1

CHAPTER 7
SPARE PARTS PROVISIONING
Introduction

2 Definition of spare parts

In order to understand the problems of spares, let us first define spare parts. In
Chamber’s Twentieth Century Dictionary, a spare part is defined as “a part of a
machine ready to replace an identical part of it, if it becomes faulty”.

The import trade control defines spare parts as follows: “Spare parts are those parts of
machines which because of wear and tear, use or breakage, need replacement”.

We can define spare parts as parts identical to the part of a machine which need
replacement due to wear and tear during the operating life of the equipment.
Contd. Introduction
3 Spare parts may look small and appear cheaper than the machine or raw material, but
they play a vital role in maintaining, ensuring and reinforcing the reliability of any
equipment.
• Spare parts include materials such as (a) pipes, tubes, springs, electrical cables, knobs,
wires, hoses, beltings, (b) sub-assemblies of essential parts of the machines like engines,
motors, compressors, and alternators, and (c) complete units which are to be fitted with
a machine, e.g. water circulating pumps, motors, panels, controls, bolts and gears.
• Items such as plates, sheets, rods, strips, etc. which have to be fabricated for
manufacturing complete units are not treated as spare parts.
categorization of spares

4
• Organizations classify spares in a variety of ways like regular, fast moving, emergency,
consumables, major, minor, moving, non-moving, electrical, obsolete, mechanical,
instruments, permissible, and project spares.

• But spare parts must be classified as maintenance, overhauling, commissioning, rotable,

insurance, and capital spares for introducing scientific controls.
Contd. Categorize…
5

• Maintenance spares are those which are fast moving like bearings, belts, and hardware items.
Normally, these are available in plenty and the spare parts can be stocked after building a
database on the consumption pattern.

• Overhauling spares are those which are specially needed during regular overhauls in order to
give a new lease of life to the equipment. Hence, these need not be stocked but ordered just in
time before overhauling.
 Contd. Categorization…
6 • Commissioning spares are needed to start a project or commission an equipment and
these parts are declared as project surplus after the machine starts its operation. Costly
assemblies like motors, engines, and pumps are repaired and stored for use.
• For example, if the engine of a bus breaks down, it can be removed for repairs and the
bus can be refitted with another good engine from the stores. This rotation process
gives the spares assembly the name of rotable spares or floats, and these have to be
tackled separately.
• Insurance spares are those vital parts of a machine, which have life nearly equal to that
of a machine itself and are held as a standby against any breakdowns. These standby
units have a high reliability of performance and can be capitalized.
 cost consideration

7
• There are a large number of factors that affect the spare parts costs
in any organization. Location of a plant is a key influencing
parameter on spare part policies.
• If a factory or the using point is located in a backward area or far
away from industrial centers, airports, national highways, railway
lines and seaports, then it is bound to carry more stocks to account
for transportation, and communication bottlenecks.
• Another aspect of unavoidable delay is the government regulations
on imports, foreign currency, customs, and other taxation policies.
Choice of equipments

8
• In choosing the equipment, the user must get adequate guidance from the manufacturer
regarding maintenance problems and spares support.
• The supplier should guarantee adequate spares for a specified time, and sufficient notice must be
given if the supply has to be discontinued. He should provide all technical details covering
maintenance manuals, spares catalogue, failure data, reliability information, drawing for critical
items, etc.
Choice of eq…
9
• Before purchasing new equipments, compatibility with the existing machineries must be
considered from the spares point of view. At the time of initial provisioning, the user should
ensure that he is not dumped with unwanted spares.

• The recommended list of the supplier must be scrutinized after assessing factors like stress,
strain, and wear and tear. Based on the number of equipments sold, the supplier must anticipate
the user’s spares requirement by means of a good feedback information system.
Purchasing
10

• In any industry purchase means buying of equipments, materials,

tools, parts etc. required for industry.
• The basic objective of the purchasing function is to ensure
continuity of supply of raw materials, and spare parts.
Contd. Purchasing
11
• The objectives of the purchasing department can be outlined as under:
1. To avail the materials, suppliers and equipments at the minimum possible costs;
2. To ensure the continuous flow of properly maintained machineries through
continuous supply of raw materials, components, tools etc. with repair and maintenance
service.
3. To develop an alternative source of supply: Exploration of alternative sources of
supply of materials increases the bargaining ability of the buyer, minimization of cost of
materials and increases the ability to meet the emergencies.
Contd. Objective of Purchasing
12
• 4. To establish and maintain the good relations with the suppliers: Maintenance of good
relations with the supplier helps in evolving a favorable image in the business circles. Such
relations are beneficial to the buyer in terms of changing the reasonable price, preferential
allocation of material in case of material shortages, etc.

• 5. To train and develop the personnel: Purchasing department is manned with varied types of
personnel. The company should try to build the imaginative employee force through training
and development.
Contd. Objective of Purchasing
13
• 6. Efficient record keeping and management reporting: Paper processing is inherent
in the purchase function. Such paper processing should be standardized so that record
keeping can be facilitated.

Periodic reporting to the management about the purchase activities justifies the
independent existence of the department.

 
Cont. Objective Purchasing
14

• 7. To achieve maximum integration with other department of the

company: The purchase function is related with,
• Engineering department for the purchase of tools, equipments and
machines;
• Financial department for the purpose of maintaining levels of materials
and estimating the working capital required;
• Personnel department for the purpose of manning and developing the
personnel of purchase department and maintaining good vendor relationship.
Parameters of purchasing
15 The success of any maintenance activity is largely dependent on the procurement of raw
materials of
1) right quality,
2) in the right quantities,
3) from right source,
4) at the right time and
5) at right price.
 These are described as the basic principles of purchasing.
• There are other well known parameters such as right contractual terms, right material, right
place, right mode of transportation and right attitude are also considered for purchasing.
Selection of suppliers
16
• Selection of the right supplier is the responsibility of the purchase department.
• Following factors are considered for the selection of suppliers:

A. Sources of supplier
• The best buying is possible only when the decision maker is familiar with all possible sources
of supply and their respective terms and conditions.
• The purchase department should try to locate the appropriate sources of the supplier of various
types of materials.
Contd. Selection of…
17 B. Development of approved list of suppliers
• The survey stage highlights the existence of the source. A business inquiry is made with the
appropriate supplier.
• Here a short listing is made out of the given sources of suppliers in terms of Maintenance
facilities and capacity, financial standing, product quality, possibility of timely supply, technical
competence, manufacturing efficiency, general business policies followed, standing in the
industry, competitive attitude, and interest in buying orders etc.
C. Evaluation and selection of the supplier
• The purchase policy and procedure differ according to the type of items to be purchased. Hence,
evaluation and selection of the supplier differ accordingly.
Contd. Selection of…
18
• The following variables are to be considered while evaluating the quotations of the suppliers:

1. Cost Factors
• Price, transportation cost, installation cost if any, tooling and other operations cost, incidence
of sales tax and excise duty, terms of payment and cash discount are considered in cost
factor.

2. Delivery
• Routing and Free on board (F.O.B.) terms are important in determining the point at which
the title to the goods passes from vendor to the buyer and the responsibility for the payment
of the payment charges.
Contd. Selection of…
19
3. Design and Specification Factors
• Specification compliance, specification deviations, important dimensions and weights are
considered in line with the demonstration of sample, experience of other users, after sale
services etc.

4. Legal Factors
• Legal factors include warranty, cancellation provision, patent protection, public liability, federal
laws and reputation compliance.
Contd. Selection of…
20 5. Vendor Rating
• The evaluation of supplier or vendor rating provides valuable information which help in improving
the quality of the decision.
• In the vendor rating three basic aspects are considered namely
• quality,
• service and price.
• How much weight should be given to each of these factors is a matter of judgment and is decided
according to the specific need of the organization.

• Quality would be the main consideration in the manufacturing of the electrical equipments while
price would be the prime consideration in the product having a tense competitive market and for a
company procuring its requirements under the blanket contract with agreed price, the supplier rating
would be done on the basis of two variables namely quality and delivery.
Vender rating illustrations

21 • ILLUSTRATION 1: The following information is available on 3 vendors: A, B

and C. Using the data below, determine the best source of supply under weighed-
point method and substantiate your solution.
• Vendor A: Delivered ‘56’ lots, ‘3’ were rejected, ‘2’ were not according to the schedule.
• Vendor B: Supplied ‘38’ lots, ‘2’ were rejected, ‘3’ were late.
• Vendor C: Finished ‘42’ lots, ‘4’ were defective, ‘5’ were delayed deliveries.
• Give 40 for quality and 30 weightage for service.

Solution: Formula:
Delivery performance:
Y : Adherence to time schedule (weightage 30%)
Contd. Vender rating…
22
Or
• Y Adherence to quantity schedule (weightage 30%)

Vendor ‘A’ is selected with the best rating.

Contd. Vender rating…
• ILLUSTRATION 2: The following information is available from the record of
the incoming material department of ABC Co. Ltd.
23

The factor weightage for quality, delivery and price (QDP) are 40%, 35% and 25% as per the
decision. Rank the performance of the vendors on the QDP basis interpret the result.
Solution: Formula:
Total vendor rating = Quality performance + Delivery performance rating + Price rating;
Formal mode:
Contd. Vender rating…

24

Vendor B is selected with higher rating.

Stores management
• The most important purpose served by the stores is to provide uninterrupted
25
service to the maintenance and repair divisions. Further, stores are often equated
directly with money, as money is locked up in the stores.
FUNCTIONS OF STORES
The functions of stores can be classified as follows:
• 1. To receive raw materials, components, tools, equipment’s and other items and
account for them.
• 2. To provide adequate and proper storage and preservation to the various items.
• 3. To meet the demands of the consuming departments by proper issues and
account for the consumption.
Contd. Stores management
26
• 4. To minimise obsolescence, surplus and scrap through proper
codification, preservation and handling.
• 5. To highlight stock accumulation, discrepancies and abnormal
consumption and effect control measures.
• 6. To ensure good house keeping so that material handling, material
preservation, stocking, receipt and issue can be done adequately.
• 7. To assist in verification and provide supporting information for
effective purchase action.
Contd. Stores management
Codification
27
• It is one of the functions of stores management. Codification is a
process of representing each item by a number, the digit of which
indicates the group, the sub-group, the type and the dimension of the
item.
• Many organizations in the public and private sectors have their own
system of codification, varying from eight to thirteen digits.
• The first two digits represents the major groups, such as raw materials,
spare parts, sub-contracted items, hardware items, packing material,
tools, oil, stationery etc.
Contd. Stores management

28 • The next two digits indicate the sub-groups, such as, ferrous, non-
ferrous etc.; Dimensional characteristics of length, width, head
diameter etc. constitute further three digits and the last digit is
reserved for minor variations.
• Whatever may be the basis, each code should uniquely represent one
item. It should be simple and capable of being understood by all.
Codification should be compact, concise, consistent and flexible
enough to accommodate new items.
• The groupings should be logical, holding similar parts near to one
another. Each digit must be significant enough to represent some
characteristic of the item.
 Objectives of Codification
29 The objectives of a rationalized material coding system are:
• 1. Bringing all items together.
• 2. To enable putting up of any future item in its proper place.
• 3. To classify an item according to its characteristics.
• 4. To give a unique code number to each item to avoid duplication and
ambiguity.
• 5. To reveal excessive variety and promote standardization and variety
reduction.
• 6. To establish a common language for the identification of an item.
• 7. To fix essential parameters for specifying an item.
• 8. To specify item as per national and international standards.
Contd. Stores management
30 Advantages of Codification
• As a result of rationalized codification, many firms have reduced the number of items. It
enables systematic grouping of similar items and avoids confusion caused by long description
of items since standardization of names is achieved through codification, it serves as the
starting point of simplification and standardization.

• It helps in avoiding duplication of items and results in the minimisation of the number of
items, leading to accurate record.

• Codification enables easy recognition of an item in stores, thereby reducing clerical efforts to
the minimum.
Inventory management
31 Meaning of Inventory
• Inventory, sometimes known as stock, refers to idle goods or materials that are held by an
organization for use sometime in the future. Items carried in inventory can be:
• raw materials
• purchased parts
• components
• subassemblies
• work-in-process
• finished goods
• and supplies
 Reasons for Keeping Inventories
32
• 1. To stabilize Operation (or production): The demand for an item fluctuates because of the
number of factors, e.g., seasonality, Operation (or production) schedule etc.; The inventories
(raw materials and components) should be made available to the Operation (or production) as
per the demand; Failing results in stock out and the Operation (or production) stoppage takes
place for want of materials. Hence, the inventory is kept to take care of this fluctuation so that
the Operation (or production) is smooth.
• 2. To take advantage of price discounts: Usually the manufacturers offer discount for bulk
buying and to gain this price advantage the materials are bought in bulk even though it is not
required immediately. Thus, inventory is maintained to gain economy in purchasing.
• 3. To meet the demand during the replenishment period: The lead time for procurement of
materials depends upon many factors like location of the source, demand supply condition, etc.;
So inventory is maintained to meet the demand during the procurement (replenishment) period.
INVENTORY ANALYSIS AND SELECTIVE CONTROL

33 For the successful spare parts management, it is essential to analyze the spare parts
inventory based on various characteristics such as the frequency of issues, the annual
consumption value, the criticality, the lead time and the unit price.

• Commonly used inventory analyses are:

(1) FSN Analysis

(2) ABC Analysis
(3) VED Analysis
(4) SDE Analysis
(5) HML Analysis
Contd. INVENTORY ANALYSIS…

34 FSN Analysis : Classification based on Frequency of Issues/Use;

• F, S & N stand for Fast moving, Slow moving and Non moving items. This
form of classification identifies the items frequently issued, less frequently
issued for use and the items which are not issued for longer period, say, 2 years.
For instance, the items can be classified as follows:

Fast Moving (F) = Items that are frequently issued say more than once a month.

Slow Moving (S) = Items that are issued once a month.

Non-Moving (N) = Items that are not issued\used for more than 2 years.
Contd. INVENTORY ANALYSIS…

35
• This classification helps spare parts management in establishing most suitable stores
layout by locating all the fast moving items near the dispensing window to reduce the
handling efforts.

• Also, attention of the management is focused on the Non-Moving items to enable

decision as to whether they are required in the future or they can be salvaged.
Experience shows that many industries which are more than 15 years old have more
than 50% of the stock as non-moving spares.

• Even if a few of them are disposed off and the locked up capital is made available, it
will make available additional working capital to the organization. Action for
disposal should be taken based on the value of each item of spare.
Contd. INVENTORY ANALYSIS…

36 SDE Analysis: Classification based on the lead time;

This classification is carried out based on the lead time required to procure the
spare part. The classification is as follows:
• Scarce (S) : Items which are imported and those items which require more than
6 months' lead time.
• Difficult (D) : Items which require more than a fortnight (Or two weeks) but
less than 6 months' lead time.
• Easily available (E) : Items which are easily available ie., less than a fortnights'
lead time.
• This classification helps in reducing the lead time required at least in case of
vital items. Ultimately, this will reduce stock-out costs in case of stock-outs.
Contd. INVENTORY ANALYSIS…
37 VED Analysis: Classification Based On Criticality;
• Several factors contribute to the criticality of a spare part. If a spare is for a machine on which
many other processes depend, it could be of very vital importance.
• Also if a spare is, say, an imported component for which procurement lead time could be very
high its non- availability may mean a heavy loss.
• Similarly spares required for fighter aircraft at the time of war could be of great value in terms of
fighting capability.
• In general, criticality of a spare part can be determined from the production downtime loss, due
to spare being not available when required.
• Based on criticality, spare parts are conventionally classified into three classes, viz. Vital,
Essential and Desirable (VED).
Contd. INVENTORY ANALYSIS…
VITAL (V) : A spare part will be termed vital, if on account of its non-availability there will be
38 very high loss due to production downtime and/or a very high cost will be involved if the part is
procured on emergency basis. In a process industry, most spare parts for the bottleneck machine or
process will be of vital nature. For example, bearings for a kiln in a cement plant will be
considered vital.

• ESSENTIAL (E) : A spare part will be considered essential if, due to its non-availability, moderate
loss is incurred. For example, bearings for motors of auxiliary pumps will be classified as essential.

• DESIRABLE (D) : A spare part will be desirable if the production loss is not very significant due
to its non-availability. Most of the parts will fall under this category. For example, gaskets for
piping connection.

• The VED analysis helps in focusing the attention of the management on vital items and ensuring
their availability by frequent review and reporting. Thus, the downtime losses could be minimized
to a considerable extent.
Contd. INVENTORY ANALYSIS…
ABC Analysis: Classification Based on Consumption;
39 • Another method of classifying spares is on the basis of annual consumption value. As it is true
for any inventory situation, Pareto's principle can be applied to classify maintenance spares
based on consumption value.
• Pareto principle : The significant items in a given group normally constitute a small portion of
the total items in a group and the majority of the items in the total will, in aggregate, be of
minor significance.
• This way of classification is known as ABC classification.
• CLASS A: 10% of total spares contributing towards 70% of total consumption value.
• CLASS B: 20% of total spares which account for about 20% of total consumption value.
• CLASS C: 70% of total spares which account for only 10% of total consumption value.
Contd. INVENTORY ANALYSIS…
40 • In a specific spares control system, it is quite possible that in a
single year, many spares would not have been consumed at all.
• In such cases, it is better to perform ABC analysis on longer
consumption period data, say 3 years. Once ABC classification has
been achieved, the policy control can be formulated as follows:
• Policy for 'A' items
* Maximum control
* Value Analysis
* More than one supplier
* Control by top executives.
41

• Policy for 'B' items

* Minimum control
* Bulk Orders
* More items from same supplier
Policy for ‘C’ Items:
The items being of low value, the control can be exercised at grass root level of
authority, i.e., by respective user department managers.
Contd. INVENTORY ANALYSIS…

42 • HML Analysis: Classification based on unit price;

 This classification is as follows:
• High Cost (H) : Item whose unit value is very high,
say, Rs.1000/- and above.
• Medium Cost (M) : Item whose unit value is of medium value, say, above Rs.100/- but less
than Rs.1000/-.
• Low Cost (L) : Item whose unit value is low,
say, less than Rs.100/-.
• This type of analysis helps in exercising control at the shop floor level ie, at the use point.
Proper authorization should be there for replacing a high value spare.
• Efforts may be necessary to find out the means for prolonging the life of high value parts
through reconditioning and repair. Also, it may be worthwhile to apply the techniques of
value analysis to find out a less expensive substitute.
INVENTORY CONTROL SYSTEMS
Introduction
43
• To ensure smooth functioning it is essential to develop a suitable inventory control by which
optimization of spare parts cost is achieved in a systematic way.
As regards the fast moving and slow moving items are concerned, the following procedure can
be followed taking into consideration various cost elements.
While managing the spare-parts inventory, basically there are four cost elements to be
considered:-
1. Cost of the spare part
2. Cost of ordering
3. Cost of storage
4. Cost of stock-out.
Contd. INVENTORY CONT…
44

Cost of the spare part (purchasing cost) can be defined as the quoted price
of inventory minus any discounts allowed plus shipping charges.

purchasing cost becomes an important factor when the spare parts unit
price becomes dependent on the size of the order. This situation is normally
expressed in terms of a quantity discount or a price break, where the unit
price of the item decreases with the increase of the ordered quantity.
Contd. INVENTORY CONT…
45 The cost of ordering includes:

1. Rent for purchase department

2. Depreciation for Office facilities
3. Salaries
4. Postage & Telephone expenses
5. Stationery expenses
6. Travel expenses
7. Incoming Inspection
8. Entertainment .
Contd. INVENTORY CONT…
The cost of storage includes
46

1. Rent for the stores

2. Depreciation on storage and
handling facilities
3. Handling charges
4. Salaries of stores staff and clerks
5. Taxes
6. Insurance
7. Costs of stationery etc.
Contd. INVENTORY CONT…
Cost of stock-out
47
The components of the stockout cost are as follows:
(a) Profit lost due to lost sales which in turn is due to production loss as the part is not
available.
(b) Loss of goodwill of the customer and future sales due to his switching over to another
supplier wherever possible.
(c) Penalties for late deliveries.
(d) The down time of the equipment and low morale of workers.
(e) Waste of products preceding, during, and following condition after repair.
(f) Cost of bringing back equipment to working condition after repair.
(g) Additional price/transportation charges to get the spares.
(h) Interest burden on investment on equipment which is lying idle due to want of spares.
 Inventory model

ECONOMIC ORDER QUANTITY (EOQ)

48
• Inventory models deal with idle resources like men, machines, money and
materials. These models are concerned with two decisions: how much to
order (purchase or produce) and when to order so as to minimize the total
cost.
• For the first decision—how much to order, there are two basic costs which are
to be considered namely, inventory carrying costs and the ordering or
acquisition costs. As the quantity ordered is increased, the inventory carrying
cost increases while the ordering cost decreases.
• The ‘order quantity’ means the quantity produced or procured during one
operation (production) cycle.
• Economic order quantity is calculated by balancing the two costs.
Contd. Inventory model…

49 • Economic Order Quantity (EOQ) is that size of order which minimizes total costs
of carrying and cost of ordering. i.e., Minimum Total Cost occurs when Inventory
Carrying Cost = Ordering Cost. Economic order quantity can be determined by two
methods:
1. Tabulation method.
2. Algebraic method.

• Before calculating economic order quantity it is necessary to become familiar with terms like maximum inventory,
minimum inventory, standard order and reorder point, which are known as Quantity Standards. Figure 4 shows
different quantity standards.

• Starting from an instant when inventory OA is in the stores, it (inventory) consumes gradually in quantity from A
along AD at a uniform rate. It is pre-known that it takes L number of days between initiating order and receiving the
required inventory.
50 • Therefore as the quantity reaches point B, purchase requisition is initiated which takes from B to
C, that is time R. From C to D is the inventory procurement time P. At the point D when only
reserve stock is left, the ordered material is supposed to reach and again the total quantity shoots
to its maximum value, i.e. the point A’ (A=A’).

• Maximum Quantity OA is the upper or maximum limit to which the inventory can be kept in the
stores at any time.

• Minimum Quantity OE is the lower or minimum limit of the inventory which must be kept in the
stores at any time.
Contd. Inventory model…

51
Contd. Inventory model…

52
 The purpose should be to hold enough and not excessive stock of material. Stock holding:
(a) Avoids running out of stock;
(b) Helps creating a buffer stock which may be utilized if the material falls below the minimum
level;
(c) Makes sure the predecided delivery dates;
(d) Provides quick availability of materials;
(e) Takes care of price fluctuations and shortage of inventory in the market;
(f) Advises regarding, obsolete and slow moving items;
(g) Helps in standardization and thus reducing the variety of items to be handle;
53

• Standard Order. (A’D) is the difference between maximum and minimum quantity and it
is known as economical purchase inventory size.

• Reorder Point (B) indicates that it is high time to initiate a purchase order and if not done
so the inventory may exhaust, and even reserve stock utilized before the new material
arrives.
Contd. Inventory model…
• From B’ to D’ it is a lead time (L) and it may be calculated on the basis of past
54
experience. It includes:
(a) time to prepare purchase requisition and placing the order;
(b) time taken to deliver purchase order to the seller;
(c) time for seller (vendor) to get or prepare inventory; and
(d) time for the inventory to be dispatched from
the vendor’s end and to reach the customer.

• Time, (a) above is known as requisition time (R) and (b) + (c) + (d) is the
procurement time (P).
• The economic lot size for an order or the economic order quantity depends upon
two types of costs, i.e. Inventory procurement cost and carrying cost.
Contd. Inventory model…
(a) Inventory procurement(ordering) costs, which consist of expenditure connected
55 with

1. receiving quotations (or costs);

2. processing purchase requisition;
3. following up and expediting purchase order;
4. receiving material and then inspecting it; and
5. processing seller’s (vendor’s) invoice.
Procurement costs decrease as the order quantity increases (see Fig.5)
 (b) Carrying costs, which vary with quantity ordered,
56
base on average inventory and consist of:

1. interest on capital investment;

2. cost of storage facility, up-keep of material, record
keeping etc;
3. cost involving deterioration and obsolescence and
4. cost of insurance, property tax, etc.
• Carrying costs are almost directly proportional to the order size or lot size or order
quantity.
Contd. Inventory model…

57

In Fig. 6. the procurement costs

and inventory carrying costs have
been plotted with respect to
quantity in lot. Total cost is
calculated by adding procurement
cost and carrying cost. Total cost
is minimum at the point A and
thus A’ represents the economic
order quantity or economic lot
size.
Contd. Inventory model…

1. Determination of EOQ by Tabulation (Trial & Error)

58
Method
This method involves the following steps:

1. Select the number of possible lot sizes to purchase.

2. Determine average inventory carrying cost for the lot purchased.
3. Determine the total ordering cost for the orders placed.
4. Determine the total cost for each lot size chosen which is the
summation of inventory carrying cost and ordering cost.
5. Select the ordering quantity, which minimizes the total cost.
59

• The data calculated in a tabular column can be plotted showing the nature of total cost,
inventory cost and ordering cost curve against the quantity ordered as in Fig. 6.

• ILLUSTRATION 1: The XYZ Ltd. carries a wide assortment of items for its customers.

• One of its popular items has annual demand of 8000 units. Ordering cost per order is found
to be Br 12.5. The carrying cost of average inventory is 20% per year and the cost per unit
is Ce. 1.00. Determine the optimal economic quantity and make your recommendations.
Contd. Inventory model…

60

Fig. 6
Contd. Inventory model…

61
2. Determination of EOQ by Analytical Method

• In order to derive an economic lot size formula following assumptions are made:
1. Demand is known and uniform.
2. Let D denotes the total number of units purchased/produced
and Q denotes the lot size in each production run.
3. Shortages are not permitted, i.e., as soon as the level of
the inventory reaches zero, the inventory is replenished.
4. Production or supply of commodity is instantaneous.
62
5. Lead-time is zero.
6. Set-up (ordering) cost per production run or procurement
cost is C3.

7. Inventory carrying cost is C1 = CI, where C is the unit cost and I is called inventory carrying cost
expressed as a percentage of the value of the average inventory.

• This fundamental situation can be shown on an inventory-time diagram, (Fig. 7) with Q on the vertical
axis and the time on the horizontal axis. The total time period (one year) is divided into n parts.
 Contd. Inventory model…

63

The most economic point in terms of total inventory cost exists where,
Inventory carrying cost = Annual ordering cost (set-up cost)
Average inventory = 1/2 (maximum level + minimum level)
= (Q + 0)/2 = Q/2
Total inventory carrying cost = Average inventory × Inventory carrying
cost per unit
i.e., Total inventory carrying cost = Q/2 × C1 = QC1/2 …(1)
64

• Total annual ordering costs = Number of orders per year × Ordering cost per order i.e., Total annual
ordering costs = (D/Q) × C3 = (D/Q)C3 …(2)

• Now, summing up the total inventory carrying cost and the total ordering cost, we get the total
inventory cost C(Q).
• i.e., Total inventory cost (Total cost of production run) = Total inventory carrying cost + Total annual
ordering costs

• C(Q) = QC1/2 + (D/Q)C3 (cost equation) …(3)

Contd. Inventory model…

• But, the total cost is minimum when the inventory carrying costs becomes
65
equal to the total annual ordering costs.
Therefore,
• QC1/2 = (D/Q)C3
• or QC1 = (2D/Q)C3 or Q2 = 2C3D/C1
Contd. Inventory model…
• ILLUSTRATION 2: An engine manufacturer purchases lubricants at the
66 rate of Br 42 per piece from a vendor. The requirements of these lubricants
are 1800 per year.
• What should be the ordering quantity per order, if the cost per placement of
an order is Br 16 and inventory carrying charges per Birr per year is 20 cents.
SOLUTION: Given data are:
• Number of lubricants to be purchased, D = 1800 per year
• Procurement cost, C3 = Br 16 per order
• Inventory carrying cost, C1 = CI= Br. 42 × Ce 0.20 = Br 8.40 per year
Contd. Inventory model…
• ILLUSTRATION 3: A manufacturing company purchase 9000 parts of a machine for its
67 annual requirements ordering for month usage at a time, each part costs Br 20. The
ordering cost per order is Br 15 and carrying charges are 15% of the average inventory per
year. You have been assigned to suggest a more economical purchase policy for the
company. What advice you offer and how much would it save the company per year?

SOLUTION: Given data are:

• Number of lubricants to be purchased, D = 9000 parts per year
• Cost of part, C = Br 20
• Procurement cost, C3 = Br 15 per order
• Inventory carrying cost, C1 = CI = C x 15% of the value of the average inventory per year
= Br 20 × 0.15 = Br 3 per each part per year
Contd. Inventory model…

68
69

• If the company follows the policy of ordering every month, then the annual ordering cost is = 12 × Br 15 = Br 180

• Lot size of inventory each month = 9000/12 = 750

• Average inventory at any time = Q/2 = 750/2 = 375
• Therefore, storage (inventory carrying) cost at any time
• = 375 × C1 = 375 × 3 = Rs. 1125
• Total annual cost = 1125 + 180 = Br 1305

• Hence, the company should purchase 300 parts at time interval of 1/30 year instead of ordering 750 parts each month.
The net saving of the company will be = Br 1305 – Br 900 = Br 405 per year.
 Materials requirement planning (MRP)
70 • 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.

• MRP techniques focus on optimizing inventory. MRP techniques are used to

explode bills of material, to calculate net material requirements and plan future
production.

MRP systems use four pieces of information to determine what material should
be ordered and when :
71

the master production schedule, which describes when each product is scheduled to be
manufactured;
bill of materials, which lists exactly the parts or materials required to make each product;
production cycle times and material needs at each stage of the production cycle time; and,
supplier lead times.
The master schedule and bill of materials indicate what materials should be ordered; the
master schedule, production cycle times and supplier lead times then jointly determine
when orders should be placed
 Contd. Materials requirement…

72 Objectives of MRP
• 1. Inventory reduction: MRP determines how many components are
required when they are required in order to meet the master schedule. It helps
to procure the materials/ components as and when needed and thus avoid
excessive build up of inventory.
• 2. Reduction in the manufacturing and delivery lead times: MRP identifies
materials and component quantities, timings when they are needed,
availabilities and procurements and actions required to meet delivery deadlines.
MRP helps to avoid delays in production and priorities production activities by
putting due dates on customer job order.
73

• 3. Realistic delivery commitments: By using MRP, production can

give marketing timely information about likely delivery times to
prospective customers.
• 4. Increased efficiency: MRP provides a close coordination among
various work centres and hence help to achieve uninterrupted flow of
materials through the production line. This increases the efficiency of
production system.
Contd. Materials requirement…
MRP System
74

• The inputs to the MRP system are: (1) A master production schedule,
(2) An inventory status file and (3) Bill of materials (BOM).

 Using these three information sources, the MRP processing logic

(computer programme) provides three kinds of information (output)
for each product component: order release requirements, order
rescheduling and planned orders.
Contd. Materials requirement…

75
Contd. Materials requirement…
• 1. MASTER PRODUCTION SCHEDULE (MPS)
76 MPS is a series of time phased quantities for each item that a company produces, indicating how many are to be produced
and when. MPS is initially developed from firm customer orders or from forecasts of demand before MRP system begins
to operate.

 The MRP system whatever the master schedule demands and translates MPS end items into specific component
requirements. Many systems make a simulated trial run to determine whether the proposed master can be satisfied.

• 2. INVENTORY STATUS FILE

Every inventory item being planned must have an inventory status file which gives complete and up to date information on
the on-hand quantities, gross requirements, scheduled receipts and planned order releases for an item. It also includes
planning information such as lot sizes, lead times, safety stock levels and scrap allowances.

• 3. BILL OF MATERIALS (BOM)

BOM identifies how each end product is manufactured, specifying all subcomponents items, their sequence of build up,
their quantity in each finished unit and the work centres performing the build up sequence. This information is obtained
from product design documents, workflow analysis and other standard manufacturing information .