• ERP is one of the most widely implemented business software systems in a wide variety of industries and
organisations.
• ERP is the acronym of Enterprise Resource Planning.
• It utilises ERP software applications to improve the performance of organisations resource planning, management
control and operational control.
• ERP software is multi-module application software that integrates activities across functional departments, from
product planning, parts purchasing, inventory control and product distribution to order tracking.
• ERP software may include application modules for the finance, accounting and human resources aspects of a
business.
• ERP is just not only a software but also a business integrating process.
4.4 Definition
'ERP' refers to both ERP software and business strategies that implement ERP systems.
ERP Software
• Software solution that addresses the enterprise needs taking the process view of an organisation to meet the
organisational goals tightly integrating all functions of an enterprise.
ERP System
• An ERP system is more than sum of its parts or components which interacts together to achieve a common goal
streamline and improve organisations business processes.
• ERP components includes; ERP Software, Business Processes, Users and Hardware.
4.5 Concept
• The term ERP originally referred to how a large organisation planned to use organisational wide resources.
• In the past, ERP systems were used in larger more industrial types of companies. However, the use of ERP has
changed and is extremely comprehensive, today the term can refer to any type of company, no matter what
industry it falls in. In fact, ERP systems are used in almost any type of organisation large or small.
• In order for a software system to be considered ERP, it must provide an organisation with functionality for two
or more systems. While some ERP packages exist that only cover two functions for an organisation (Payroll
and Accounting) most ERP systems cover several functions.
• An ERP system is based on a common database and a modular software design. The common database can
allow every department of a business to store and retrieve information in real-time. The information should be
reliable, accessible, and easily shared.
• The modular software design should mean a business can select the modules they need, mix and match modules
from different vendors, and add new modules of their own to improve business performance.
• Today’s ERP systems can cover a wide range of functions and integrate them into one unified database. For
instance, functions such as Human Resources, Supply Chain Management, Customer Relations Management,
Financials, Manufacturing functions and Warehouse Management functions were all once stand alone software
applications, usually housed with their own database and network, today they can all fit under one umbrella of
ERP system.
4.6 Implementation of an ERP System

• Implementing an ERP system is not an easy task to achieve, in fact it takes lots of planning, consulting and in
most cases 3 months to 1 year.
• ERP systems are extraordinary wide in scope and for many larger organisations can be extremely complex.
Implementing an ERP system will ultimately require significant changes on staff and work practices.
• While it may seem reasonable for an in house IT staff to head the project, it is widely advised that ERP
implementation consultants be used, due to the fact that consultants are usually more cost effective and are
specifically trained in implementing these types of systems.
• One of the most important traits that an organisation should have when implementing an ERP system is
ownership of the project. Because so many changes take place and its broad effect on almost every individual
in the organisation, it is important to make sure that everyone is on board and will help make the project and
using the new ERP system a success.
• Usually organisations use ERP vendors or consulting companies to implement their customised ERP system.
• There are three types of professional services that are provided when implementing an ERP system, they are
Consulting, Customisation and Support.
 Consulting services: Usually consulting services are responsible for the initial stages of ERP implementation,
they help an organisation go live with their new system, with product training, workflow, improve ERP’s
use in the specific organisation, etc.
 Customisation services: Customisation services work by extending the use of the new ERP system or changing
its use by creating customised interfaces and/or underlying application code. While ERP systems are made
for many core routines, there are still some needs that need to be built or customised for an organisation.
 Support services: Support services include both support and maintenance of ERP systems. For instance,
trouble shooting and assistance with ERP issues.
4.7 Advantages of ERP

Advantages can be both direct and indirect.
The direct advantages are:
• improvement in integrating business
• communications with the use of information within the organisation is made fast and effective
• creating adequate function and flexible efficiency
• a unifying system smoothens out the various bottlenecks of information and uses a single language for maintaining
business advantage
• providing advantage for planning and analysis
• easy access to update information helps in proper planning, decision making utilising relevant analysis
• updating information and technology in the organisation
• by continuous up gradation in both information and technology the organisation remains modern and avoid
stagnancy
The indirect advantages are:

• Customer goodwill and relations: Rapidly responding to customer demands is one of the great advantages
that ERP can offer for successful business. Fulfilling the demands automatically creates goodwill and strong
relationships with the customer.
• Helps in creating customer satisfaction: Changes in customer demands can be rapidly incorporated with the use
of the ERP. Customer satisfaction is thus maintained.
• Enhances the image of the organisation: The ability to deliver on time and with effectiveness creates a strong
trust in the minds of the customers and society. This enhances the corporate image of the organisation.
4.8 Disadvantages of ERP

Usually many obstacles can be prevented if adequate investment is made and adequate training is involved however,
success does depend on skills and the experience of the workforce to quickly adapt to the new system. While
advantages usually outweigh disadvantages for most organisations implementing an ERP system, here are some of
the most common obstacles experienced some of the most common obstacles experienced are listed below:
• customisation in many situations is limited
• the need to reengineer business processes
• ERP systems can be cost prohibitive to install and run
• technical support can be shoddy
• ERPs may be too rigid for specific organisations that are either new or want to move in a new direction in the
near future
4.9 Applicability of ERP

ERP and its predecessors MRP-II have been successfully implemented in companies with the following
characteristics:
• make-to-stock
• make-to-order
• design-to-order
• complex product
• simple product
• multiple plants
• single plant
• contract manufacturers
• manufacturing with distribution networks
• sell direct to end users
• sell through distributors
• business heavily regulated by the government
• conventional manufacturing
• process manufacturing
• repetitive manufacturing
• job shop
• flow shop
• fabrication only
• assembly only
• high-speed manufacturing
• low-speed manufacturing
In every sector of an industry network, ERP has virtually universal application. ERP is the body of knowledge that
contains the standard best practices for managing an enterprise.
4.10 Reasons for the Growth of the ERP Market

There is no question that the market for enterprise resource planning (ERP) systems is much demanded. Industry
analysis is forecasting growth rates of more than 30% for at least the next five years. Why are so many companies
replacing their key business systems?
Here are some reasons:

• enables improved business performance
 cycle time reduction
 increased business agility
 inventory reduction
 order fulfilment improvement
• supports business growth requirements
 new products/product lines, new customers
 global requirements including multiple languages and currencies
• provides flexible, integrated, real-time decision support
 improve responsive across the organisation
• eliminates limitation in legacy systems
 century dating issues
 fragmentation of data and processing
 inflexibility to change
 insupportable technologies
• takes advantage of the untapped mid-market (medium-size organisations)
 increased functionality at a reasonable cost
 client-server/open system technology
 vertical market solutions
There are some of the reasons for the explosive growth rate of the ERP markets and ERP vendors. As more and more
companies are joining the race and as the ERP vendors are shifting their focus from big fortune 1000 companies to
different market segments the future will see fierce battle for market share and mergers and acquisitions for strategic
and competitive advantage. The ultimate winner in this race will be the customer, who will get better products and
better service at affordable prices.
4.11 Success of the ERP

It is important to understand that choosing the right the ERP package and ensuring its correct implementation is of
utmost importance. A wrong package wrongly implemented can threaten the organisational efficiency.
To ensure the effective use of ERP

• A proper understanding of the business in the organisation by its people is necessary.
• ERP package should best be suited to meet the requirements of the organisation. A good vendor can make a
significant difference in this regard.
• Implementation of the ERP program should be accurately planned and executed well .
• End user training is necessary to ensure the correct implementation and maintenance of the ERP.
Summary
• Enterprise Resource Planning is one of the fastest growing segments in information technology. It enables
organisations to respond quickly to the ever increasing customer needs and to capitalise on market
opportunities.
• According ERP definition it is a combination of management practice and technology, where information
technology integrates with your company’s core business processes to enable the achievement of specific
business objectives.
• The term ERP originally referred to how a large organisation plans to use its wide resources.
• ERP systems were used in larger more industrial types of companies.
• In order for a software system to be considered ERP, it must provide an organisation with functionality for two
or more systems.
• The modular software design should mean a business can select the modules they need, mix and match modules
from different vendors, and add new modules of their own to improve business performance.
References
• Schonberger, R. J., 1986. World Class Manufacturing, New York: Free Press.
• Sommers, M. S. & Kernan, J. B., 1965. A Behavioural Approaching to Planning, Layout and Display.
• 2012. Capacity Planning & Facility Location, [Pdf] Available at: <http://www1.pu.edu.tw/~ylai/OM/1011/
ppts_f12/1011_OM_Ch09_F12.pdf> [Accessed 13 February 2013].
• PRODUCTION PLANNING AND CONTROL, CHAPTER 4: FACILITY CAPACITY, LOCATION AND
LAYOUT, [Pdf] Available at: <http://www1.pu.edu.tw/~ylai/OM/1011/ppts_f12/1011_OM_Ch09_F12.pdf>
[Accessed 13 February 2013].
• 2008. Capacity Planning and Capacity Management Tips, [Video online] Available at: <http://www.youtube.
com/watch?v=m4NJnhekJPw> [Accessed 13 February 2013].
• Prof. Singh, I., 2010. Mod-4 Lec-6 Capacity Planning – I, [Video online] Available at: <http://www.youtube.
com/watch?v=FHauhdppEDA> [Accessed 13 February 2013].
Recommended Reading
• Bollinger, S., 1998. Fundamentals of Plant Layout, Society of Manufacturing Engineers in Association with
Richard, Muther and Associates.
• Francis, R. L. & White, J. A., 1992. Facility Layout and Location: An Analytical Approach. Englewood Cliffs,
NJ: Prentice Hall.
• Ghosh, S. & Gagnon, R., 1989. A Comprehensive Literature Review and Analysis of the Design, Balancing and
Scheduling of Assembly Systems, International Journal of Production Research.
Self Assessment
1. ERP is combination of and .
a. technology, assessment
b. assessment, management
c. management, technology
d. technology, business process
2. In EPR information technology integrates with company’s to achieve its ultimate goal.
a. business ethics
b. business processes
c. management
d. resources
3. ERP is evolution of .
a. manufacturing requirement planning
b. material resource planning
c. production planning
d. capacity resource planning
4. MRP is evolution of .
a. capacity resource planning
b. manufacturing requirement planning
c. production capacity and control
d. inventory management and control
5. utilises software applications for scheduling production processes.

a. Manufacturing requirement planning
b. Materials requirement planning
c. Inventory management and control
d. Enterprise resource planning
6. Match the following

1. ERP software A. ERP software, Processes, Hardware
2. MRP-II B. Scheduling Production Processes
3. MRP C. Coordinating manufacturing processes
4. ERP system D. Multi-module application software

a. 1-D, 2-A, 3-C, 4-B
b. 1-A, 2-B, 3-C, 4-D
c. 1-B, 2-C, 3-D, 4-A
d. 1-D, 2-C, 3-B, 4-A
7. Which of the following services is responsible for the initial stages of ERP implementation?
a. Generation
b. Customisation
c. Consulting
d. Support

a. ERP systems are used only for large organisations.
b. ERP systems are used only in small organisations.
c. ERP systems are used in both large as well as small organisations.
d. ERP systems are used in long term planning.
9. In ERP systems, common database can allow every department of a business to .

a. store information
b. retrieve information
c. store and retrieve information
d. store and process information
10. On which of the following is the ERP system based?

a. Database and Software design
b. Database and Processes
c. Processes and Software design
d. Database
Chapter V
Inventory Models
Aim
• introduce to the concept inventory models
• explain the model of accepting and rejecting discounts on purchases
• elucidate the advantages and disadvantages of the inventory models
Objectives
• define concept of material requirement planning (MRP)
• explicate the inputs and outputs of material requirement planning (MRP)
• enlist the fixed order and fixed interval system
Learning outcome
• understand the concept of inventory turnover
• identify the benefits of material requirement planning (MRP)
• recognise the applicability of material requirement planning system

5.1 Introduction to Inventory Models

Material management is a day to day function. Various decisions regarding right size of the order, right price have to
be taken on an on going basis. These decisions are repetitive in nature. They involve a lot of calculations. Therefore,
it is advisable for the industries to develop certain models especially using information technology. These models
can take care of calculation part and give enough time to the material managers to take the decision. The models
will act as an aid to the managers to compare various offers, discounts prices etc.Inventory model is “a mathematical
equation or formula that helps a firm in determining the economic order quantity, and the frequency of ordering, to
keep goods or services flowing to the customer without interruption or delay”.
5.2 Models for Accepting/Rejecting Discounts on Purchases

Many a times the suppliers of raw material come with an offer of discount on the catalogue price if a certain minimum
quantity is ordered. The manufacturers may be tempted to accept the order thinking that they will make profit by
availing the discount. Accepting or rejecting such decisions should not be impulsive decisions of the purchase
department. They should be conscious decisions based on calculations and quantification of benefits.
If a manufacturer orders a quantity which is more than the economic order quantity (EOQ) the following two things
will happen:
• Reduction in cost due to:
 discount on the price of the raw material
 reduction in ordering cost, because the number of orders goes down
• Increase in Carrying cost:
 If the reduction in cost is more than the increase in carrying cost then only a manufacturer should accept
the discount offer. Other wise he should reject the offer.
If A > B, accept the discount offer.

If A < B, reject the discount offer.
We can develop a model using excel spread sheet which will help us in taking a decision. We have to just feed the
original data. Rest of the calculations and comparisons are done by the computer.
The following is the model developed in excel spread sheet. Those have working knowledge of Excel can easily
understand this format and formulae used.
Row No.\Column Name A B C

1 Accept/reject a discount model
2 A) Basic information
3 1 Annual requirement units 20,000
4 2 Ordering cost per order 2,000
5 3 Carrying cost 20%
6 4 Price per unit 100
7
8 5 Discount quantity units 5,000
9 6 Discount rate 1%
10
11 B) If EOQ model followed
12 1 EOQ units -SQRT((2*C3*C4)/(C5*C6))

13 2 No. of orders -C3/C12
14 3 No. of orders rounded off -CEILING(C13,1)
15 4 Ordering cost -C4*C14
16 5 Carrying cost -C12/2*C5*C6
17 6 Material cost -C3*C6
18 7 Total Cost in Rupees -C15+C16+C17
19
20 C) If discount offer is accepted
21 1 Discount quantity -C8
22 2 No. of orders -C3/C21
23 3 No. of orders rounded off -CEILING(C22,1)
24 4 Ordering cost -C4*C23
25 5 Carrying cost -C21/2*C5*C6
26 6 Material cost -C3*C6*(1-C9)
27 7 Total cost rupees -C24+C25+C26
28
29 D) Benefit of discount offer =C18-C27
30 E) Decision =IF(C29>0, “Accept”,” Reject”)
Table 5.1 Model developed for accepting/rejecting discounts on purchases in excel spread sheet
Illustration 1
A B C
Accept/reject a discount model
A) Basic information
1 Annual requirement units 20,000
2 Ordering cost per order 2,000
3 Carrying cost 20%
4 Price per unit 100
5 Discount quantity units 5,000
6 Discount rate 1%
B) If EOQ model followed

1 EOQ units 2,000
2 No. of orders 10
3 No. of orders rounded off 10
4 Ordering cost 20,000
5 Carrying cost 20,000
6 Material cost 2,000,000
7 Total Cost Rupee 2,040,000
C) If discount offer is accepted
1 Discount quantity 5,000
2 No. of orders 4
7 Total cost rupees 2,038,000
D) Benefit of discount offer 2000
E) Decision Accept
Illustration 2
A B C
Accept/reject a discount model
1 Annual requirement units 10,000

2 Ordering cost per order 1,000
3 Carrying cost 10%

4 Price per unit 200
5 Discount quantity units 4,000

6 Discount rate 1%

1 EOQ units 1,000
2 No. of orders 10

7 Total Cost Rupee 2,020,000
C) If discount offer is accepted

1 Discount quantity 4000
2 No. of orders 3
7 Total cost rupees 2,023,000
D) Benefit of discount offer -3000

E) Decision Reject
Illustration 3
The Purchase Department of the organisation has received an offer of quantity discounts on its orders of materials
as under:
Price Per Ton Order Size in Tons
1,200 Less than 500
1,180 500 and less than 1000
1,160 1000 and less than 2000
1,140 2000 and less than 3000
1,120 3000 and above
The annual requirement for the material is 5000 tons. The delivery cost per order is Rs.1,200 and the stock holding
cost is estimated at 20% of material cost per annum. You are required to advice the Purchase department the most
economic purchase level.
Solution:
Price per Purchase No. of Ordering

Lot Size Carrying cost Total cost
ton price orders cost
1 2 3 4 5 6 7
3- 4- 5000/ 5-1200X-
6-col.3X20/2 7-col.3+col.5+col.6
5000Xcol.2 col.1 col.4
100 1,200 6,000,000 50 60,000 12,000 6,072,000
250 1,200 6,000,000 20 24,000 30,000 6,054,000
500 1,180 5,900,000 10 12,000 59,000 5,971,000
625 1,160 5,900,000 8 9,600 73,750 5,983,350
1000 1,160 5,800,000 5 6,000 116,000 5,922,000
1250 1,160 5,800,000 4 4,800 145,000 5,949,800
2500 1,120 5,600,000 2 2,400 280,000 5,882,400
5000 1,100 5,500,000 1 1,200 550,000 6,051,200
Observations from the above table:

• As the lot size increases the number of order decreases, hence the ordering cost also decreases.
• As the lot size increases the carrying cost increases.
• As the lot size increases the material cost decreases due to discount for higher quantity.
• A lot of size of 500 units is the economic order quantity (EOQ) since the total cost is lowest at this level.
• Even though the discount is highest for an order of 2500 units, this is not economical because, the benefit of
discount plus reduction in ordering cost is less than increase in carrying cost.
5.3 Fixed Order vs. Fixed Interval System

There are two basic systems of managing or controlling inventory under the independent demand pattern:
• Cyclical ordering or Fixed period system (Time based)
• Order point or Fixed order quantity system (Quantity based)
5.3.1 Cyclical Ordering or Fixed Period System (Time Based)

• Fixed period based systems (also called cyclical systems), are designed so that each inventory item is reviewed
and reorders are placed after a predetermined time interval (i.e. every two weeks, every thirty days, etc.).
• Orders are placed for each item equal to the difference between current inventory level and a predetermined
maximum. In cyclical systems, time between reorders is constant, but reorder quantity is variable.
• Predetermined maximums are set with a consideration of order lead time.

• It involves scheduled periodic reviews of the stock level of all inventory items. This is given below in detail.
Fixed schedule (calendar) for reviewing a group of items is drawn, fixed Desired Inventory Level (DIL) of each
item or group of items is calculated. In case where stock level of an item is insufficient to sustain the production
operation until the next scheduled review, order is placed to replenish the stock to DIL, maintenance of perpetual
inventory records.
Procedure
• First, all the inventory items are grouped in certain feasible categories or classes of items such as pipes & pipe
fittings, raw materials, chemicals and reagents, oil and lubricants, etc.
• Now, a calendar is drawn for all the classes so that depending upon the number of classes each class is reviewed
for replenishment during certain specified time frame.
• The DIL for each group or individual item is fixed.
• DIL = (Review Period + Lead Time + Safety Stock) x Periodical Demand
Illustration
Review Period = 30 days
Lead Time = 15 days
Safety Stock = 10 days
Daily Demand = 100 units
Desired inventory level (DIL) = (30 +15 +10) x 100 = 5,500
If the actual quantity on hand is 1,400 on the date of reorder, the reorder quantity will be 5,500 - 1,400 = 4,100.
Depending upon the review period, a class of items is reviewed with reference to its stock position, production plan,
any dues in quantity against any previous order. During review and based on the lead time, if the present stock of
an item or group of items is not expected to last the next production plan then action for replenishment is taken by
raising the material procurement requisition.
The order quantity = (DIL - (Present stock + dues in)
This system is suitable for the following:

• for materials whose purchases can be planned months in advance
• for materials which exhibit an irregular or seasonal usage pattern
• for items with volatile prices
• for group of items purchased from and shipped together by one supplier
Disadvantages of the system are as under:

• compels periodic reviews of all items
• not effective to combat stock out situations
• actual ordering quantities may deviate from optimum quantity
• tends to peak the purchasing work load around the review dates
• there is no automatic trigger for reorder before the review time in the event of increased usage, which generally
leads to increased inventory levels as a means of stock out prevention
• system does not permit effective use of economic order quantities
Illustration of disadvantages of fixed period
Change in Change in Change in Change in

annual quantity unit price ordering cost carrying cost
1 Annual requirement units 20,000 12,000 20,000 20,000 20,000
2 Ordering cost per order 2,000 2,000 2,000 1,000 2,000
3 Carrying cost 20% 20% 20% 20% 10%
4 Price per unit 100 100 200 100 100
1 EOQ units 2,000 1,549 1,414 1,414 2,828
2 No. of orders 10 8 14 14 7
3 No. of orders rounded off 10 8 15 15 8
4 Ordering cost 20,000 16,000 30,000 15,000 16,000
5 Carrying cost 20,000 15,492 28,284 14,142 14,142
6 Material cost 2,000,000 1,200,000 4,000,000 2,000,000 2,000,000
7 Total cost rupees 2,040,000 1,231,492 4,058,284 2,029,142 2,030,142

C) If fixed period is
followed
1 Review period days 30 30 30 30 30
2 Lead period days 15 15 15 15 15
3 Safety stock days 10 10 10 10 10
4 Daily demand 67 40 67 67 67
5 DIL 3,667 2,200 3,667 3,667 3,667
9 Ordering cost 24,000 24,000 24,000 12,000 24,000
10 Carrying cost 36,667 22,000 73,333 36,667 18,333
11 Material cost 2,000,000 1,200,000 4,000,000 2,000,000 2,000,000

D) Benefit/loss due to fixed
-20,667 -14,508 -39,049 -19,525 -12,191
period
The above illustration shows that if a fixed period system is followed, there will be loss compared to EOQ model.
Order point or fixed order quantity system (Quantity based)

Order point system/fixed order quantity system of inventory control is based on the order point and order quantity
factors rather than on the time factor. The inventory policy is drawn after defining the following:
• fixed order point/re-order level (ROL) for each item
• fixed maximum, minimum levels for each item
• fixed quantity to be ordered often called Min-Max systems; these involve both a maximum inventory level and
a minimum at which reorders are generated
Basically, units of an item are issued until the level of that inventory reaches the predefined reorder point. An order
is then triggered for a predetermined quantity (usually a calculated economic order quantity). In this system, the
order quantity is constant and the time between orders is variable.
The different inventory points (Levels) of stock for an item are:

• Maximum level (Max.), predetermined
• Minimum Level (Safety Stock, SS), predetermined
• Lead time (LT), predetermined
• Monthly demand = D (often based on Moving average method)
• MaxL= (Review period + LT + SS) x D
• Reorder level (ROL) = (LT + SS) x D
• Order Quantity (OQ) = Max – (Present stock + Pipeline dues)
Process
In course of consumption of an inventory item in the form of issue from stores to the users, the stock level of the
item starts depleting through its usage rate D. As per the above definition, the stock goes up to the maximum level
in the first replenishment and then, because of steady consumption, comes gradually down. In that process, again
it touches the Reorder Level (ROL). As soon as the stock level touches the ROL, fresh replenishment action is
initiated. It is presumed that the next lot shall arrive by the time the present depleting stock touches the safety stock,
keeping a stable lead time and a stable usage rate D.
Advantages of Fixed order quantity system

• Each item is procured in the most economical quantity
• An item is attended to only when it needs attention i.e. when its stock has reached the ROL
• Control can be exercised on inventory with reference to maximum & minimum levels.
• Applicability of Order Point system: Item must have a reasonable stable usage
• Lead time should not have radical variation
• Supplier should be able to accept irregularly timed and unscheduled orders
Limitations of the Fixed order quantity system:

• Needs continuous monitoring of stock level of each item
• Cumbersome to operate for items with unstable usage and lead time
• Perpetual inventory records are required
Change in Change in Change in Change in

annual quantity unit price ordering cost carrying cost
1 Annual requirement units 20,000 12,000 20,000 20,000 20,000
2 Ordering cost per order 2,000 2,000 2,000 1,000 2,000
3 Carrying cost 20% 20% 20% 20% 10%
4 Price per unit 100 100 200 100 100
B) If EOQ model
followed
1 EOQ units 2,000 1,549 1,414 1,414 2,828
2 No. of orders 10 8 14 14 7
4 Ordering cost 20,000 16,000 30,000 15,000 16,000
5 Carrying cost 20,000 15,492 28,284 14,142 14,142
6 Material cost 2,000,000 1,200,000 4,000,000 2,000,000 2,000,000
C) If fixed order is
followed
1 Fixed order quantity 1,000 1,000 1,000 1,000 1,000
2 No. of orders 20 12 20 20 20
3 No of orders rounded off 20 12 20 20 20
4 Ordering cost 40,000 24,000 40,000 20,000 40,000
5 Carrying cost 10,000 10,000 20,000 10,000 5,000

Illustration to highlight disadvantages of the fixed order system
6 Material cost 2,00,000 1,200,000 4,000,000 2,000,000 2,000,000
D) Benefit/loss due to
-10,000 -2,508 -1716 -858 -14,858
fixed order
5.4 Material Requirement Planning (MRP)

Dependent demand occurs when the need for parts, supplies, or materials is dependent upon a predetermined usage
or production schedule. In such cases, a description and quantity of components needed and the exact date of each
need is defined by a production schedule. Required delivery dates for each component will then be offset by lead
time, and orders will be placed accordingly.
Example
If a pen manufacturing company plans to produce 1000 pens in a period, it will need 1000 nibs, 1000 caps, etc., and
will need them at the rate they will be installed in the finished pens. Such needs, with consideration for lead time,
are considered in a dependent demand planned order schedule.
Material Requirement Planning is one example of a system specifically designed to manage dependent demand
reorders. Material Requirement Planning (MRP) happens to be the best model of dependent demand pattern of
Inventory. Under it, the requirement of an item is predetermined as it depends upon the actual need of it, triggered
by certain production schedule. Obviously MRP has two main characteristics, the known requirement and the known
period of requirement (time).
Materials Requirements Planning (MRP) is a set of techniques that takes the master production schedule and other
information from inventory records and product structure records as inputs to determine the requirements and
schedule of timing for each item. Based on a master production schedule, a material requirements planning system
performs the following functions:
• creates schedules identifying the specific parts and materials required to produce end items
• determines exact numbers needed
• determines the dates when orders for those materials should be released, based on lead times
MRP does not need carrying of any inventory ahead of requirement. It starts with the finalisation of the production
plan in a firm. The production plan then is used by the materials management professionals to explode the 'Bill of
Material' which is a complete detailing of the materials needed including their various components. It is exploded
for the number of units to be produced, to obtain that product’s exact requirement.
Since a given common part is used in many items, sub-assemblies, etc., total requirement of that part is summed up
to draw a consolidated requirement. Since this exercise is done for a great number of materials, computers become
very useful for the purpose. After the bill of material is finalised, its taken over by the materials professionals of the
firm who check the availability of any item. A detailed action plan indicating the materials, quantity to be procured
and most importantly the time all of these are required at is prepared. Accordingly, the orders are placed and the
suppliers are asked to match the given delivery period.
In practice under this system, the production material requirements are calculated on weekly basis. It then generates
requisitions for each material to be delivered in the required quantity a given number of days prior to the start of
manufacturing operation. Obviously it puts more pressure on purchasing and production planning rather than on
maintenance of inventory. In MRP system master production schedule which is updated periodically is the force
that directly initiates and drives subsequent activities of the purchasing and manufacturing functions.
5.4.1 Applicability of the MRP System
• It is best suited where production is not done on a continuous basis.
• It is ideally suited for the job shop operations environment.
• It is ideally suited where the demand is directly dependent on the production of other specific inventory items
or finished products.
• It is used where the demand of the individual components are dependent on the requirement of the main
product.
• It can be used where the flexibility is possible in placement of orders or delivery releases is to be done on short
term basis.
5.4.2 Inputs for MRP

MRP process is triggered by the Master Production Schedule (MPS) which indicates the production volume of
finished products on weekly basis. MPS is the primary input. Therefore, for a successful run of the MRP, MPS must
have a time schedule that is greater than the total lead time of the finished product.
Bill of Materials (BOM) which is a detailed item wise requirement document is the second input for MPR. It may
contain multistage type of products that may require several stages of a number of components to be fitted or
converted into leading to the making of the final or finished product.
Inventory Record File (IRF) is the third input for MRP. It contains the status of an inventory item. It indicates the
current stock position, the past timing and sizes of all orders, including the open orders for the item, the lead time
for each item. IRF basically happens to be the past experience and serves as a good reference point for planning
for the future MRP.
5.4.3 MRP Process

The MRP process involves the following steps:
• Determine the gross requirements for a particular item.
• Determine the net requirements and when orders will be released for fabrication or subassembly.
• Net Requirements = Total Requirements – Available Inventory.
• Net Requirements = (Gross Requirements + Allocations) – (On Hand) + Scheduled Receipts.
• Develop a master production schedule for the end item (this is the output of the aggregate/production
planning).
• MPS is adjusted accordingly .
• Create schedules identifying the specific parts and materials required to produce the end items. The bill of
materials will be useful here.
• Determine the exact numbers needed.
• Determine the dates when orders for those materials should be released, based on lead times.
5.4.4 Outputs of MRP

The basic outputs of the MRP system are the planned orders from the planned order release row of the MRP matrix
which details the timing and the quantity of subassemblies, parts and raw materials used to plan purchasing and
manufacturing actions. Specifically, these outputs include:
• Purchase orders - sent to outside suppliers
• Work orders - to be released to the shop floor for in-house production
• Action notices or rescheduling notices - issued for items that are no longer needed as soon as planned or for
quantities that may have changed
5.4.5 Benefitstoofhighlight
Illustration MRP disadvantages of the fixed order system
The MRP is a framework for providing useful information for decision makers. The key to realizing the benefits
from any MRP system is the ability of the inventory planner to use the information well. The specific benefits of
MRP include the following:
• increased customer service and satisfaction
• improved utilisation of facilities and personnel
• better inventory planning and scheduling
• fast response to market changes and shifts
• reduced inventory levels without reduced customer service
The MRP is also a very powerful tool since it takes into consideration changes in certain assumptions especially
under uncertain conditions, especially when the inputs to the MRP system change because of the following realities
in the production area:
• delays in scheduled receipts
• changes in planned order sizes because of capacity constraints
• changes in gross requirements which dictate changes in lot sizes at subcomponent levels
Unavailability of raw materials for one sub-component which negates the need for a fellow sub-component as both
must be ready for the parent production. Utilisation of same parts at different levels indicating the need to restructure
the bill of materials and presence of price discounts or some other features which makes it advisable to purchase
more than the anticipated need. Thus MRP can be summarised as being a system which is solely dependent upon
three concepts:
• dependent demand
• inventory/open order netting, and
• time phasing on the basis of requirement period and the lead time for each item
MRP system, thus, generates a complete set of planned orders for all manufactured parts and purchased materials
based on information inputs. Accurate forecast and a timely lead time happen to be the main determinant of its
success in a run.
5.5 Inventory Turnover

Inventory turnover indicates the ratio of materials consumed to the average inventory held. It is calculated as
below:
Inventory turnover = Value of material consumed/Average inventory held
where, Value of material consumed can be calculated as;
Opening Stock + Purchases - Closing Stock
Average inventory held can be calculated as;

(Opening Stock + Closing Stock)/2
Inventory turnover can be indicated in terms of number of days in which average inventory is consumed. It can be
done by dividing 365 days (a year) by inventory turnover ratio.
Illustration 1
From the following data for the year ended 31st March, 2010, calculate the inventory turnover ratio.
Opening Stock 10,000
Purchases during the year 50,000
Closing Stock 12,000
Value of material consumed = Opening Stock + Purchases - Closing Stock

= 10,000 + 50,000 – 12,000

= 48,000
Average inventory = (Opening Stock + Closing Stock)/2
= (10,000+ 12,000)/2
= 11,000
Inventory turnover ratio = Value of material consumed /Average Inventory held
= 48,000/11,000
= 4.36 times
Inventory Turnover Period = 365/Inventory turnover ratio
= 365/4.36
= 84 days
Illustration 2
Opening Stock: 100
Closing Stock: 120
Sales: 1,100
Inventory turnover = Sales / Average Stock

= 1,100/110 = 10 times
Inventory turnover (Average Stock Holding period)
= Average Stock x 365 / Sales
= 110 x 365/1,100 = 37 days
Inventory turnover (Average Stock Holding %)
= Average Stock x 100 / Sales
= 110 X 100/1,100
= 10%
5.5.1 Interpretation of Inventory Turnover

Inventory turnover of 4 times is concerned as normal. Any turnover more than 4 times is desirable. Average stock
holding period of 90 days is concerned as normal. Any stock holding period less than 90 days is desirable. Average
stock holding percentage of 25% is concerned as normal. Any Stock Holding percentage less than 25% is desirable.
Any turnover more than 4 times also means Stock Holding period less than 90 days which in turn means Stock
Holding percentage less than 25%. From the above illustration it can be seen that the Inventory Turnover can be
expressed in three ways. The meaning of all the three is same. Inventory turnover of 10 times indicates a very high
rate of turnover, which in turn means more profit. 'More turnover, more profit' is the general interpretation.
Summary
• Inventory models is a mathematical equation or formula that helps a firm in determining the economic order
quantity, and the frequency of ordering, to keep goods or services flowing to the customer without interruption
or delay.
• If a manufacturer orders a quantity which is more than the Economic Order Quantity (EOQ) two things will
happen: reduction in cost and increase in carrying cost.
• There are two basic systems of managing or controlling inventory under the independent demand pattern:
cyclical ordering or fixed period system (Time based), and order point or fixed order quantity system (Quantity
based).
• Fixed period based systems (also called 'cyclical systems') are designed so that each inventory item is reviewed
and reorders are placed after a predetermined time interval
• Order point system/fixed order quantity system of inventory control is based on the order point and order quantity
factors rather than on the time factor.
• Dependent demand occurs when the need for parts, supplies or materials is dependent upon a predetermined
usage or production schedule. In such cases, a description and quantity of components needed and the exact
date of each need is defined by a production schedule.
• Material Requirement Planning (MRP) happens to be the best model of dependent demand pattern of inventory.
Under it, the requirement of an item is predetermined as it depends upon the actual need of it, triggered by
certain production schedule.
• MRP has two main characteristics: the known requirement and the known period of requirement (time).
• Materials Requirements Planning (MRP) is a set of techniques that takes the master production schedule and
other information from inventory records and product structure records as inputs to determine the requirements
and schedule of timing for each item
• Inputs of MRP are: master production schedule (MPS), bill of materials (BOM), and inventory record file
(IRF).
• Outputs of MRP are purchase order, work orders, and action notices.
• Inventory turnover indicates the ratio of materials consumed to the average inventory held.
References
• Martinich, S. J., 2008. Production And Operations Management: An Applied Modern Approach, John Wiley
& Sons.
• Facility Layout, [Pdf] Available at: <http://www.me.utexas.edu/~jensen/ORMM/omie/design/unit/layout/layout.
pdf> [Accessed 13 February 2013].
• CHAPTER FIVE FACILITY LAYOUT, [Pdf] Available at: <http://labs.fme.aegean.gr/decision/images/stories/
docs/HealthCare_FacilityLayout.pdf> [Accessed 13 February 2013].
• Prof. Kanda, A., 2008. Lecture - 31 Layout planning, [Video online] Available at: <http://www.youtube.com/
watch?v=IhGBUcMM-rE> [Accessed 13 February 2013].
• Prof. Kanda, A., 2008. Lecture - 30 Mathematical Models for Facility Location, [Video online] Available at:
<http://www.youtube.com/watch?v=xk7hS8zCHgA> [Accessed 13 February 2013].
Recommended Reading
• Bitner, M. J., 1992. Servicescapes: The Impact of Physical Surroundings on Customers and Employees, Journal
of Marketing 56.
Richard, Muther and Associates
• Francis, R. L. & White, J. A. 1992. Facility Layout and Location: An Analytical Approach. Englewood Cliffs,
NJ: Prentice Hall.
Self Assessment
1. Inventory turnover indicates the ratio of materials consumed to the .
a. average inventory held
b. opening stock
c. closing stock
d. purchases
2. The two main characteristics of material requirement planning are the known requirement and .
a. known period of manufacturing
b. known period of stock
c. known period of planning
d. known period of requirement

a. MRP is a framework for providing useful information for decision makers.
b. MRP does need carrying of any inventory ahead of requirement.
c. Material Requirement Planning (MRP) happens to be the best model of dependent demand pattern of
Inventory.
d. Orders are placed for each item equal to the difference between current inventory level and a predetermined
maximum.

a. Many a times the suppliers of raw material come with an offer of discount on the catalogue price if a certain
minimum quantity is ordered.
b. In cyclical systems, time between reorders is variable, but reorder quantity is constant.
c. Predetermined minimums are set with a consideration of order lead time.
d. Units of an item are issued until the level of that inventory is low than the predefined reorder point.
5. Average inventory held can be calculated as:

a. (Opening Stock + Closing Stock)/3
b. (Opening Stock + Current Stock)/2
c. (Optimum Stock + Closing Stock)/2
d. (Opening Stock + Closing Stock)/2
6. What does DIL stands for?

a. Desired Inventory Level
b. Determined Inventory Level
c. Desired Inventory Lead
d. Demand inventory Level
7. turnover can be indicated in terms of number of days in which average inventory is consumed.
a. Stock
b. Inventory
c. Goods
d. Services
8. and a timely lead time happen to be the main determinant of its success in a run.
a. Accurate forecast
b. Inventory planning
c. Fixed order
d. Inventory control
9. Order point system/fixed order quantity system of inventory control is based on the
a. order point and order planning
b. order time and order quantity
c. order point and order quantity
d. order point and order turnover
10. The key to realising the benefits from any MRP system is the
a. ability of the inventory planner to use the information well
b. other information from inventory records
c. requirement of an item
d. demand pattern of inventory
Chapter VI
Purchase Management
Aim
• explain the concept of purchase management
• elucidate the objectives of purchasing
• introduce the students to the concept of vendor management
Objectives
• define the functions of purchase management
• explicate the concept of purchase requisition
• enlist purchase procedure
Learning outcome
• understand the types of tenders
• recognise about inspection of materials
• identify the discrepancies in material receipts

6.1 Introduction to Purchase Management

Corporate purchasing dates back to its history sometimes to the late 1890s. Purchasing was mainly seen then as a
different department except some railroad organisations. Even during the early 1900s, purchasing was considered
to be a clerical work. During World War I and II, purchasing function increased due to the importance of obtaining
raw materials, supplies and services needed to keep the factories and mines operating.
During 1950s and 60s, purchasing continued to gain stature as the techniques for performing the function became
more refined and as the number of trained professionals increased but still purchasing agents were basically order-
placing clerical personnel serving in a staff-support position.
In the late 1960s and early 70s, purchasing personnel became more integrated with a materials system. As materials
became a part of strategic planning, the importance of the purchasing department increased.
In the 1970s the oil embargo and the shortage of almost all basic raw materials brought much of business world’s
focus to the purchasing arena. The advent of just-in-time purchasing techniques in the 1980s, with its emphasis
on inventory control and supplier quality, quantity, timing and dependability, made purchasing a cornerstone of
competitive strategy.
During early 1990s, value proposition in purchasing is increased. People realised that by letting purchaser negotiate
and ask for discount bring lots of cost reduction. Cost savings become a buzz word and of course control over the
buying process remains one important function of purchasing.
During late 1990s, the purchasing evolved into strategic sourcing. Enterprise wide process that continuously
improves and re-evaluates the purchasing activities of a company had started. More emphasis on supplier data base
begun. Contracts were sourced for long term basis to have better cost. Supplier relationship building and supplier
management started.
Purchasing function in a business environment is one of the most critical functions as it provides the input for the
organisation to convert into output. Materials today are lifeblood of industry. They must be available at the proper
time, in the proper quantity, at the proper place and the proper price. Company costs and company profits are greatly
affected by them as normally, a manufacturing organisation spends nearly 50% of its revenue in purchasing.
6.1.1 Objectives of Material Management

The key objectives of material management are given below:
• to buy the materials at the lowest price
• consistent with desired quality and service
• to maintain continuity of supply of materials and services to users
Purchasing administration plays an important role in this regard. Every organisation establishes a purchase department
to carry out different functions. Purchasing is responsible for spending nearly half of a company’s income for buying
the input materials. Obviously, any saving achieved by it results into direct saving for the company and all such savings
are a company’s profit. One percent saving achieved in purchasing results in 5% profit for any organisation.
6.2 Functions of Purchase Department

The job of a materials manager is to provide, to the user departments, the right material at the right time in right
quantity of right quality at right price from the right source. To meet these objectives, the activities undertaken include
selection of sources of supply, finalisation of terms of purchase, placement of purchase orders, follow up, maintenance
of relations with vendors, approval of payments to vendors, evaluating, rating and developing vendors.
The functions of purchase department are to:

• support company operations with an uninterrupted flow of materials and services
• buy competitively and wisely
• help keep a minimum inventory
• develop reliable alternate sources of supply
• develop good vendor relationship and a good continuing supplier relationship
• achieve maximum integration with the other departments of the firm
• train and develop highly competent personnel who are motivated to make the firm as well as their department
succeed
• develop policies and procedures which permit accomplishment of the preceding objectives at the lowest
reasonable operating cost
Before deciding the quantity to be purchased, the following factors should be taken into consideration:
• Quantity already ordered
• Quantity reserved: It may happen that a particular quantity, though in hand, might have been reserved for a
particular job which is not available for other purposes. In such cases, this quantity is treated as if it is not in
stock.
• Funds availability: Amounts which are kept aside for drawing up purchase budget should be considered are
used.
For any organisation, purchasing function assumes importance for the reason that it fulfils, to a great extent, the input
needs of the organisation. An organisation needs input of right quality at right price from the right source in right
quantity at the right time. Called 5 R’s (right things to do), these determine the broad parameters within which the
purchasing functions in any organisation. Depending upon the size and nature of operation, the quantum of purchase of
product and services vary. Purchase Department carries out all the tasks associated with the development of policies,
procedures, controls and the mechanics for coordinating purchasing operations with those of other departments.
The following are the important activities of a purchase department:

• Buying activity: It addresses to a wide gamut of activities such as, reviewing requisitions, analysing specifications,
investigating vendors, interviewing sales people studying costs and prices and negotiating.
• Expediting: This is basically the order follow up activity involving various types of vendor relationship work. It
involves reviewing order status, providing clarifications on transportation, writing and emailing vendors etc.
• Special projects (Non routine): In order to facilitate smooth purchasing in a highly competitive business
environment, purchasing authorities have to keep building the capacity to do better by taking up as special projects
activities such as vendor development, vendor registration, value analysis, market studies, system studies etc.
• Routine: Purchasing process or procedure involving routine or every day activities such as dealing specific
purchase file, placing orders, maintaining records of commodities, vendors etc.
6.2.1 Purchasing Function vs. Purchase Department

Purchasing functions Purchase department
• This function is commonly seen in all those

• It is a unit of an organisation that performs
organisations that undertake purchasing
purchasing function.
activities.
• It is directed by an efficient manager to achieve
• It is usually performed by a specialised and
the performance in an economical manner.
centralised purchasing department.
Table 6.1 Purchasing function vs. purchase department

6.2.2 Procurement vs. Purchasing

Procurement is one of several supply functions involved in logistics activities. In the broadest sense procurement
includes the entire process by which all classes of resources (people, materials, facilities and services) for a particular
project are obtained.
Where as Purchasing is a unique function, it differs a bit from procurement in the sense that while procurement,
with the same objective has a wider domain, purchasing with the same objective is included in it.
6.2.3 Objectives of Purchasing

The basic objective of purchasing is to derive the maximum value for each unit of money spent in buying. A purchaser
has to find answers to the following questions:
• Are we buying at right cost?
• Supplier is producing it at right quantity or not?
• Whether supplier is producing the right product or not?
• Whether material will come at right time or not?
• Whether buyer is buying for the company or for personnel gain?
Formalised systems and procedures are required to run its purchasing function, to ease in operation and accountability.
Formal procedures are required to be laid down for initiating purchase, selecting suppliers, placing purchase orders,
follow-up, receiving materials and so on.
6.3 Purchase Requisition

Purchase Requisition is an indication given to the purchases department to purchase certain material. It is issued either
by the storekeeper (in respect of material required for regular production purposes) or by production department (in
respect of special materials required).
Following particulars must appear in purchase requisition:

• Material to be purchased: It should be clearly specified. To make it more specific, in addition to the description
of the material required, the code number should also be specified.
• When it is required: Unless the material is required for regular production purposes (when the storekeeper
himself will place the purchase requisition as soon as it reaches the ordering level), purchase requisition should
mention the last date by which the material is required. Ideally the material should be purchased whenever the
market for the same is favourable.
• How much to be purchased: Purchase requisition should state the quantity of the material required.
6.3.1 Types of Purchase Requisitions

Different kinds of requisitions used are as follows:
Standard requisition
Also called as indent for material (or service), materials requisition plan etc., a requisition is made by an authorised
person in the concerned department. However, it has to be countersigned by a senior officer who checks the entries
made in. Normally a requisition, in a pre-printed format, contains particulars such as, the detailed description of
materials or services to be purchased, desired quantity, schedule for receipt of such material/service, the estimated
price, possible sources and the account head, requisitioner’s identity.
In any organisation, only a limited number of personnel are empowered to countersign the requisition as it amounts
to authorisation of the expenditure. Purchase department usually maintains a list of such officers so as to check
the validity of the purchase requisitions. Normally, there is a delegation of power of authority for authorising a
requisition. This is expressed in terms of the financial limits up to which an officer can authorise a requisition for a
capital or revenue item. These details must also be available with the purchase department.
Travelling requisition
As the name suggests, this requisition form travels from the requisitioning department to the purchaser directly
who then only authorises the supplier through a purchase order to deliver the required material. This document is
generally used for requisitioning items that are required frequently in bulk quantities over a long period of time.
Usually, for repeat items such as, in inventory, a card containing the details of previous supply containing material
specifications, suppliers details, last purchased price, reorder point, usage details are written permanently and
provisions for entering date, quantity required, names of requisitioned and authoriser are available. On getting it,
the purchaser only has to take these details for placement of order. The travelling requisition which is a permanent
document of the originating department is returned to it. It reduces the paper work and eases the operation.
Bills of materials
Bill of material is a comprehensive list of materials needed to produce a product or service. It is basically the details
of materials needed, their specification, quantity, required delivery schedule, etc. It is often used as a sequel to firming
of a production plan, a stage where the exact material/service needs are known.
6.4 Purchase Procedure

A purchase department is usually engaged in purchasing a number of materials and services falling in different
categories. The activities are performed regularly by purchase professionals with the objective of fulfilling
organisation’s materials and services needs. Therefore, depending upon the nature of procurement, environmental
practices etc the purchasing systems and procedures may also vary substantially. However, purchase procedure can
be seen to have a bit of standardisation across the globe.
A professional purchasing system does show following steps that eventually constitute a purchasing cycle:
• recognition and description of need
• transmission of need
• selection of source to satisfy the need
• contracting with the accepted source
• following up with the source
• receiving and inspecting material
• payment and closure of the case
6.5 Types of Purchasing

The following are the different types of purchasing:
• Forward buying
• Tender buying
• Systems contract
• Speculative buying
• Rate contracts
• Reciprocity in buying
• Zero stock buying
• Blanket orders
6.5.1 Forward Buying

Forward buying, as the name suggests, is the system under which buying is done with longer term in perspective. It is
not meant for meeting the present consumption requirement. It is rather a commitment on part of both the buyer and
the seller, normally for a period of one year. Depending upon the availability of the item, the financial policies, the
economic order quantity, the quantitative discounts and the staggered delivery, the future commitment is decided.
A few organisations do hedge, particularly in the commodity market by selling or buying contracts. Forward buying
helps a firm in booking capacity of a supplier and thus often results into a safeguard against a competitor acquiring
his capacity. It is usually done for raw materials but is not limited to it. Such an arrangement is a win-win situation
for both, the buyer and the supplier
6.5.2 Tender Buying

Tender buying has always been considered the only way of buying materials/services in the government and quasi
government procurements. Selecting a supply source (supplier) out of many sources available is called tender
buying. Many applicants are invited to participate in the tendering process and then one or more than one tender
is selected for order placement. Such tenders are also called the accepted tender's (A/Ts). The main focus through
tender buying is on competition of price and quality. Usually, the best quality (T1 or Q1) is selected after assessment
of the technical offers and then the lowest offered price (L1) tender is selected for order placement.
Process of tender buying

• A purchase function starts with the raising of a requisition (indent/material procurement requisition) for an item
which is required for a stated purpose.
• This requisition is then converted into an enquiry form which is issued to the probable vendors who are asked to
respond within a given date and time (called tender opening date) as mentioned in the enquiry issued to them.
• The interested vendors respond to the tender enquiry by giving their tenders.
• Tenders thus, received are opened on the tender opening date at the fixed time.
• The tenders are then subjected to evaluation with respect to a tenderer’s capability, financial as well as technical,
and other criteria as laid down in the tender enquiry.
• This step also witnesses series of discussions, clarifications and negotiation with the tenderers.
• Some tenders can be rejected at this stage as they might not meet the requirement of the purchaser.
• Finally, the tenders that are found suitable are subjected to price comparison and usually the tenderer offering
the lowest price (L1) is selected for placement of order.
• The process explained above shows a great deal of variations depending upon a company’s procurement
policy.
• In some places, the best quality offering tenders are accepted for subsequent price comparison whereas in some
other place all the tenderer’s who meet the minimum requirement are considered accepted for price comparison
and order placement.
• Similarly, in some places the order is placed only on L1 (lowest offered price) whereas in some other places
it may not be rigidly followed so.
Price/Quantity High Medium Low

Low Q1L1 Q2L1 Q3L1
Medium Q1L2 Q2L2 Q3L2
High Q1L3 Q2L3 Q3L3
Table 6.2 Matrix of price and quality of the tenders
Q1L1, Q1L2 and Q1L3 are short listed. After negotiations Q1L1 is selected normally. Q3L1, Q3L2 and Q3L3 are
normally rejected at the initial stage.
Types of tenders
Since the tenders are sent to the probable vendors, knowledge of vendors for the item in question is a necessity. It’s
based on this concept that the types or mode of tendering is decided against a particular purchase requisition. Most
commonly used types of tendering/tender buying are mentioned below:
• Global tender
 A global tender is floated with a view to elicit offers/response from any vendor situated anywhere in the
world.
 The need for a global tender arises when the purchaser either does not know about the vendors for a particular
item in question or when he thinks that a wider choice of vendor is possible through it, irrespective of his
nation’s boundaries.
• Open tender
 An open tender too like a global tender tends to invite tender from any interested vendor.
 The basic difference assumed between an open tender and a global tender enquiry is essentially the range of
its applicability. While a global tender gets the worldwide publicity, an open tender is limited only within a
country. Otherwise, the concept remains the same as it also seeks to elicit better or wider response.
 Since the open tender enquiry is limited within the country itself, besides the internet mode, the enquiry
is also printed in the national dailies, internal trade bulletins etc. for ensuring its wide publicity, within the
country. Any vendor who meets the tender requirements can make an offer.
• Limited tender
 When the issue of tender enquiry is limited only to a selected few vendors, it is called limited tender enquiry
(LTE).
 LTE is issued when the capabilities of the vendors is well known to the purchaser.
 It is considered better than global and open tender modes as there is always an element of uncertainty in
those two modes with respect to the capabilities of the vendors.
 For issuing LTE, a purchaser maintains a list of approved /registered vendors whose capabilities are checked
periodically.
• Single tender enquiry
 An STE is issued only when either the item is proprietary in nature, that is only one supplier produces that
item or where there may be more vendors but due to certain exigencies it is not possible to devote time on
evaluating the vendors offers/one supplier can fulfil the needs.
 The mode to tender depends on many factors as well a company’s procurement policy. For example, for
a small value purchase, if the policy does not prohibit, single tender enquiry or limited tender enquiry is
considered ideal.
 These are also ideal for high value and frequently bought items. On the other hand, for high value and non-
frequently bought items/systems, open/global tenders are suited.
 In many government organisations, whose procurements are also called public procurements for the reason
that they spend public money for the public cause, all the tenders are to be invited only through open/global
tenders.
6.5.3 Systems Contract

Systems contract is a contract of system of buyer with that of the seller. It is a release system in which items,
usually, commonly available off-the-shelf, are identified and pre-priced in anticipation of certain usage. Delivery
releases are made against existing orders placed by purchase. This is a procedure intended to help the buyer and the
seller to reduce administrative expenses and at the same time to ensure proper controls. The system authorises the
designated persons of the buyer to place orders directly to the supplier with the specific materials during a given
contract period. The contract is thus finalised only after it is ensured that an attempt has been made to integrate as
many buyer-seller materials management functions as possible.
In this system the original indent, duly approved by competent authorities, is shipped back with the items and avoiding
the usual documents like purchase orders, materials requisitions, expediting letters and acknowledgements, goods
in transit report, etc. The contract is simple, covering only delivery period, price and invoicing procedure. System
contracting is particularly useful for items with low unit price and high consumption profile and thus, relieves the
buyers of the routine work.
While systems contract has certain features in common with other purchasing agreements, it is this integration of
buyer-seller operations that clearly distinguishes it from other types of contracts. Obviously, the systems contracts
are an excellent way of simultaneously cutting costs while building efficiencies through simplifications.
6.5.4 Speculative Buying

When purchasing is done purely from the point of view of taking advantage of a speculated rise in price of the
commodity it is called speculative buying. The intent is not to buy for the internal consumption but to resell the
commodity at a later date when the prices have gone up and to make a profit by selling. The items may be those
that are needed for internal consumption but the quantity shall be much more than the requirement so as to take
advantage of the coming price rise.
6.5.5 Rate Contracts

Rate contracts are mutual agreements between the buyer and the seller to operate a set of chosen items, during a
given period of time, for a fixed price or price variation. Under this system the rates are fixed and at times even the
quantity of the selected items. As and when the need arises the buyer issues a purchase order directly on the basis
of the rate chart available on the supplier who in turn supplies the items.
The system of rate contract is prevalent in public sector organisations and government departments. It is common
for the suppliers to advertise that they are on rate contract with the DGS&D (Directorate General of Supply &
Disposal), for the specific period for the given items. After negotiation, the seller and the buyer agree to the rates of
items. Application of rate contract helps organisations cut down the internal administrative lead time as individual
firms need not go through the central purchasing departments and can place orders directly with the suppliers.
However, suppliers always demand higher prices for prompt delivery, as rate contracts normally stipulate only the
rate and not the schedule on which the item is needed. This difficulty has been avoided by ensuring the delivery of
a minimum quantity at the agreed rates. This procedure of fixing a minimum quantity is called the running contract
and is being practiced by the railways and the DGS&D.
As mentioned above, this system of buying helps an organisation reduce its internal as well as the external lead
time, reduces administrative work load as the files don’t need to go up and down, helps in building buyer-supplier
relationship as the contract period is usually one year and then there is always a chance of the same players doing
the next contract.
The system works well normally in a situation where the selected items are routinely consumed. However, there is
no compulsion that the demand be uniform over the period of time.
6.5.6 Reciprocity in Buying

In certain business situations a buyer may give preference to a supplier who also happens to be his customer. This
relationship is known as reciprocity. It is something like 'I buy from you if you buy from me'.
One of the main questions for which this, otherwise simple way of buying, is always under the scanner of purchasing
ethics is its undue ability to restrict competition and fair play. One of the major roles that any purchaser plays for
his firm is in cost reduction arena which is attempted by generating competition among the suppliers. This principle
gets a jolt through reciprocity in buying. However, when factors such as quality, after sales service, price etc, are
equal normally a buyer would like to buy from his customer, if for nothing then at least for having a good working
relationship. However, the distinct disadvantages of reciprocal buying outweigh the limited and narrow advantage
that a firm may derive out of it.
Some of the main disadvantages of reciprocity are not being able to follow the well laid criteria of quality, price and
service. A purchasing executive should not indulge in reciprocity on his initiative when the terms and conditions are
not equal with other suppliers. It is often found that less efficient manufacturers and distributors gain by reciprocity
what they are unable to gain by price and quality. Since this tends to discourage competition and might lead to higher
prices and fewer suppliers, reciprocity should be practiced on a selective basis.
6.5.7 Zero Stock Buying

Zero stock buying refers to buying in a manner that the system ensures that the material is delivered by the seller
only when it is required and that no prior inventory of the item is maintained by the buyer. As the competition
becomes more intense the need for a lean manufacturing system becomes more focussed. Keeping inventory thus
is blocking huge money that is idle for the firm. Thus, zero stock buying is more of an inventory safeguard rather
than the normal buying.
Normally, under this system the firms try to operate on the basis of zero stock and the supplier holds the stock for
these firms. Usually, the firms of the buyer and seller are close to each other so that the raw material of one is the
finished product of another. Alternatively, the system could work well if the seller holds the inventory and if the
two parties work in close coordination. However, the price per item in this system is slightly higher as the supplier
may include the inventory carrying cost in the price. In this system, the buyer need not lock up the capital and so
the purchasing routine is reduced. This also significantly reduces obsolescence of inventory, lead time and clerical
efforts in paper work. Thus, the seller can devote his marketing efforts to other customers and production scheduling
becomes easy.
In practice, the buyer is called upon to pay to the supplier only when the material is delivered as per the need. For
example, in India say the Indian Oil Limited maintains its petrol and diesel refilling stations inside the manufacturing
premises of many companies. As and when petrol or diesel is required, say in a lorry, IOL fills that and a coupon is
signed by the driver of the lorry. Buyer makes the payment to IOL against that coupon.
Zero stock is becoming popular with the concepts such as Just-in-time approach that is similar to it. However, in
situations where the supplier has to transport material from one place to the other with a fair distance in between,
this system needs careful handling as one never knows the road or weather conditions. Normally, the system caters
to those items that are not very critical to manufacturing. It best suits the situations where the output of one firm is
the input of the other firm with both the firms located nearby.
6.5.8 Blanket Orders

Under this system, an agreement is done between the buyer and the supplier to provide a required quantity of specified
items, over a period of time, usually for one year, at an agreed price. This system minimises the administrative
expenses and is useful for ‘C’ class items for which rigid controls are not required. Deliveries are made depending
upon the buyer’s needs. The system relieves the buyer from routine work, giving him more time for focusing attention
on high value items such as ‘A’ and part of ‘B’ class. It requires fewer purchase orders and thus reduces clerical
work. It often achieves lower prices through quantity discounts by grouping the requirements. The supplier, under
the system, maintains adequate inventory to meet the blanket orders, but he does not incur selling costs, once the
negotiations are finalised.
6.6 Vendor Management

Prerequisite to a successful materials management is the availability of a sound vendor base which is now rightly
acknowledged as an extended arm of the business. One of main reasons of failure of many supply chains has been the
inability to hold trusted vendors together. Vendor management, therefore, requires careful planning and execution,
over a fairly long period of time.
Management of vendors is attempted through the following ways:

• Vendor Registration
• Vendor Development
• Vendor Rating
• Vendor Exploration
For ensuring continuous supply of right quality materials required, at the optimum cost, it is essential to have a
dependable, competent & competitive vendor base. The Limited Tender Enquiry (LTE) is issued only when reliable
manufacturers/suppliers/traders/contractors are known and for this purpose, there is a need to maintain a list of
registered vendors. So, vendors are empanelled for the supply of various categories/subcategories of items.
Vendor registration
For this purpose, the vendors interested to supply the specific category/subcategory of items are asked to submit the
application along with all the documents required to establish their financial & technical capability. The application
forms so received are scrutinised and the vendor capacity assessment is carried out through inspection department/
technical experts to establish the technical capability of the vendors. These vendors are listed as ‘registered’ after
following up certain processes.
Vendor development
Many process industries like to search the alternative and less costly material as substitution of the currently
used costlier materials. The less the procurement cost the more is the profit. Also, there may be situations where
the existing suppliers may not be willing to supply the items on various grounds thus, necessitating, looking into
different alternatives. An efficient materials manager would devote enough time to develop substitutes & sources of
supply with a view to reduce cost of input materials and also to have reliable alternative source for foreign sources.
Normally, in large manufacturing organisations, a Vendor Development Cell (VDC) remains engaged all through
for the purpose. When the need to develop a vendor for an item is felt the requisition for such items is made by
concerned department indicating the trial quantity and the potential vendors. Trial orders are placed on potential
vendors and also necessary help is rendered to them to come up to the desired level.
Vendor rating
The vendors also like to be given priority to be the purchaser if it constantly improves its selling performance
which from a purchaser point of view is mainly its offered price, quality and punctuality in delivery. For purchaser,
there shall always be a need to continuously monitor and update its registered vendor base so that the organisation
continues to have the most competent & competitive vendors in its list of vendors. For this purpose the efforts are
made to monitor supply performance of the vendors and rate them objectively. The major factors usually considered
for such vendor rating are competitiveness of vendor (price), quality of supply and delivery adherence. Vendor
rating may also be used for removing a vendor from registered vendor list and also in the selection of vendors while
issuing Limited Tender Enquiry.
Vendor exploration
To have competitive & competent sources of supply, efforts are made to explore suitable vendors from various
sources like, internet websites, international bulletins, vendors list of other similar manufacturing organisations etc.
This is known as vendor exploration and in the competitive environment it is taken as a serious activity.
6.7 Inspection of Materials

Any organisation, 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. Inspection is
an important aspect of integrated materials management. It is an accessory 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. A few of these are mentioned below:
6.7.1 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.
The accepted materials are marked by stamping/punching/stickers/seal/ tag etc as a mark of acceptance. The supplier
is asked to deliver the same to the consignee as mentioned in the PO.
6.7.2 Stage Inspection/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 (IR) 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.
6.7.3 Document Inspection

Sometimes and usually for every 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.
6.7.4 Stores/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 include:

• 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: This category contains the 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 consists of materials which have been received and are awaiting delivery
to the using/testing department.
6.7.5 Third Party Inspection

In case of specialised items, which require special proficiency for inspection, help of third party inspection agencies
is taken. After material is received from the supplier, the quantity received actually, is compared with quantity
ordered. Variations if any, are taken up with the supplier again.
Excess material received may be dealt with using any of the following ways:
• accepting all the material received
• accepting the material ordered and return the excess to the supplier
Before accepting, material may be subjected to inspection. The extent of inspection may vary from material to
material. The supplier’s invoice received for the supply of material is subjected to scrutiny before a voucher is
passed for the same for making the entry in the books of accounts. For this purpose, the supplier’s invoice may be
compared along with the following documents.
• Purchase Order
• Goods Received Note
• Inspection Report
If the quantity and/or rate as per purchase order and invoice match with each other, the invoice of the supplier is
passed for making the entry in the books of accounts. If the quantity and/or rate as per purchase order and invoice
differ from each other, the difference is adjusted by raising a debit or credit note in favour of the supplier.
Discrepancies in material receipts

The material physically received when compared with material ordered as per the purchase order may reveal certain
discrepancies which may take any of the following forms:
• Quantity received in excess
• Quantity received in short
• Quantity received of different quality
Excess quantity received may be retained and accepted, if required, with the approval of the purchase department.
Alternatively, if it is not accepted, it may be returned to the supplier with Goods Returned Note (GRN). The usual
form in which Goods Returned Note is prepared in the following format:
GOODS RETURNED NOTE
To: No.
Date:
Following material supplied by you vide your D.C. No. and Invoice No.
against our Purchase Order No. is being returned to you for the reasons stated below:
Description Quantity Reasons
Signature
Usually, three copies of Goods Returned Note (GRN) are prepared to be distributed as below:
• one copy to the supplier
• one copy to the purchase department
• one copy to be retained by the stores department
Excess quantity accepted

If excess quantity is already billed in the invoice, it will be approved and paid. If not, either the supplier may be
asked to give a supplementary invoice or credit note may be issued to the supplier for amending the amount.
Excess quantity returned

If excess quantity is already billed in the invoice, debit note may be issued to the supplier for amending the amount.
In case the quantity received is short, purchase department may take up the case with the supplier or carrier or
insurer as per the terms of purchases. If quantity short supplied is billed in the invoice, invoice is suitably amended
and debit note is issued to the supplier. If quantity received is of different quality and is rejected in inspection, it
can either be retained or returned. It may be retained by accepting some mutually decided concessional price. The
variation in prices may be adjusted by issuing either the credit note or debit note in favour of the supplier.
Summary
• Purchasing function in a business environment is one of the most critical functions as it provides the input for
the organisation to convert into output.
• Purchasing is responsible for spending nearly half of a company’s income for buying the input materials.
• The job of a materials manager is to provide, to the user departments right material at the right time in right
quantity of right quality at right price from the right source.
• Factors to be kept in mind before deciding the quantity to be purchased are: quantity already ordered, quantity
reserved and funds availability.
• The important activities of purchase department are: buying activity, expediting, special projects, and routine.
• Purchase Requisition is an indication given to the purchases department to purchase certain material. It is issued
either by the storekeeper or by production department.
• Standard requisition is also called as indent for material; it is a requisition is made by an authorised person in
the concerned department, which has to be countersigned by a senior officer who checks the entries made in.
• Travelling requisition form travels from the requisitioning department to the purchaser directly who then only
authorises the supplier through a purchase order to deliver the required material.
• Bill of material is a comprehensive list of materials needed to produce a product or service. It is often used as
a sequel to firming of a production plan, a stage where the exact material/service needs are known.
• The steps in a purchasing cycle are: recognition and description of need, transmission of need, selection of
source to satisfy the need, contracting with the accepted source, following up with the source, receiving and
inspecting material, and payment and closure of the case.
• Different types of purchasing are: forward buying, tender buying, systems contract, speculative buying, rate
contracts, reciprocity in buying, zero stock buying and blank orders.
• A global tender is floated with a view to elicit offers/response from any vendor situated anywhere in the
world.
• An open tender too like a global tender tends to invite tender from any interested vendor. The basic difference
assumed between an open tender and a global tender enquiry is essentially the range of its applicability. While
a global tender gets the worldwide publicity, an open tender is limited only within a country.
• When the issue of tender enquiry is limited only to a selected few vendors, it is called Limited Tender Enquiry
(LTE). LTE is issued when the capabilities of the vendors is well known to the purchaser.
• A Single Tender Enquiry (STE) is issued only when either the item is proprietary in nature, that is only one
supplier produces that item or where there may be more vendors but due to certain exigencies it is not possible
to devote time on evaluating the vendors’ offers / one supplier can fulfil the needs.
• Management of vendors is attempted through; vendor Registration, vendor Development, vendor rating, and
vendor Exploration.
• Control on incoming materials is exercised through inspection by the purchaser. Inspection is an important
aspect of integrated materials management.
References
NJ: Prentice Hall.
• Production System Design: Work Structuring Revisited, [Pdf] Available at: <http://www.leanconstruction.org/
pdf/WP_11_Work_Structuring.pdf> [Accessed 13 February 2013].
• Nadler, G., WORK SYSTEMS DESIGN: THE IDEALS CONCEPT, [Pdf] Available at: <http://www.library.wisc.
edu/selectedtocs/da1311.pdf> [Accessed 13 February 2013].
• Prof. Kanda, A., 2008. Lecture - 1 Project and Production Management - An Overview, [Video online] Available
at: <http://www.youtube.com/watch?v=obzp6biyAN0> [Accessed 13 February 2013].
• Prof. Jain, K. P., 2009. Mod-1 Lec-1 Production Planning and Control, [Video online] Available at: <http://www.
youtube.com/watch?v=yYIVumq6sVM&playnext=1&list=PL54140420A2274299&feature=results_main>
Recommended Reading
• Norman, R., 1991. Service Management, 2nd ed., New York: John Wiley and Sons.
• Manufacturing and Operations Management, Nirali Prakashan.
• Brown, S., Blackmon, K., Cousins, P. & Maylor, H., 2012. Operations Management: Policy, Practice and
Performance Improvement, Routledge.
Self Assessment
1. Standard requisition is also known as .
a. Bill of materials
b. Indent of material
c. Open requisition
d. Global requisition
2. is basically the order follow up activity involving various types of vendor relationship work.
a. Expediting
b. Purchasing
c. Selling
d. Inspection

a. Purchasing is responsible for spending nearly half of a company’s income for buying the input materials.
b. For any organisation, purchasing function assumes importance for the reason that it fulfils, to a great extent,
the input needs of the organisation.
c. An organisation needs input of right quality, at right price, from the right source in right quantity at the
right time.
d. Formalised systems and procedures are required to run its manufacturing function, to ease in operation and
accountability.
4. is one of several supply functions involved in logistics activities.

a. Procurement
b. Inspection
c. Tender buying
d. Purchasing
5. The basic difference assumed between an open tender and a global tender enquiry is .
a. order follow up activity
b. capabilities of the vendors
c. receiving and inspecting material
d. essentially the range of its applicability
6. Which of the following is issued only when either the item is proprietary in nature, that is only one supplier
produces that item or where there may be more vendors?
a. Open tender
b. Single tender enquiry
c. Global tender
d. Limited tender enquiry

a. A purchase department is usually engaged in purchasing a number of materials and services falling in one
category.
b. Forward buying helps a firm in booking capacity of a supplier and thus often results into a safeguard against
a competitor acquiring his capacity.
c. Tender buying is selecting five supply sources or suppliers out of many sources available.
d. A global tender is floated with a view to elicit offers/response from any vendor situated anywhere with in
the country.
8. In certain business situations a buyer may give preference to a supplier who also happens to be his customer,
this relationship is known as .
a. reciprocity
b. indentation
c. expediting
d. procurement
9. is a comprehensive list of materials needed to produce a product or service.

a. Purchase requisition
b. Inventory list
c. Bill of material
d. Open tender
10. Materials in the receiving bay are segregated into several categories, based on their quality control status
and .
a. destination
b. industry type
c. cost
d. usage
Chapter VII
Stores Management
Aim
• introduce the students to the concept of store management
• explain the functions of stores department
• elucidate the company motives to hold the inventory
Objectives
• define the four types of movements of material from the stores department
• explicate the concept of bin card and stores ledger
• enlist proper storage function
Learning outcome
• understand the methods for valuation of issues
• identify about valuation of material in three ways
• recognise the comparison of value of stock under different methods

7.1 Introduction to Stores Management

Management of inventory assumes importance due to the fact that investment in inventory constitutes one of the major
investments in current assets. The various forms in which a manufacturing concern may carry inventory are:
• Raw material: These represent inputs purchased and stored to be converted into finished products in future by
making certain manufacturing process on the same.
• Work in progress: These represent semi-manufactured products which need further processing before they can
be treated as finished products.
• Finished goods: These represent the finished products ready for sale in the market.
• Stores and supplies: These represent that part of the inventory which does not become a part of final product
but are required for production process. They may be in the form of cotton waste, oil and lubricants, soaps,
brooms, light bulbs, etc. Normally, they form a very minor part of total inventory and do not involve significant
investment.
7.1.1 Motive to Hold Inventory

A company may hold the inventory with the following motives:
• Transaction motive: A company may be required to hold the inventories in order to facilitate the smooth and
uninterrupted production and sales operations. It may not be possible for the company to procure raw material
whenever necessary. There may be a time lag between the demand for the material and its supply. Hence it is
needed to hold the raw material inventory. Similarly, it may not be possible to produce the goods immediately
after they are demanded by the customers. Hence it is needed to hold the finished goods inventory. The need to
hold work in progress may arise due to production cycle.
• Precautionary motive: In addition to the requirement to hold the inventories for routine transactions, the company
may like to hold them to guard against the risk of unpredictable changes in demand and supply forces. For
example- the supply of raw material may get delayed due to the factors like, strike, transport, disruption, short
supply, lengthy processes involved in import of the raw materials etc. Hence the company should maintain
sufficient level of inventories to take care of such situations. Similarly, the demand for finished goods may
suddenly increase (especially in case of seasonal types of products) and if the company is unable to supply them,
it may mean gain of the competitions. Hence, the company will like to maintain sufficient stock of finished
goods.
• Speculative motive: A company may like to purchase and stock the inventory in the quantity which is more
than needed for production and sales purpose. This may be with the intention to get the advantages in terms of
quantity discounts connected with bulk purchasing or anticipated price rise.
After the material is received, inspected and approved, the process of storing comes into operation which deals
with storing the material in good condition till it is required for use by production departments and issuing the same
whenever required. Stores department plays an important role in this respect.
7.2 Functions of Stores Department

The following are the types of movement of the material from the stores department:
• Receipt of material
• Issue of material
• Return of material from Production Department to Stores Department.
• Transfer of material
7.2.1 Receipt of Material

Usually the receipt of material is accompanied by delivery challan given by the supplier. On receipt of the material,
quantity received is checked with the quantity ordered by the stores department. The received material may be
inspected, before acceptance either by separate inspection department or by stores department itself. A document
known as Goods Received Note or Goods Received Report (GRN or GRR) is prepared to record the details of the
material received. The usual form in which GRN or GRR is prepared is as below:
GOODS RECEIVED NOTE

No.
Date:
Sr. No. Description Code Qty. Recd. Qty. Accepted Qty. Rejected Remarks
Prepared by Received by Inspected by Store Keeper
It may be prepared in quadruplicate to be distributed as follows:

• one copy to purchases department for comparing with purchases order and approving the invoice of the
supplier
• one copy to accounts department for making the payment of supplier’s invoice
• one copy to costing department for pricing and entering in stores record
• one copy to be retained by stores department
GRN/GRR should be serially numbered in order to locate the material which is physically received but for which
invoice is not received.
7.2.2 Issue of Material

Here, the issue of material refers to issue of material from stores department to production department. The material
should not be issued from the stores unless a proper authority in writing is produced before the stores department.
Usually, this authority is in the form of material requisition note or material requisition slip.
The normal contents of this note/slip are as follows:

• number and date (ideally, they should be serially numbered)
• department demanding the material
• description and code of material demanded
• quantity of material demanded
• signature of authority approving the demand
• signature of the person receiving the material
Normally one note/slip is prepared for requisitioning a single item of material. The usual form in which it is prepared
is as below:
MATERIAL REQUISITION NOTE

Production/Job Order No.
No.
Bill of Materials No.
Date :
Department :
Description
Code
Qty.
Unit Cost (for costing Dept. only)
Rate per unit Amount Rs.
Authorised by Issued by Received by Entered by Valued by
Normally, it is prepared in three copies. Two copies to stores department which in turn passes one copy to costing
department for pricing while second copy is retained by the stores department. One copy is for demanding
department.
7.2.3 Return of Material

There can be some situations, when material once issued to production department is returned back to the stores. It
can happen in the following circumstances:
• material issued in excess than the requirement
• scrap or defective work arising out of the production processes
Under these circumstances, a document in the form of materials returned note is prepared, which is to record return
of unused materials. The usual form in which this document is prepared is as below:
MATERIALS RETURNED NOTE
Production/Job Order No. No.
Bill of Materials No. Date :
Department :
Description Code Qty. Unit Cost (for costing Dept. only)
Authorised by Received by Posted by
As far as the valuation of the returned material is concerned, it may be treated as the fresh receipt of the material or
alternatively, it may be treated as the negative (minus) issues.
7.2.4 Transfer of Materials

In some situations, considering the urgency for the requirement of the material, it may be necessary to transfer the
material from one production/job order to another. Such transfer of material is usually accompanied by preparing a
document in the form of material transfer note. The usual form in which this document is prepared is as below:
MATERIAL TRANSFER NOTE

No.
Date :
From…………Dept. To… ............... Dept.
Production/Job Production/Job
Order No. Order No.
Description Code No. Qty. Cost (for costing Dept. only)
Authorised by Received by Posted by
Transfer of materials does not result into any fresh issue of material. However, material transfer notes will have to
be valued and considered in order to compute the material cost as per the job orders and production orders.
7.2.5 Proper Storage Function

The proper conduct of storage function requires that material should be properly stored in a good condition till it is
required for use by production departments and should be issued whenever required. This proper conduct is ensured
by what is known as 'Perpetual Inventory System'. The aims of the perpetual inventory system are two fold:
• Recording receipts and issues in such a way so as to know at any time, the stock in hand, in quantity and/or
value, without the need of physical counting. This aim is achieved by maintaining what is called as bin card
and stores ledger.
• Continuous verification of physical stock at regular intervals.
Bin Card
It is only a quantitative record of receipts, issues and closing balance of an item of material. Separate bin card is
maintained for each item of material. The usual form in which a bin card is maintained is as below.
BIN CARD
Description Maximum level
Code No. Minimum level
Location/Unit Reorder level
Date Document No. Receipt Issue Balance Remarks
Entries in receipts column are made on the basis of goods received note or material returned note. Entries in issues
column are made on the basis of material requisition note. After every entry of either receipts or issues, the balance
quantity is calculated and recorded so that the balance can be known at any point of time. The levels indicated on
bin card enable the stores department to keep a watch on balance and replace the material as soon as it reaches the
reorder level. Ideally, the bin card should be placed along with the material. But it may not be possible in all the
cases, so the bin cards are placed at a centrally located place but within stores department only.
Stores Ledger
Like the Bin Card, it is maintained for the recording of all receipts and issue transactions of material, but with the
exception that it records not only the quantities received or issued or in stock but also the financial expressions of
the same. The usual form in which the stores ledger is maintained is as follow:
STORES LEDGER
Description Maximum level
Code No. Minimum level
Location/Unit Reorder level
Date Doc. No. Receipts Issues Balance

Quantity Rate Rs. Quantity Rate Rs. Quantity Rate Rs.
By summing up the amounts appearing in the ‘issues’ column of stores ledger, one can get the cost of material
issued to production department which forms the ‘Material Cost’. As in case of bin card, separate store ledger sheets
are maintained in case of each item of material. The stores ledger sheets are maintained either in loose form or in
bound book form.
Bin Card vs. Stores Ledger

If the stores ledger is having all the information mentioned in a bin card plus some additional information is
also available, the next question which arises is why is it necessary to maintain both bin card and stores ledger
simultaneously as it will be only duplication of work. In the situations of computerised inventory accounting
system, maintenance of bin card and stores ledger simultaneously can be avoided. However, in the situation of
manual inventory accounting system, it will be ideal to maintain bin card and stores ledger simultaneously due to
the following reasons:
• Bin card is maintained by stores department while stores ledger is maintained by costing department.
• Bin card is not an accounting record but only a quantity record and as such is not concerned with the financial
implications of stores transactions.
• Maintenance of stores ledger provides a second check on maintenance of bin cards.
Reconciliation of Bin Card and Stores Ledger

As the source documents for the entries in Bin Card and Stores Ledger are the same, the closing balances disclosed
by both of them should match with each other. But in practice, they may not match due to the following reasons.
• arithmetical error in calculating balance
• non-posting of a certain document in either of these documents
• posting on wrong bin card or stores ledger sheet
• treating receipts transaction as issue transaction or vice versa
If the closing balance as per bin card and stores ledger is not matching, the very purpose of maintaining these two
documents simultaneously will be defeated. As such, it is necessary to reconcile both balances at regular intervals by
keeping all the entries up to date. If the balances as on a particular day are not matching, all the previous transactions
should be checked to locate differences.
7.3 Valuation of Material

The stores ledger considers not only the movement of material in terms of quantity but also in terms of its financial
implications. As such, it is necessary that all the possible movements of material are valued properly and are expressed
in terms of money. We will consider this problem under the following heads:
• Valuation of receipts
• Valuation of issues
• Valuation of returns from production department to stores department
7.4 Valuation of Receipts

Valuation of receipts is a relatively easy task, as the invoice or bill received from the supplier of the material is
available as a starting point. Following propositions should be considered for this purpose:
• The price as billed by the supplier will be the valuation of the receipts. The trade discount is deducted from
the basic price and all other amounts as billed by the supplier are added, like excise duty, sales tax, octroi duty,
transport/insurance charges, etc. There are different opinions in respect of the treatment of cash discount. One
opinion says that cash discount should be ignored, being purely of a financial nature, while valuing the receipts,
while another opinion says that it should be considered while valuing the receipt of the material.
• In some cases, more than one item of material is included in one single bill and some costs are jointly incurred
for all the items of material. Such joint costs may be distributed on the basis of the basic price of the material.
• In case of the imported material, the cost of the material consists of a basic price (which may be stated in foreign
currency and should be converted in Indian Rupees), customs duty, clearing charges, transport charges, octroi
duty, etc. In some cases, the point of receipt of imported material and the point of making the payment of invoice
amount may be different. As such, the rate of foreign currency may be different at the time of payment of the
customs duty and at the time of payment of the invoice amount. In such cases, the rate of exchange existing
at the time of making the payment of invoice amount should be considered for valuing basic cost of material
imported.
Illustration 1
The particulars relating to 1,200 kilograms of a certain raw material purchased by a company during April, 2010
are as below:
a. Lot prices quoted by suppliers and accepted by the company for placing the purchase order.
Lot up to 1000 kgs. @ Rs. 22 per kg. For
Between 1000 - 1500 kgs. @ Rs. 20 per kg. Supplies
Between 1500 - 2000 kgs @ Rs. 18 per kg. to Factory
Trade Discount 20%.
Additional charge for containers @ Rs. 10 per drum of 25 kg.
Credit allowed on return of containers @ Rs. 8 per drum.

Sales Tax at 10% on raw material and 5% on drums.
Total freight paid by the purchaser Rs. 240.
Insurance at 2.5% (on net invoice value) paid by the purchaser.
Stores Overheads applied at 5% on total purchase cost of material.
The entire quantity was received and issued to production:
The containers are returned in due course. Draw up a suitable statement to show:
• total cost of material purchased
• unit cost of material issued to production
Solution
b. Statement showing cost of purchases
Basic Cost (Rs.) Rs.1,200 kg x Rs. 20/kg = 24,000
Less: Trade discount @ 20% 4,800
Total cost 24,000 – 4,800 = 19,200
Container Cost
48 Drums x Rs. 10/Drum 480
Total cost 19,200 + 480 = 19,680
Sales Tax
10% on Rs. 19,200 192
5% on Rs. 480 24
Total Tax 216
Total cost 19,680 + 216 = 19,896
Other charges
Insurance 2.5% on Rs. 21,264.00 531.60
Freight 240.00
20.667
Less: Credit for drums returned
Rs. 8 per Drum x 48 Drums 384.00
TOTAL COST 22,020.60
Add: Stores Overheads 5% 1,101.03
23,121. 63
c. Unit cost for valuation of issues: Rs. 23,121/1,200 kg = Rs. 19.268/kg
7.5 Valuation of Issues

This is a more complex process than the valuation of the receipts. It is because of this reason that the material may
be issued out of the various lots which might have been purchased at various prices. As such, a problem may arise
as to which of the receipt prices should be used to value the material requisition notes.
Various methods used for this purpose are as below:

• First In First Out (FIFO)
• Last In First Out (LIFO)
• Highest In First Out (HIFO)
• Simple Average Rate (SAR)
• Weighted Average Rate (WAR)
• Market rate
7.5.1 First In First Out (FIFO) Method

Under this method, the price of the earliest available lot is considered first and if that lot is exhausted, the price of
the next available lot is considered. It should be remembered that the physical issue of the material may not be made
out of the said lots, though it is presumed that it is made out of these lots.
Illustration
Following transactions have taken place in respect of a material during March 2010.
Date:
1 Opening Balance 400 units @ Rs. 10 per unit
3 Purchased 100 units @ Rs. 9.5 per unit
7 Issued 300 units
15 Issued 200 units
22 Issued 50 units
30 Issued 350 units
Prepare the Stores Ledger assuming that the issues are valued on FIFO basis.
Solution
Valuation of stock by FIFO method
Date Receipts Issues Balance Total

Quantity Rate Rs. Quantity Rate Rs. Quantity Rate Rs. Value
1 400 10.00 4,000 4,000
3 100 9.50 950 400 10.00 4,000
100 9.50 950 4,950
7 300 10 3,000 100 10.00 1,000
100 9.50 950 1,950
10 500 9.75 4,875 100 10.00 1,000
100 9.50 950
500 9.75 4875 6,825
15 200 10 2,000 500 9.75 4875 4,875
22 50 10 488 450 9.75 4,388 4,388
28 300 10.25 3,075 450 9.75 4,388
300 10.25 3,075 7,463
30 350 10 3,413 100 9.75 975
300 10.25 3,075 4,050
The objections raised against this method are mentioned below:

• Calculations become complicated if the lots are received frequently and at varying prices
• Costs may be wrongly presented if the price of different lots of material is being used for pricing issues to
various batches of production
• In case of varying prices, the pricing of issues does not consider current market prices
7.5.2 Last In First out (LIFO) Method

Under this method, the price of the latest available lot is considered first and if that lot is exhausted, the price of the
lot prior to that is considered. Here also, it should be remembered, that the physical issue of the material may not
be made out of the said lots, though it is presumed that it is made out of the lots.
Illustration
Valuation of stock by LIFO method:
1 400 10.00 4,000 4,000
3 100 9.50 950 400 10.00 4,000
100 9.50 950 4,950
7 100 9.50 950
200 10.00 2,000 200 10.00 2,000 2,000
10 500 9.75 4,875 200 10.00 2,000
500 9.75 4,875 6,875
15 200 9.75 1,950 200 10.00 2,000
300 9.75 2,925 4,925
22 50 9.75 488 200 10.00 2,000
250 9.75 2,438 4,438
28 300 10.25 3,075 200 10.00 2,000
250 9.75 2,438 7,463
300 10.25 3,075 7,513
30 300 10.25 3,075 200 10.00 2,000
50 9.75 488 200 9.75 1,950 3,950
The advantages of this method are as below:

• It is simple to operate.
• The cost of materials issued considers fairly recent and current prices. The prices quoted on this cost fairly
represent the real cost.
• It can be conveniently applied if transactions are not too many and prices of the material are fairly steady.
The objections raised against this method are as below:

• Calculations become complicated if the lots are received frequently and at varying prices.
• Costs may be wrongly presented if the price of different lots of material is used for pricing issues to various
batches of production.
• In case of falling prices in the market, this method may give wrong results.
7.5.3 Highest In First Out (HIFO) Method

This method assumes that the stock should always be shown at the minimum value and hence the issues should
always be valued at the highest value of receipts. For example, assume a situation as follows:
Mar. 1 Purchased 100 units @ Rs. 12
On March 20, 120 units are issued to production and they will be valued at Rs. 18 per unit being the highest price.
This method is not very popular. It always overvalues the issues and undervalues the closing stock. This method
may be useful in case of the organisations dealing with monopoly products which is a rare possibility.
Illustration
Valuation of stock by HIFO method:
1 400 10.00 4,000 4,000
3 100 9.50 950 400 10.00 4,000
100 9.50 950 4,950
7 300 10.00 3,000 100 10.00 1,000
100 9.50 950 1,950
10 500 9.75 4,875 100 10.00 1,000
500 9.75 4875 6,825
15 100 10.00 1,000 100 9.50 950
100 9.75 975 400 9.75 3900 4,850
22 50 9.75 488 100 9.50 950
350 9.75 3,413 4,363
28 300 10.25 3,075 100 9.50 950
350 9.75 3,413
300 10.25 3,075 7,438
30 300 10.25 3,075 100 9.50 950
50 9.75 488 300 9.75 2,925 3,875

7.5.4 Average Rate Method

Both the above methods, i.e., FIFO and LIFO, consider the exact or actual cost for valuing the issue of material.
However these methods may prove to be disadvantageous if the transactions are too many and are at varying prices.
In such cases, instead of considering the exact or actual cost, average cost may be considered to lessen the effect of
variation in prices, either upward or downward.
For example: Assume a situation as below:

Mar. 1 - Received - 1500 units @ Rs. 10 - Rs. 15,000
Mar. 15 - Received - 1600 units @ Rs. 30 - Rs. 48,000
On March 20, 1800 units were issued to production.
If FIFO method is followed to price the issues, the issues will be valued as below:
1500 units @ Rs. 10 per unit Rs. 15,000
Total Rs. 24,000
The issues will be considerably under-valued and closing stock will be considerably over valued, as compared to
the current market prices.
If LIFO method is followed to price the issues, the issues will be valued as below:
Total Rs. 50,000
The closing stock will be considerably under valued as compared to the current prices.
To lessen the effect of such drastic price variation, both on the valuation of issues as well as of closing stock,
instead of considering the actual/exact price of Rs. 10 per unit or Rs. 30 per unit, average price may be taken into
consideration.
There are mainly two ways in which average prices may be considered.
• Simple Average Rate Method
• Weighted Average Rate Method
7.5.4.1 Simple Average (SAR) Method

Under this method, the simple average of the prices of the lots available for making the issues is considered for
pricing the issues. After the receipt of new lot, a new average price is worked out. It should be remembered in this
connection that, for deciding the possible lots out of which the issues could have been made, the method of First
in First Out (FIFO) is followed.
This method is suitable if the material is received in uniform quantity. If the material quantity of each lot varies
widely, this method may lead to wrong results.
Illustration
Date Receipts Issues Balance
1 400 10.00 4000.00
3 100 9.50 950 500 9.75 4875.00
7 300 9.75 2925 200 9.75 1950.00
10 500 9.75 4875 700 9.75 6825.00
15 200 9.75 1950 500 9.75 4875.00
22 50 9.75 487.5 450 9.75 4387.50
28 300 10.25 3075 750 10.00 7500.00
30 350 10.00 3500 400 10.00 4000.00
7.5.4.2 Weighted Average Rate (WAR) Method

As stated above, the simple average method of valuation of issues may lead to wrong results, if the quantity of each
lot of material received varies widely.
For example: Assume the following situation.

Mar. 1 - Received - 100 units @ Rs. 10 Rs. 1,000
Mar. 10 - Received – 5,000 units @ Rs. 30 Rs. 1,50,000
Total Rs. 1,51,000
On March 20, 4,800 units were issued to production. As both the lots are possible lots for making the issue, the
average of prices of both the lots will be taken into account if simple average method is considered. Hence, per unit
issue price will be.
(Rs. 10 + Rs. 30)/2 = Rs. 20
As such, the issue quantity will be priced at : 4,800 units x Rs. 20 i.e. Rs. 96,000, which will be incorrect, as
considering the quantity of issue, the price of the material received on March 10 should get more weightage.
To overcome this drawback of simple average method, weighted average method may be used which considers
not only the price of each lot but also the quantity of the same. Though this method involves considerable amount
of clerical work, in practice, this method proves to be very useful in the event of varying prices and quantities. In
practice, the calculation of weighted average rate proves to be very simple. The products of quantity and price divided
by the total quantity of all lots, just before the issue, gives the unit price in respect of the subsequent issues.
Illustration
The same example given under 5.5.1 in this unit will be solved as per weighted average rate method.
Valuation of stock by weighted average method.
Date Receipts Issues Balance

1 400 10.00 4000.00
3 100 9.50 950 500 9.90 4950.00
7 300 9.90 2970 200 9.90 1980.00
10 500 9.75 4875 700 9.79 6855.00
15 200 9.79 1959 500 9.79 4896.43
22 50 9.79 489.6 450 9.79 4406.79
28 300 10.25 3075 750 9.98 7481.79
30 350 9.98 3492 400 9.98 3990.29
Q1R1 = 4000 Q2R2 = 950 Q1R1+ Q2R2 = 4950. Q1+Q2 = 500

Weighted Average Cost = (Q1R1+Q2R2)/( Q1+Q2) = 4950/500 = 9.9
Comparison of value of stock under different methods:
Sl. No. Method of valuation Value of Inventory
1 First in First Out 4,050.00
2 Last in First out 3,950.00
3 Highest in first Out 3,875.00
4 Simple Average 4,000.00
5 Weighted Average 3,990.29
From the above table it is clear that the value of stock will be different in different methods of valuation. It is expected
that a company should follow the same method every year. This is called principle of consistency in accounting. If
the method of valuation is changed, it may lead to change in profit. In such case, the effect of change in the method
on profitability has to be shown separately.
7.5.5 Market Rate

Explained below are three methods of valuation under market rate:
Market Price
Under this method, market price is considered to be the base for pricing the issues. In this case, market price may be
treated as the latest purchase price, realisable price or replacement price. This method is used mainly in respect of
obsolete stock items or non-moving stock items. The defect in respect of this method is that the price concessions
obtained in respect of bulk purchases are not reflected in the cost of material.
Specific Price
If the material is purchased against a specific job or production order, the issue of material is priced at actual purchase
price. This method can be adopted if the purchase prices are fairly stable.
Standard Price
This is the normal or ideal price which will be paid in the normal circumstances, based on the basis of estimated
market conditions, transportation costs and normal quantity of purchases. Any issue of material will be priced at
standard prices irrespective of actual prices. This enables the simplification of accounting system with reduced
clerical work and also enables to decide the efficiency of purchase department.
7.6 Valuation of Returns

This indicates the material returned by the production department to stores department. The way in which the returned
material can be valued is shown below:
• At the same price as when issued
 The original price of issue will be a base for valuing the returns, for which original material requisition
note will be the base.
• At the current price of issues
 The method which is followed for valuing the issue on the same date is considered for valuing the
returns.
 This will avoid the clerical efforts, but at the same time the track of original issue of material can’t be
maintained.
Treatment of shortages
In some cases, the physical verification of stock may reveal that the physical stock is less than the stock as per the
stores ledger. The valuation of this shortage is done as if it is an issue of material. The treatment given to the valuation
of shortages in cost accounts depends upon the nature of the shortage i.e. normal shortage or abnormal shortage.
Bill of materials
In order to ensure proper inventory control, the ‘basic principle to be kept in mind is that proper material is available
for production purposes whenever it is required. This aim can be achieved by preparing what is normally called as
'Bill of Materials'.
A bill of material is the list of all the materials required for a job, process or production order. It gives the details
of the necessary materials as well as the quantity of each item. As soon as the order for the job is received, bill of
materials is prepared by production department or production planning department.
The form in which the bill of material is usually prepared is as below:
BILL OF MATERIALS
No. Date of Issue Production/Job Order No.
Department authorised
Sr. No. Description Code Qty. For Department Use only
Remarks of Material No. Material Date Quantity
Requisition No. demanded
The functions of bill of materials are as below:

• Bill of material gives an indication about the orders to be executed to all the people concerned.
• Bill of material gives an indication about the materials to be purchased by the purchases department if the same
is not available with the stores.
• Bill of material may serve as a base for the production department for placing the material requisitions ships.
• Costing/Accounts Department may be able to compute the material cost in respect of a job or a production
order. A bill of material prepared and valued in advance may serve as a base for quoting the price for the job
or production order.
• Perpetual Inventory System: In order to exercise proper inventory control, perpetual inventory system may be
implemented. It aims at two facts, given below.
 maintenance of bin cards and stores ledger in order to know about the stock in quantity and value at any
point of time
 continuous verification of physical stock to ensure that the physical balance and the book balance tallies
The continuous stock taking may be advantageous from the following angles:
• Physical balances and book balances can be compared and adjusted without waiting for the entire stocktaking
to be done at the year-end. Further, it is not necessary to close down the factory for annual stocktaking.
• The figures of stock can be readily available for the purpose of periodic profit and loss account.
• Discrepancies can be located and adjusted in time.
• Fixation of various levels and bin cards enables the action to be taken for the placing the order for acquisition
of material.
• A systematic maintenance of perpetual inventory system enable in locating the slow and non-moving items and
to take remedial action for the same.
• Stock details are correctly available for getting the insurance of stock.
Summary
• Management of inventory assumes importance due to the fact that investment in inventory constitutes one of the
major investments in current assets. The various forms in which a manufacturing concern may carry inventory
are; raw material, work in progress, finished goods and stores and supplies.
• A company may hold the inventory with the following motive: transaction motive, precautionary motive, and
speculative motive.
• The types of movement of the material from the stores department are: receipt of material, issue of material,
return of material from production department to stores department, and transfer of material.
• The proper conduct of storage function requires that material should be properly stored in a good condition till
it is required for use by production departments and this is ensured by perpetual inventory system.
• Valuation of material is done in valuation of receipts, valuation of issues and valuation of returns from production
department to stores department.
• Valuation of receipts is a relatively easy task, as the invoice or bill received from the supplier of the material
is available as a starting point.
• Valuation of the issues is done by First In First Out (FIFO), Last In First Out (LIFO), Highest In First Out
(HIFO), Simple Average Rate (SAR), Weighted Average Rate (WAR) and Market rate.
• Highest in first out method assumes that the stock should always be shown at the minimum value and hence
the issues should always be valued at the highest value of receipts.
• Simple average (SAR) method, the simple average of the prices of the lots available for making the issues is
considered for pricing the issues.
• Weighted average (WAR) method considers not only the price of each lot but also the quantity of the same.
• Valuation of the returns is done on two bases: at the same price at which issued and at the current price if
issues.
References
• Crosby, Philip, B., 1974. Quality Without Tears: The Art of Hassle-Free Management, New York: McGraw-
Hill.
• Evans, J. R. & Lindsay, W. M., 1999. The Management and Control of Quality, 4th ed., Cincinnati: South
Western.
• Quality Management Systems, [Pdf] Available at: <http://www.abahe.co.uk/business-administration/Quality-
Management-Systems.pdf> [Accessed 13 February 2013].
• Rijn, J., QUALITY MANAGEMENT An Introduction, [Pdf] Available at: <http://www.indevelopment.nl/PDFfiles/
QualityManagement.pdf> [Accessed 13 February 2013].
• Prof. Chakravarti, K., 2010. Lec-13 Total Quality Management, [Video online] Available at: <http://www.
youtube.com/watch?v=ksR4Xy6tFcM> [Accessed 13 February 2013].
• Module 11: Quality Management, [Video online] Available at: <http://www.youtube.com/watch?v=QJNVrY_
Z2NM> [Accessed 13 February 2013].
Recommended Reading
• Goetsch, D. L. & Stanley, D., 1995. Implementing Total Quality, Upper Saddle River, N. J: Prentice-Hall.
• Hall, R., 1977. Attaining Manufacturing Excellence, Burr Ridge III: Down-Jones Irwin.
• Kitazawa, S. & Sarkis, J., The Relationship Between ISO 14001 and Continuous Source Reduction Programs,
International.
Self Assessment
1. Which of the following document is used to record the details of the material received?
a. Inspection receipt
b. Goods received report
c. Bin card
d. Stores ledger
2. Which of the following methods assumes that the stock should always be shown at the minimum value and
hence the issues should always be valued at the highest value of receipts?
a. First in first out
b. Last in first out
c. Highest in first out
d. Simple average rate
3. If the material is purchased against a specific job or production order, the issue of material is priced at
purchase price.
a. actual
b. cost
c. selling
d. inventory
4. Which of the following statement is false?

a. A company may be required to hold the inventories in order to facilitate the smooth and uninterrupted
production and sales operations
b. Usually the receipt of material is accompanied by delivery challan given by the supplier
c. On receipt of the material, quantity received is checked with the quantity ordered by the stores
department
d. The material can be issued from the stores without a proper authority in writing is produced before the
stores department
5. Which of the following system ensures the proper conduct of storage?

a. Perpetual inventory
b. Bin card
c. Stores ledger
d. Valuation of receipts
6. Which of the following method may be useful in case of the organisations dealing with monopoly products
which is a rare possibility?
a. First in first out
b. Last in first out
c. Highest in first out
d. Simple average rate

a. Bill of material gives an indication about the orders to be executed to all the people of the organisation
b. Bill of material gives an indication about the materials to be purchased by the purchases department if the
same is available with the stores
c. Bill of material may serve as a base for the production department for placing the material requisitions
ships
d. Bill of material prepared and valued later on and may serve as a base for quoting the price for the job or
production order
8. Bin card is maintained by stores department while stores ledger is maintained by department.
a. manufacturing
b. distribution
c. packaging
d. costing
9. The levels indicated on bin card enable the stores department to keep a watch on balance and replace the material
as soon as it reaches the level.
a. minimum
b. re-order
c. actual
d. valuation
10. The stores ledger considers not only the movement of material in terms of quantity but also in terms of its
implications.
a. distribution
b. economical
c. financial
d. production
Chapter VIII
Quality Management
Aim
• explicate the concept of quality management in operations management
• explain the terms: 'quality' and 'quality management'
• enlist different types of costs in quality management
Objectives
• explain the tools of quality control
• elucidate the quality standards in quality management
• explicate the total quality management in operations management
Learning outcome
• understand the reasons for failure of quality management in various fields
• identify the importance of quality standards in management education and try to apply it
• describe total quality management

8.1 Introduction
Successful companies understand the powerful impact customer-defined quality can have on their business. For
this reason many competitive firms continually increase their quality standards. For example, both the Ford Motor
Company and the Honda Motor Company have recently announced that they are making customer satisfaction their
number one priority. The slow economy of 2003 impacted sales in the auto industry. Both firms believe that the
way to rebound is through improvements in quality, and each has outlined specific changes to their operations. Ford
is focusing on tightening already strict standards in their production process and implementing a quality program
called Six-Sigma. Honda, on the other hand, is focused on improving customer-driven product design. Although
both firms have been leaders in implementing high quality standards, they believe that customer satisfaction is still
what matters most.
8.2 Definition of Total Quality Management

Total Quality Management (TQM) is an integrated effort designed to improve quality performance at every level of
the organisation. Customer-defined Quality is defined by the customers is called Customer-defined Quality.
8.2.1 Defining Quality

Conformance to specifications
How well a product or service meets the targets and tolerances determined by its designers.
Fitness for use

It is the quality that evaluates how well the product performs for its intended use.
Value for price paid

Quality is defined in terms of product or service usefulness for the price paid.
Support services
Quality defined in terms of the support provided after the product or service is purchased.
Psychological criteria
It is the quality that focuses on judgmental evaluations of what constitutes product or service excellence:
• TQM is an integrated organisational effort designed to improve quality at every level.
• In this chapter you will learn about the philosophy of TQM, its impact on organisations, and its impact on your
life.
• You will learn that TQM is about meeting quality expectations as defined by the customer; this is called
customer-defined quality.
• However, defining quality is not as easy as it may seem, because different people have different ideas of what
constitutes high quality. Let’s begin by looking at different ways in which quality can be defined.
8.3 Cost of Quality

• The reason quality has gained such prominence is that organisations have gained an understanding of the high
cost of poor quality. Quality affects all aspects of the organisation and has dramatic cost implications.
• The most obvious consequence occurs when poor quality creates unhappy customers and eventually leads to
loss of business. However, quality has many other costs, which can be divided into two categories.
• The first category consists of costs necessary for achieving high quality, which are called quality control
costs.
• These are of two types: Prevention Costs and Appraisal Costs.
• The second category consists of the cost consequences of poor quality, which are called Quality Failure costs.
• These include External Failure Costs and Internal Failure Costs. These costs of quality are shown in Table 8.1
• The first two costs are incurred in the hope of preventing the second two.
• Prevention costs are all costs incurred in the process of preventing poor quality from occurring. They include
quality planning costs, such as the costs of developing and implementing a quality plan.
• Also included are the costs of product and process design, from collecting customer information to designing
processes that achieve conformance to specifications.
• Employee training in quality measurement is included as part of this cost, as well as the costs of maintaining
records of information and data related to quality.
• Appraisal costs are incurred in the process of uncovering defects. They include the cost of quality inspections,
product testing, and performing audits to make sure that quality standards are being met.
• Also included in this category are the costs of worker time spent measuring quality and the cost of equipment
used for quality appraisal.
• Internal Failure Costs are associated with discovering poor product quality before the product reaches the
customer site. One type of internal failure cost is rework, which is the cost of correcting the defective item.
• Sometimes the item is so defective that it cannot be corrected and must be thrown away. This is called scrap,
and its costs include all the material, labor, and machine cost spent in producing the defective product.
• Other types of internal failure costs include the cost of machine downtime due to failures in the process and the
costs of discounting defective items for salvage value.
• External Failure Costs are associated with quality problems that occur at the customer site.
• These costs can be particularly damaging because customer faith and loyalty can be difficult to regain.
• They include everything from customer complaints, product returns, and repairs, to warranty claims, recalls,
and even litigation costs resulting from product liability issues.
• A final component of this cost is lost sales and lost customers. For example, manufacturers of lunch meats
and hot dogs whose products have been recalled due to bacterial contamination have had to struggle to regain
consumer confidence.
• Other examples include auto manufacturers whose products have been recalled due to major malfunctions such
as problematic braking systems and airlines that have experienced a crash with many fatalities.
• External failure can sometimes put a company out of business almost overnight.
• Companies that consider quality important invest heavily in prevention and appraisal costs in order to prevent
internal and external failure costs.
• The earlier defects are found, the less costly they are to correct. For example, detecting and correcting defects
during product design and product production is considerably less expensive than when the defects are found
at the customer site as shown in Fig. 8.1.
• External Failure Costs tend to be particularly high for service organisations. The reason is that with a service the
customer spends much time in the service delivery system, and there are fewer opportunities to correct defects
than there are in manufacturing. Examples of external failure in services include an airline that has overbooked
flights, long delays in airline service, and lost luggage.
Prevention Cost Cost of preparing and implementing quality
Appraisal Cost Costs of testing, evaluating, and inspecting quality
Internal failure Costs of scrap, rework, and material losses.
External failure Costs of failure at customer site, including returns, repairs, and recalls.
Table 8.1 Cost of quality

Cost of defect Design Production Customer

Location of Defect
Fig. 8.1 Cost of defects
8.4 Continuous Improvement (Kaizen)

• Another concept of the TQM philosophy is the focus on Continuous Improvement.
• Traditional systems operated on the assumption that once a company achieved a certain level of quality, it was
successful and needed no further improvements.
• We tend to think of improvement in terms of plateaus that are to be achieved, such as passing a certification test
or reducing the number of defects to a certain level.
• Traditionally, change for American managers involves large magnitudes, such as major organisational
restructuring.
• The Japanese, on the other hand, believe that the best and most lasting changes come from gradual
improvements.
• To use an analogy, they believe that it is better to take frequent small doses of medicine than to take one large
dose.
• Continuous improvement, called 'Kaizen' by the Japanese, requires that the company continually strive to be
better through learning and problem solving. Because we can never achieve perfection, we must always evaluate
our performance and take measures to improve it.
• Now let’s look at two approaches that can help companies with continuous improvement: The Plan-Do-Study-
Act (PDSA) cycle and benchmarking.
8.4.1 Plan to Study Cycle

The Plan-Do-Study-Act (PDSA) cycle describes the activities a company needs to perform in order to incorporate
continuous improvement in its operation. This cycle, shown in Fig. 8.2 is also referred to as the Shewhart cycle or
the Deming wheel. The circular nature of this cycle shows that continuous improvement is a never-ending process.
Let’s look at the specific steps in the cycle.
Plan
• The first step in the PDSA cycle is to plan.
• Managers must evaluate the current process and make plans based on any problems they find.
• They need to document all current procedures, collect data, and identify problems.
• This information should then be studied and used to develop a plan for improvement as well as specific measures
to evaluate performance.
Do
The next step in the cycle is implementing the plan (Do). During the implementation process managers should
document all changes made and collect data for evaluation.
Study
The third step is to study the data collected in the previous phase. The data are evaluated to see whether the plan is
achieving the goals established in the plan phase.
Act
• The last phase of the cycle is to act based on the results of the first three phases.
• The best way to accomplish this is to communicate the results to other members in the company and then
implement the new procedure if it has been successful.
• Note that this is a cycle; the next step is to plan again. After we have acted, we need to continue evaluating the
process, planning, and repeating the cycle again.
Do Act
Plan Study
Fig. 8.2 PDSA cycle
8.4.2 Benchmarking
• Another way companies implement continuous improvement is by studying business practices of companies
considered “best in class.” This is called as benchmarking.
• The ability to learn and study how others do things is an important part of continuous improvement.
• The benchmark company does not have to be in the same business, as long as it excels at something that the
company doing the study wishes to emulate.
• For example, many companies have used Lands End to benchmark catalog distribution and order filling,
because Lands End is considered a leader in this area. Similarly, many companies have used American Express
to benchmark conflict resolution.
8.5 Employee Empowerment

• Part of the TQM philosophy is to empower all employees to seek out quality problems and correct them.
• With the old concept of quality, employees were afraid to identify problems for fear that they would be reprimanded.
Often poor quality was passed onto someone else, in order to make it “someone else’s problem.”
• The new concept of quality, TQM, provides incentives for employees to identify quality problems. Employees
are rewarded for uncovering quality problems, not punished.
• In TQM, the role of employees is very different from what it was in traditional systems.
• Workers are empowered to make decisions relative to quality in the production process. They are considered a
vital element of the effort to achieve high quality.
• Their contributions are highly valued, and their suggestions are implemented. In order to perform this function,
employees are given continual and extensive training in quality measurement tools.
• To further stress the role of employees in quality, TQM differentiates between external and internal
customers.
• External customers are those that purchase the company’s goods and services. Internal customers are employees
of the organisation who receive goods or services from others in the company.
• For example, the packaging department of an organisation is an internal customer of the assembly department.
Just as a defective item would not be passed to an external customer, a defective item should not be passed to
an internal customer.
8.5.1 Team Approach

• TQM stresses that quality is an organisational effort. To facilitate the solving of quality problems, it places great
emphasis on teamwork. The use of teams is based on the old adage that “two heads are better than one.”
• Using techniques such as brainstorming, discussion, and quality control tools, teams work regularly to correct
problems. The contributions of teams are considered vital to the success of the company. For this reason,
companies set aside time in the workday for team meetings.
• Teams vary in their degree of structure and formality, and different types of teams solve different types of
problems.
• One of the most common types of teams is the quality circle, a team of volunteer production employees and
their supervisors whose purpose is to solve quality problems.
• The circle is usually composed of eight to ten members, and decisions are made through group consensus. The
teams usually meet weekly during work hours in a place designated for this purpose.
• They follow a preset process for analysing and solving quality problems. Open discussion is promoted,
and criticism is not allowed. Although the functioning of quality circles is friendly and casual, it is serious
business.
• Quality circles are not mere “gab sessions”. Rather, they do important work for the company and have been
very successful in many firms.
8.6 Tools of Quality Control

• You can see that TQM places a great deal of responsibility on all workers. If employees are to identify and
correct quality problems, they need proper training.
• They need to understand how to assess quality by using a variety of quality control tools, how to interpret
findings, and how to correct problems.
• In this section we look at seven different quality tools. These are often called the seven tools of quality control
and are shown in Fig. 8.3.
• They are easy to understand, yet extremely useful in identifying and analysing quality problems. Sometimes
workers use only one tool at a time, but often a combination of tools is most helpful.
8.6.1 Cause-and-Effect Diagrams

• Cause-and-effect diagrams are charts that identify potential causes for particular quality problems. They are
often called fishbone diagrams because they look like the bones of a fish.
• A general cause-and-effect diagram is shown in Fig.8.3. The “head” of the fish is the quality problem, such as
damaged zippers on a garment or broken valves on a tire.
• The diagram is drawn so that the “spine” of the fish connects the “head” to the possible cause of the problem.
These causes could be related to the machines, workers, measurement, suppliers, materials, and many other
aspects of the production process.
• Each of these possible causes can then have smaller “bones” that address specific issues that relate to each cause.
• For example, a problem with machines could be due to a need for adjustment, old equipment, or tooling problems.
Similarly, a problem with workers could be related to lack of training, poor supervision, or fatigue.
• Cause-and-effect diagrams are problem-solving tools commonly used by quality control teams.
• Specific causes of problems can be explored through brainstorming. The development of a cause-and-effect
diagram requires the team to think through all the possible causes of poor quality.
8.6.2 Flowcharts
• A flowchart is a schematic diagram of the sequence of steps involved in an operation or process.
• It provides a visual tool that is easy to use and understand. By seeing the steps involved in an operation or
process, everyone develops a clear picture of how the operation works and where problems could arise.
8.6.3 Checklists
• A checklist is a list of common defects and the number of observed occurrences of these defects. It is a simple
yet effective fact-finding tool that allows the worker to collect specific information regarding the defects
observed.
• The checklist in Fig.8.3 shows four defects and the number of times they have been observed. It is clear that
the biggest problem is ripped material.
• This means that the plant needs to focus on this specific problem for example, by going to the source of supply
or seeing whether the material rips during a particular production process.
• A checklist can also be used to focus on other dimensions, such as location or time. For example, if a defect is
being observed frequently, a checklist can be developed that measures the number of occurrences per shift, per
machine, or per operator.
• In this fashion we can isolate the location of the particular defect and then focus on correcting the problem.
8.6.4 Control Charts

• Control charts are a very important quality control tool.
• These charts are used to evaluate whether a process is operating within expectations relative to some measured
value such as weight, width, or volume.
• For example, we could measure the weight of a sack of flour, the width of a tire, or the volume of a bottle of
soft drink. When the production process is operating within expectations, we say that it is “in control.”
• To evaluate whether or not a process is in control, we regularly measure the variable of interest and plot it
on a control chart. The chart has a line down the center representing the average value of the variable we are
measuring.
• Above and below the center line are two lines, called the Upper Control Limit (UCL) and the Lower Control
Limit (LCL). As long as the observed values fall within the upper and lower control limits, the process is in
control and there is no problem with quality. When a measured observation falls outside of these limits, there
is a problem.
8.6.5 Scatter Diagrams

• Scatter diagrams are graphs that show how two variables are related to one another. They are particularly useful
in detecting the amount of correlation, or the degree of linear relationship, between two variables.
• For example, increased production speed and number of defects could be correlated positively; as production
speed increases, so does the number of defects.
• Two variables could also be correlated negatively, so that an increase in one of the variables is associated with
a decrease in the other.
• For example, increased worker training might be associated with a decrease in the number of defects
observed.
• The greater the degree of correlation the more linear are the observations in the scatter diagram. On the other
hand, the more scattered the observations in the diagram, the less correlation exists between the variables.
• Of course, other types of relationships can also be observed on a scatter diagram, such as an inverted.
• This may be the case when one is observing the relationship between two variables such as oven temperature
and number of defects, since temperatures below and above the ideal could lead to defects.
8.6.6 Pareto Analysis

• Pareto analysis is a technique used to identify quality problems based on their degree of importance.
• The logic behind Pareto analysis is that only a few quality problems are important, whereas many others are not
critical. The technique was named after Vilfredo Pareto, a nineteenth-century Italian economist who determined
that only a small percentage of people controlled most of the wealth.
• This concept has often been called the 70 – 20 rule and has been extended to many areas.
• In quality management the logic behind Pareto’s principle is that most quality problems are a result of only a
few causes. The trick is to identify these causes.
• One way to use Pareto analysis is to develop a chart that ranks the causes of poor quality in decreasing order
based on the percentage of defects each has caused.
• For example, a tally can be made of the number of defects that result from different causes, such as operator
error, defective parts, or inaccurate machine calibrations.
• Percentages of defects can be computed from the tally and placed in a chart like those shown in Fig. 8.3. We
generally tend to find that a few causes account for most of the defects.
8.6.7 Histograms
• A histogram is a chart that shows the frequency distribution of observed values of a variable.
• We can see from the plot what type of distribution a particular variable displays, such as whether it has a normal
distribution and whether the distribution is symmetrical.
1. Cause and Effect Diagram 4. Control Chart

Suppliers Workers Machines UCL
Quality
Problems LCL
Environment Process Material 5. Scatter Diagram
2. Flowchart Y
6. Pareto Chart
%
3. Checklist
Detect type No. of Defects Total A B C D E
Broken Zipper  3
Ripped material  7 7. Histogram
Missing buttons  3 F requency
Faded colour 2
Frequency

A B C D E
The seven tools of quality control
Fig. 8.3 Seven tools of quality control

(Source: http://www.scribd.com/doc/24650872/Seven-Tools-of-Quality-Control)
8.7 Process Management

• According to TQM a quality product comes from a quality process. This means that quality should be built
into the process.
• Quality at the source is the belief that it is far better to uncover the source of quality problems and correct it
than to discard defective items after production.
• If the source of the problem is not corrected, the problem will continue. For example, if you are baking cookies
you might find that some of the cookies are burned. Simply throwing away the burned cookies will not correct
the problem.
• You will continue to have burned cookies and will lose money when you throw them away. It will be far more
effective to see where the problem is and correct it. For example, the temperature setting may be too high, the
pan may be curved, placing some cookies closer to the heating element, or the oven may not be distributing
heat evenly.
• Quality at the source exemplifies the difference between the old and new concepts of quality. The old concept
focused on inspecting goods after they were produced or after a particular stage of production.
• If an inspection revealed defects, the defective products were either discarded or sent back for reworking. All
this cost the company money, and these costs were passed on to the customer.
• The new concept of quality focuses on identifying quality problems at the source and correcting them.
8.8 Quality Standards

Various quality standards are discussed below:
8.8.1 ISO 9000 Standards
• Increases in international trade during the 1970s created a need for the development of universal standards of
quality. Universal standards were seen as necessary in order for companies to be able to objectively document
their quality practices around the world.
• Then in 1977 the International Organisation for Standardisation (ISO) published its first set of standards for
quality management called ISO 9000.
• The International Organisation for Standardisation (ISO) is an international organisation whose purpose is to
establish agreement on international quality standards.
• It currently has members from 91 countries, including the United States. To develop and promote international
quality standards, ISO 9000 has been created.
• ISO 9000 consists of a set of standards and a certification process for companies. By receiving ISO 9000
certification, companies demonstrate that they have met the standards specified by the ISO.
• The standards are applicable to all types of companies and have gained global acceptance.
• In many industries ISO certification has become a requirement for doing business. Also, ISO 9000 standards
have been adopted by the European Community as a standard for companies doing business in Europe.
• In December 2000 the first major changes to ISO 9000 were made, introducing the following three new
standards:
 ISO 9000:2000 Quality Management Systems Fundamentals and Standards: Provides the terminology and
definitions used in the standards. It is the starting point for understanding the system of standards.
 ISO 9001:2000 Quality Management Systems Requirements: This is the standard used for the certification
of a firm’s quality management system. It is used to demonstrate the conformity of quality management
systems to meet customer requirements.
 ISO 9004:2000 Quality Management Systems Guidelines for Performance: Provides guidelines for
establishing a quality management system. It focuses not only on meeting customer requirements but also
on improving performance.
8.8.2 ISO 14000 Standards

The need for standardisation of quality created an impetus for the development of other standards. In 1996 the
International Standards Organisation introduced standards for evaluating a company’s environmental responsibility.
These standards, termed ISO 14000, focus on three major areas:
• Management systems standards measure systems development and integration of environmental responsibility
into the overall business.
• Operations standards include the measurement of consumption of natural resources and energy.
• Environmental systems standards measure emissions, effluents, and other waste systems.
8.9 Reason for TQM Failure

• The most important factor in the success or failure of TQM efforts is the genuineness of the organisation’s
commitment. Often companies look at TQM as another business change that must be implemented due to market
pressure without really changing the values of their organisation.
• Recall that TQM is a complete philosophy that has to be embraced with true belief, not mere lip service. Looking
at TQM as a short-term financial investment is a sure recipe for failure.
• Another mistake is the view that the responsibility for quality and elimination of waste lies with employees
other than top management. It is a “let the workers do it” mentality.
• A third common mistake is over or under reliance on Statistical Process Control (SPC) methods.
• SPC is not a substitute for continuous improvement, teamwork, and a change in the organisation’s belief system.
However, SPC is a necessary tool for identifying quality problems. Some common causes for TQM failure
are:
 Lack of a genuine quality culture
 Lack of top management support and commitment
 Over- and under-reliance on statistical process control (SPC) methods.
• Companies that have attained the benefits of TQM have created a quality culture.
• These companies have developed processes for identifying customer-defined quality.
• In addition, they have a systematic method for listening to their customers, collecting and analysing data
pertaining to customer problems, and making changes based on customer feedback.
Summary
• Total Quality Management (TQM) is different from the old concept of quality because its focus is on serving
customers, identifying the causes of quality problems, and building quality into the production process.
• There are four categories of quality costs. The first two are prevention and appraisal costs, which are incurred
by a company in attempting to improve quality. The last two costs are internal and external failure costs, which
are the costs of quality failures that the company wishes to prevent.
• Seven features of TQM combine to create the TQM philosophy: customer focus, continuous improvement,
employee empowerment, use of quality tools, product design, process management, and managing supplier
quality.
• Quality Function Deployment (QFD) is a tool used to translate customer needs into specific engineering
requirements. Seven problem-solving tools are used in managing quality. Often called the seven tools of quality
control, they are cause-and-effect diagrams, flowcharts, checklists, scatter diagrams, Pareto analysis, control
charts, and histograms.
• Reliability is the probability that the product will function as expected. The reliability of a product is computed
as the product of the reliabilities of the individual components.
• Companies are evaluated in seven areas, including quality leadership and performance results. These criteria
have become a standard for many companies that seek to improve quality.
• ISO 9000 is a certification based on a set of quality standards established by the International Organisation for
Standardisation. Its goal is to ensure that quality is built into production processes. ISO 9000 focuses mainly
on quality of conformance.
References
• Gopalkrishan, P. & Sundaresan, M., 1977. Materials Management, An Integrated Approach, New Delhi: Prentice
Hall.
• Kalakota, R. & Whinston, A. B., 1996, Frontiers of Electronic Commerce, Addison Wesley.
• U.S. Department of Energy, 2003. Work Breakdown Structure, [Pdf] Available at: <http://condor.depaul.edu/
dmumaugh/readings/handouts/SE477/WorkBreakdownStructure.pdf> [Accessed 13 February 2013].
• WORK BREAKDOWN STRUCTURE (WBS), [Pdf] Available at: <http://www.projectmanagementdocs.com/
template/Work-Breakdown-Structure.pdf> [Accessed 13 February 2013].
• What is a work breakdown structure? lynda.com overview, [Video online] Available at: <http://www.youtube.
com/watch?v=CQ_QfrClfR4> [Accessed 13 February 2013].
• Introduction to Project Planning, [Video online]Available at: <http://www.youtube.com/watch?v=VgdChg5kF1E>
Recommended Reading
• Norman, G. & Fraizer, G., Operations Management, 9th ed., Thomson South Western.
• Krajewski, L. & Ritma, L., Operations Management, Processes and Value chains, 7th ed., India: Prentice
Hall.
• Drucker, P., 1981. Managing Turbulant Times, London: Pan books.
Self Assessment
1. The category consists of costs necessary for achieving high quality, which are called costs.
a. quality control costs
b. prevention costs
c. appraisal costs
d. quality failure costs
2. includes quality planning costs, such as the costs of developing and implementing a quality plan.
a. Appraisal costs
b. Internal failure costs
c. Prevention costs
d. External failure costs
3. The is the first step of Shewart Cycle.

a. Plan
b. Do
c. Study
d. Act
4. is an integrated organisational effort designed to improve quality at every level.

a. TPM
b. TQM
c. Kaizen
d. Kanban
5. In 1977 the International Organisation for Standardisation (ISO) published its first set of standards for quality
management called .
a. ISO
b. ISO 9001
c. ISO 9000
d. ISO 14000
6. In 1996 the International Standards Organisation introduced standards for evaluating a company’s environmental
responsibility called as .
a. ISO
b. ISO 9000
c. ISO 14000
d. ISO 9001
7. Which of the following phases explains the data are evaluated to see whether the plan is achieving the goals
established in the plan phase?
a. Plan
b. Do
c. Study
d. Act
8. is the sequence of steps involved in an operation or process.

a. Checklist
b. Flowchart
c. Control charts
d. Cause and effect diagrams
9. Technique used to identify quality problems based on their degree of importance is known as .
a. Parreto analysis
b. Statistical process control
c. Histogram
d. Scatter diagrams
10. In which type of diagrams or charts are the upper control limit and the lower control limit reflected?
a. Scatter charts
b. Histograms
c. Control charts
d. Statistical Process control
Case Study I
Materials Handling Management
Introduction
There is a strong concern to adjust the supply system in a company to achieve a higher service level internally and
to the outside customers. This brings to a higher operational level and even a possible differential when compared
with the other competitors.
Materials handling management is among many factors that contribute to improve a company’s performance. The
Materials Handling Industry of America [MHIA] defines materials handling management as “Material Handling is the
movement, storage, control and protection of material, goods, and products throughout the process of manufacturing,
distribution, consumption and disposal. The focus is on the methods, mechanical equipment, systems and related
controls used to achieve these functions”. Then it is observed that handling is broader than simple materials movement,
although both terms are sometimes used as synonyms.
The relevance of materials handling stems from the intrinsic relationship that it has with production flow. When it
presents an imbalance, there is formation of extra stock or rupture in supply. When the flow does not have enough
velocity, transit time is long and the system is not capable of serving the customers when they need it. It is well
understood that material handling improvement may have positive effects over production. However, it is not
only production, but the way the employees see the new situation. When the perception is favourable, the benefits
are possible; if not, behavioural issues can emerge. Evaluations are important when interventions into the work
environment are implemented. The present work is specifically related to materials handling management.
By means of effective materials handling management, the company’s operational performance may improve aiming
to satisfy the customers or meet their expectations in terms of their needs, desires and demands. The case study
related in this work was performed in an automotive industry located in the north eastern part of Rio Grande do Sul
State of Brazil. It was founded more than 50 years ago and is classified as a large-sized company since it has more
than 2000 employees. This region contains a cluster of industries of metal-mechanic, automotive and metallurgical
sectors that in its majority belong to production chains which demand a high internal performance level from their
partners.
The company in question, after analysing production flow as a whole, identified that among other measures it would
be necessary to improve materials handling management in the manufacturing process. This was motivated by the
observed delay in forklifts service and their high maintenance cost. Forklifts were used both for parts handling
and transportation and to assist in tooling changes, which many times resulted in excessive setup time leading to
production delays. Changes were made in the materials handling process to address these concerns.
The main objective of this case study was to evaluate internal customers’ satisfaction levels after the change. In order
to do this, it was necessary to identify the factors that explain overall satisfaction; to do it, open-ended questionnaires
were applied. The respondents – 26 people directly linked to daily materials flow – were requested to identify the
attributes and unfold them into sub-factors which represented the internal process in more details. The identified
attributes were cost, safety in service, service reliability and agility. After this step, a second questionnaire with
close-ended questions was applied to the same respondents in order to evaluate performance satisfaction at each
factor and sub-factor and also overall satisfaction. The questions requested the respondent perception about the
improvement – perceived or not – after the interventions.
The collected data were analysed with multiple regressions. Data analysis indicated that the factors agility, service
reliability and cost are able to explain overall satisfaction. In addition to that the satisfaction level of most of internal
customers with the new materials handling management system is equal or even superior when compared to the
previous one.
Material Flow
Materials handling makes production flow possible, as it gives dynamism to static elements such as materials, products,
equipments, layout and human resources. Groover highlights that despite its importance, materials handling is a
topic that frequently is treated superficially by the companies. However, other authors have perceived its relevance.
During the period in which Shingo contributed to the development of the Toyota Production System, he developed
the Production Function Mechanism that proposes to explain how the production phenomenon happens.
Shingo indicated that, in the West, production was treated as a process of a sequence of operations. In the Production
Function Mechanism, the concepts are directly related to a production analysis focus. A process analysis consists
of an observation of the production flows that turn raw materials into final products. From this concept, the author
highlights that the main analysis is the one associated with the process, because it follows the production object. The
analysis of the operations comes later because it focuses on production subjects (operators and machines). When
making this distinction, it is possible to perceive the relevance of materials handling.
Beyond the basic function of movement, it is also relevant to cite the functions of storage and information transfer,
which occurs simultaneously and has both strategic and operational dimensions. Organisations are relying on
information systems using tools like Electronic Data Interchange (EDI), or similar information technology resources,
to gain in precision and reliability, in the interchange, and availability of information.
According to Asef-Vaziri & Laporte (2005) an important proportion of manufacturing expenses can be attributed
to material handling and the most critical material handling decisions in this area are the arrangement and design of
material flow patterns. This idea is shared by Ioannou (2002), which argues that an important aspect of any production
system is the design of a material handling system (MHS) which integrates the production operations. The relevance
also occurs in another context. Ballou (1993) states that the storage and handling of goods are essential among the
set of logistics activities, and their costs can absorb 12% to 40% of its costs. In addition, the MHIA estimates that
20% to 25% of manufacturing costs are associated to handling. According to Sule (1994) apud Sujono & Lashkari
(2006), material handling accounts for 30–75% of the total cost of a product along the production chain, and efficient
material handling can be responsible for reducing the manufacturing system operations cost by 15–30%.
For Bowersox and Closs (1996), the main logistic responsibility in manufacturing is to formulate a master-program
for the timely provision of materials, components and work-in-process. Stevenson (2001) understands that logistics
(including materials and goods flowing in and out of a production facility as well as its internal handling) has become
very important to an organisation to acquire competitive advantages, as the companies struggle to deliver the right
product at the correct place and time. The main challenge is to promote, with low cost, a flow whose velocity allows
the execution of manufacturing process with the expected satisfaction level.
Elements and Characteristics of a Material Handling System

Materials handling study requires that several elements are considered. The first is a handling system project, which
covers activities of sequencing, velocity, layout and routing. In order to complete the analysis, Groover (2001)
recommends analyzing the material itself (or object) to be transported. Therefore, it suggests the classification of
Muther and Hagan, which considers:
• physical state (solid, liquid, gas)
• size (volume, length, width, height)
• weight
• condition (hot, cold, dry, dirty, sticky, adhesive)
• risk of damage (weak or strong)
• safety hazards (explosive, flammable, toxic, corrosive, etc)
Additionally, the issue of equipment and devices must be examined. Dias adopts the term “moving” to describe what,
in this article, is called management (handling) to adopt the terminology of Groover. When dealing with equipment,
Dias presents a broad classification that covers five categories:
• transporters (belts, chains, rollers)
• cranes, hoists and lifts
• industrial vehicles (carts, tractors, pallet transporters, forklifts)
• positioning equipment, weighing and control
• (ramps, transfer, equipment)
• stents and support structures (pallets, holders, reels)
According to Chan, Ip & Lau (1999), a key factor in material handling system design process is the selection and
configuration of equipment for material transportation. This is directly related to this study. According to Gurgel
(1996), the equipment should be selected based on some preliminary considerations: take into account the utilisation
of the factory floor and its load capacity; examine the dimensions of doors and corridors; pay close attention to
ceiling height, identify the environmental conditions and their nature, avoid the use of combustion engines traction
equipments in storage of food products, meet all safety standards to protect humans and to eliminate the possibility
of incurring criminal and civil liabilities arising from accidents, and examine all kinds of available energy options
and their capacity to supply required movements.
The right choice of equipment and location of working-process is fundamental for the optimisation of a company’s
manufacturing capacity. Bowersox and Closs (1996) state that; a critical factor in positioning stocks in process is a
balance between convenience and consolidation to create efficiencies when the stock flows along the value chain.
The importance of layout, which defines the placement of equipment and, consequently, restricts possible routes and
sequencing, can be perceived by the prominence that the subject is treated in production management literature. The
analysis of the relationship between layout studies and material handling, however, does not receive much attention
in the same literature. This lack of attention can be seen in works like Gaither and Frazier (2002), Chase, Jacobs
and Aquilano (2006) and Slack, Chambers, Harland, Harrison and Johnston (1997).
Finally, the systems and information technology constitute essential factors for materials handling management.
Stair and Reynolds (2006), Laudon and Laudon (2006) and O’Brien and Marakas (2007) support the study of
fundamentals and general principles of information systems. In order to improve the performance of distribution
operations and, in this specific case, the internal material handling process, it is important to consider both human
and technical factors. In this sense, this study assesses the internal customers’ perception of a material handling
process improvement. With regard to the attributes to be considered in a material handling system, according to
Kulak (2005), effective use of labor, providing system flexibility, increasing productivity, decreasing lead times and
costs are some of the most important factors influencing selection of material handling equipment.
These factors are directly related to some attributes found in the present study. The determination of a material
handling system involves both the selection of suitable material handling equipment and the assignment of material
handling operations to each individual piece of equipment. Hence, according to Sujono & Lashkari (2006) material
handling system selection can be defined as the selection of material handling equipment to perform material handling
operations within a working area considering all aspects of the products to be handled. In this context it is important
to mention that, in this study, only the selection of the material handling equipment was considered.
Problem and Intervention Description

The first sub-section describes the situation prior to the intervention, identifying the problems that were found. The
second describes the factors that motivated the change. The third describes the changes and the situation after its
completion. Besides variables and sub-variables, customers’ overall satisfaction regarding the implemented changes
was also evaluated.
Situation Prior to the Intervention

This study was conducted in the manufacturing sector of an automotive company. The manufacturing sector is
responsible for almost all of the supply of assembly lines, including the components that go through a pre-assembly
process before proceeding to final product assembly. In this sector are concentrated cutting and bending tools and
dies required for components manufacturing to assembly lines.
The whole process runs with the aid of forklifts. Often, the setup time is equal to or higher than the time needed
for parts manufacturing. This situation, coupled with the cost of downtime, demonstrates the importance of the
tooling exchange process. Besides helping in the execution of setups and carrying out internal transport managed
by an electronic scoreboard installed in the factory roof, forklifts also performed activities for transporting materials
between pavilions. When executing this last activity, the forklifts often travelled on uneven roads, which caused
great bouncing, burdening maintenance cost for equipment wear or premature breakage.
Often, when a forklift leaves its workplace to transport a container between pavilions, delays in machines’ setups
are generated, causing unnecessary costs and stress on the forklift operator. The operator could do little besides feel
forced to increase the speed during the route, creating risks of accidents with personal injury and/or materials damage.
This activity as well as the studied process relate to Goldratt’s Theory of Constraints (TOC) to seek bottlenecks and
reduce or eliminate them.
Although there were enough forklifts to meet the demand from the manufacturing sector, many times it was not
possible to meet immediately the manufacturing needs due to reasons like long distances to travel and frequent
maintenance due to excessive use of the equipment. This directly affected internal customers’ satisfaction. The
presented problem was: how to increase internal customer satisfaction, while stabilising or decreasing forklifts’
maintenance cost?
Change Motivators
Due to development of new markets, manufacturing demands for a large variety of components and final product
assemblies increased. This demand growth led to speed increases and changes in how materials and tools were
being handled and transported in order to monitor manufacturing requirements. With these changes and demands
for manufacturing to attain the company’s goals, there was also pressure for growth and lack of tolerance with
forklift operators, since the work did not always run quickly and with quality. Additionally, forklift maintenance
costs were increasing, demanding sometimes excessive spending that jeopardized the budget. The dissatisfaction
and de-motivation of forklift operators was notorious, and an increase was also noticed in the number of collisions
between the equipments. Finally, boxes and containers were unsatisfactorily stored in the hallways together with
the machines to attempt to reduce production interruptions.
The Changes and the Situation after the Implementation

One suggested solution was to rent two forklifts as a way to solve the problem. But this only served to soften it, and
brought a larger cost to the company. It was realised then that it was not the quantity of equipments that was going
to solve the problem but the way material handling was being executed in relation to the necessity of the presented
changes. From this observation, processes and material flows were mapped and separated in two ways:
• vertical movements which make greater efforts and little ground movement
• horizontal movements that rely on traction to travel longer distances, including transport out of the work
units
Another proposed solution was to use a tractor towing small “wagons”, forming a kind of train. Ballou (1993) states
that; this approach is more economical for larger volumes that must be moved over long distances along the same
route. Several cargo (pallets) units were constructed with special wheels, fitted with suspension coupled to support
the material weight and traverse the gaps between the pavilions. Afterwards, several “cages” were made to be used
for holding the parts that go through the processes of bath and painting. More robust containers for heavier and less
delicate parts storage were also constructed.
The next step was to create spaces (pit stops) for pallets with their mobile parts on each workstation. In order to the
truck driver to know when he could transport material, it was necessary to create an identification system. It was
decided that every time that the operator finished the process in his station, he would put on the packaging a green
sign indicating that the container would be ready to be transported to the next production step. The truck driver,
when removing a filled container, should replace it with an empty one in the vacant post.
Tests were conducted with a timetable for the train passage, but this alternative did not meet the need for flexibility in
case of emergencies (pieces to technical assistance and replacement of damaged materials in the assembly process).
It was then decided to set a path that would follow the manufacturing process sequence. To inform the train operator
of some urgency, a mobile phone was given to him. Thus, the supervisor could communicate with the operator
instantly when there were critical parts and/or components to be collected. After the changes were completed, it
was necessary to evaluate their impacts. This study evaluated internal customers’ satisfaction level with the new
materials handling and transporting configuration.
Research Methodology
Research methodology is explained with the help of various points in the section below:
Company Characterisation
The studied company, Marcopolo S/A., is one of the main bus body producers in the world. Founded in 1949, in
Caxias do Sul, the company is divided into four business units:
• bus, with bodies of Marcopolo and Ciferal brands
• LCV, with complete minibus under the Volare brand
• plastic products, with MVC brand
• parts and components, with service parts for the company brands and parts for other segments of the Syncroparts
brand
The company maintains a technology transfer contract with the Iveco SPA. The transferred technology from the
lines Midi bus, Low Entry and High Decker was made in the factory of CBC-Iveco in China. Currently, Marcopolo
has a representative office called Marcopolo Changzhou Office at Changzhou and has also been developing a joint
venture agreement with Tata Motors in India. This study took place only at the Brazilian facility.
Objectives
The present study had as its objective to evaluate, in a systematic way, the impact of the implemented changes
in materials handling management on the internal customers’ perceptions at the manufacturing department in
Marcopolo S/A. unit located in Caxias do Sul – RS. To reach this objective, the following specific objectives were
established:
• describe the changes in material handling processes at the company
• evaluate internal material handling flow in manufacturing, verifying the improvements
• analyse internal customers’ satisfaction levels relative to the new system
Data Collection
The sample was the people directly involved with the daily flow of materials, selected intentionally. The respondents
held positions as leaders, supervisors, forklift drivers and warehouse operators, enabling a comprehensive view of
the problem. Data collection for the satisfaction survey was divided into two stages.
The first step was an open-ended question survey. Respondents were asked about their perceptions regarding the
changes in materials handling emphasizing evidence of the improvements, problems still identified after change
implementation and suggestions for the relevant attributes in question. Two criteria were used to define factors and
sub-factors from the obtained answers:
• the factor must be cited by respondents of all positions (leaders, supervisors, forklift drivers and warehouse
operators)
• the number of times that the criterion has been cited by the 26 respondents. Table 1 shows the evaluated factors,
their definitions and the associated sub-factors
Factors Factors Description Sub-factors
Monetary value available to maintain the Mechanical shutdowns

Cost operation: expenditures with periodic Electrical shutdowns
maintenance linked to forklifts use Corrective painting
Safety in handling
Identifies forklifts operator’s conduct on
Safety in Service Tooling storage
new handling and internal transport way
Efficient routing
Operator’s autonomy
Service Identifies manufacturing satisfaction level
Operator’s performance
Reliability in terms of reliability
and availability
Setup agility
Identifies the time spent with tool
Material handling
exchange coupled handling (discounting
Agility quickness
the times associated with the machine,
Tooling handling
such as loose and/or fix arrays or tools)
quickness
Table 1 Factors and sub-factors of satisfaction survey
Performance improvements (current state vs. status quo) were measured using the following scale: 1 = much worse,
2 = worse, 3 = same, 4 = better and 5 = much better. For instance, the employee was asked: “Comparing previous
and current procedures for handling and internal transport, how do you assess the costs related to mechanical
downtime?” To answer the question, the options of the scale mentioned above were offered. At this point it is
important to highlight that the study was evaluating the respondents’ perception, starting from the assumption that
they had knowledge enough (even empirical) because they are directly involved in the process.
(Source: MATERIALS HANDLING MANAGEMENT: A CASE STUDY, [Pdf] Available at: <http://www.joscm.com.
br/download/JOSCM_VOL4_NUMBER%202_2.pdf> [Accessed 13 February 2013]).
Questions
1. Define MHIA
Answer
Material Handling is the movement, storage, control and protection of material, goods, and products throughout
the process of manufacturing, distribution, consumption and disposal. The focus is on the methods, mechanical
equipment, systems and related controls used to achieve these functions.
2. What does a process analysis consists?

Answer
A process analysis consists of an observation of the production flows that turn raw materials into final
products.
3. What is the use of Forklifts here?

Answer
Forklifts were used both for parts handling and transportation and to assist in tooling changes, which many
times resulted in excessive setup time leading to production delays.
Case Study II
JIT in TOYOTA
Introduction
The Just in Time, JIT is a set of techniques that was first adopted and publicized by Toyota Motor Corporation of
Japan as part of its Toyota Production System (TPS).
History of JIT
The technique was first used by the Ford Motor Company during 1920s, but the technique was subsequently adopted
and publicized by Toyota Motor Corporation of Japan as part of its Toyota production System (TPS). In 1954 Japanese
giant Toyota implemented this concept in order to reduce wasteful overstocking in car production.
JIT Implementation
Back in Japan, Sakichi customised the Ford production system to suit Japanese market. He also devised a system
wherein each process in the assembly line of production would produce only the number of parts needed at the
next step on the production line, which made logistics management easier as material was procured according to
consumption. This system was referred to as Just-in-Time (JIT) within the Toyota Group.
The JIT production was defined as ‘producing only necessary units in a necessary quantity at a necessary time
resulting in decreased excess inventories and excess workforce, thereby increasing productivity.’
Benefits OF JIT
• Reduced set up times in warehouse – TOYOTA in this case focused on other processes that might need
improvement.
• Improved flows of goods in/through/out warehouse employees were able to process goods faster.
• Employees who possessed multi-skills were utilised more efficiently.
• Better consistency of scheduling and consistency of employee work hours if there is no demand for a product
at the time
(Source: Radisic, M., Just-In-Time concept, [Pdf] Available at: <http://smallb.in/sites/default/files/Just-In-Time%20

Concept_0.pdf> [Accessed 13 February 2013]).
Questions
1. Explain the Just in Time technique?
2. Why Japanese implemented JIT technique?
3. How was JIT implemented in Toyota?
Case Study III

Ford Production System-A Lean Manufacturing
Introduction
Ford has established several innovative automobile manufacturing techniques from its beginning. In the mid 1990s,
Ford modernised its manufacturing operations in its efforts to induce more flexibility and enhance the efficiency
of its automobile production systems. The restructuring effort was known as Ford Production System (FPS). Ford
was established by Henry Ford on June 16, 1903, with an initial investment of $100,000.
Ford Production System

In January 1995, Ford employed a company-wide re-engineering initiative called Ford 2000. One of the major
objectives of Ford 2000 program was to develop and implement a new manufacturing system called the Ford
Production System (FPS). According to Ford’s website, “The vision of FPS is a lean, flexible and disciplined common
production system, defined by a set of principles and processes, that employs groups of capable and empowered
people, learning and working safely together, in the production and delivery of products that consistently exceed
customers expectations in quality, cost and time.”
Lean Production
Lean production aimed at bringing together human, material and mechanical resources at the right time and place
to accomplish a task. It strived to eliminate every kind of waste including wastage of time, labour, scrap material,
defective parts, etc.
Benefits of Lean Production

• Production cost reduction by 50%
• Manufacturing cycle times decreased by 50%
• Labor reduction by 50% while maintaining or increasing throughput
• Inventory reduction by 80% while increasing customer service levels
• Capacity in current facilities increase by 50%
(Source: The Ford Production System, [Online] Available at: <http://www.icmrindia.org/casestudies/catalogue/

Operations/Ford%20Production%20System-Operations%20Management%20Case%20Studies.htm> [Accessed
21 February 2013]).
Questions
1. How was the Ford Production System established?
2. What was the vision of FPS?
3. What are the benefits of Lean Production?
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• Drucker, P., 1981. Managing Turbulant Times, London: Pan books.
• Francis, R. L. & White, J. A. 1992. Facility Layout and Location: An Analytical Approach. Englewood Cliffs,
NJ: Prentice Hall.
• Gaither, N., Fraizer, G., 2002. Operations Management-Overview, Thompson Learning, 9th ed.
• Goetsch, D. L. & Stanley, D., 1995. Implementing Total Quality, Upper Saddle River, N. J: Prentice-Hall.
• Hall, R., 1977. Attaining Manufacturing Excellence, Burr Ridge III: Down-Jones Irwin.
• Khanna, Production And Operations Management, PHI Learning Pvt. Ltd.
• Kitazawa, S. & Sarkis, J., The Relationship Between ISO 14001 and Continuous Source Reduction Programs,
International.
• Kolli, S., Essentials of Production and Operations Management, Research and entertainment Association.
• Krajewski, L. and Ritma, L., Operations Management, Processes and Value chains, 7th ed., India: Prentice
Hall.
• Krajewski, L., Ritzman, L. P., Malhotra, M, K., 2009. Operations Management: process and supply chain,
Operations Management, Prentice Hall Publication.
• Manufacturing and Operations Management, Nirali Prakashan.
• Murthy, P. R., 2006. Production and Operations Management, Introduction to Operations Management, 2nd
ed., New Age International Publishers.
• Norman, G. & Fraizer, G., Operations Management, 9th ed., Thomson South Western.
• Norman, R., 1991. Service Management, 2nd ed., New York: John Wiley and Sons.
Self Assessment Answers

Chapter I
1. b
2. a
3. d
4. d
5. c
6. c
7. a
8. b
9. a
10. a
Chapter II
1. c
2. d
3. d
4. a
5. b
6. b
7. b
8. d
9. a
10. d
Chapter III
1. a
2. d
3. b
4. a
5. d
6. a
7. b
8. a
9. c
10. a
Chapter IV
1. c
2. b
3. a
4. d
5. b
6. d
7. c
8. c
9. c
10. a
Chapter V
1. c
2. b
3. a
4. d
5. b
6. d
7. c
8. c
9. c
10. a
Chapter VI
1. b
2. a
3. c
4. a
5. d
6. b
7. b
8. a
9. c
10. a
Chapter VII
1. b
2. c
3. a
4. d
5. a
6. c
7. c
8. d
9. b
10. c
Chapter VIII
1. a
2. c
3. a
4. b
5. c
6. c
7. c
8. b
9. a
10. c

Supplychain Management Dadhich

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Material and Store Management

II. List of Figures .........................................................VI

III. List of Tables ........................................................... VII

IV. Abbreviations .....................................................VIII

V. Case Study ............................................................. 116

VI. Bibliography ........................................................ 124

VII. Self Assessment Answers .................................. 127

Chapter VII ................................................................................................................................................ 84

Chapter VIII ............................................................................................................................................. 103

• introduce the students to material management

• explain the scope of material management

• elucidate the various motives of inventory

• define the classification of inventory

• explicate the key objectives of material management

• enlist the functions of material manager

• understand the materials requirement planning technique (MRP)

• analyse about the process of purchasing

• identify the effects of overstocking and under stocking

1.2 Classification of Inventory

Raw Material Work in Progress Finished Goods

Fig. 1.1 Inventory classification

1.3 Meaning of Material Management

Materials management has such sub-fields as:

The key objectives of material management are as follows:

1.5 Motives of Material Management

1.6 Scope of Material Management

1.7 Material Planning

Factors affecting material planning

1.8 Technique of Planning Materials

Cataloguing or coding the materials

Use of drawing numbers

1.9 Process of Codification

An illustrative list of classification of inventories:

Abrasives Bearings Belt and beltings

Table 1.1 List of classification of inventories

Specifications are divided generally into two main categories:

Procurement involves the following activities:

Inspection is generally divided into three categories:

1.15 Quality Control

1.18 Inventory Control

1.21 Functions of Material Manager

1.22 Effects of Over Stocking and Under Stocking

Overstocking will result into the following consequences:

Understocking will result into the following consequences:

3. Inventory is a name collectively given to raw material; work in process and .

4. Which of the following statements is false?

6. is first subjected to a manufacturing process before it becomes finished goods.

7. What do the idle resources have in an inventory?

9. Which of the following statements is true?

• introduce the concept of economic order quantity

• explain the material cost management

• elucidate the various inventory levels

• define material cost

• explicate the drawbacks of Economic Order Quantity model (EOQ)

• enlist the ABC analysis

• define the XYZ analysis

• recognise about AX control

• identify the advantages of ABC analysis

2.1 Introduction to Material Cost Management

Cost of increasing production and employment level, involves the following:

Cost of decreasing production and employment level, involves the following:

The functions of inventories are to: