Materials Management

Materials Management
1.1 INTRODUCTION TO MATERIALS MANAGEMENT________________
Materials are the key resource in an industrial enterprise; no production is possible without
materials. Materials also form a major constituent of the cost of the product and, therefore,
proper control over their procurement, storage, issue, movement and consumption is
necessary. Materials management exactly does this.
Material Management according to Bethel and others, is a term used to connote

"controlling the kind, amount, location, movement and timing of the various
commodities used in and produced by the industrial enterprise." It involves all
activities concerning materials right from the time the need for the materials is established
until they are issued to production.
Materials management covers all aspects of materials and their supply, which are
necessary for converting raw materials into finished products. It is thus concerned
with planning and programming of materials (material planning), market research
for purchase (purchase market research), procurement of materials and capital
goods (purchasing), receiving, store keeping, warehousing, inventory control,
packaging and packing of materials, materials movement, disposal of scrap, surplus
and obsolete materials. (Fig. 1.1).
Waste
Management
FUNCTIONS OF
MATERIALS
MANAGEMENT
JDisposal of
plus m aterial
\
Transportation
Fig. 1.1: Functions of Materials Management
Importance of Materials Management
Materials productivity has a significant and direct effect on a company's profitability (i.e.
Return-on-Investment). Rate of return on investment is the ratio of profit to capital which
Unit 1 Introduction to Materials Management
in turn (for the purpose of analysis) may be split into its two basic constituents profit
margin and capital turnover ratio. (Fig. 1.2).
Rate of Return on investment

(R.O.R.)
P = Profit C = Capital S = Sales
Fig. 1.2: R.O.R. and its constituents
Two basic ways to improve R.O.R. are
(a) Increasing profit keeping the capital constant
Profit is the lifeline of an organisation. Good profits help everybody. Profits give
shareholders a dividend. Profits give employees their wages, job security and all that
goes with it. Profits give the company the capital to buy materials, machines, tools
and other inputs for its operations. It enable a company to expand, which brings in
greater job opportunities, and replace old machinery that has rendered its share of
service. Profits help the company to improve quality of life (i.e. make buildings, roads,
community centres, schools and dispensaries while providing drinking water) around
it. Profits, therefore, is a must since in its absence there would be no
investment, no machines, no companies and no products. Profits, when balancing
the books is treated as negative cost, yet in reality it is the "cost of staying in business."
Profit is the first test of management effectiveness. Fig. 1.3 suggests the areas of control
to improve profit.
Unit Unit Unit Unit cost

sold X price produced (C)
(S) (P) (N)
S X P N X C
Assuming what is
produced is sold i.e.
S=N
Fig. 1.3: Profit and its constituents
(i) Increase units sold (S): Sales and production must be evenly balanced to
ensure that whatever is produced is sold, failing which the company will
end up with unsold stocks. "If the Production Department put out 3000 sewing
machines, its Sales Department must per force sell the 3000 units, otherwise
another crop of ills will come up: storage costs are loss due to deterioration."
(ii) Increase production (N): Production can be increased either by dupl icating
resources (e.g. adding another identical production line) or by better management
of existing resources (i.e. by improving productivity).
The duplication of resources requires extra capital, which depends on the

company's financial position, while improvement in productivity is within the
control of the management.
(iii) Increase unit price (P): Price is generally a function of demand and is controlled
by the forces of supply and demand. A company operating in a buyer's market
may find it impossible to increase the price, thus leaving us with the second
factor to deal with, namely cost.
(iv) Reduce unit cost (C): Reduction in cost is something which is within the control
of the company. The total cost of a product consists of three main constituents:
material cost, labour cost and overheads, the material cost being the major
portion of the total cost.
In the Indian context, materials constitute more than half of the cost of production in
most industries and projects. In some industries, 60 to 70 per cent of the total
production cost is due to materials. This makes Materials Management the biggest
single area with tremendous scope for cost reduction. A well co-ordinated Materials
Management Programme may lead to around 20% reduction in cost.
(b) Reducing Capital '
An alternative to increasing profit to improve ROR is to reduce capital. Capital can

either be fixed capital or working capital, which, in a manufacturing firm, is generally
tied up in the proportion of 60 : 40. The fixed capital - capital deployed in fixed
assets like land, buildings, plant and machinery, jigs and fixtures etc. - is fixed anyhow
and hence a little can be done about it. This leaves us with the working capital. The
study of this portion of the capital reveals that a little over 80% of the working
capital is locked up in inventory (i.e. raw materials, work-in-process, finished
goods, spares etc.), which can be released if proper materials management techniques
(i.e. scientific inventory control, JIT, MRP etc.) are employed.
Costs involved in the Management of Materials

:•».-.. ' ; . f
The various costs involved in the management of materials are as follows:
• Basic cost of materials - cost paid to the supplier as price of goods.
• Government levies and taxes - cost paid to the supplier towards Government
levies and taxes, namely excise duty, sales tax, octroi etc.
• Ordering costs - cost incurred in effecting purchasing, such as cost of tendering,

stationery, postage, visits to the suppliers' plant to expedite delivery, cost of receiving,
inspection and bill payment, including cost on staff.
• Inventory carrying costs - cost incurred in maintaining inventory such as interest

on capital locked, losses due to deterioration and obsolescence, insurance premium,
storage and preservation expenses etc.
• Packaging and packing cost - cost incurred in packaging and packing of the
products.
• Material handling costs - cost incurred for movement, storage and making supply
to the indentor.
• Freight cost - cost incurred in movement of materials from suppliers' works to

buyer's works.
• Insurance cost - cost incurred in providing adequate insurance cover to the materials
in transit and in storage.
• Wastage during receipt, storage, production etc. - cost of losses due to

defects
in design, poor quality of material, improper storage methods, improper issues, rework
i and rejection during manufacture etc.
The primary objective of any organisation is to reduce the above costs so that the
cost of material is the lowest.
Objectives of Materials Management
There are ten objectives of Materials Management:
a) To maintain a steady flow of materials to ensure uninterrupted production. Any

disruption affects cost of the product.
b) To achieve economy in cost of materials by adopting cost reduction techniques

like value analysis, variety reduction, JIT, MRP etc.
c) To ensure consistency of quality by providing right materials, of the right quality,

in the right quantity and at the right time.
d) To reduce inventory investment through scientific inventory control techniques.
e) To improve corporate image by maintaining good buyer-seller relations.
f) To maintain goods records of purchase, stores, traffic, etc. to eliminate the possibility
of corruption.
g) To preserve/conserve materials in stock so that losses due to pilferage,

deterioration, obsolescence etc. are kept at minimum.
h) To reduce operating cost by minimising/eliminating wastage and improving

productivity of materials.
i) To improve competitive strength of the firm by producing the best quality products
using quality materials at the lowest possible cost.
Fig. 1.4 below lists the objectives of Materials Management.
Elimination/ Speedy ^ ^
Improving
minimisation of disposal of Goods
competitive
wastage of surplus records
strength
materials materials
L
• ^ i ^ - ^ •^
4 ^ \
Preservation/ ( Dbjectives of Speady flow of
conservation materials materials
of materials management
^
1 r
i -+
Improved
corporate image Lower Economy in
Consistency
through goods inventory cost of
of quality
buyer seller investment materials
relationships
Fig. 1.4: Objectives of Materials Management
Integrated approach to Materials Management
To improve materials productivity and get the most out of every rupee invested in materials,
it is essential to follow a well co-ordinated and integrated approach towards the various
areas that involve decision making with respect to materials. For best results, all activities
related to materials must be placed under one department viz. Materials Management
department. The activities as in Materials Management are as follows:
• Materials planning - Ascertaining the needs of the users well in advance, translating
sales projection into production requirements and making realistic estimates of various
items of materials required, their quantities and the time that it is required.
• Make-or-buy decisions - Deciding the items that are to be produced at the home
plant and the items to be procured from outside sources based on relative economics.
Purchasing -Arranging uninterrupted supply of raw materials, parts, components

and consumables to meet the production target.
Receiving and inspection - Inwarding of materials and deciding, with the help of quality
control/production/maintenance/others, the acceptability or otherwise of materials.
Storage - Taking physical custody of materials, providing the right kind of storage,
using proper methods of preservation, providing proper security against pilferage/
theft/malpractices and taking steps to minimise wastage and storage losses.
Inventory control - Maintaining optimum investment in inventories and at the same
time ensuring uninterrupted supply of materials required for production. Distribution
of materials -Arranging the fastest and the most efficient supply to
the indentors.
Transportation -Arranging the must cost effective and efficient transport for incoming
and outgoing materials.
Disposal of surplus, obsolete and scrap materials -Analysing and selecting the
most economical channel to dispose of whatever is surplus or not required.
Developing new sources of supply - Locating, selecting and developing new

sources of supply for improving quality and reducing cost.
Import substitution - Developing indigenous sources of supply for imported materials
and parts, in order to reduce purchasing cost and save on foreign exchange.
Ancillarisation - Developing small scale captive sources to manufacture parts and

components required by the company.
Insurance Management -Arranging adequate insurance cover for materials in
transit and in storage, lodging claims for loss of materials and damages in transit and
recovery thereof, and reducing insurance cost. > Materials cost reduction
and cost control - Utilising various cost reduction
techniques such as value analysis, variety reduction, transportation models, critical
path analysis, line-of-balance, learning curve, JIT, MRP etc. » Waste
Management - Minimising materials waste by identifying the causes for
rework/rejection/scrap of materials. It also includes measures such as design reviews,
methods improvement etc., with a view to improving material productivity.
Effective participation of employees is possible only when they clearly understand their
roles (positions), responsibilities and authority, for which a clear internal structure of the
department and working relationships of the various jobs is a must.
Thus, for effective working of the people, irrespective of their number, proper organisation
structure is a must and it is one of the top management functions, so it is called organising.
Organisation structure for the Materials department involves decisions regarding the status
of the department in the company, degree of centralisation and the internal structure of the
department.
Status of the department
Status of the department refers to the placement of the department in the structure of the
company. The materials department should be placed as a top management function,
headed by a Senior executive reporting to the Chief Executive/Managing Director.
Typical organisation structure under this type of situations would be as shown in Fig. 1.5
Fig. 1.5: Material department being considered top management function

Degree of Centralisation
The department may have either a centralised or a decentralised system of working.
Centralised arrangement refers to the procurement of the requirements of all the departments
of the firm or of all the plants, by a central purchase organisation. The merits of this set up
are as follows:
f) Consistency in buying policies, since all the purchase contracts and related decisions
are being taken by one department.
ii) Economy in buying due to better bargaining on price and terms and conditions
with vendors, reduction in transport costs etc., on account of large scale purchasing.
to
iff) Uniformity in purchase records, since one department handles all purchases.
iv) Economy in maintenance of records in the purchase (few purchase indents),
receiving and inspection (fewer receipts) and accounts (fewer

payments) departments.
v) Low inventory investment.
vi) Reduction in handling and storage costs due to centralisation of receiving

inspection and storage.
• . '; " • ' ,
*< -.
vii) Performance of specialist functions by non-specialists.
viii) Avoidance of irritation of the vendors at having a number of contacts

with the company.
Decentralised arrangement refers to the system of procurement of requirements

of the different divisions (or different plants) by local buying sections vested with
all the powers of a purchase department, each attached to the division (or situated at
the plant) concerned. The merits of a decentralised set up are as follows:
(i) Decentralisation enables individual buyers to react rapidly to changes in

the requirements of the divisions/plants to which they are attached.
(ii) Since local buyers are in close contact with their respective divisions, they can
render greater assistance to them by providing information on probable
prices, deliveries and performance of items to the concerned departments.
Cm) A local buyer under the decentralised system is under the control of the senior
executive of the division/plant and executives can be held responsible for the
production loss due to failures attributable to the buyer (since the executive
concerned is in-charge).
Both centralised and decentralised buying, as discussed above, have their own
merits and demerits. The most common concept, therefore, is to have a
compromise where both centralised and decentralised buying concepts exist
together.
11
The internal structure of the Materials department depends on
i) Complexity of operations (i.e. quantity and variety of items to be purchased)

if) Size of the com pany (i.e. sm all m edium or large setup)
in) Single or multi-plant/multi division.
A . Internal structure in a sin gle p lan organisation
The general rules are as follow s:

• Materials related activities like store keeping, receiving, traffic etc. may be combined
with purchasing, if purchases are small and not very complex (Fig. 1.6).
• Greater degree of functionalised sub-division is employed, if purchases are large
and varied (Fig. 1.7).
Fig.1.6: Organisation showing receiving, store keeping and traffic

(
-I
(Capital
i r
Buyer - II
(Imports )
^
Buyer - III
(Raw
i
Buyer -IV
(Supplies)
i
Buyer -V
r
(Press parts)
al
goods & materials)
MRO)
Fig. 1.7: Organisation structure showing greater (i
degree of functionalised sub-divisions ii
)
B. Multi-plants/multi-divisions organisations structure u
n
The general rules are as follows: d
e
• Centrali sed structure is preferred if the company has different rt
manufacturing a
divisions or closely located plants. k
e
• Each division has its own purchase manager/buyer to co-ordinate the m
activities a
of the division and all buyers in turn are answerable to the head of the r
Materials k
e
department.
t
• Semi-centralised structure - Acombination of the centralised and r
e
decentralised
s
concepts. This works better if the various division of a company e
manufacture a
diversified products, with a few or no common items. Under this r
setup, each c
division has its own separate materials department under the control of the h
head o
of the division, with a centralised agency that will f
a
(f) co-ordinate the activities and directing policies of the local buyer. ll
d
(ii) undertake contract buying of important materials, while local buyers i
place orders against the contract and buy miscellaneous items from v
local suppliers. is
ions.
13
Decentralised set up is preferred in organisations having more than one plant

division geographically located at different places in the country.
A semi-centralised setup is shown in Fig. 1.8.
Managing Director
1 '
General
r
4
General
^
General
J
General
1
General
Manager Manager Manager Manager Manager
(Personnel) (Materials) (Marketing) (Engg.)
*"-
Materials Materials Materials

Manager Manager Manager
(Plant B) (Plant A) (Plant C)
Receiving & Inventory Purchasing Traffic Materials

Storing handling
Buyer I Buyer II Buyer III
Fig. 1.8: Semi centralised set up
Responsibilities of different divisions of Materials Department.
The respective functions of the materials department of a medium-sized firm are

detailed as under:
1) The Material Planning division is mainly concerned with assurance of materials

in the right quality, in the right quantities, at the right price and at the right
time. The various responsibilities of the division are as follows:
• Determining net requirement of materials by considering sales budget

and
inventories on hand.
• Scheduling and planning orders for purchase.

• Developing a master production schedule.
14
d
e
• Co-ordination with purchase, stores and production to identify deviations
and l
undertake corrective actions.
i
• M aintaining records of materials receipts and shortages.
v
2) The Purchase Division is responsible for the purchase of goods of right e
quality, in
the right quantities, at the right tim e and price and from the right source.
r
Specific
responsibilities include i
• Locating, selecting and developing qualified sources of supply. e
• Scrutinising purchase indents and selecting appropriate method of s

buying. ,
• Floating enquiries, processing quotations, conducting negotiations and
releasing
purchase orders. t
• Pre-delivery follow up and shortage chasing.

• Co-ordination with inward section including timely return of defectiveM
materials a
back to suppliers.
i
• Endorsing suppliers'invoices for paym ent. : ,, ,,,
n
• Processing suppliers' requests for price increases, including price
negotiations. t
• a
Arranging discussion m eetings between the suppliers' representatives
and the
i
company's officials.
n
• Disposal of surplus, obsolete and scrap m aterial.
i
• Acting as a link between the company' s finance departm ent and the
suppliers n
for timely payment/settlement of suppliers' bills.
g
• Maintaining the com pany's image am ong suppliers.
3) The Inventory control division

is concerned with controlling inventories at the c
various
stages of production, without affecting the continuity and efficiency of o
production.
flt The main responsibilities of this function are as follows: n
. • Ensuring service to customers by giving prom pt t

inuity of productive operations.
• Fixing inventory levels.
• Ensuring econom y in purchase by determ ining the optim um quantities
to be
stocked or purchased.
15
4) The Materials handling division is mainly concerned with transport of materials

from one place to another, within the company i.e. ensuring right materials at the right
time and right place. The various responsibilities of this department are as follows:
• Selection of right mode of materials handling.

• Location of materials handling equipments at appropriate place.
• Ensuring smooth movement of materials from one place to another.
• Co-ordinating with the stores, production and traffic departments of the company.
5) The Traffic division is mainly concerned with the arrangement of economic

transportation of incoming and outgoing materials.
The main responsibilities of the traffic division are:
• selecting the right kind of shipping service (rail, road, steamer, parcel post, air
etc.) on the basis of lowest total charge, best care of goods, smallest transit time
etc.
• providing instructions for packaging and packing to guarantee the lowest freight
cost, protection of goods during transit and ease of handling.
• preparing bills of lading (contract between the company and the carrier).
• scrutinising and auditing freight bills for payment.
• filing claims against carriers for shortages and insurance companies for any
damages and losses during transit.
• tracing missing consignments and expediting shipments wherever required.
• preparing a route-wise rate chart, thereby assisting the purchase department in
arriving at transportation costs and the sales department in quoting
shipping
costs to the customers.
• supervising the company's transport and ensuring its effective utilisation in
collecting/delivering materials from/to transporters' godowns.
• attending to customers' instructions and complaints relating to transportation.
6) The Receiving division is mainly concerned with verification of goods, with respect
to correctness of papers, quality and delivery schedule. Its responsibilities include
verification of correctness of paperwork and appropriateness of supply.

• e
* n
• in warding of the consignment through proper documents such as GRR.
s
• verification of quantities against suppliers' packing slip/delivery advice
slip and ur
notifying discrepancies, if any.
e
• notifying indentors and purchase regarding receipt of materials.
n
• offering materials to quality control for verification of quality.
o
• delivering accepted materials to appropriate stores.
m
• returning defective materials to the suppliers. , , - , ,,< - , , - , , ,
aj
• returning all changeable empties to the suppliers.
or
7) TheStoring divisionis mainly concerned with proper storage of materials, a
preservationof materials and issue of materials. Its responsibilities include
I ct
• Keeping the stores/stock in proper order.
iv
• Receiving and issuing materials. , , > .
t
it
•
It ° ° -•••' • - ••:' . ' '
y
• Inspecting stores on their receipts, for any damages or quantity
is
discrepancy.
o
• Arranging materials in such a way that they are easily traceable and
v
approachable.
er
• Keeping a record of each item received and issued.
lo
• Giving information about stocks to the concerned people.
o
• Taking precautions to avoid pilferage, theft, deterioration,
k
obsolescence.
e
• Providing information on surplus and obsolete materials on periodic
d
basis.
b
Job descriptions of key position in the M aterials Department y
The next logical step after preparation of organisation structure is to prepare jobd
descriptionfor each incumbent in the department, so as to make him know his broad
responsibilitiesand how they correlate to his peers. ef
Job descriptions a
• avoid overlaps and conflicts. ul

t.
• make each individual accountable for specific tasks.
17
Materials Management '
A c t i v i t y D" "; • • " • * ' " " • • ' • • ' • -• . . - •• •. • • • . • . . < . . • . : , • • . . >
Draw an organisation chart for the materials department of a large scale organisation.
1.3 CLASSIFICATION OF MATERIALS

_____________________________________________________________
_____
A manufacturing or a service organisation generally requires large numbers of items.

Handling of such items - planning, procurement, storage, accounting - becomes
difficult (if not impossible), if each one of them is handled separately. Some sort of
classification, therefore, is a must, since concentration of effort according to class
system is more efficient and effective compared to diluted effort corresponding to
individual items.
Classification of materials is the process of grouping of items into a few categories,
based on a set criteria. Everybody is familiar with classification of domestic articles
into clothes, kitchenware, grocery, electrical gadgets, furniture, consumables, non-
consumables etc. Since an item can be placed into more than one class depending
upon the criteria used, some sort of formal classification, therefore, is a must.
Materials may be classified as per the following classification:

I. Classification on the basis of stage of conversion process
Inamanufacturing organisation, store materials canbe classified broadly into direct
materials and indirect materials. Direct materials, in turn, can be further classified into
raw materials, work-in-process, finished parts (bought out parts and works made
parts) and finished goods. Fig. 1.9 shows the classification on the basis of
conversion process.
If
Store
J
1
Direct Materials Indirect
]
1
Raw
i
Work-in
1
Works made
1Purchased
Materials process parts parts
I
Standard
I
Special
(bought out parts)
after being processed and assembled
F in ish ed P ro d uFig.
cts 1.9: Classification of stores
on the basis of conversion process
II. Classification on the basis of nature of Materials
This is the most common criterion used in classification of materials. Based on

this criterion, materials may be classified into the following categories:
1. Raw materialsare the basic materials which have not undergone any
conversionsince their receipt from suppliers. They are the basic materials
from which thecompany's parts/products are manufactured.
Raw materials are different for different industries. For example, cotton for
textile mills, cloth for dress makers, fruits for canning industry, turpentine and
spirit for paintmanufacturers, timber for furniture makers, polythene granules
for the producers ofplastic goods and steel (bars, sheets, plates etc.) for
automobile firms are the raw
materials.
The products of one manufacturer is usually the raw material for another. For
example pig iron, lime, manganese and carbon are the raw materials for a steel
mill while steel(rolled bars, billets, sheets etc.) is the final (or finished)
product; rolled bars and billets are the raw materials for a forge shop while
forgings are its final product;forgings are the raw materials for an
automobile producer and vehicles are its final
product.
19
2. Consumablesare material s which either cease to exist or change their shape

during
the manufacturing process and cannot be used for the second time. Typical
examples
of consumable items are coal, coke, lubricants, cotton waste, stationery items
(e.g.
pencil, paper, carbon paper, refill etc.)
>*--
h) Chemicalsare substances in the form of powder, liquid, tablets, etc. that
undergo
certain process according to a devised formula. They require to be stored,
preserved
and issued very cautiously, after a careful scrutiny/analysis, since they involve
risks.
Typical examples of chemicals are acids.
i) Inflammable itemsare materials which are highly susceptible to fire. Being

hazardous,
they require to be stored farther from the main store with complete fire-
fighting
equipment as standby. Typical examples of inflammable items are petrol,
kerosene,
paints, films etc.
j) Furnitureare the movable items of a house or a place. Typical examples of

such
items are tables, chairs, benches, stools, almirahs etc. They require -
• large storage space, as they are usually bulky.
• careful handling/storage, as they get easily damaged or bruised while in storage.
• maintenance of proper records of their repairs, renewals and

replacements.
Some sort of register requires to be maintained, as a record of their issue to
the
user departments'on loan'.
k) Perishable materials are materials which are short-lived and decay easily.
Milk,
fruits, vegetables, eggs, medicines etc. are typical examples of perishable
20 materials.
Many a chemical and rubber part are also perishable because of their limited
shelf-
life. Such materials require to be stored in temperature controlled rooms to
pr per
ol shreddings, straw, saw dust etc.), protective coating (e.g. wax, grease) and
on containers
g (e.g. corrugated boxes, glassware such as glass bottles/jars/tubes/ampules etc.,
th metal
eir containers such as cans/barrels etc. plastic containers, wooden containers such
lif as
e. wooden boxes/crates etc.).
l) P m) Emptiesare used packages which have been scrapped after use. Typical
ac examples
ka of empties are wooden cases (boxes, crates etc.) metal containers (e.g.
gi barrels,
ng drums or cans), glasswares (e.g. bottles, jars, etc.).
m
at
eri
al
s
ar
e
m
at
eri
al
s
th
at
in
cl
ud
e
wr
ap
pi
ng
m
at
eri
al
s
(e.
g.
pa
pe
r,
pa
Unit 1 Introduction to Materials Management m
at
eri
Some of these empties can be reused or recycled. Others require to be
al
stored in heaps in stockyards to be burned or disposed of by auction.
s
9. Supplies include materials used in running the plant or in the making of a ar
company's products but do not themselves go into the product. Supplies, e
therefore, include: w
or
(a) Miscellaneous consumable stores such as brooms, cotton waste, cloth n
waste, toilet paper, cleaning powder, jute twine etc. ou
t/
(bj Welding, soldering and tinning materials such as electrodes, gas, solder br
etc.
ok
n) Abrasive materials such as emery cloth, emery belts, sand paper, emery en
graphite to
etc. ol
s,
o) Shipping containers such as bags, glass bottles, boxes, carboys, st
drums, jars, ee
tins etc. lc
p) Oils and greases such as kerosene oil, transformer oil, lubricating and hi
cutting ps
oils etc. fr
o
q) General office supplies such as blotters, candles, sealing wax, ink and m
inkpads, m
nibs, pencils and refills, files, pins, clips, carbon papers, erasers etc. ac
hi
r) Electric supplies such as cables, cutouts, fuses, lamps, hoses, shades,
ne
switches,
s,
etc.
pr
Supplies are also called indirect materials. III. oc
es
Classification on the basis of usability of materials s
re
Materials may be classified on the basis of usability, as je
cti
under; 1. Serviceable and Unserviceable Materials
on
Serviceable materials are items that have gone temporarily out-of-order and ,
can be put back into use after repairs (service). Typical examples of as
serviceable materials are chucks/fixtures requiring reconditioning, tools such h
as hacksaw/bandsaw blades that need regrinding. fr
o
Unserviceable materials are items that have outlived their life or gone out-of- m
order permanently or damaged so badly that they cannot be repaired, or a
their repair is economically inadvisable. Typical examples of unserviceable fu
rnace or boilers etc.
21
2. Semi-finished and Finished Materials
Semi-finished materials are items in a partially completed condition of

manufacture and need some further processing before they are ready for
sale/shipment to the customer. Such materials are manufactured by different
suppliers and collected and turned into a final product by the company's
production department. Typical examples of semi-finished materials are:
• Machined castings procured from foundries.

• Parts procured from suppliers on which certain operations are to be carried
out
at the company's own plant.
Finished materials on the contrary are items that have been manufactured in
complete form by the production department and are ready for sale.
3. Dead Stock Items
Dead stock items, also called capital equipment, are the furniture (e.g. tables,
chairs, almirahs), office equipment (e.g. typewriters, duplicating machine,
etc.) material handling equipment (e.g. pallets, trolleys, fork lift trucks, conveyers
etc.), machinery (e.g. lathes, milling machines, grinders, shapers, welding sets
etc.), tools (e.g. drills, reamers, taps, milling cutters, dies etc.), measuring
instruments (e.g. micrometers, verniers, thread gauges, ring gauges etc.) and
other items which have definite life and cannot be written off before the expiry
date of their life. Dead stock is the term used in the government departments.
4. Obsolete Items
Obsolete items are items that have gone out of date because of new invention
in design, use etc. and therefore cannot be profitably used.
g$ Activity E;
Discuss four approaches to Material categorisation, classified as per the nature of the
item.
22
Unit 1 Introduction to Materials Management tim e.
Typic
1.4 SU M M A R Y al
exam
ples
Classification of materials is the process of grouping of items into a few categories,
either onthe basis of stages of conversion process or the nature of materials, ofor the
usability of materials. consu
Classification of materials is required to devise purchase, storage,
inspection, issue, accounting and evaluation procedures comm on to materialsmable in
different groups/classes. item s
are
M aterials are key resources in an industrial organisation. M aterials M anagem coal, ent
coversall those activities which concern procurem ent, receiving, storage and issue
coke,of
materials. It covers activities like materials planning, purchasing, receiving lubricand
storekeeping, inventory control, m aterials handling, transportation, disposalants, of
surplus and obsolescent materials,materials economics and waste management. cotton
waste,
M aterials productivity has a significant and direct impact on a company's profitability.
statio
The main objectives of materials management are: maintaining a steady flow of materials,
nery
achievingeconomy in cost of materials, ensuring consistency of quality, reducing item s.
inventory investment, im proving corporate im age, maintaining good records,
preserving/conserving m aterials, reducing operating cost and im proving the
com pany's competitive strength.
For effective working of the people, a proper organisation structure is a must. The
organisation structure of a department indicates three things: (i) Status of the department in
the organisation(ii) Degree of centralisation and (iii) Internal structure of the
department.
The Materials department in firms manufacturing multiple products or requiring high

precisionitems or procuring numerous diverse items, should be placed directly under
the M anagingDirector/Chief Executive, thereby giving the department a status equal to
that of production,
sales, finance etc.
The internal structure of the department depends on the quantity and variety of items
to bepurchased, size of the firm and multiplicity of plants/divisions.
The M aterials department is a service department and it must have continuous

interactionw ith other departm ents, to serve their needs efficiently and w ith
m inim um cost to the
com pany.
1.5 KEYW ORDS

_________________________________________________________
__
Consum ables - Consum ables are the materials which either cease to exist or change
their shape during the m anufacturing process and cannot be used for the second
23
Materials Management ,
Inventory carrying costs - Cost incurred in maintaining inventory e.g. interest on capital
locked up, losses due to deterioration and obsolescence, insurance premium, storage and
preservation expenses etc.
Material management - Controlling the kind, amount, location, movement and timing
of the various commodities used in and produced by the industrial enterprise.
Materials research - Systematic, formal and continuous analysis of all factors affecting
the function of materials management (e.g. economic analysis, market analysis, suppliers'
analysis, price analysis, lead time analysis, transportation analysis etc.)
Ordering costs - Cost incurred in effecting purchasing e.g. cost of tendering, stationery,
postage, visits to the suppliers' plant to expedite delivery, cost of receiving, inspection and
bill payment, including cost on staff.
Return on investment - The ratio of profit to capital, which, in turn, may be split into its
two basic constituents; profit margin and capital turnover ratio for the purpose of analysis.
Raw materials - Raw materials are the basic materials which have not undergone any
conversion since receipt from suppliers. They are the basic materials from which a
company's parts/products are manufactured.
1.6 SELF-ASSESSMENT QUESTIONS__________ ,________
Ql. What is Materials Management? What are the broad functions of Materials
Management?
Q2. "Materials constitute the most fruitful area for cost reduction." Discuss.
Q3. Give a typical organisation structure of a company manufacturing a single product.
Q4. What is meant by decentralisation of purchasing? Why is decentralisation generally

disapproved by the management?
Q5. What do you understand from Classification of materials? Why is it done? In what
different ways can materials be classified?
Q6. (a) Describe briefly the classification of materials.
(b) Classify the following materials giving reasons for the same:
(i) Tyres used by scooter manufacturing company
2.1 INTRODUCTION TO MATERIALS PLANNING____________________

Materials Planning is a scientific way of determining the requirements of raw
materials, bought out parts and others and ensuring their availability in the right
quantities, at the right time with minimum capital lockup.
Lack of Materials Planning
• causes ill-planned purchasing (i.e. over ordering or under ordering) of

materials.
Over-ordering results in over investment and unproductive use of working
capital,
shortage of storage facilities, deterioration and obsolescence of stocks etc.
Under-
ordering causes stockouts and leads to partial utilisation of facilities.
• leads to unwanted emergency orders which are usually processed at high

cost.
• increases workload of the purchase department, receiving stores and

primary
(inward) inspection, thereby increasing manpower requirement.
Factors Influencing Materials Planning
Materials Planning is influenced by two major factors -
s) External factors
t) Internal factors
External factors (or also called macro factors in economic terminology) include:
i) National Economy
fi) Price Trends
iii) Credit Policy
iv) Direct and Indirect Taxes
v) Foreign Exchange Regulations
vi) Import Policy

28
vii) International Market
viii) Business Cycle

Unit 2 Materials Planning
Internal factors (also called micro factors) include: """" '*T * "''"" • »*
i) Corporate objectives
ii) Technology available
iii) Market demand and supply
iv) Procurement lead times
v) Rejection rates (both in the incoming supplies and during manufacturing)
vi) Working capital available
vii) Inventory norms
vi) Storage facilities
k) Nearness to sources of supply
x) Information data (suppliers, materials substitute, etc.)
AM Delegation of power
xi) Communication system
xii) Management policy towards stocking
xiv) Buyer-seller relationships
xv) Company's financial position
xvi) Company's corporate image
^ A c tiv ity A ;
Mention five external factors and 5 internal factors which affect the material
planning.
29
2.2 TECHNIQUES OF MATERIALS PLANNING _ _____
Techniques of Materials Planning may be classified into two groups: i)
Materials Planning Techniques for Direct Materials i) Materials
Planning Techniques for Indirect Materials
Materials Planning Techniques for Direct Materials may be further classified into two sub-
groups -
i) Techniques for High Value Materials ii) Techniques for
Low Value Materials Table 2. 1 below summarises
Materials Planning techniques.
Table 2.1 : Materials Planning Techniques
Material group Technique
A. Direct Materials
a) High Value i) Bill of Materials/Explosion charts
ii) Materials Requirement Planning
iii) Inventory Control
b) Low ValueB. iv) Inventory Control ->•••' -••,-••
Indirect Materials
i) Past Consumption Analysis Technique
ii) Exponential Smoothing
in) Inventory Control
Bill-of-Materials
Bill-of-Materials (BOM), also called part lists or building lists, is a document generated at
the design stage. It details the structure of the product by dividing the final assembly into
major assemblies; the major assemblies into sub-assemblies; and the sub-assemblies into
parts. The individual parts are listed in the manner in which each part is assembled. The
Bill-of-Materials provides details such as part number, description, quantity required,
material specifications etc.
U n it 2 M aterials Planning
*
For determining the requirement of materials, each product is split (product explosion)
into its basic requirements (e.g. boughtout parts, raw materials for works made parts) with
the help of its Bill-of-Material. The quantity required per item is multiplied by the quantity
of the product to be produced to arrive at the total requirement of each item. The
requirements are adjusted after considering any rejections during manufacturing.
An explosion chart may be prepared for a single end-product or a group of end-products.

The explosion chart of a group of products is drawn from a series of Bill-of-Materials of
the products and it provides the total requirement of the components for all the products.
Materials planning using the Bill-of-Materials technique may be explained with the help of
the chart drawn in Fig. 2.1.
Bill-of-Materials of products Bill-of-Materials of products
Forecasting Product
ft- Requirements
• Moving Average or
Explosion chart • Exponential Smoothing or
• Regression Analysis or
• Decomposition of the time
series
Total requirement of
materials
Delivery schedule
Order placing and

procurement
Fig. 2.1: Materials planning using BOM
31
2.3 MATERIAL REQUIREMENT PLANNING (MRP) _____________
Material requirement planning (MRP) is a scientific technique for planning the ordering
and usage of materials at various levels of production and for monitoring the stocks
(inventories) during these transactions. MRP, therefore, is both inventory control and a
scheduling technique. It utilises the master schedule for the end product (a master schedule
shows the quantities of each end product to be produced in each period of the planning
horizon), product structure for determining requirement of sub-assemblies, components
and raw materials (both common and unique to the products) procurement/manufacturing
lead times and inventory status of products sub-assemblies, parts and materials. Utilising
these data bases in a series of steps, it draws up the timings of procurement/manufacture
of all the sub-assemblies, parts and raw materials required over the product horizon to
meet the given end product schedules.
MRPI
MRP I is based on the concept of independent and dependent demand. The demand for
the products is considered independent, since orders may not necessarily be related to
others in terms of customers and quantity. However, but once the sales requirements are
either known or forecasted, the quantity of raw materials and components required
to make the products can be calculated, depending upon the manufacturing schedule.
This dependent demand condition is served by MRP I.
Material requirement planning (MRP I) is particularly useful when one or all of the following
conditions are present:
• The final product is complex and is made up of several levels of assemblies that have
many common part and sub-assemblies.
• The procurement lead times for components and raw materials are relatively long.
• The manufacturing cycle for the finished product is long.
• The demand for the products is known and it is better to make specific
procurement/manufacturing plans (especially when the products are expensive).
Terminology of MRP I
The vocabulary of MRP I is composed mostly of terms from MRP, inventory management
and production control. To understand MRP I, it is important to be familiar with the following
terms and tools:
i) Master production schedule '

A master production schedule is the backbone of an MRP system. A master
schedule gives the product-wise quantities to be produced over the
planning horizon. The master schedule is prepared from inputs that include:
• time period wise actual quantities taken from the sales orders on hand.
• time period wise quantities forecasted from time series analysis.

• time period wise quantities based on feedback from the sales force.
• management decisions to alter quantities, derived from the above

sources, to
smoothen out peaks and valleys in capacity utilisation.
ii) B ill-of-M aterial
Bill-of-Material, also called product structure or assembly parts list, describes

how a product is made from its component parts and assemblies. It contains the
information for identifying each item of the assembly and the quantity required
per assembly, of which it is a part. The modular concept of bill-of-material,
which is most common, shows the immediate components required to produce
one unit for each item, which is called parent. This is done level by level. An
item which is a component to the parent at the previous level becomes a
parent for the constituent parts. An illustrative example is given in Fig. 2.3
below:
Fig. 2.3: 33
Levd
H i) Level Coding
Each Bill-of-Materials is assigned a level code accruing to its linkage from the end
product. The basic rules for this are
• a finished product is placed at level 0
• the components of level 0 parent and not common to any other sub-component
are assigned level 1
• the components of level 1 parent, which are not common to any other sub
component, are placed at level 2
• the components of level 2 parent, which are not common to any other sub
component, are placed at level n
• the components of a particular level which are common to the sub-component
at some level are assigned level according to its linkage to the sub-component
(i.e. accordance with low level coding).
Based on the above principles, the low level coding of components of the Bills-of-Materials
of product X (Fig. 2.3) is shown in Fig. 2.4 below.
Level
34
34 Fig. 2.4: Bill-of-Material according to low level coding
i) Product X is classified as a level 0 item, since it is not used as a component in

any other product.
U n it 2 M aterials P lan n in g
'' ii) Components A and Care the items of a level 0 parent and is not used in any
other sub-component; they are placed at level 1.
I) Component B is assigned level 4, even though it is a component of level 0

parent, l because it is also required for sub-component J. Similarly, component
D is assigned
5
I level 3, even though it is component of level 1 parent, because it is also
required for
1*11 sub-component
H.
'•«
iv ) L ead tim e
• ,*
Lead time is the time that elapses between issuing a replenishment order and
receiving the material in stores. For boughtout parts and raw materials, the
lead times are assumed to be known, based on past experience/negotiations.
Lead times for works-made-parts are similarly assumed to be known and
have the added advantage of being controllable.
Lead time is vital for MRP, since time phasing of components for
purchase/manufacture depends on their lead time. Time phasing in MRP is the
same as activity sequencing in critical path analysis or stage lead time concept
in line-of-balance.
Assume 100 units of product X (Fig. 2.3) are required by week 40 and
this manufacturing stage has a lead time of 2 weeks then components, A,
B and C must arrive at the workstation by week 38. Similarly, if A has a
lead time of 3 weeks then sub-components D and E must reach their
workstation by week 35 and so on.
& Activity B;
Prepare a Bill of Material for your computer.
35
The steps of Materials Requirement Planning
MRP I is composed of a series of twelve steps.
Step 1: Determine the aggregate requirements of finished products
The aggregate quantity represents the gross requirement of a product over a given
period. The gross requirements are obtained from one or more of the following
sources:
• Time period wise actual quantities taken from the sales orders on hand.
• Time period wise quantities forecasted from time series analysis.
• Time period wise quantities based on feedback received from sales force.
• Management decisions to alter quantities derived from the above sources to

smoothen
out peaks/valleys in demand.
Step 2 : Determine the net requirements of finished products
The gross requirements obtained in step 1 are adjusted by the available inventory of
the product to obtain net requirements . That is
Net requirement = Gross requirements - Inventory
available. Step 3 : Develop a master production
schedule
From the net requirements for each time period as determined in step 2, a master
production schedule is prepared. Master production schedule is the key to MRP.
A master production schedule expresses the overall plan of production. It spells out
the different products to be manufactured over the given span of time.
Step 4: Explode the Bill-of-Material and determine gross requirements
For each assembly, a structured Bill-of-Material is available and it contains the

information to identify each item of the assembly and the quantity required per
assembly, of which it is apart.
36
Unit 2 Materials Planning • V. '
4
The gross requirement of each part is ascertained by multiplying the net requirement of the
assembly on the master schedule by the quantity required of the part per assembly as
given in the Bill-of-Material. Acomputer software computes the requirement of parts on a
level-by-level basis (i.e. on completion of first level, it does the computation for next level
and so on).
If the part is a purchased item, the order would be placed and this would conclude the
procedure. Of course, the purchased quantity is adjusted for expected losses in scrap.
Step 5 : Screen out B and C category of items Step
6: Determine the net requirements of items
The gross requirements of an item obtained in step 4 is adjusted for the "stock on
hand" and "stock on order". At times, it may be found that the item is over stocked and
does not require to be replenished. At times, it needs to be ordered/manufactured.
Step 7: Adjust requirement for scrap allowance
Depending upon the criticality of the dimensions, there may be some rejection during
manufacturing, which needs to be accounted for so that the correct numbers will be available
for assembly. This is usually done by estimating the percentage of loss and adding it to the
net requirement when the item is being ordered. In a computerised MRP system, the
percentage loss is kept in the file so that it may be automatically added when the item is
being ordered.
Step 8: Schedule planned orders
Once the quantity of an item is determined, the next logical step is to schedule it. While
scheduling, manufacturing cycle time is taken into account and (to that extent) the item is
offset for delivery. The offset information on the item can be had on item record for ready
reference.
Step 9: Explode the next level

As mentioned in step 4, the entire assembly is not exploded at one time but it is done
level by level, after all the previous steps have been completed. That is, each level
of explosion is followed through steps 5 to 7 and the steps are repeated again and
again until the entire assembly has been exploded through all the levels and the
quantities of items determined
and time phased.
Step 10: Aggregate

requirem ents and determ ine order quantities
Some of the items may be common to a number of assemblies at various levels. It
will be,therefore, wrong to place on order each tim e an item appears during
explosion but waituntil the demand is developed after the entire assembly of each
product has been exploded and then aggregate the demand so that just one order
can be placed.
Step 11: W rite and place the planned orders

After the requirement of each item has been determined, their purchase orders/work
orders can be printed in the form of a computer printout.
Step 12: Maintain the schedules

W riting the orders is no assurance that the product will be delivered on time.
Regular follow up is necessary. Expediting may be required in som e cases, until
the product isready to be delivered to the customer. i i
ComputerisedSystem of M RP I
Since the amount of computation involved in MRP I is extensive, particularly when

gross to net requirements are being computed down through the levels of a complex
assembledproduct, manual computation takes lot of time and creates a lot of
delay. The materialsrequirem ents planning com puter software generates tim e
period wise requirem ents assemblies,
of sub-assemblies, components and raw
materials from an input of orders demand
and forecast.
The computer functions in the following manner. It takes a master schedule, looks
up the bill-of-material in its own file to determine what material is required to
manufacture theproduct in the schedule, checks up the availability of material in the
inventory file and tells the planner when and how much material is to be ordered. If
the material is on order, itevaluates
re- the due dates and comm unication to the
planner if the due date needs tochanged.
be
The MRP computer software programme does the following: 4)

i) Determines gross requirements of finished product.
ii) Determines net requirements of finished product.

in) Determines net component requirements.
iv) Plans order size.
v) Offsets requirements considering lead times.

vi) Maintains and updates the requirements plan.
vii) Provides a review of planned orders and adjustments to the planned orders.
viii) Provides "control by exception."
Input files and reports
The different types of input files and reports are as follows:
1) Master Production Schedule File (Order File)
This file gives the overall plan of production of each of the final products. The
order file contains data which are generated in the sales department after
receiving orders from the customers. These data are sales order code,
product code, product description, customers description, quantity on order,
date of receiving order, sales order release date, delivery date, penalty
clause etc.
2) Bill-of-Materials (or Product structure) File
This file contains all the sub-assemblies, components and raw materials in
hierarchial fashion and these are coded. It contains information such as
product description, l product code, sub-assembly code, component code,
component description, quantity of component per sub-assembly, item
description, item code, quantity of item per component and component
source code (purchased/manufactured).
3) Inventory Record File (Item Master File)
This file contains the item code, item description, storage location of the item,
lead time, standard cost, safely stock, gross requirements, scheduled receipts,
inventory on hand and planned order release.
U nit 2 M aterials
P lan ning
4 ) Inventory Transaction File
The accuracy of in ventory transactions is an im portant pre-requisite to

an effective M RP I system. Stock records m ust be updated regularly and
withoutany time lag.
Inventory transaction file stores all receipt and issue inventory transactions
and is used to update the inventory record file. Input specifications for receipt
transactionsare purchase order, item code, item description, quantity received,
quantity accepted,quantity rej ected, vendor code, vendor description, date of
delivery of item and dateof acceptance of items. Input specifications for issue
transactions are item code, item
description, quantity issued and date of issue.
5) Process Card File
T h is f i l e c o n ta i n s t h e l is t o f o p e ra ti o n s , s e q u e n c e o f o p e r a ti o n s , m a n u f a c t u r i n g
le a d t i m e e t c . I t i s d e v e l o p e d a n d m a i n t a i n e d o n l y f o r w o r k s m a d e p a r t s .
T h e in p u t sp ec ific atio n s o f p ro c ess c a rd file are w o rk o rd e r co d e , p ro d u c t
c o d e , p r o d u dc et s c rip tio n , p ro d u c tio n s ta rt d a te , s u b -a s s e m b ly d e s c rip tio n ,
c o m p o n e n t s e ria l n u mc boemr,p o n e n t c o d e , p r o c e s s s e r i a l n u m b e r , p r o c e s s
d e s c r i p t i o n , m a n u f a c t u r i n tgiml eea, dm a c h i n e c o d e , i n s p e c tio n r e p o r t e tc .
6) M a c h i n e U t i l i s a t i o n C a r d F i l e
T h is file c o n ta in s in fo rm a tio n g e n e ra te d fro m d a ily p ro d u c tio n s re p o rts /jo b s c a rd s

re c e iv e d f ro m s h o p s a n d h e lp s in lo a d in g a n d s c h e d u lin g . T h e in p u t s p e c ific a tio n s fo r
th is file a re m a c h in e c o d e , m a c h in e c a p a c ity (in h o u rs ), s c h e d u le d h o u rs fo r o p e ra tio n ,
a c tu a l h o u rs fo r o p e ra tio n , m a c h in e id le tim e d u e to n o o p e ra to r/m a te ria l/
c r a n e / p o w e r/w o rk lo a d /re c o n d itio n in g /m a in te n a n c e , p e rc e n ta g e u tilis a tio n o f
s c h e d u le d h o u* rsa n d c u m u l a t i v e a v e r a g e p e r c e n t a g e u t i l i s a t i o n .
£ > A c tiv ity C ;

L i s t th e i n p u t s f o r M R P «. : .:, ,f, ,
41
2.4 MRP II (MANUFACTURING RESOURCE PLANNING)

________________________________________________________________
'
MRP II is a computer based system designed to synchronise all the aspects (not
just manufacturing) of the business and thereby overcome the limitations of MRP I,
which does not take into account the capacity required to execute the plan. It acts as a
planning and scheduling system, linking manufacturing with sales, engineering,
purchasing and finance by adopting a focal production plan and one unified data
base to plan and update activities of all functions.
MRP II is also called closed-loop MRP. The feedback loop is used to ascertain
whether sufficient manufacturing capacity exists to execute the proposed master
schedule and effect adjustments in the manufacturing plan (i.e. master plan) where
required. Thus, MRP II serves as an excellent tool that can help the organisation in
implementing its master production schedule by balancing production possibilities
and capacities with demand forecasts and drawup plans to provide the materials
resource required.
According to the American Production and Inventory Control Society,

"Manufacturing Resource Planning is a system built around materials
requirements planning and also including the additional functions of production
planning, master production scheduling and capacity requirements planning.
Further, once the planning phase is complete and the plans have been accepted
as attainable, the execution functions come into play. They include the shop
floor control functions of input-output measurements, detailed scheduling and
dispatching, plus anticipated delay reports from the shops and the vendors,
purchasing, follow-up and control etc. The term 'closed loop' implies that not
only is cdch of these elements included in the overall system but also that there
is feedback from execution functions so that the planning is kept valid all
times."
Elements of MRP II
A typical MRP IT system involves flow of information and activities as shown in Fig.
2.6. The essential elements of the system are as follows:
u) Demand forecast, which takes into account the orders on hand and sales
forecasts.
v) Production planning, which converts the demand forecast into output

requirements
42 and the necessary production programme.
w) Resource planning, which determines the manufacturing resources

(materials,
purchased parts, personnel, money, capacity etc.) to meet production
pr
og
ra
m
m
e.
Unit 2 Materials Planning pl
an
t s.
4. Rough-cut capacity planning, which checks whether capacity available is
roughly B en efi
• adequate to meet the production programme.
ts of
x) M aster Production Schedule (MPS), which is the final schedule of the
M RP
period-
wise quantities of specific products to be produced. The MPS is drawn by S yste
integrating
demand forecasting, production planning, resource planning and rough-cut ms
capacity
planning processes. T he
y) which specifies the components and materials required toadvanta

Bill-of-Materials,
produce
an end-product or assembly. ges of
z) M aterials R equirem ent Planning, w hich determ ines the net M R P II

requirem ent of are:
components and raw materials by taking into account the requirement of
products as • In
per the master production schedule and the availability of inventories of sub-
assemblies, ve
components and materials as per inventory records.
nt
aa) Detailed material and capacity plans, which sets out the detailed
schedules for or
providing materials and capacity as derived from materials requirement
y
plans and
detailed capacity planning. The plan is allowed to proceed only if capacity is re
available;
otherwise, the master production schedule is revised to suit available du
capacity.
cti
bb) Shop order and purchase order release, which sets the production and
purchasing on
activity in motion.
• Im
cc) Shop floor control, which monitors production against the plan and
feedback data pr
to enable updating of master production schedule and capacity and materials
ov
plans.
ed
dd) Purchase and inventory control, which monitors purchasing against the
plan and ca
feedback data to enable updating of master production schedule and materials
shflow
• Better financial planning
t Im p ro ved u tilisation o f m achines
43
• Better customer service
• Greater effectiveness of management and supervision
• Team work
Disadvantages of MRP
Systems
The MRP systems has the following disadvantages :
• High initial cost of software
• Large amount of data required
• High accuracy of data i nput
jSf Activity D :
State five elements of MRP II in a large scale organisation.

•:
44 2.5 SUMMARY
Materials Planning is the determination of the requirements of materials and ensuring their
availability in the right quantities at the right time. It is influenced by a large number of
external ls Planning include: Bill-of-Materials/ Explosion charts, Materials Requirement Planning
and (MRP), Inventory Control, Past Consumption Analysis Technique etc.
internal
factors. Materials Requirement Planning (MRP I) is a scientific technique for planning the ordering
The and usage of materials at various levels of production and monitoring the stocks during
techniq these transactions. MRP I is both an inventory control and a scheduling technique and is
ues of particularly useful when the final product is very complex and is made up of several levels
Materia of assemblies which have many common parts. Since the computation involved in MRP is
extensive, the computer is a great boon.
U nit 2 M aterials P lanning
MRP n is a closed loop MRP that includes material planning along with capacity
planning, inventory management, shop floor control, purchasing, finance,
marketing, engineering, purchasing etc. It uses the same data for a common data
base. The main elements of MRP II system include demand forecasting, production
planning, resource planning, rough cut capacity planning, master production
scheduling, materials requirement planning, detailed capacity planning, shop orders
and purchase order release, shop floor control and purchase and inventory control.
2.6 KEYWORDS
Bill-of-Material: Bill-of-Material (BOM) is a document generated at the design

stage. It details the structure of the product by dividing the final assembly into
major assemblies, major assemblies into sub-assemblies, and sub-assemblies into
parts
Level Coding: Each Bill-of-Material is assigned a level code accruing to its linkage
from
the end product.
Lead Time: Lead time is the time that elapses between issuing replenishment
order and receiving the material in stores.
Materials Planning: Materials Planning is a scientific way of determining the
requirements of raw materials, bought out parts and others and ensuring their
availability in the right quantities, at the right time with minimum capital lockup
Material Requirement Planning: MRP is a scientific technique for planning the

ordering and usage of materials at various levels of production and for
monitoring the stocks (inventories) during these transactions
MRP I: MRP I is based on concept of independent and dependent demand. The

demand
for the products is considered independent, since orders may not necessarily be
related to others in terms of customers and quantity. However, once the sales
requirements are either known or forecasted, the quantity of raw materials and
components required to make the products can be calculated, depending upon the
manufacturing schedule. This dependent demand condition is served by MRP I.
Master Production Schedule: A master production schedule is the backbone
of an MRP system. A master schedule gives the product-wise quantities to be
produced over the planning horizon.
MRPII: It is a planning and scheduling system, Unking manufacturing with sales,

engineering, purchasing and finance, by adopting a focal production plan and one 45
unified data base to plan and update activities of all functions.
3.1 INTRODUCTION TO PURCHASING

"Purchasing is the procuring of materials, tools, stores (or supplies) and services
required for the manufacture of a product, maintenance of the machines, and
uninterrupted running of the manufacturing plant in a manner that guarantees the
marketing of the company's products in the quantities desired, at the time
promised and at the competitive price consistent with quality desired."
Purchasing in essence is the task of buying goods of right quality, in the right quantities.
at the right time and at the right price. The buyer may have a source who is capable of
giving quality product but he may not have enough capacity to meet quantity requirements
in time, or the source may have the capability to supply goods of right quality and in the
right quantities but he may not supply at the right price or at the right time.
Although the terms 'purchasing' and 'procurement' are used interchangeably, they are, in
fact, different. The term purchasing covers the functions of identifying and communicating
the need for an item, locating and selecting a supplier, negotiating price and other terras of
contract and following up with the suppliers until receipt of delivery. The term procurement
covers a much broader area and includes the functions of purchasing, materials planning
and budgeting, inventory management and control, traffic and transportation, receiving
and incoming inspection and disposal of surplus, obsolescent and scrap materials.
The growing importance of purchase

Traditionally, purchasing was regarded as one of the activities of Production Management.
Now it is being considered too specialised an activity to be treated as line function. Many
a progressive management has already realised that in the context of changing business
conditions, growing competition and continual escalation in the cost of inputs, purchasing
must be given status equal to that of other major functions (i.e. production, sales and
finance). A few important reasons for the change in emphasis are as follows:
a) Higher cost of goods and services

Raw materials, components and services account for a significant - as much as 50 to
70% -proportion of the company's total expenditure. In the paint industry, materials
account for over 60% of the cost of the product. Effective purchasing, therefore, can
result in a substantial saving for the company. A small one percent saving in material
cost can offer benefit equivalent to an eight to nine per cent rise in sales volume. g)
b) Escalating cost of stockouts
Lack of continuity in the availability of materials seriously affects all major companies.
It can damage the profitability of the company and lower employee morale. Financial
50
U n it 3 P urch ase M anag em ent: A n O v erv iew
loss due to stockouts of materials in mass/flow production units, process

industries and in capital intensive units is very high.
c ) H igher presen t day cost of capital

In a firm, the capital distribution between fixed and working capital is normally
around 60:40. Further, around 80% of the working capital is locked up in
inventory of raw materials, work-in-progress, finished goods, spares etc. No
organisation can afford to invest such a big part of its capital in the stocks,
especially these days when the cost of borrowing money is as high as 12%.
Abulk of these stocks can be reduced and unnecessary capital lock-up can be
avoided if purchasing is made efficient.
d) P urchase is not a m ere act of buying

Purchase is not a mere act of buying. It is, in fact, a much broader concept.
Purchasing, in today's context, includes a wide range of related activities such as
market research, vendor rating, standardisation and variety reduction,
codification, indent control, pre-purchase value analysis, price negotiations,
inventory control, surplus disposal, purchase budget, import substitution,
purchase system design etc.
e ) C hanging nature of purchases

Today, purchasing is no longer just a commercial activity it is a techno-
commercial activity. More and more technical persons are being inducted
into the purchase department and they, naturally, expect better treatment
like their counterparts in Production, Design and the other departments.
f) P rofessionalisation of M aterials function

Like the other branches of industry, the development of many management
concepts, such as ABC analysis, economic lot size, learning curve,
critical path analysis, line of balance, variety reduction, codification,
value analysis and vendor rating have had an impact on purchasing. It is
essential for the middle and senior management
' *'' personnel in the purchase department to have a good knowledge of these
techniques. »i
g ) C hanging concepts of buyer-seller relations
The buying scene also has undergone a major change. The old concept of a
supplier
being dependent upon the buyer no longer exists. With increasing competition, 51
retention
£ of good suppliers, is becoming difficult and hence the function of buying is
becoming
challenging.
Objectives of scientific purchasing
The objectives of scientific purchasing include the following:
i) To procure at a competitive price the required materials, supply of tools and services of
the right quality, in the right quantity and at the right time.
i) To maintain continuity of supply to ensure production schedule at minimum inventory

investment.
iii) To ensure the production of goods of better quality, at a competitive price, by procuring
*| materials which best suit the product and the purposes for which they are intended.
iv) To suggest better substitutes to materials which are currently being used, with a view to
lowering cost and maintaining quality of the products.
v) To render assistance in standardisation, variety reduction, value analysis and cost

reduction programmes.
vi) To advise on probable prices, deliveries and performance of items under consideration by
the design, development and estimating departments.
vii) To create goodwill and enhance the company's reputation for fairness and integrity
through dealings with the suppliers.
viii) To enable the company to maintain a competitive position and earn a fair return on its
investment.
Purchase as a Profit Centre g)
The purchasing department, in almost all the companies, is the biggest spending department
and literally the "custodian" of the company's purse. Almost 50 to 60 per cent of a company's
income is spent on materials. The very fact that the purchase department is responsible
for such a high percentage of company's money highlights its role in the profit-making
potential of the company. The purchase department is a cost centre, no doubt, but
considering the scope for saving company's money it should be looked upon as a profit
centre. Moreover, unlike in sales, a rupee saved is not a rupee earned. To earn a rupee,
sales volume equal to ten rupees or more is required which implies that a rupee saved
is equal to a ten rupee sale. Also, a sale is one time sale. A saving on the other hand is
repetitive saving. Every
52
SS Unit 3 Purchase Management: An Overview
4
rupee saved goes straight to profit. Therefore, effective purchasing can make a tremendous
impact on the profitability of the firm.
J S $A c tiv ity A ;
State any five advantages of scientific purchasing.
ry
3.2 FUNCTIONS OF THE PURCHASE DEPARTMENT___________________
The functions or the duties to be performed by the purchasing department may be classified
asunder:
OSt
/very
ion
rity
nits
nent
ny's
efor
ntial
gthe
Dver,
lalto
upee
f) Performance evaluation and feedback
g) Disposal of surplus, obsolete and
Primary Duties 'scrap materials'
(1)
3.3 ELEMENTS OF PURCHASE MANAGEMENT

a) Receipt, scrutiny of purchase
indents and determination of
method of buying Purchasing is the most important function of Materials Management, an exercise which
b) Search for suppliers may be called scientific purchasing. Scientific purchasing, however, is not mere procurement
c) Acquisition and analysis of
of needed materials at the lowest price but procuring materials in a way that minimises the
suppliers' proposals
overall cost of the product. To ensure this, scientific purchasing is governed by five well-
d) Selection of suppliers
known
e) Follow-up with suppliers parameters known as the basic elements of scientific purchasing or the "5 R's of
for timely
receipts of materials buying." These include:
0 Right Quality
fi) RightQuantity
in) Right Price
iv) RightTime
v) Right Source
Constituents of each element
1) Right Quality
The quality of a product is measured in terms of its design, materials, chemical
composition, heat treatment, surface treatment, manufacturing processes, mechanical
and electrical properties, workmanship, etc. Two distinct but closely inter-related
aspects of quality are 'Quality of design' and 'Quality of conformance.'
In the case of, purchased items, quality of design refers to the quality specified by the
company's design department, in the form of specifications while quality of conformance
refers to the extent to which the goods and services purchased complies with the laid
down specifications. To determine the quality of conformance of purchased items,
sampling plans may be used.
There are different methods of providing quality specifications and these include brand or
trade names, commercial standards, performance standards, blue prints, samples etc.
2) RightQuantity
Right quantity is another important parameter in buying. Quantity decisions are
influenced by 'replenishment methods' and 'buying methods.'
Replenishment methods such as re-order level, two-bin-system, review system: optional
replenishment and review system: compulsory replenishment help to provide broad
guidelines. For example, order quantity under the first three replenishment system is
fixed and is generally me economic order quantity, though the same might have been
modified in the light of constraints. However, the re-order quantity under the fourth
system (i.e. review period: compulsory replenishment) varies and it equals the difference
between the maximum level less the sum of "stock on hand" and "stock on pipeline."
Besides these factors, consumption, market conditions, lead time, source of supply
(indigenous or foreign) etc. also influence the decision of right quantity.
3) Right Price
Right price does not mean the lowest price but the price which minimises the overall
cost. Right price is not easy to determine. The technique for determining the right price
involves:
Unit 3 Purchase Management: An Overview fro
m
• negotiation, which is used when there are limited vendors, when the the
time tran
available to make purchase is short and/or when the items belong to fixed spo
price rter'
s
I category.
god
• tender system, which is followed in public sector organisations to ow
identify the ns,
9
lowest potential bidder. veri
fy
• learning curve, which is employed to determine the price of the item with
rec
high eiv
labour content. ed
4 ) R ig h t T im e qua
ntiti
Right time and lead time are closely related. It implies the time at es
which the goods requested should be received while lead time refers the and
time that elapses between the communication of the need for the item by pre
indentor to purchase till the time the item is actually received and made par
available for consumption. The buying department has the sole e
responsibility of developing lead time information for all items and make it nec
available to those concerned - mainly Planning and Stores - so that they ess
indent requirements well in advance and avoid the need for rush ary
purchases. doc
um
Basic elements of lead time are: ent
• Time required by the indentor to communicate requirement to purchase. s.
• Time required by the purchaser to locate, select and develop qualified •

sources
Ti
of (supply including agreement on contractual terms). m
e
• Transit time for the purchase order to reach supplier.
re
• Time required by the supplier to route the buyer's order through q
ui
administrative
re
channels. d
b
• Time required by the supplier to fill the buyer's order (i.e. time required
y
by the th
supplier to manufacture goods). e
b
• Transportation time for the goods to reach the buyer's destination. u
ye
• Time required by the buyer's receiving department to collect materials
r's
inward inspection to verify the quality of goods.
55
Materials Management " ',• ••;•••• ;
• Time required by the main stores to take possession of the goods, deposit them in
appropriate bins and update stock cards.
5) Right Source
Only the right source can give goods of the right quality, in the right quantities, at the
right price and at the right time. Right source aspect requires decisions regarding the
classification items to be purchased directly from the manufacturers, items to be brought
from dealers and items to be purchased in the open market. Right source also requires
the analysis of transportation costs, along with the basic price, to make the choice
between a distant supplier and local supplier.
J & >A c tiv ity B ;

State the five elements of Purchasing.
3.4 PURCHASE CYCLE
Purchasing activity plays a vital role in all the firms in general and in the manufacturing firms
in particular. Purchasing is not merely "buying to satisfy the indentor 's requirements"
but "buying goods of right quality, in the right quantities, at the right time and at
the right price."
Purchase cycle consists of eight major activities, as shown in Fig. 3.1
Establishing the need for procurement Scrutiny of the purchase indent
Order preparation Purchase market research
Follow up with vendor Receiving & Inspection
Invoicing & payment Storage & record keeping

i
Fig. 3.1: Major activities of Purchase
Cycle
I
Unit3 Purchase Management : An Overview
E le m e n ts o f P r o c u r e m e n t C y c le
1. E s t a b l i s h i n g a n d c o m m u n i c a t i n g t h e n e e d f o r p r .o .c u, ,r e, m
, ent
T h e n e e d f o r p u r c h a s e o r ig in a te s in o n e o f th e f ir m 's o p e r a tin g d e p a r tm e n ts
o r its in v e n to ry c o n tro l s e c tio n . T h e n e e d is c o m m u n ic a te d to th e p u rc h a s e
d e p a r t m e n t t h r o u g h a f o r m a l d o c u m' Pe nutr c ha lalseed I n d e n at ' Bo ri l l o f
M a te r ia l'.
a) P u r c h a s e I n d e n t
P u rc h a s e in d e n t, a ls o c a lle d p u rc h a se re q u isitio n , is a fo rm a l re q u e s t m a d e to th e
p u r c h a s e d e p a r t m e n t t o p u r c h a s e m a t e r i a l s o r s e r v i c e s s p e c i f i e d t h Ie r e i n . T h e
d o c u m e n t s e rv e s a s a n a u th o rity to th e p u rc h a s e d e p a rtm e n t to g o a h e a d w ith th e
» " p u r c h a s e a c t i v it y . I t a ls o p r o v id e s w r i tt e n in f o r m a t i o n r e g a r d in g q u a n ti t y
s p e c i f i c a t iotim
n , e w h e n r e q u ir e d e tc . A p u r c h a s e in d e n t o r ig in a te s e ith e r f r o m th e
f ir m 's in v e n t oc royn t r o l s e c t i o n , p r o d u c t i o n c o n t r o l d e p a r t m e n t o r f r o m o n e o f
t h e o p e r a t i dn egp a r t m e n ts . T h e in d e n t m a y b e r a is e d e i th e r b y th e p l a n t e n g in e e r , th e
m a i n te n a n ec ne g i n e e r , t h e o f f i c e m a n a g e r o r a n y o t h e r r e s p o n s ib l e p e r s o n a u th o r i s e d
t o f o r w a rad r e q u e s t . T h e p u r c h a s e i n d e n t s f r o m t h e i n v e n t o r y s e c t i o n o r s t o r e s a r e
g e n e r a l l fyo r i t e m s o f r e g u l a r u s e ( s t o c k i t e m s ) . T h e i n d e n t s f o r n o n - s t a n d a r d
i t e m s , w h iac rhe n o t c a r r i e d i n s t o c k , a r e f i l l e d i n b y t h e o p e r a t i n g d e p a r t m e n t s .
b) B i l l - o f - M a t e r i a l
B ill- o f- m a te r ia l a l s o c a lle d p a r ts lis t o r b u il d in g lis t i s y e t a n o th e r d o c u m e n t
w h ic hf o r m s t h e b a s i s f o r t h e p u r c h a s e d e p a r t m e n t t o t a k e a c t i o n . T h i s i s
d e t a i l e d ti hn e c h a p t e r o n M R P .
2. S cr u tin isin g P u r ch a se In d en ts
A ll in d e n ts re c e iv ed in th e p u rc h a se d ep a rtm e n ts m u st b e sc ru tin ise d fo r
a c c u r a cayn d c o m p l e t e n e s s o f q u a l i t y d e s c r i p t i o n .
T h e s c r u t i n y o f th e i n d e n t s i s a r o u t i n e a c t i v i t y o f t h e p u r c h a s e d e p a r t m e n t . T h e
i n d e n ist s c r u ti n i s e d t o s e e w h e th e r
i) i t i s s ig n e d b y th e a u t h o r i s e d s ig n a t o r ie s in o r d e r t o a v o i d i r r e s p o n s i b l e
p u rch ases;
h) it is r o u te d th r o u g h s to r e d e p a r t m e n t to c e r tif y n o n - a v a i la b ili ty o f th e ite m in
s to r e ;
iii) t h e d e s c r i p t i o n o f t h e r e q u i r e d i t e m i s w r i t t e n c o r r e c t l y a n d c l e a r l y ;
iv) w h e t h e r q u a l i f i e d a n d d e v e l o p e d s o u r c e s a r e a v a i l a b l e o r n o t ;
v) l a s t s u p p l y o f t h e s t a t e d i t e m i s c o m p l e t e d o r p e n d i n g ;
vi) t h e q u a n t i t y s h o w n a g a i n s t t h e i t e m i s c o r r e c t l y a n d c l e a r l y w r i t t e n .
3. Market Research and Selection of Sources of Supply

The next to follow after the scrutiny of the indents is the stage of market study and
selection of the sources of supply. This stage involves segregation of items into item
groups, review of available information (source register, catalogues, general information,
quotations received previously from potential sources/traders/manufacturers) and
selecting potential source(s) of supply, as per the following flow chart.
Make short list of

possible sources
Obtain
Is there an annual
quotations statement
contract for it?
Is this a
regular item?
Prepare comparative
Was last supplier statement
satisfactory?
Select supplier
Is it time to check
Finalise terms of
the market?
contract
Fig. 3.2:
Flow chart
of
guidelines
Evaluate performance to select a
supplier
U nit 3 Purchase M anagem ent: A n O verview
4. O rder Preparation
Having selected the source of supply, the next step is to authorise the selected
supplier to supply material, which is done by placing the purchase order. A
purchase order is ?| a formal document (a written commitment) prepared by the
buying department on behalf of the company to authorise (request) the supply of
the goods and services in the quantities, at the time and at the price specified in the
document.
A purchase order, in fact, is a legal document and serves as an evidence

of the contract between the buyer and the seller.
A written purchase order serves the following objectives:

i) It gives full and complete details of the materials to be supplied, thereby
avoiding ambiguities.
if) It helps the buyer's receiving department to verify that the materials
received are in accordance with those ordered.
m) It helps the buyer's accounts department in linking goods-receipt-reports

with supplier's invoices and preventing duplicate payments.
iv) It serves as a future reference for placement of orders.
Copies of the purchase order are sent to the supplier, the accounts
department, the receiving department, the indenting department, the reference
file and the follow-up section. The placement of an order cannot be
considered complete until the acknowledgement of the purchase order is
received from the vendor.
5. Follow-up with Suppliers

Follow-up is the function of seeing that the suppliers effect deliveries on time.
Follow up has become the foremost function of buyers. Vendors, be it a small
manufacturer, a trader or a supplier at a distance, take little initiative in
delivering the goods on time.
Purchase follow-up is required in two stages: pre-delivery follow-up and

shortage
chasing.
Pre-delivery follow-up is intended to remind the supplier of the due date and
obtain advance information of expected delays. Pre-delivery follow-up
enables the buyer 59
• to make alternate arrangements (i.e. request other supplier for early
delivery) if it is expected that the supplier will fail in his delivery
commitment;
Materials Managem ent v/"' ..wt^r
• to decide expedited routing of goods from suppliers.
Typical methods used are: r
i) phone call to local suppliers at a set period prior to due

date; if) letters to outside supplier, typed and signed by the
buyer;
iii) delivery confirmation cards to be returned by the supplier, intimating

whether the delivery will be made/or not, on the promised date;
iv) regular visits, particularly to new suppliers, to review progress.
Shortage chasing is the universally accepted most vital part of the purchase
follow-up Shortage chasing is initiated as soon as the due date is over. The
nature of the follow-up and the level at which the follow-up is done depends on
the criticality of items, availability of alternative sources, quantity on hand,
coverage for future period etc.
6. Receiving and Inspection
The supplier, on receipt of the purchase order, fills up the buyer's requirements
and arranges for delivery of the materials in accordance with the instructions
relating to the quantities, time, route, mode of transport etc. mentioned in the
purchase order. The section or department that is entrusted the responsibility of
receiving materials and getting them inspected is known as 'Receipt'or
'Receiving' department/section. In a small company, the function of receiving
materials is generally looked after by the store department. The activities involved
are as under:
a) Receipt or collection of materials :
Materials in the receiving department are received against a specific

document, depending upon mode of dispatch and distance of the
supplier.
Materials to be delivered by the suppliers are received accompanied by

the supplier's 'Delivery Challan', 'Delivery Note'or'Delivery Advice'in
duplicate or triplicate. The original copy of the delivery challan is retained
by the receipt department. The duplicate copy is stamped 'subject to
physical count and inspection 'and is signed by the receipt clerk and is
handed over to the supplier's representative.
60
Unit 3 Purchase Management: An
Overview
rir b) Recording of register

receipt of materials called
'?! "Goods
When materials Receipt
are received with the Register
supplier' s delivery challan, ."
the person
•,-, from the receiving c)
department takes out the
copy of the relevant Pre
purchase order par
and verifies to ati
ensure on
of
i) that the goods goo
actually ordered ds
have been rec
received; eip
f t
ii) the supplies are rep
f
in accordance ort
with the s
delivery
schedule (i.e. The
excess supply goods
is not receipt
received); register,
which
iii) Purchase order gives
number, part the
name, part record
number, broad of the
purchase material
categoryand s
so on are receive
mentioned d in the
clearly and compan
correctly. y cannot
be made
After verification,
availabl
the receipt clerk
e to
makes the entry of
differen
the receipt
t
materials in a
departments, be it urgentl
accounts, indentor, y. It is,
purchase or others therefor
who are concerned e, a
with the good
information. practice
Therefore, to
information from intimate
the goods receipt the
register is concer
transformed to a ned
document called depart
'Goods Receipt m ents
Report' (GRR), as soon
also called 'Goods as
Inward Note' m ateria
(GIN), Receipt- ls are
cum-Inspection receive
Advice (RCIA) or d.
Materials Inward A lthou
Note (MEN). gh
commu
d) Intimation of nication
receipt of material can be
made on
The preparation of the
GRRs, physical interco
verification of the m,
quantities, written
inspection of commu
materials and nication
distribution of the is
copies of the GRRs preferre
takes time d.
especially when
inspection e)
involves
metallurgical Ph
and/or ysi
performance cal
checks. Moreover, cou
the receiving as nt
well as inspection of
personnel may not the
know whether a rec
particular material eip
is required ted
material
The receipt
department is not
only responsible
for taking
possession of the
incoming materials
but also for their
correct quantities.
This implies that
materials received
require to be
verified for
quantities.
61
While verifying the quantity, the receipt clerk has to attach a receipt tag, which
includes all details about the delivery challan to the part or to the package. The
receipt tag also contains challan numbers, description of materials, code numbers
of materials, name of the suppliers, number of packages received, quantity
received and date of receipt.
After verification of quantity, an entry is made in the document called goods receipt
report. Situations do arise when goods received are found to be short. Suppliers
need to be notified regarding such discrepancies. This is done through a formal
document called Discrepancy Note.
7. Inspection of Goods
All supplies are subjected to inspection and testing. Branded items or items with a
trade name do not require detailed inspection. These are accepted and put to
use after visual inspection of their packing and verification of labels or cases.
Critical items requiring use of specialised and sophisticated measuring instruments,

whose cost is not justified are inspected at the vendor's plant, prior to delivery by the
vendor.
All remaining items (i.e. except those mentioned above) are inspected on receipt by
the inward inspection at the buyer's works for one or more of the following
checks:
• Conformance to dimensions;
ft
• Conformance to materials specifications, and
• Conformance to performance.
9.
The responsibility of inspection varies, depending upon the nature of goods. These
are detailed below:
Item group Department responsible
f) Raw m aterial Inspection departm ent Inspection departm en

if) B ought out com ponents Q uality control
Inspection departm ent
iii) G auges and m easuring instrum ents Planning departm ent+Inspection
departm ent
iv) Standard cutting tools
v) Special cutting tools
62
U nit 3 Purchase M anagem ent: A n O verview
vi) Replacement spares Maintenance department

\S) Supplies
a) Empties Dispatch department
b) Welding & soldering materials Production
c) Stationery Stores
d) Consumable spares Maintenance
e) Capital equipment Plant Engineer
Removal of the accepted and rejected materials
The GRR is handed over to the inspection department or the concerned

department. The inspector or an authorised person from the department checks
receipted materials and affixes a stamp ('Accepted' or 'Rejected') on the
receipt tag.
Then the duly signed and checked GRR is returned to the receipt store. The
GRRs are then sorted out and all accepted GRRs are sent to the main store. The
respective materials are sent along with the GRR. However, rejected materials are
sent to the rejection store, where they lie until they are collected by the supplier or
sent back to the supplier.
8. S torag e an d R ecord K eep in g

After inspection, the goods are segregated into accepted/rejected or
rework categories and only the fully accepted quantity is forwarded to the
stores. The quantity is physically verified and entered in the kardex/ledger or bin
cards and then issued. In emergencies, however, stores personnel accommodate
by issuing without storing the materials in bins.
9. Invoicing and Paym ent
R eceipts o f su p plier's
in voice
Normally, when the supplier supplies goods, he immediately prepares

invoices. Sometimes, both the buyer and the supplier have a discussion and the
supplier agrees to raise invoices after the receipt of goods receipt reports.
Scru tin y o f th e invoices

63
Supplier's invoices, on receipt are sent to the accounts department, where
they are sorted out supplier-wise and temporarily filed, until the GRRs are
received. The
accounts department also maintains a control register, wherein all GRRs are
serially entered as they are received from receiving stores. Linked up
invoices (invoices linked with GRRs) are taken up for verification. The price,
sales tax, transport/carriage charges, discount etc. are verified against purchase
order, while quantity is checked against the GRR. Arithmetical calculations are
also checked to ensure correctness of the invoiced amount. The invoice is then
stamped for the verification, countersigned by the authorised person and is
passed for payment.
Journal entries ......
Verified invoices are entered in a purchase register called "purchase

journal." A purchase journal is a register wherein invoices are entered supplier-
wise (i.e. a few pages are reserved for each supplier). Prior to its entry in the
purchase journal, each invoice is allotted a serial number, which is called "JE
No."
Effecting payment
The purchase journal is reviewed periodically (may be weekly) and the

cashier is informed of the invoices which are due for payment. Cheques are
drawn to effect payment on the due dates.
Activity C :
List all the documents used for purchasing, from identification of need to the receipt
of invoice.
3.5 MAKE OR BUY DECISION
No firm can manufacture each and every item of its product. It is neither possible
nor desirable. Items which do not form the company's product line are always
purchased from outside. An automobile firm for example requires to purchase raw
materials, forgings, castings, tyres, bearings etc. from others.
64 Items which require specialised technical knowledge or procurement of special
equipment are generally sub-contracted. A small firm, for example, normally gets its
items heat-treated,
U nit 3 Purchase M anagem ent: A n O verview I
supply
unless
surface coated (zinc plating, or galvanizing or phosphating) from outside vendors to
buyers
get the benefit of low price.
bring
The exclusion of the above categories of items leaves the firm with items pressur which
require to be manufactured to its design either at the home plant or to onbe e
purchased from outside suppliers. The decision whether to make the item at them
the
home plant or buy it from outsidevendors is referred to as 'make-or-buy decision.'with
their
Factors influencing M ake-or-Buy decisions freque
nt
The following factors generally influence make-or-buy decisions: visits
ee) Cost analysis: Cost analysis refers to the determination of the cost to makeor an
item teleph
one
and cost buying it. The cost of making an item should include the estimated
cost of calls.
raw materials, direct labour, depreciation, interest on investment, Thus,
insurance and the
property taxes, incremental administrative overheads, incremental fixed buyer's
cost and compa
carrying cost of raw materials and work-in-progress, appropriate ny
allowance for should
machining and work spoilage, idle time and other risks of doing business. either
The
cost of locate
alterna
buying an item should include purchase price of the part, transportation cost,
octroi te
and sales tax, incremental procurement cost and carrying cost, incrementalsource
receiving s of
and inspection cost etc. supply
or Vi
ff) Availability of production capacity: The bulk of cost associated with make a
make-or- the
buy decision is the cost of production capacity. W e have to bear in mind item at
that the the
costs which influence make-or-buy decisions are just the incremental home costs
- the plant.
costs which will be incurred if the part currently being made is purchased
or vice d)
versa.
Qu
gg) Supplier's perform ance: A situation may arise when the item s currentlyant
being ity
purchased from outside needs make-or-buy investigations. Some suppliers req
may not uir
give quality items, some may not ship as per promise and som e others em
m ay not
ent: Quantity requirement is another factor which influences
make-or-buy decisions. A company generally prefers to make an item if the
quantity
required per year is fairly large and buy it if its annual requirement is small.
Suppliers,
on the contrary, discourage small orders as they (small orders) tend to push up
their
65
manufacturing costs. A situation, therefore, may arise when the company virtually
fails to locate a satisfactory suppler who can process the buyer's small quantity. The
buyer having failed to locate such a supplier may thus be forced to make the item at
the home plant though it would have preferred to sub-contract it.
hh) Quality requirements: A company's product may comprise certain parts which are
quite difficult to manufacture to buyer's quality specifications. A buyer generally
understands the intricacies of his parts better than his vendors. Moreover, the buyer
can get immediate feedback from his assembly benches about the defects in the
critical dimensions, when such parts are in manufacture. Such quick feedback is not
available to the vendors.
ii) More than one supplier policy: More than one supplier policy refers to a buyer's
decision to manufacture the part that it requires at the home plant and buy the rest.
Such a policy offers following benefits -
The buyer can use supplier's rate as yardstick to measure the profitability of his
operations.
The buyer knows better when the supplier's demand for revision of rate is to be
accepted or rejected.
Cost stockouts due to increase in consumption or delay in delivery can be prevented

by processing larger lots at the buyer's own plant.
Fluctuation in demand-rise in sale or fall in sale can be better met by purchasing more
quantity in case of the former or less quantity in case of the latter.
g) Physical location: Physical location can exert a considerable influence on make-or-

buy decisions. A firm which is situated in an area populated with a variety of ancillaries
is more prone to "buy from outside" than a firm which is isolated from such amenities.
Cost analysis for 'Make-or-Buy' decisions
Cost analysis refers to the determination of the cost of making an item and the cost of
buying it. A complete and correct assessment of the various elements of cost is essential
for making sound economic decisions.
The following data need to be collected and analysed:

Unit 3 Purchase Management: An Overview
Particulars Departm ents from which the inform ation

originates
Raw materials Purchase

Landed cost of the item being Purchase or sub-contracting
subcontracted
Weight of raw materials/castings/forgings Purchase/Production Planning & Control
Weight of finished component Production Planning & Control Production
Present utilisation of company's facilities Planning & Control Production Planning &
Method of manufacture (Route Sheet) ControlIndustrial Engineering
Set up times and operational times Costing/Industrial Engineering
Industrial
Machine hour cost and labour hour cost EngineeringInspection & Quality Control
Tooling
Average % spoilage
The analysis is based on the annual requirements of components against the following re
elements: q
ui
jj) Raw m aterial: The raw m aterial cost includes the cost of raw m aterials less re
value to
recovered due to the sale of scrap like turning, boring, end pieces etc. be
The raw m
material cost is considered towards the cost of making. However, if the raw ad
material e.
is supplied to the vendor free of cost, the cost of such material also requiresT
to be he
added to the cost of purchasing. co
st
kk) Labour cost: Labour cost implies the wages and costs of other benefits of
(Providend to
fund, E.S.I., bonus, gratuity etc.) payable to the workmen engaged on the ol
job. This in
cost, however, requires to be considered only when additional labour force g
needs to th
be employed while production capacity is available. us
ll) Tooling cost: Jigs and fixtures generally require to be m ade if the item isre
to be q
machined at the home plant. The jigs and fixtures once made maintain their ui
accuracy re
only for certain quantity, say 'n' pieces, after which a new set of jigs and s
fixtures to
be
amortised over 'n' pieces
and the annual cost of tooling requires to added to 'cost to make.'
At times, when an item is purchased from outside vendors, certain special

cuttingtools (broaches, hobs, shaping cutters etc.) and jigs and fixtures require
to be suppliedto the vendor free of cost. The cost of such tooling, therefore,
requires to be considered
separately as tooling cost toward 'cost-to-buy.'
67
mm)Overhead cost: The bulk of cost associated with a make-or-buy decision is

the
cost of production capacity. This is the area where, most often, mistakes
occur.
These costly errors can be avoided by keeping a single fact in mind that the
costs
which influence make-or-buy decisions are just the incremental cost - the costs
which
will be incurred if the part currently made is purchased or vice versa.
nn) Recoupment cost: Recoupment cost implies the setup costs (if the item is to
be
manufactured at the home plant) or the procurement cost (if the item is
purchased).
Set-up cost is the 'preparation cost' of the machines and it varies, depending
upon
the number of production runs in a year. The procurement cost is the cost of
raising a
purchase order and processing the deliveries from the vendor(s) and it varies,
depending
upon the frequency of receipts of the item from the vendor(s).
oo) Outside operations cost: The item manufactured at the home plant may
require
subcontracting of certain operations such as rough blanking, heat treatment, plating
etc.
The cost of such operations requires to be considered separately towards 'cost to
make.'
pp) Purchase cost: Purchase cost includes the price given to the vendor, packing
and
forwarding, excise, sales tax, transport cost, octroi etc.
h) Capacity cost: Capacity cost implies the cost of capacity rendered idle if the item
currently being manufactured is purchased. Such a cost requires to be added to
"cost to buy".
JS$ Activity D:
Discuss the relative benefits of Make Vs. Buy
68
g$
Activi
ty E;
State
the
costs
conside
red for
Take-
or-Buy
decisio
n in a
large
scale
manufa
cturing
industr
y.
Unit 3 Purchase Management: An Overview
3.6 SUMMARY Jt
Scientific purchasing involves buying goods of right quality, in the right quantity, at the
right time and at the right price. Only a right source can meet these requirements of
the buyer, which are so crucial in every purchase transaction. These five essentials of
scientific buying are usually labelled as the 5R's of buying.
Scientific procurement is the purchase of goods of right quality, in the right quantity,
at the right time, at the right price and from the right source. Procurement cycle
encompasses eight major activities performed by an organisation, between receipt of
the purchase indent until payment to the supplier. They include (i) Establishing and
communicating the need (ii) Scrutiny of the purchase indents (iii) Market study and
selection of the source of supply (iv) Order preparation (v) Follow-up (vi) Receiving
and inspection (vii) Storage and record keeping and (viii) Invoicing and payment.
Make-or-Buy decisions generally concern items required for the company's own
design. Make-or-Buy investigations are generally necessary when a company
introduces new products, experiences an increase in the demand for its existing
products, finds the performance of its existing suppliers unsatisfactory or finds the
cost of present practice of buying/manufacturing apparently high. The various
factors what influence Make-or-Buy decisions are cost analysis, availability of
capacity, suppliers' performance, quantity requirements, quality requirements,
more than one source policy, physical location etc. Different elements of costs, tool
cost, overhead cost, procurement cost, inventory carrying >t, outside operation cost,
inside operation cost, purchase cost, capacity cost etc. also influence Make-or-Buy
decision.
3.7 KEYWORDS ________________________ .
Cost analysis: Cost analysis refers to the determination of cost to make an item as
well
as cost to buy it.
Purchasing: Purchasing is the procuring of materials, tools, stores (or supplies) and
services required for the manufacture of a product, maintenance of the machines and
uninterrupted running of the manufacturing plant in a manner that guarantees the
marketing of the company's products in the quantities desired, at the time promised
and at the competitive price consistent with quality desired.
Purchase Cycle: It is the sum total of all the activities from the initiation of the need
for the material till the usage of material and payment to the supplier.
69
4.1 INTRODUCTION TO BUYING
Buying is a process which is balanced on 2 wheels. The buyers and seller are the two
wheels of the industry, be it that of the buyer or that of the seller. For smooth running, the
industry requires cordial relationships. Every buyer and seller must realise that the growth
of the respective firms depends on the goodwill and good relationship between the two.
Every buyer must realise that success of his firm depends on how good his suppliers are
and similarly every supplier must realise that his firm's prosperity depends on the prosperity
of his buyer's company. Buyer and seller relationships are at the optimal level when the
supplier supplies goods of right quality, in the right quantities, at the right price, and at the
right time and the buyer understands the problems of the supplier and ensures that the
supplier's firm makes profit and growth.
Essentials of Buyer-Seller relationships
The essentials of good buyer-seller relations are:

• Both buyer and seller must realise that strong and healthy business relationships are
important for the growth of their respective firms.
• Both must realise that their respective organisations can benefit from the progress of
the other.
• Each party should have the full appreciation of each other's viewpoint.
• Mutual trust, co-operation and understanding should replace hostility and suspicion.
• Each party must strive hard to discharge its obligations under the contract honestly
and faithfully.
• Each party should try even beyond the contractual terms to satisfy needs of other.
What does a buyer expect?
a) Timely deliveries without constant follow up

Timely deliveries is the essence of a good buyer-seller relationship. At times, non-
conformance to delivery commitments make the relations tense and too frequently take
the relationship to a state of non-repairs. The seller, therefore, must exercise care while
making a commitment, but once a commitment is made, it must be honoured. Good
planning backed by sound progress chasing can help on-time delivery. Too frequently
buyer's revise their schedule for the items ordered on the supplier. Such amendments
require the supplier to frequently reallocate factors of production, procure additional
U n it 4 B u yin g P olicies
materials, split-up planned batches, work over-time, increase sub-contracting

etc. A supplier who can do this time and again is sure to find favour with the
buyer.
b ) A dvan ce com m u nication in case of expected failu res in delivery
Manufacturing is never smooth sailing. Some delays and interruptions do
crop up, which tend to push the job off its delivery date. In such a situation, the
supplier must advise the buyer in advance of the expected failures in the
delivery commitments and ask for some more time. But this luxury should not
be availed of frequently. Such an advance communication usually enables the
buyer to seek help from other suppliers or at least be prepared for the worst.
c ) Short lead tim e in em ergency

Thirdly, a buyer wants occasional special favours. He may expect his
supplier to entertain his occasional rush orders when the (buyer) is in
difficulty. Supplier can always accommodate the buyer's occasional request by
keeping his planning flexible or having a little extra capacity to meet such
occasional requests. Aplain "no" can spoil the buyer-seller relationship.
d ) D efect free supplies

The fourth requirement of a buyer is the consistency in the quality of the goods
received from the supplier. Frequent rejections in the supplies usually
cause bitterness and spoil vendor-vendee-relationships.
e ) Ability to hold on price

The fifth thing, which a buyer expects from his supplier, is not to bring pressure
for a price increase when the cost of inputs goes up, but to send the request
and give him time to him to process the request. The threat on the part of
supplier to hold supplies until a favourable price decision is given by
the buyer spoils the relationship.
f) Correctness of paper work

Though a small requirement, correct paperwork is very important. The buyer
expects the supplier to follow document discipline. The buyer expects the
supplier to do the paper work correctly.
g ) A dequate after sales service

The supplier must provide adequate after sales service, particularly in case of
office equipment (e.g. Xerox machine, fax machine, PBEX board etc.). He must
have trained 75
maintenance staff and maintain adequate supply of spares at his end.

Delayed response and poor after-sales-service spoil good business
relationships.
h) Transparency at the vendor end

If the buyer treats his vendors as an extension, he should have easy access
to suppliers' input costs etc.
What does the supplier want from the buyer?

a) Long term business agreements
Sound buyer-seller-relationships envisage a long term relationship which alone ensures
quality and reliability. Frequent changes of vendors may enable the buyer to have
, cost savings but it does affect the assurance of supply. Buyers may develop
new sources to affect cost savings but they must avoid cancellation of orders
on old suppliers. B oth together must find out ways to reduce cost.
b) Long term hand holding

Vendor relationships should extend beyond technology and team work. At times,
the vendor may require to be provided with anything from technical and quality
inputs to financial support, including quality management of their processes, to
enable them to reach a stage where they can self certify their products. Vendors'
requests for premature payment or on account payment) at the time of dire needs
should be attended to promptly.
c) Sharing information on future plans

Sharing information about the production plans of the company is another facet
of long term relationship with vendors. Vendors must be told months in advance
what the company will need and how much, so that the suppliers can gear up their
production. In fact, efforts should be made to move to an open order system,
wherein the requirements are conveyed four to six months in advance.
d) P ricing
Pricing is one of the most sensitive areas and sometimes leads to a situation
where relationships get strained. Prices should be discussed by breaking down
cost into various elements like raw material cost, tool cost, labour cost, profit
etc. and the supplier should be given the rates which are truly due to him.
There are many occasions when a supplier approaches a buyer for a price
76 increase due to factors beyond his control. At that time, the supplier's request
should be |
Unit 4 Buying Policies
scrutinised by the buyer patiently. The supplier must be given a fair

opportunity to justify his case for an increase in price.
e) Timely payments
Payment is yet another sensitive area which sometimes affects the relationship.
For a good buyer-seller relationship, each buyer must ensure that once the
material has been supplied and accepted, payment is released to the supplier
on the due date. For this, the buyer should ensure that payment to the supplier
is not held up for want of necessary paperwork or due to breakdown of
communication.
f) Non-cancellation of orders
The buyer should not resort to cancellation of contracts, whatever the reason,
be it fall in demand, strikes, lock-outs, seller's failure of deli very commitments
etc. unless they are compelling. Sudden cancellation of an order creates
problems for the vendor to fill up the capacity created due to the cancellation.
;
. ' • ' " . •' - . •
' * ' ? :
g ) M inim isation of unscheduled deliveries and rush orders

The buyer must keep his requests for unscheduled deliveries at its minimum.
Rush orders, to the extent possible, should be avoided.
h) A voidance of unnecessary rejection

Any rejection that takes place either at the supplier's plant or at the buyer's
plant adds to the cost of the item, which is ultimately passed on to the buyer.
Rejection affects the supplier's cash flow and the buyer's production schedules.
It is, therefore, in the interest of both the buyer and the seller to find out ways to
avoid rejection, for which major responsibility rests with the buyer. The buyer
must help his suppliers in design, manufacture and in consistency of quality of
products by providing necessary assistance in the form of training, technology,
inspection facilities etc.
^ A c tiv ity A :
List seven things that you, as a buyer expect from a seller.
77
Activity B :
List five things that you, as a seller, expect from the buyer.
4.2 METHODS OF BUYING

The buying department of a company is responsible for providing goods and
services required by the company at the least cost to the company. The request to
procure may bereceived either from the stores department or from one of the
functional departments.
Factors influencing selection of Buying Methods
A number of factors influence the selection of a buying method. They are:
i) Nature of the item
ii) Regularity of its demand
iii) Quantities required ,
iv) Susceptibility to price variations
The different buying methods are as
follows:1. Hand to M outh Buying
Hand to mouth buying also called
"buying according to the
requirements"refers
to the frequent purchases of an item in small quantities.
The important characteristics of hand to mouth buying are:
qq) purchases are made only when the demand arises.
rr) purchases are made to cover immediate requirements.
ss) quantity purchased is generally small, though, at times, large quantity may
be
purchased.
tt) the terms of contract are negotiated. Competitive bids are generally not
78 obtained,
as there is no sufficient time.
U nit 4 B uying Policies
Advantages of the m ethod

i) Lower inventory in vestment
/
a) Low carrying charges

iii) Reduced deterioration and obsolescence of materials
•*• ' f
iv) Lesser losses from price declines.
D isadvantages of the m ethod
i) Comparatively higher price due to urgencies and loss of quantity ii)
discounts.
Possible losses occasioned by an upw ard m ovem ent in prices.
in) Possible interruptions of production schedules because of m arket shortage of
materials at the time of need.
iv) Higher clerical costs due to frequent purchases. v)
Acceptance of sub-standard goods in em ergency.
Responsibility of the buying departm ent
The effectiveness of the buying department depends on their connections with vendors.
The selected vendors must be known for quality, reliability and integrity, so that they
fill the buyer's order without taking advantage of the situation. Along list of vendors
is generally necessary.
Suitability of the method
This methods apply to
uu) item s required for prototypes and for products under developm ent
vv) item s w hich are used infrequently and would not be required to be stocked,
because of w h ich they are purchased w h en th ey are n eeded fo r defin ite
consumption. M achine tools, special building materials, office furniture etc. are
some of the examples of this group
w w )the im m ediate requirem ents of a stock item caused either due to a delay in
delivery from regular suppliers or due to an increase in consumption
xx) the im m ediate requirem ents of items, w hose prices are expected to fall in the
nearfuture;
yy) the procurement of replacement spares '
zz) items which have a limited shelf life and are not stocked for fear of perishability
aaa) items which are bulky (e.g. packing materials like wooden boxes and
thermocole
sheets, cotton waste etc.) and need a lot of storage space.
2. Scheduled Buying
Scheduled buying is the process of procuring an item in staggered

deliveries according to the delivery schedule furnished to the supplier by
the buyer. The salient characteristics of scheduled buying are as follows:
i) A purchase order covering annual requirements (alternatively a purchase

order without specifying the order quantity, called open order) is placed
with the supplier.
if) The supplier is given the estimate of the procurement needs covering a
mutually agreed period of time. It is a common practice to give 2-3
months confirmed schedule and 2-3 months tentative schedule.
in) Fresh delivery schedules are given to the supplier prior to the completion of
the previous schedule. Fresh schedule supercedes the previous schedule.
Advantages of scheduled buying
i) Both the buyer and the seller enjoy the savings resulting from regularity
of production and smaller inventories.
ii) The buyer is assured of supply of goods, while the supplier is assured of
business.
iii) The supplier can effectively plan his factors of production, while the buyer
can plan his requirements of finance.
Suitability of the system
Scheduled buying is best suited for
• items of regular use such as cutting tools, castings, forgings, lubricants etc.
• items produced to the buyer's design and requiring long lead time to manufacture.
• proprietary items from suppliers who insist on long-term schedules.

80
3 . F o rw ard B u y in g
F o rw a rd b u y in g re fe rs to th e p ro cu rem en t o f su ffic ie n t q u an tity o f a n item in a d v an ce

o f its n e e d a n d a t a tim e w h e n th e p ric e s a re lo w (a n d /o r e x p e c te d to rise ).
T h e im p o rta n t c h arac te ristic s o f fo rw a rd b u y in g a re a s fo llo w s:
b b b )P u rc h a se s a re m a d e to c o v e r p ro d u c tio n re q u ire m e n ts fo r a c o n sid e ra b le p e rio d

c cc ) Q u an tity p u rch a sed is g e n e ra lly la rg e
d d d )T h e atm o sp h e re is u su ally fav o u ra b le fo r n eg o tia tio n
e e e ) P u rc h a se s a re m a d e w h e n th e p ric e s a re lo w . T h e b u y e r a lso g e ts a d isc o u n t o n
larg e pu rc hase s.
A d v a n ta g e s o f th e m e th o d ,r.-,»f!. s
Forward buying results in -

• lower purchase price
• greater margin of profit on finished goods
• saving in procurement expenses, as purchases are usually consolidated

• security against shortage
Disadvantages of the method
• Such a buying may not serve the needs of the production department entirely.
• Price expectations, if not realised, may result in a major financial loss to the
firm.
• Inventory holding charges are considerably higher.
• Large scale obsolescence may result, if design changes occur.
4. Speculative Buying
Speculative buying refers to the buying of large requirements of an item, when its
price is low with the intention to sell a bulk of it at a higher price for speculative
profits.
Some important characteristics of speculative buying are:

fff) Purchases are in no way related to the compay's production programme.

An
item which is not required for production may be purchased.
ggg) Speculative buying does not base decisions on quantity. Its single aim is to
make
speculative profits. The quantity purchased is thus generally high and is as
much
as the company finance can permit to buy.
5. Contract Buying
Usually, all purchases are by contract. The term contract buying is applied to
those special contracts which call for deferred delivery over a period of time.
According to Spriegal, "Contract buying is the purchasing made under
contract, usually formal, of needed materials, the delivery of which is
frequently spread over a period of time."
Some important characteristics of contract buying are:
hhh) Contracts are given to suppliers for a large amount of future requirements or
for
a certain period (say a year).
iii) Quantity received per occasion is generally small. The cycle time between
two
consecutive receipts may be a week, fortnight, a month or any period
considering
the value of requirements, distance and the mode of transport.
jjj) The buying department usually finds sufficient time to secure competitive
bids
and negotiate terms of contract.
Pros and cons of the method
Contract buying offers a number of advantages over other methods, such as

forward buying or buying as per requirements. Some of these are listed below:
i) It saves the company the trouble of inviting quotations, preparing

comparative statements, placing of orders etc., which otherwise will be
necessary every time the items are required. This reduces the
procurement expenses.
82
if) The buyer's company is assured of regularity in supply, despite market
fluctuations.
iii) The buyer needs to keep very little working stock and safety stock. This
r the barest minimum.
e
d iv) Prices and other terms of contract are generally favourable to the parties
involved.
u
c
e
s
c
a
p
it
al
l
o
c
k
u
p
a
n
d
t
h
e
c
o
st
o
f
c
a
rr
y
i
n
g
i
n
v
e
n
t
o
r
y
t
o
U nit 4 B uy in g P o licies
v) The buyer can plan his requirem ent of finance, as he has an advance idea about
w hen and w hat am ount he has to pay to his vendor.
Types of contracts
Contract buying is of three types:
• R ate contract,
w here the rate is fixed and not the quantity. Som e indications of
the probable requirem ents, how ever, are given.
• Running contract,where the rate and the quantity both are fixed for the contract
period. As soon as the specified quantity is supplied by the vendor, the contract
autom atically com es to an end.
t Service contract
w here the various services are obtained periodically.
Suitability of contract buying
Contract buying is suited for the procurem ent of m aterials and production item s of
regular use. Service contract m ay be entered into to obtain periodical services such
as servicing of typewriters, punching clocks, air conditioners, repairs or calibration of
measuring instruments and gauges, filtering of oils etc.
6. B la n k et O rd ers
B lanket orders refers to the purchase of a variety of item s from a single source,
usually a middlem an. Som e im portant characteristics of blanket orders are:
kkk)A blanket order specifies the categories of item s covered by the order
lll) The item s covered by the order generally have low unit value
mmmM
) ore than one m iddlem an m ay be selected to avoid hold-ups in case of non
availability of an item with one
nnn)'M arket-price' is generally specified on the order, which may include a specified
method of determining price variations;
ooo)T he supplier is given requ irem ents regarding w ho supplies and bills at th e
'prevailing prices less agreed discount' on the phone. The records of the supplier
are open to inspection on dem and. Alternatively, the buyer may contact vendors
on phone, enquire about price and buy from one w ho quotes the low est the
other term s of contract being comm on to all.
Suitability of the method
The method is best suited for general hardware, electrical supplies, stationery, small
cutting tools etc.
7. Tender Buying
Government departments and public sector undertakings in India follow this method
of buying. Private sector organisations too adopt tender buying, if the value of the
purchase exceeds the prescribed limit, say Rs. 25,000 or Rs. 50,000, fixed by the
management as a policy decision. Salient characteristics of the system are as follows:
i) The buying department establishes a bidder's list and invites each bidder to
submit bids (a tender or quotation is a written offer from a supplier to render a
specified service or supply materials of the specified quality, at the specified
price and within the specified item).
ii) B ids on receipt are evaluated by comparison and the right supplier is selected.
Lowest price is the criterion used, except when the supplier quoting the lowest
price has questionable delivery time, quality, reliability or financial stability.
Advantages of the method

i) Tender buying is the purchaser' s most important single tool for selecting a qualified
supplier on the basis of competitive prices.
ii) It eliminates possibility of favouritism, patronage and personal preferences.
Disadvantages of the method
Tender buying is costly and time-consuming and therefore used by private sector
undertaking only when the value of purchases is high.
Types of tenders
Tenders are of four types:
i) Single tender refers to the system of tendering wherein the details of the
requirements are communicated only to one firm. Competition in this system is
altogether eliminated and price is fixed by mutual agreement. Single tender system
is used when there is only one supplier of the item. Quotation from the sole
selling agents of the manufacturers belong to this group.
Unit 4 Buying Policies 9.
ii) Limited or closed tender refers to the system of tendering wherein Sub-an
enquiryis sent to a limited number of suppliers who are on the approvedContra list
of suppliersand bids are received in response. The decision concerning cting
the number ofsuppliers to whom the enquiry be sent is usually laid down in S
the 'buying policies'
framed by the management. The firms in the private sector u
usually send an enquiryto three to eight suppliers, depending upon the rupee b
value of the order. However,firms in the public sector are not able to restrict -
the number of tenderers to eight. All registered suppliers require to be c
mailed a buyer's copy of the enquiry. o
iii) Open tender system is the system of tendering wherein the enquiry is advertised n
tr
in the newspapers or periodicals or trade journals of the home country and bids
a
H, are received in response. Since the system encourages unlimited
ct
competition by
i
_,;, publicising an enquiry, the term 'open tender', 'advertised tender', or
n
'unlimited
g
tender' is used. Open tender system is used for items which are required in large
is
value and/or are difficult to procure.
t
iv) Global tender is the system of tendering wherein the enquiry is advertised h
in e
the newspapers and trade journals of not only of the home country but also in w
;, foreign countries and bids are received in response. The global tendero
system is r
used for purchase involving huge investments such as procurement of plant and k
machinery i.e. purchases that are both capital and technical. p
la
8. Seasonal Buying c
Seasonal buying refers to 'buying of the annual requirements of an item e
during its season.' This method is used for items available in a particular d
season only. Some important characteristics of seasonal buying are: w
it
ppp)The items involved are available in a particular season only and thereforeh
need a
to be purchased and stocked in sufficient quantities till the next season n
(e.g. o
oranges, sugarcane, apples etc.). u
qqq)The items covered may be small in size but they are required in large ts
quantities. i
d
rrr) The market price is the lowest during the season. Therefore, the items e
can be s
purchased at the cheapest rates. u
p
sss) Usually purchase are made directly from manufacturers/producers of the p
goods.
lier to design peculiar to the
main contractor for economic reasons or to
augment the facilities of an existing
85
manufacturer. Sub-contracting is the hiring of another firm to perform some of

the manufacturing operations or to furnish certain parts and sub-assemblies
to be incorporated in the buyer's end product.
Types of sub-contracting
Sub-contracting is of three types:
i) The company makes some quantity of the final product and buys the
balance from outside. This happens when the company receives big orders
but is unable to supply the full quantity within the contract period.
if) The company concentrates on certain items of the assembly and buys
others from outside. It is this type of sub-contracting with which the
industrial buyer is concerned.
in) The company gets certain operations like electroplating, heat-treatment,
rough blanking etc. done from outside because either it does not have the
necessary manufacturing facilities or its present facilities are overloaded.
10. Central Purchase Organisation
A large firm in the public or private sector may have section-wise stores at
different places. The requirements of these stores can be satisfied by either of
the following two methods:
i) Each store to make its own purchase.

if) A central store to make purchases and supply material in turn to
sectionwise stores.
The advantages of central purchases are:
i) The central purchase organisation (CPO) can obtain quantity discounts,

lower rate and better contract terms due to large purchases made
possible by consolidating the requirements of individual stores.
ii) The CPO can exercise strict control on consumption, thereby minimising
the risk of malpractices.
iii) The CPO can contract directly with the manufacturers and obtain items as
per specifications. Individual section stores may not be able to do this.
86
U n it 4 B u y in g P o licie s
iv) Malpractices by individual purchase officers, who may have an

understanding with the local dealers which could result in high prices for
purchase, are avoided.
Typical examples of central purchase organisation are:
State Road Transport Corporation (i.e. MSRTC, GSRTC, etc.) Nationalised

Banks, Co-operative Banks, etc.
11. Directorate General of Supplies & Disposal (DGS&D)
The DOS & D is the Central Purchasing Organisation for the various
government departments. It enters into contract with various firms for the supply
of certain materials to the government departments during the year, at an agreed
rate. A formal document raised for the purpose is called 'rate contract.'
& Activity C;
State the type of buying method you would use for following items:
i) Raw Material
i) Spare parts for machines

i) Raw material which is a commodity
iv) Seasonal item
v) Services like-Loading/Unloading
vi) Repairs to motors in a large factory
4.3 BUYING FROM THE RIGHT SOURCE
It is commonly believed that the best source is from where the buyer gets the
material at the lowest price. This is not normally so. There are several other
aspects related to this problem. Quality of the material cannot be ignored.
Equally important are quantity and
pricecriteria. 87
Situations are not uncommon when it is found that the source offering the right quality
does not have the capacity for desired quantity or that the price quoted by him is much
higher. At times, his terms and conditions of supply may not match those of the buyer.
The choice of the right supplier is therefore very important, and in order to enable the
buyer to achieve other principles of purchasing. Only from the right source right
quantity, right quality, right price be expected.
A buyer can get many sources but good sources are difficult to get. Source selection
and source development require time and efforts on the part of the buyer.
Stages in the source selection and source development process
Source selection and source development is the systematic process of locating,

investigating, selecting and developing suppliers who can give acceptable delivery,
quantity, quality and services at the acceptable price to the company. Source selection
and source development is necessary for raw materials, tools, spares or items
produced to commercial standards, items required to buyer's design or imported
items. Though the basic approach is the same, sincere efforts are required to select
and develop sources for items required fora buyer's design. There are eight stages
in the source selection and source development process of this category of items.
These stages are:

i
i) Source requirement stage to identify the need for source selection and
source development.
ii) Source location stage to collect information on potential sources of supply.
iii) Source investigation stage to identify technical, financial, managerial and

quality assurance capability of the vendors and thereby generate data to serve as
a basis for preliminary source selection.
iv) Preliminary source selection stage to narrow down the choice to those who
are most likely to fulfil the requirements successfully.
v) Techno-commercial discussions stage to discuss the technical aspects of the

item and finalise the terms of contract of the trial order.
vi) Trial order stage to carry out follow up with the supplier, until sample
submission, sample validation, defect analysis and defect prevention, including
follow-up for pilot lot and bulk production lot.
88
ydoes vii) Sourceappraisal stageto review perform ance of the vendor, render assistance (if
ligher. required) and decide on future business w ith the vendor. The appraisal stage m ay
choice require review of the earlier steps to search for a m ore satisfactory source.
chieve
y, right viii) Sourceretention stage
to create necessary conditions, so that supplier sticks
the to
company.
ion and The m ajor activities under each of the above m entioned stages of sourceand
selection
source developm ent are detailed below .
N eed for Source Selection and S ou rce D evelopm ent
itigating, Source selection and source development becomes necessary under the following situations:
ality and
a) N ew products or m odification in existing products
;lopm ent
and ard s, W hen new products are introduced and existing products are m odified, it becom es
ich is the necessary to go for developm ent of sources w herever necessary.
ired fo ra
elopm ent b) M arket conditions
A su dd en in crease in th e d em an d fo r a pro d u ct w o uld po se a pro b lem fo r th e

management, since its installed capacity may seem inadequate to cope with the demand.
ind source c) Supplier'spoor perform ance
At tim es, the perform ance of the established supplier m ay fall short of expectations.
It then becom es necessary to locate other sources.
A
and quality,s d) D iv ersion/L oss of su pp liers' in terest d u e to m ore attra ctiv e offers
a basis for
Suppliers do not rem ain the sam e. A n established supplier m ay divert his ftinterest to
new areas that prom ise m ore lucrative and prosperous offers. The supply,, incase, such a
ose w ho are is bound to suffer adversely.
e) N ew regulations/directives
ts of the item
The governm ent issues new regulations from time to time. New regulationsthe
m ay be in
form of curb on im ports/heavy duties on imported m aterial or restrictions on the
• subm ission, m anufacture of goods under collaboration. All these result in a spurt of dem and for
w -up for pilot indigenous m aterials. Consequently, im port substitution em erges as an im portant
element in the purchase market.
8
9
f) Alternate source of supply
Even though a company wants to depend on one reh'able source for its
requirements of materials, it may adopt a pragmatic policy to develop alternate
sources so as to :-
i) have insurance against failure of present suppliers to honour their

commitments;
ii) reduce inventory levels when the existing suppliers demand long delivery
lead times;
iii) create competition and thereby secure price advantage.
g) Emergence of new suppliers
New suppliers may approach a buyer to convey their interest in the supply of
items currently being purchased from outside or currently being
manufactured at the company's own works. Such suppliers are normally
given those items where -
i) the buyer is facing price, delivery or quality problems with the existing
supplier; S) the buyer has failed to develop a good source earlier;
iii) the buyer has already one good source but would like to have another source
as a standby.
h) Reluctance of the existing supplier to expand ,
Situations may arise when the buyer is fully satisfied with the existing supplier
and wants him to expand to supply his enhanced requirements. But inspite of
active cooperation from the buyer, the supplier may not prefer the option to expand
his business. Consequently, a buyer is under business compulsion to tap new
sources for coping with the increased demand.
i) New plant location
Economy in transportation cost and ease in follow up work are accepted as

justifiable reasons for the dependence on local sources. However, new
situations may arise because of the location of plants at different places, which
may compel a buyer to explore new sources in and around the new plants.
j) Closure of the existing supplier
m The closure of the existing supplier due to labour problems, financial difficulties,
disputes among the owners or any other reason compel the buyer to look for
new sources.
U n it 4 B uy in g P olicies
*T <
> Collecting Data on Prospective Suppliers (i.e. Locating Suppliers)
Before proceeding to select sources, available prospective sources should be

studied. The type of information can be obtained from any one of the
following sources:
a) O ld su p p liers
i
For a new item to be procured, the old suppliers should be consulted.
There are good chances that one of the old suppliers would be able to give
information on the new suppliers.
b) T ra d e d irecto rie s
Trade directories are publications listing suppliers against their products. At
times, these directories also give other relevant information like suppliers'
addresses, telephone numbers, telegraphic addresses etc.
c ) Professional Institutes
There are quite a few professional institutes in our country like the National
Institute of Material Managers, Institute of Engineering (India), etc. These
institutes can advise on prospective suppliers from among their members.
d) 'C lassified Yellow Pages' of telephone directories

Another commonly known source of information is the "Classified Yellow
Pages" of a telephone directory.
e ) C irculars
Circulars received in the daily mail can also provide information on the
vendors of items, which the buyer's company is interested in developing.
f) Trade exhibitions and trade fairs , ,

One of the main purposes of such exhibitions and fairs is to promote sales and
advertise a company's capabilities. All important manufacturers participate in
such fairs and display their items.
g) Advertisem ent in m ass m edia

All manufacturers of repute give wide publicity of their capability and
achievements through advertisements in mass media like the radio, TV,
newspapers and magazines. A regular study of these helps buyers in locating
91
prospective suppliers.
h) Salesmen '" ? - » . . « .. n
Salesmen of manufacturers who call on the buyer are an extremely valuable source of
information about suppliers and their products. They not only give complete
information about their own products but also highlight deficiencies of the products
of their competitors.
i) Company's personnel
Personnel working in the other departments of the company often can give
information about the suppliers.
Investigating in Vendors' Capabilities (Part 1: Collection of Data)
The preceding step - location of sources - may provide a long list of all possible
sources. They must be pruned to weed out the technically incompetent. Managerial
ineffectiveness, financial unsoundness and poor quality assurance capability are
additional considerations for dropping some suppliers from the list. In other words, the
aim is to identify possible sources and select potential sources which will be able to
supply goods at competitive prices and meet a buyer's requirements for quality,
quantity and delivery. Evaluation of vendors, therefore, requires specific information
that will enable assessment of the firm's capability in fulfilling its part of the contract.
Since the best source of information is generally the source itself, the most common
method employed is to mail a proforma to each potential source, with a request to fill up
the same and return it by a specific date.
The proforma should seek the following information about the supplier:
a) Address:
i) Office ii)
Factory iii)
Telephone No. iv)
Telex
b) Ownership details
(
ttt) Pasthistory V S)
uuu) Details of machines held, their life, capacity, condition
92
in) Finance department
iv) Quality assurance
department rtf'
1
The duties of the team are two-
folds:
i) The team verifies the contents of the first part of theproforma(itis worthwhile carrying
the proforma along for verification). Discrepancy, if any, is recorded on the proforma.
fi) The team collects information given in the second part of the proforma. Over and
above, various points are discussed by members of the team to remove doubts and
eliminate dark areas. The findings of the team may be recorded in the second part of
the vendor data form (Annexure A), to ensure homogeneity in recording.
Another method of securing information on the vendors' capabilities is to write in confidence

to some of the firms which are using the materials supplied by the source under scrutiny.
Investigating Suppliers'Capabilities (Part II)
The information secured directly from the firm on the prescribed forms and observations
of the team during their visits must assess a firm's capabilities in the following areas:
a) Technical/production ability
The technical capability of a source depends mainly on the quality and quantity of
technical/skilled manpower and machines. The firm chosen for the purpose should
possess a high level of technical proficiency in terms of human skills and machines.
i) Manpower: The prospective vendor must have sufficient skilled, semi-skilled

and unskilled labour. Workers skill can be found out on the shop floor by the
team members by observing them when being taken around the manufacturing
facilities during the visit.
ii) Machines: The details of machines, their types, makes, condition, life and the
degree of accuracy they are capable of should be found out. Details of machines
purchased in the last 2 years give indications of growth in the technical field.
iii) Drawing and design office: A good supplier should have a well equipped
design and drawing office to carry out day-to-day work. Small scale industrial
units may not have this facility of their own. As long as they have some
arrangements with other firms/organisations/institutions, it should suffice.
U nit 4 B uy ing P olic ie s
iv ) ro o /ro o m r A w e U - e q u ip p e d to o lro o m is a n in d ic a tio n o fth e te c h n ic a lc z ^ a b ility

o f th e su p p lie r.
b) Q u a lity a ss u r a n c e a b ility
T h e e n d e a v o u r s h o u ld b e to f in d o u t th e fir m 's c a p a b ility fo r q u a lity a s s u r a n c e a n d
re liab ility . R e liab ility re fe rs to th e firm 's ab ility to a d h ere to a ll th e te rm s a n d c o n d itio n s
o f su p p ly , irre sp e c tiv e o f e x te rn a l a n d in te rn a l e n v iro n m e n ts i.e . e n s u rin g d e liv e ry o f
d e sire d q u a n tity a t th e p re d e te rm in e d tim e .
c) F in a n c ia l c a p a b ility
Financial capability of the vendors is essential to ensure uninterrupted supply and
quality of the product. A company with sound financial position is in a better position
to absorb development cost. A company which is financially weak can hardly be
expected to keep its commitments. Financial documents like balance sheet,
profit and loss account, and fund flow statements are quite useful in analysing
the financial stability of the vendor
d ) M a n a g e r ia l c a p a b ility
W h ile a s s e s s in g a s u p p lie r , th e s tu d y o f a n o rg a n is a tio n is a ls o n e c e s s a r y , sin c e a n
o r g a n i s a t i o n i s w h a t i t s p e o pTlhe e a frier.m 's a b i l i t y t o d e l i v e r q u a l i t y g o o d s a t
th e rig h t tim e a n d in th e rig h t q u a n tity d e p e n d s o n th e c a p a b ilitie s o f th e
m a n a g e r sT. h e y s h o u l d h a v e a p o s i t i v e a t t i t u d e a n d a p o s i t i v e a p p r o a c h f o r
o v e rc o m in g d e la y s. T h is re d u c e s th e r isk o f slip p a g e o f d e liv e ry d a te s b y th e v e n d o r.
e) L a b o u r m a n a g e m e n t r e la t io n s
T h e b u y e r w ill o fte n fin d it b e n e fic ia l to u n d e rs ta n d la b o u r m a n a g e m e n t r e la tio n s a t
th e supp lier's plan t.
P r e lim in a r y S e le c tio n o f th e S u p p lie rs
T h e d ata co llected abo u t the v end ors, follo w ed b y sy stem atic ev alu ation o f th eir cap ab ilities,
p ro v id e th e b a sis fo r a p re lim in a ry se le ctio n o f th e su p p liers.
T h e fo llo w in g c o n sid e ra tio n s a re im p o rta n t fo r n a rro w in g d o w n th\)e sc o p e o f c h o ic e :
S iz e
Q u ite o f te n th e b u y e r fa c e s th e d ile m m a o f s iz e o f th e o p e r a tio n s o f a s u p p lie r . S iz e
s h o u ld n o t e ith e r b e a c r ite r io n f o r e f f e c tiv e n e s s o r a n a s s u ra n c e o f s u p p ly . Q u ite
o f t e n , i t h a s b e e n f o u n d t h a t s m a l l c o m p a n i e s a r e b e t t e r s u p p l i e r s , w i l l i n g to c o -
operate with large companies. In our country, quite a few large firms have the reputation
of poor performance either due to their monopoly position or due to their
carelessness and mismanagement.
ii) Type of supplier
A buyer may have an option of selecting between the actual manufacturer and/or his
selling agent or distributor or dealer.
Obviously, the best of the lot from the buyer's point of view should be
selected. Generally, manufacturers of repute should be given preference in case a
buyer desires to have new equipments and new designs. Direct contact with them has
the advantage of better communication in the technical field. Local
distributors/agents are preferred when stores are required in small quantities.
Hi) Location of the firm
Local sources should be preferred, as communication with local firms is very quick,
easy and effective. Local sources are also economical due to reduced transportation
cost.
iv) General reputation of the firm
"A known devil is better than unknown angel" is a wise saying. v)
BIS coverage
Firms on the approved list of Bureau of Indian Standards (BIS) should be given
preference over others.
vi) Experience c)
Suppliers having experience in manufacture of similar goods should be given preference
over others.
96
vii) Firms known for business ethics
It is unwise to risk dealing with suppliers who are known to have questionable ethics. viii)
Reciprocity, or trade relations as it is often called, should never be the primary basis for selection
Recipro
of a supplier, unless all other pertinent factors are clearly and unmistakably satisfied.
city
U n it 4 B u y in g P o lic ie s TC- . •
ix) Past perform ance
T h e re c o rd o f p a s t p e rfo rm a n c e p ro v id e s a n e x c e lle n t in s ig h t in to th e fir m 's p ro b a b l e

fu tu re p e r f o r m a n c e . S o m e f i r m s a r e p e r p e tu a l d e fa u l t e r s . T h e b u y e r s h o u ld d o w e ll
to c o n s i d e r h is o w n e x p e r ie n c e w ith t h e s e s u p p lie rs .
T ech n o -C o m m ercial D iscu ssion an d T rial O rd er
This includes the follow ing:
a) T e c h n i c a l d i s c u s s i o n s b e t w e e n t h e r e p r e s e n t a t i v e s o f a b u y e r a n d a
su p plier
- D e ta ile d sp e c ific a tio n s a n d d ra w in g s o f th e e q u ip m e n t, th e ir su b -a sse m b lie s a n d

'* c o m p o n e n ts, in d ic a tin g c le a rly th e ra w m a te ria ls u s e d , to le ra n c e s p e rm itte d a n d s p e c ia l
p ro c e s s re q u ire d , if a n y , is p ro v id ed to th e su p p lie r. O th e r te ch n ic a l a c ts d e ta ilin g
" w h a tth e ite m is " , " w h a t a s s e m b ly it is in " , " w h a tfu n c tio n itp e rfo rm s " , " w h ic h q u a lity
c h a ra c te ris tic s g o v e rn p e rfo rm a n c e " e tc . are d is c u s s e d b y th e re p re s e n ta tiv es . T h e
in s p e c tio n c rite ria to b e fo llo w e d is d isc u s se d , fin a lis e d a n d a p p ro v ed b y b o th th e
S parties.
b) C o s t e s t i m a t i o n a n d q u o t a t i o n s s u b m i s s i o n
T h e su p p lie r is n e x t as k e d to m ak e c o s t e stim a tio n a n d su b m it h is q u o ta tio n .

3 D isc u ss io n s a n d n e g o tia tio n s are h e ld , w h ic h u ltim a te ly le a d to th e fm a lis a tio n o f a
' tr ia l o r d e r . V a r io u s o th e r a s p e c t s in c i d e n t a l t o p r ic e , n a m e l y t r a n s p o r ta ti o n , d e li v e r y
'' e t c . a r e a ls o f i n a l i s e d d u r in g n e g o t ia t io n s . P u rc h a s e o r d e r s a re r e l e a s e d f o r t h e t r i a l
o rd e r. T h e o rd e r q u a n tity o f th e tria l o rd e r is g e n e ra lly le ss th a n a m o n th 's re q u irem en ts.
c ) T im e schedule for subm ission of sam ples
The buyer next prepares tim e schedule for subm ission of sam ples, in consultation
with the supplier's representative. To arrive at the tim e schedule, all major activities
are recorded. Technological relationships are established next, to know which activities
are independent and which activities depend on the other. This is followed by drawing
a netw ork. Tim e estim ates of activities are also entered into the netw ork. C ritical
path is used to identify the duration, which gives the delivery date for the subm ission
of samples.
Sample Validation
The activities involved are as follows:

a) Follow-up with the supplier until sample submission

Buyer must follow-up with the supplier on a continual basis, so that different
activities, be it design, process planning, materials procurement, manufacture of
jigs and fixtures etc. are started and completed on time.
b) Sample inspection
Sample pieces received from the vendor are submitted for inspection, where they
are checked for every quality characteristic.
c) Feedback on defects and defect prevention
The inspection results of the sample pieces are conveyed to the supplier. The
inspection report carries unqualified disposition details like "accepted", or
"rejected". Reasons where the samples are rejected are also specified.
d) Resubmission of samples
Wherever samples are rejected, the supplier is made to resubmit the samples
after correcting the faults. The second sample lot too undergoes detailed
inspection.
Pilot Lot and Bulk Production Lot Trial
Approval of the samples is followed by the production of pilot lot (i.e. first batch of
the item on production basis). The size of the pilot lot depends on the type of
equipment and quantity on order. The pilot lot too is checked and tested as per
detailed testing and inspection criteria. After clearance of pilot lot, bulk production
commences for completion of the pre-production of a trial order.
After successful execution of trial/pre-production order, the production level is

considered to be stabilised. The job is then transferred to a regular supply cell. At
the time of this transfer, the stores should have in stock at least two months'
requirements.
& Activity D;
i
\
Design a supplier selection plan for raw material for a medium scale industry.
<
98
U nit 4 B uying P olicies
4 .4 S O U R C E A P P R A IS A L
The successful completion of trial order qualifies the vendor as a regular supplier. At this
stage, the buyer, needs to determine the division of business among (he vendors. Logically,
the quantity to be ordered on the vendor depends on the expected performance measured
interns of their ability to meet the requirements of 'quality', 'delivery', 'price',and 'services'
of the buyer. For this purpose, buyers employ some vendor rating systems, wherein vendor
rating, computed on periodic basic, provides the basis for:
i) comparing one vendor against the other and thereby helping decide the share of
business for each vendor.
I) eliminating vendors who repeatedly fail to meet the required standards.

i) holding discussions with the representative of the supplier and identifying the areas
where the buyer wants supplier to improve.
4.5 SUMMARY_______________' __________
Good buyer-seller relationships are necessary to achieve principles of scientific buying.

Both the buyer and the seller must realise that their respective organisations can benefit
from the progress of the other. Each party must have full appreciation of the other's
viewpoint. Mutual trust, co-operation and understanding must form the basis of every
contract. Each party must strive hard to discharge its obligations under contract honestly
andfaithMy.
Relationships are good when the buyer as well as the seller both try to satisfy the
requirements of each other.
Right source is one who can give goods of the right quality, in the right quantities, at the
right time and at the right price. To be able to do this, the source must
li) be technically and financially very strong.
(ii) have good administrative/managerial capability.
(iii) have good employer-employee relations.
The Quality Control department of the supplier must have a staff function thereby enjoying
astatus equal to production. Management must be progressive. The buyer, must take all
the necessary steps to ensure that once developed, a supplier remain his loyal source.
4.6 KEYWORDS
Blanket orders: Blanket orders refers to the purchase of a variety of items from a single
source, usually a middleman.
Contract buying: Contract buying is purchasing made under contract, usually formal, of
materials needed, the delivery of which is frequently spread over a period of time
Forward buying: Forward buying refers to the procurement of sufficient quantity of an

item in advance of its need and at a time when prices are low.
Hand to mouth buying: Hand to mouth buying also called "buying according to the
requirements" refers to the frequent purchases of an item in small quantities.
Scheduled buying: Scheduled buying is the process of procuring an item in staggered

deliveries according to the delivery schedule furnished to the supplier by the buyer.
Speculative buying: Speculative buying refers to buying large requirements of an item

when its price is low, with the intention of selling a bulk of it at a higher price, for speculative
profits
Sub-Contracting: Sub-contracting is the hiring of another firm to perform some of the

manufacturing operations or to furnish certain parts and sub-assemblies to be incorporated
into the buyer's end product.
Tender Buying: Tender buying is a process where the buying department establishes a
bidder's list and invites the members to submit bids. Bids on receipt are evaluated by
comparison and the right supplier is selected. Lowest price is the criterion used, except
when the supplier quoting the lowest price has questionable delivery time, quality, reliability
or financial stability.
4.7 SELF-ASSESSMENT QUESTIONS________________________________
Ql. "The success of a Materials Manager depends on the buyer-seller relationships."

Explain.
Q2. Why are sound buyer-seller relationships important? What can a buyer and a seller
do to improve these relationships?
Q3. What are the qualities of a good supplier? What will you consider while making a
visit to the supplier's plant?
U n it 4 B u y in g P o licies
Q4. What do you understand from source selection and source development?
When is source selection and source development necessary?
Q5. What factors influence a buyer in selecting his suppliers? Discuss briefly the
steps involved in developing sources for machined items.
Q6. What different methods of buying are available to a buyer? Discuss each
method for its suitability in a given situation, advantages, disadvantages and
responsibility of the buying department.
Q7. Under what conditions should a firm practice the following methods of
buying?
i) Forward buying
i) Hand to mouth buying •—•-- •-—
i) Speculative buying
iv) G ro u p p u rc h a s in g
v) S c h e d u le d b u y in g ..............„ .__________
vi) C o n tra c t b u y in g
Q 8 . D iffe re n tia te b e tw e e n th e fo llo w in g p a irs :
v v v )F o rw a r d b u y in g a n d s p e c u l a t iv e b u y in g
w w wC) o n t ra c t b u y i n g a n d s c h e d u l e d b u y in g
x x x )R a te c o n tr a c t a n d ru n n i n g c o n t r a c t
y y y )L i m i te d t e n d e r a n d o p e n t e n d e r
z z z ) S u b - c o n tr a c ti n g a n d p u r c h a s i n g .
ft
101
5.1 RIGHT PRICE
One of the primary functions of purchasing is to buy goods at the 'right' price. But what is
the 'right price'? Is it market price, competitive price, standard cost price,
negotiated price, fair price, lowest of the bid prices or lower-than-last price! Price is
a dynamic factor. Price varies from vendor to vendor, at one time to another time
and at the same time. The right price assumes greater importance, as it has a significant
effect on the cost of the final product.
Two distinct but closely related aspects of right price are right quality and right time. For
example
• Delayed purchases-effecting delivery date and utilisation of plant, loss of production.
idle men and machines, etc. made at a very low price after long negotiations are
deemed to be made at a poor price. Right price must enable purchase of goods at
the right time.
• A cutting tool purchased from a new source at too low a price compared to the
historical prices may not represent a good purchase if the tool does not give adequate
life. Right price must result in purchase of goods of the right quality.
,
Therefore, right price is the price that must be paid to the supplier to obtain the
goods of the right quality at the right time.
Factors Influencing Price
A number of factors have a bearing on the determination of the right price of an item
They are:
i) Quantity requirements
A higher price is usually charged when the quantity required is small. Bigger
quantities, on the other hand, give the buyer a leverage to negotiate for a better
price.
ii) Quality requirements
x)
A higher price is usually demanded (and is paid) for the critical items, since bu\r>
have lesser options available compared to other items where many alternative
source> are available.
iii) Job life
A higher price is normally charged for one time requirement since development,
engineering and tool cost are recovered from one batch. However, if the item
is repetitive, it can be obtained at a lower price.
104
U n it 5 Buying at the Right
Price
B ffect on the
u
t
;ht time. For
w
h [production,
a Dilations are
t 2 of goods
at
i
s
ipared to
n
the rive
e adequate
g
o ty-
t to obtain the
i
a
t
e ce of an item.
d
a
d gger quantities,
y price.
n
a
m is, since buyers
i ^native sources
c
a
n
d 2 development,
;r
, if the item is
a
t
t
h
e
A
i higher price is
v generally
) charged/paid
D when a buyer
e has limited
l
time to wait
i
v and he has to
e create an urge
r in the supplier
y to supply or
when the
t buyer has no
i time to locate
m other sources
e who can
supply at a
Ti
lower price.
me - ' • r,rt ""
.?..-.- : '-•. -
av :
ail v) Demand and

abl supply
e condition
to
the The price of
bu a commodity
yer is
ha conditioned
sa by the forces
ma of supply and
jor demand. The
inf price charged
lue by the
nc supplier is
e generally
on competitive
the when supply
pri of the
ce commodity is
ch more than its
arg demand. On
ed the other
by hand, higher
the price is
su required to be
ppl paid if the
ier. item is in short
A supply.
v etition
i enables
) buying at
competitive
E rates.
x
t vii) Standard or
e non-standard
n materials
t
Standard
o parts - those
f produced to
commercial
c
standards -
o
m cost less to
p buy than
e those
t produced to
i buyer's
t design.
i
o iii) Buyer-seller
n relationships
Li Good buyer-
mit seller relations
ed provide a good
co ground for
mp negotiation,
etit while strained t
ion relations make
is the supplier
ass quote higher.
oci
ate ix) Government
d restrictions
wit
h Prices of
hig certain
her commodities
pri may be fixed
ce, by the
wh Government
ile , thereby
wi putting a
der restriction
co on both the
mp buyer and
the chase
sell
er. * Some
Lo suppliers
cal may ask for
tax a higher unit
es price but
in give longer
diff credit
ere period,
while others
nt
may quote
geo
lower unit
gra
price but
phi
demand
cal
payment
loc
against
atio
delivery or
ns
through the
ma
bank. Cost
y
of special
be tools may be
diff included in
ere the rate by
nt. some
suppliers,
x
while others
)
may ask the
T buyer to
e supply the
r tooling free
m of cost.
s Some
suppliers
o may quote
f F.O.R./F.O.
B. while
p others may
u quote Ex-
r works.
U n it5 B u yin g at the R ight P rice
i) Comm odity prices
This category covers com modities such as steel, copper, tin, rubber, lead, cotton etc.
T he prices in this category are set by dealers in the organised m arket and prices
invariably change sharply with changes in expectations of dem and and supply.
The responsibilities of the purchase department include:
• • keeping abreast with market price fluctuations, which the buyer cannot influence.
• adjusting the size and timing of an order, to take advantage of favourable market.
ii) Industrial - special prices

This category includes item s w hich are required to m eet buyer's design. Typical
exam ples of such item s are castings, forgings, m achined com ponents, press parts,
plastic mouldings and others made to customers' design.
The salient characteristics of industrial prices are as follows:
• The prices are based on the m anufacturing cost of the supplier.

• Price can be calculated and verified by the buyer.
• Different cost elem ents can be analysed and negotiated.
The responsibilities of purchase department include:
• scientific source selection and source developm ent.

• continuous evaluation of low cost alternatives.
• negotiation w ith suppliers after careful scrutiny of cost and price analysis.
• value analysis.
i) Industrial - standard prices
This category covers a wide range of standard item s such as

tl*
• cutting tools like drills, ream ers, taps, m illing cutters, hacksaw blades etc.
• m achinery spares like electric m otors, V -belts, bearings, oil seals, o-rings etc.
••< • stationery items like pencils, rubbers, refills, erasers, typing papers, carbon papers
etc.
• electric supplies like wires, fuses, bulbs, fluorescent tubes, shades etc. v
• hardware like bolts, nuts, washers etc.

Salient characteristics of this type of purchase are as follows:
• The prices are governed by the published price li sts of the manufacturers.
• A wide range of discounts are offered by the manufacturers and middlemen.

The responsibility of purchase department include:
• Raising blanket orders based on classification of items.
• Being aware of discounts allowed, in order to negotiate better.
iv) Miscellaneous: minor items
This category includes a wide variety of non-stock low priced items from
category (ii) and (iii). Since the items are required occasionally, no price record
is available.
The responsibilities of purchase department includes -
Simple commonsense method of buying to reduce lead time and to pay just
the correct price.
' ' ' ' ' • , . ' ., 1'
Obtaining Price Information
The price of an item may be ascertained by preparing a comparative statement with

help of the information obtained from the following sources:
i) Published price lists
Catalogues and price lists of the suppliers are good sources of information on
the price of the items produced to commercial standards. Since prices are revised
by the manufacturers from time to time, buyers must obtain the latest catalogues
and maintain them correctly in the department.
ii) Old records
For the items produced to buyer's design, old records of the same/similar
items usually serve as a basis for finalisation of rates. Old records,
however, have a disadvantage: if the buyer has in the past paid a higher price
because of urgencies or some other reasons, he is likely to pay a higher price
101 even now.
L 'n u 5 B u ying at th e R ig h t P rice
i i i )T e l e p h o n i c q u o t a t i o n s ; - '• '."•"'" '"Jr :
Suppliers are contacted on phone and oral quotations are obtained from them. These
quotations are compared and an oral order is given to the supplier whose terms and
conditions are found to be favourable. The selected supplier in the meanwhile is
asked to confirm his quotation in writing so that formal (a written) purchase order can
be raised
i v )T e n d e r i n g
Tendering is a purchasing procedure whereby prospective suppliers are invited to

submit firm and unequivocal offers of price and other terms which, on acceptance,
shall form the basis of subsequent contract.
v) Cost estimates prepared by the company's industrial engineering department usually

provide a good idea of the target price.
vi) Price of items similar in shape and size
vii) Price of items performing same function
vffi) Information from other buyers
ix) Price being paid by the company's other plants/divisions
\) Punished price indices
5 . 3C O N S T I T U E N T S O F____________________________________
P R IC E
P ric e is a c o m p o s ite fig u re w h ic h c o m p ris e s
i) B a s ic p r ic e •. •T, . , • • • . , .
i) D is c o u n ts
i) G o v e rn m e n t le v ie s ;
iv ) P a c k in g a n d fo rw a rd in g e x p e n s e s
v ) E x c is e /C u s to m s D u ty
v i) S a le s T a x
v ii) F re igth t
viii) Transit insurance
ix) Expenses incurred in collection of materials from transporter godown (carriage
inward)
x) Materials handling
xi) Clearing and Forwarding
'•
xii) Octroi etc.
The elements mentioned above are only major cost constituents. Over and above
these, expenses incurred in loading and unloading, trucking and retrucking etc. also
require to be added.
£$ Activity C;
Write down all the constituents of price for a refrigerator.
5.4 SHIPPING TERMS AND THEIR IMPACT ON PRICE______________

A shipping term represents a particular place of delivery (i.e. place of transfer of
ownership rights) and as such it demarcates the legal obligations of the buyer and
those of the seller. It also signifies that the price includes expenses up to the place as
implied from the shipping term. Shipping term also highlights who (seller or buyer)
runs the risk in the event of damage/loss of goods. (Refer Table 5.1)
The various shipping terms are given below:
aaaa)Ex-works
bbbb)F.O.R. (Station of dispatch)
l,
cccc)F.O.R. (Destination)
110 dddd)Buyer's works .

*j
eeee)At site
ffff) W
or
ks
co
nt
ra
ct
U n it 5 B uy in g at the R ig ht P rice
Fig. 5.1 shows the place of delivery for each shipping term.
•dl Ex-Works F.O.R. (Station of dispatch)
Seller's premises Seller's station
Buyer's works F.O.R. (Destination)
Door delivery Buyer's station
:se, )be
At site Works contract
Delivery at site/store Ready for use
Fig. 5.1: Place of delivery as indicated by the shipping term
Table 5.1: Place of Delivery (Risk & Price)

Shipping P ric e to in clu d e R isk o f lo ss to R isk of loss to
term th e se lle r th e b u y e r
(1) (2) (3) (4)

1. Ex-works C o st o f g o o d s in - Seller m ay provide
d e liv e ra b le sta te . facility but any dam age
w hile loading and unloading is

to buyer'saccount. H ow ever, if
seller charges for the help, loss
(if any) is toth e seller's
ac co unt. A n y d am age or loss
of goods from the statio n of
C ost of goods, expenses A n y d am ag e tothe goods w hile disp atch o nw ards is to th e
1 F.O.R.(Station
upto thetransporter's they are at hisw orks or w hilein b u y e r's ac co u nt.
of dispatch)
godow n, loading and transit toth e tra n sp o rte r's
unloading atthe godow n, or atthe tim e of
transporter'splace. loadinginto the vehicle(even if
it is beingdo ne b y tran sp orter)
is to the seller's account
Ill
Shipping Price to include Risk of loss to Risk of loss to s

term the seller the buyer fa
(1) (2) (3) (4)
U
3. F.O.R. Cost of goods, Any loss or Any damage or loss
(Destination) freight and insurance damage to the of goods while they
upto the buyer's goods while are at transporter's 1
station. they are at godown (after buyer
seller's works, has been notified)
• • a transporter's while loading into
godown, and the vehicle, during
during transit movement to the buyer's
(until they reach plant is to the buyer's
buyer's station account.
and buyer gets
notified) is to the
seller's account ',
(PS. Road is safe
for seller since it
intimates while
railway does not. !( i
Seller needs to w I
. . . . . . .
intimate the buyer).
4. Buyer's Cost of goods, insurance and Any loss or damage to the •;. I
Any damage to the goods
Works freight up to the security gate goods from seller's works to while taking them to the
of the buyer's works. the buyer's works is to the stores and/or at the time of
seller's account. unloading is to the buyer's
account.
Cost of goods, insurance, Any loss of damage to the
freight and expenses and goods at the seller's works,
5. At Site risks until goods are transporters' godowns, in
unloaded at the seller's transit, within the buyer's
store/site. works including while
unloading is to the sellers'
account.
Any loss or damage to the
goods until the entire work is
Cost of goods erection completed fully is to the
and commissioning sellers' account
6. Works
Contract
112 Table 5.2 gives the responsibility of the buyer and seller for each shipping term
U nit 5 B uying at the R ight P rice
Table 5.2 : Responsibilities of the buyer/seller under the shipping terms
S h ip p in
te rgm Meaning Responsibilities
Seller Buyer
(2) (3) (4)
/e r s 's Ex-works/ Sa le at sup p lier's S e lle r to b e re s p o n s ib le B u y e r i s r e s p o n s ib l e

Ex.Godown place. fo r fo r
(i) k e ep in g th e m ate ria l (i) arran g in g fo r
in d e liv e ra b le s ta te tr a n s p o r t in c lu d in g
(ii) in tim a tin g b u y er l o a d i n g o n to th e
re g a rd in g d e liv e ry v e h ic le a t su p p lie r 's
o f th e g o o d s . w o rk s.
(ii) p a y in g fo r fre ig h t
(iii) arrang ing fo r
tra n s it in s u r a n c e . (iv )
p a y in g o c tro i a nodth e r
ta x e s (v ) a r ra n g in g fo r
c o llec tio n o f m a te rials
f r o m tr a n s p o r te r s '
g o d o w n .(v i) p a y in g fo r
th e
lo c a l tr a n s p o r t in c lu d in g
it.
a t th e tr a n s p o r te r s '
g o d o w n .B u y e r is
r e s p o n s ib lefo r all
2.F.O.R.(Stati.- Sale is m ade on S e ller is re sp o n sib le fo (i)r ac tiv ities referred to
n Of ra il/tru ck at the a n d (ii) a s a b o v(iii)
e a b o v e ex c e p t (i).
dispaU :) sta tio n o f arran g ing fom r ovem ent of
(Free-u d isp a tch . g o o d s to th e tr a n s p o r te r s '
-Rail/Road) godown.
(iv ) sa fe lo a d in g inth to e
v e h ic le ( A n y d a m a gweh ile
lo ad in ge v e n if tra n s p o r te r /
r a ilw a y s is d o in g - to is
th e s e ll e r s ' a c c o u n t)
11
3
Shipping Meaning Responsibilities Buyer

term Seller
(1) (2) (3) (4)
3. F.O.R. Sale is made Seller is responsible for Buyer is responsible
(Destination) at the station of (i) to (iv) as above for all activities referred
destination (v) paying for freight above except (i)
(vi) arranging for transit to (iii) -i
insurance.
4. Buyer's Sale is made at Seller is responsible for Buyer is responsible
works buyer's plant (i)to(vi) for safe unloading
(Door (vii) arranging for of goods at his
delivery) movement of works and its
material from storage.
transporter's godown
to buyer's works
(i.e. upto gate of the
buyer)
(viii) paying octroi and
other local taxes.
5. At Site Sale is made at the Seller is responsible for —
place of storage (i) to (vii) : as above
(viii) safe unloading at the
buyer's designated
place of storage
6. Works Sale is effected Seller is responsible for —
Contract after commissioning (i) to (viii) : as above
& erection (ix) erecting and
commissioning (i.e.
ready for use by the buyer)
5.5 NEGOTIATION
Negotiation is a critical part of every purchase transaction and is the 'art of possible.'
Since one cannot get what one wants, negotiation provides an opportunity to persuade the (b)
other party to do what one would like to have without demanding it. Negotiation is the
process of planning, reviewing, analysing and discussing the information between
the buyer and the seller, to arrive at an acceptable agreement. It is, in fact an art by
which a buyer and a seller, usually face to face, tend to resolve differences to reach at the
(c)
precise terms of a contract.
Some buyers feel that the only way to secure a concession from a supplier is to be
intimidating and devious. This is not correct! True negotiation is not 'adversarial'but
114
U nit 5 B u y ing at th e R igh t P rice
'working together' to an agreement.

A real good negotiation is one in which both
parties
win something.
Som e buyers look upon negotiation as a battle of wits or an art of m anoeuvring facts.
This is w rong N
. ego tiation is essen tially an oppo rtun ity to analyse fa cts and
p ersuadeothers to agree upon certain term s.
The objectives of negotiation are as follows:
t to obtain a fair price for the specified quality of the item.
• to agree on the delivery period.
• to decide on the packaging, packing and m ethod of
transportation,
i to agree on the payment terms.
• to agree on the liability for claims and damages.
• to discuss incentives e.g. discounts, bonus clause etc.
• to decide on the frequency of progress reports.
• to agree on the common methods of inspection, time and place of inspection,

nature
and type of test certificates etc.
When to Negotiate?
Negotiation is generally desirable under the following situations:
(a) L i m i t e d c o m p e t i t i o n
N e g o tia tio n sh o u ld b e u se d w h e n th e n u m b e r o f b id d e rs is in a d e q u a te .
(b) T o o s h o r t a t i m e
N eg o tia tio n is d esirab le w h en th e b u y er d o es n o t h av e su ffic ien t tim e to
in v ite
c o m p e titiv e b id s .
115
(c) Low rupee value of the order
Loiv rupee value of the order may not justify cost of inviting and evaluating
competitivebids. (e.g. low value orders of non-recurring nature).
(d) Lack of clarity of specifications
Negotiation is desirable when specifications of the items required are not clear.
(e) Fixed price items
Negotiation is particularly useful for items of fixed price due to one or several
reasons, e.g. monopoly, collusion, seller controlling multiple sources, governmental
control etc.
(f) Knowledge of the market ,., .......
Negotiation is desirable if the buyer has sufficient knowledge of the market,

availability of the items and an average price to be paid.
What to Negotiate?
• Rate
*
First and foremost, the buyer should discuss and negotiate the basic price quoted
by the prospective supplier. A detailed cost break-up obtained from the supplier
usually gives the buyer an opportunity to find out the areas where the padding,
if any, has been done by the supplier. Having identified the areas, a skilled
buyer can always secure concessions.
. • • • - • -.. • • •• • ••:-" *
• Quantity discount
Reduction may not be possible if the items involved are out of fixed-price-
category. The buyer under such a situation may obtain a price reduction for
purchasing larger quantities of materials.
• Cash discount
f
A cash discount is a reduction offered by the supplier on his invoice value, for
the prompt payment of his bills. A2.5% cash discount though on its face value
does not represent much money but actually it is slightly more than 40% of
annual rate.
• Change in specifications
Another option open to the buyer to secure a concession from the seller is to
become the unique user of the item by changing one or more of the quality
116 characteristics of his products. This is possible if the quantity required is very
large.
U nit 5 B uyin g at the R ight Price th e
s e lle r
's
T ran sp ort ch arg es "* * * •...
b a rg
S i t u a t i o n s d o a r i s e w h e r e t h e p o t e n t i a l s u p p l i e r n e i t h e r a g r e e s t oa in
r e in
d u c e p ric e
g
n o r p a rts w ith a n y o n e o f th e frin g e b e n e fits . T h e le a s t th a t th e b u y e r c a n d o is to
c o n v in cth e e s e l le r to b e a r a t l e a s t t h e tr a n s p o rt c h a r g e s to t h e b u y e r's strep nla n t.
g th .
P a y m e n t te rm s W he
A n o t h e r m e t h o d o f g e t t i n g b e n e f i t f r o m t h e s e l l e r i s t o s e c u r en car e d i t f o r a
p e r i o de x te n d in g b e y o n d th e n o r m a l p e r io d . O n e m o n t h o f e x t r sau pp pe lr i o d o f
c r e d i t if v i e w ce ad s u a l l y d o e s n o t a p p e a r t o r e p r e s e n t m u c hie rm o n e y .
A c t u a l l y , i t i s e q u a l t o r1e.d5u%c t io n in p r ic e c o n s i d e ri n g 1 8 % a s t h e kannon u a l
c o s t o f b o rr o w in g m o n e y . ws
th a t
V e n d o r 's i n v e n to r y th e
buye
T h e b u y e r m a y m a k e t h e s e l l e r a g r e e t o m a i n t a in a n in v e n t o r y a t t h e la tt e r 's
r's
p la n t ,t h e r e b y e f f e c t i n g d e l i v e r i e s t o t h e b u y e r 's p l a n t f r o m r e a d y s t o c k s .
re q u i
A c c e p t a n c e soufc h a c o n d itio n b y th e s e lle r g iv e s th e b u y e r a b e n e fit e q u iv a le n t
re m e
to th a t o f p e rc e n ta ingventory
e carrying co st.
n ts
P a ck in g a n d fo rw a rd in g ch arg es are
u rg e
P a c k in g an d fo rw ard in g its elf is a b ig ex p e n se, ev en fo r fix e d p ricnet, item s. T h e
co m p an w y i ll b e a b le to s a v e a s u b s ta n tia l a m o u n t, e v e n if th e b u y ehr e isis a b le to
m a k e th e s e lle r a g re e to b e a r p a c k i n g a n d fo rw a r d in g e x p e n s e s . l ik e l
P rin c ip le s o f N e g o tia tio n s y to
b eco
T h e p rin c ip le s o f g o o d n e g o tia tio n a re a s fo llo w s: me
adam
• P r i o r k n o w l e d g e o f o p p o n e n t 's b a r g a i n i n g s t r e n g t h s h e l p s b u y e r t o p l a n
ant
h is
and
a p p ro p ria te n e g o tia tio n ta c tic s .
n ego
• T h e s u p p l ie r's b a rg a i n in g s t re n g th u s u a l ly d e p e n d s o n t h e f o ll ot iaw te ing
facto rs: for
term
g g g gS) e l l e r ' s n e e d f o r t h e o r d e r s : T h e l e s s e r a s u p p l i e r n e e d s t sh e c o n t r a c t ,
the fav o
g r e a t e r i s h i s b a r g a i n i n g s t r e n g t h . H o w d o e s o n e j u d g e a s u pupra l i be rl 's n e e d
fo r e to
o r d e rs ? T h e m o r e f r e q u e n tly th e s u p p lie r's r e p re s e n t a tiv e c a lls o n thhe b u y e r ,
th e i
m o r e h e n e e d s t h e o r d e r . T h e s u p p l ie r's a n n u a l p ro fi t a n d l o s s a c c o m unt can
a ls o s
g i v e s o m e id e a o f t h e s u p p li e r 's n e e d f o r n e w b u s i n e s s . e
l
h h h hT) i m e a v a i l a b l e f o r n e g o t i a t i o n : S h o r t l e a d t i m e s i g n i f i c a n t l y i m p r o v e s
f
.
117
iiii) Criticality of the item involved:The supplier is usually strong when he

knows
that he is the only one who will be able to process the job because of its
criticality.
The mere knowledge that the buyer has failed previously to procure the
item
from others makes the new supplier quote higher and become inflexible
during
negotiation sessions.
jjjj) General market conditions: General economic conditions have a

substantial
effect on the supplier's bargaining strength. When there are too many buyers
in
the market compared to the number of suppliers, the latter is usually not
flexible
during the negotiation sessions. Therefore, selection of the right time for
negotiation
is very important.
kkkk)Monopolistic status: The absence of competition generally

strengthens the
supplier's negotiation strength. The supplier can be expected to act tough if
he
knows that
• he is the only source of supply
• he is the only one who has the necessary raw materials and toolings
• his competitors will not show interest in such items
Such a supplier usually does not show any interest in the contract and
therebybuilds up pressure prior to consummation of the contract.
f) Knowledge of cost elements: A smart supplier can readily judge whether

or
not the buyer has adequate information on cost and price of the item. If
he
knows that the buyer has no knowledge of the item and its cost, the supplier
is
usually adamant in his stand.
118
2. Good initial preparation can increase your chances of success
Good initial preparation can produce positive results during negotiation.

Preparationinvolves information gathering, team formation and being clear about
t formation such as:
h
e • product knowledgee.g. what the item is, what it does, what assembly it
a is
d in, alternatives, substitutes etc.
m
i • present and future requirement of the items
e.g. job life, job quantity
n
is
tr
at
i
v
e
m
at
te
rs
o
f
t
h
e
m
e
et
i
n
g
.
T
he
bu
ye
r
m
us
t
co
lle
ct
rel
ev
an
t
in
U nit 5 B u ying at th e R ig ht Price
• cost element e.g. material cost, labour cost, tool cost, overheads etc.
• customs and practices i.e. what has been done in the past
• capacity of company's staff "
• suppliers' strength i.e. market position, range of product, financial

stability,
reliability etc.
Administrative matters such as time, date, and place of meeting also need to be
given due attention in the planning process.
3. 'T alk to the proper m an'

At the outset, the buyer must make sure that the supplier's representative(s) has
full legal authority to conclude the contract on behalf of his (their) company.
The buyer should not discuss his negotiation plan with supplier's
representatives who have no authority to make a commitment on behalf of
the company and who need to obtain approval from their superiors.
4. 'A b u y e r a lso h a s so m e se llin g to d o '

The rule may appear strange but it is a fact. Before starting discussions, the
buyer •hould mentally make the supplier ready for concessions. This is
possible if the supplier is truly convinced that the contract following the
negotiation session is in the long term interest of his company. To create
suppliers' interest, the buyer should enumerate whatever positive features of
the business transaction are. For example, the buyer may mention-
i) the growth plan of business in the ensuing years

h) his company's track record of timely payments
in) his company's fairness in dealing with the vendors "
.
While making a mention of these features, he should not exaggerate. He must

be
honest.
5. 'A g o od o ffen ce is th e b est d e fe n ce' . •

t
119
To be a successful negotiator, it is always desirable to maintain the pressure
on the person on the other side of the table. "Good offence is the best
defence" is an age-
old saying. The best strategy will be to "listen more and talk less" and to be able to
do this, the buyer should take up the role of an interviewer. For example,
let the buyer ask the seller questions such as: "What are the major elements in
your cost estimate?"
6. 'Time constraints in negotiations, as in other activities, are subject to the

80/
20 rule'
Deadlines are inevitable and common deadline spurs both sides to generate a
solution. Statistics show that 80 per cent of concessions tend to be made during
the last 20 per cent of the negotiation time. To be in the driver's seat, the
buyer should hold his concessions until late in the process.
7. 'Diversions at the appropriate time are essential for keeping control

and
avoiding bad judgement'
Direct confrontations do come up in negotiations. Tempers may rise but they

would not help. One can lose more by losing control and making bad
judgements. An experienced negotiator can divert attention away from the issue at
hand (when tempers flare) by making a joke or calling a coffee break, thus giving
him or her the edge. He also knows when to stop or say, "let us think through this
again and meet tomorrow."
8. Hard-won concessions, regardless of its value to the buyer, provide

greater
satisfaction to the receiver (the seller) of the concession
Buyer should learn to concede slowly and carefully. A quick concession will have
no value to the supplier. Also, the rate at which concessions are made affect the
supplier's expectations. A hard-won concession earns greater appreciation from
the supplier. It also gives the supplier the satisfaction that a concession has
been made.
9. 'Tact and diplomacy are necessary to make a supplier do face-saving'
Everyone likes to be appreciated. No one likes to be criticised. Having obtained

the desired concessions, the buyer should never give the impression to the supplier
that the supplier has reduced that rates because he had done some padding. The
buyer on the other hand should compliment the supplier for having agreed to the
buyer's request.
120
10. "Commitments once made must be kept"
I
i
Suppliers must learn to trust the buyer. A buyer who builds up trust with his
s n how the buyer lives
u
p
pl
ie
rs
j
c
a
n
a
c
c
o
m
pl
is
h
a
n
yt
hi
n
g.
S
u
p
pl
ie
rs
tr
u
st
in
th
e
b
u
y
er
d
e
p
e
n
d
s
o
U n it 5 B uy in g at the R ig ht P rice
*
up to the terms of the deal. Commitment once given must be kept. One
should not give one's word lightly but keep it up once it is given.
& Activity D:
Negotiate for vegetable at a local vegetable market and write down the factors
which
affect the negotiation.
5 .6S U M M A R________________________________________________
Y
R 'ght price is the price that m ust be paid to the supplier to obtain the goods of the
right quality at the right tim e. A num ber of factors, nam ely quantity, quality,
delivery, job life,
demand and supply position, degree of competition, buyer-seller
relationships, geographical
location, size of the suppliers' firm etc. have an effect on
the price.
Price inform ation can be obtained from a w ide variety of sources such as -
(i) suppliers'price lists

(ii) old records
(i) telephonic quotations
(iv) tendering
(v) letters of offer
(vi) buying personnel of sister company and so on
Price is a com posite figure and it com prises basic price, discounts, govt. levies,
packingand forw arding charges, excise, sales tax, freight, transit insurance, octroi
etc.
A shipping term signifies the place of transfer of ow nership rights and also expenses
uptothe place implied by the shipping term.
Pricing agreem ents can be either 'fixed price' agreem ent or 'cost plus agreem
121 ent'
and there are two basic m ethods to arrive at the final prices.
(i) competitive
bidding (ii)
negotiation
Negotiation is a powerful tool for the buyer to gain value for money. Negotiation
requires good initial preparation, knowledge of the suppliers' bargaining strength and
acourteous and tough personality on the part of the buyer to achieve the desired
objective.
5.7 KEYWORDS
Cash discount: Cash discount is the deduction allowed by the seller from his bills, if
the buyer makes payment on the spot or before the mutually agreed date.
Negotiation: Negotiation is the process of planning, reviewing, analysing and

discussing the information between buyer and the seller to arrive at an acceptable
agreement.
Original Equipment Manufacturers Discount: OEM Discount is the discount

offered by the supplier to the manufacturers who use the supplier's items in their original
equipment.
Off-season discount: Off-season discount is the deduction allowed by the buyer for
offseason purchases. Since these discounts are allowed on some consumer
products, they are generally not of significant importance to an industrial buyer.
Price Panel: Price panel is a committee of members of various functional areas such
as purchase, manufacturing, finance, technical, quality control, etc. to discuss the cost
details of an item and accord approval to the price asked for by the prospective
supplier.
Price adjustment: Price adjustment is the price correction based on a supplier's for
price increase, which has been reviewed, negotiated and accepted by the buyer.
r
Quantity Discount: Quantity Discount is the price reduction offered by the seller for
the purchase of goods in large quantities.
,
1 Right price: Right price is the price that must be paid to the supplier to obtain the
goods
of the right quality at the right time.
Standard Package Discount: Standard Package Discount is the discount offered

122 for >
purchasing quantity in the standard packing.
I
Trade
Discou
nt:
Trade
discou
nt is
the
deduct
ion
allowe
d by
the
manuf
acturer
off
the ;
catalog
ue (or
list)
price.
6.1 PURCHASE OF CAPITAL EQUIPMENTS
Capital equipment includes production machinery (e.g. machine tools), plant

service equipment (e.g. power generating sets, materials handling equipment),
inspection equipment (e.g. test rigs, laboratory and test equipment) and office
equipment (e.g. computers, weighbridge).
Procedure for Purchasing Capital Equipment

i/.
Though the stages in the purchase of capital equipment are identical to those for
materials, they differ substantially in content. The purchase procedure for capital
equipment is as under:
Initiation of the need
The need for the capital equipment is identified in the user departments, which are
generally manufacturing departments (e.g. machine tools), plant service department
(e.g. materials handling equipment, inspection equipment, laboratory equipment
etc.) or general management (e.g. computers, weighbridge etc.). They are
purchased for one or more of the following purposes:
i) replace existing worn-out equipment

ii) augment existing production capacity
iii) diversify in the new line of production

iv) reduce manufacturing cost
v) improve quality
vi) attain higher productivity, or
vii) modernise the manufacturing activity
viii) effect saving in labour
The intensity of the need for capital equipment is usually not high. Unlike materials,
the purchase of capital equipment can be delayed or in some cases postponed.
Equipment specifications .... , ._„,
The technical specifications for the capital equipment are drawn by the user department
on the basis of past experience, literature obtained by the purchase department from the
128
Unit 6 Project and Capital Goods Purchasing ;
•i O b tai
n in g
suppliers of such equipment, technical discussions with representatives of the
approv
manufacturingfirm s, feedback data obtained from the current users of the equipment
and opinion of the al
company's own maintenance personnel. fro m
concer
The specifications cover features such as size, weight, dim ensions, comn position,
ed
a
H.P., r.p.m., quality requirements etc. Different equipment require different u th o r
specifications. i ty
Certain com plex m achines and equipm ent require efforts for '• draw T h e ing
specifications. Prelim inary specifications are draw n by the user departm ent, which purc
are refined during discussions with representatives of manufacturing firms. hase
of
Vendorselection . . . . . r..> .-.;..... , ,; c a p it
al
Source identification and source selection process for the purchase of capital equipment equi
is sim ilar to that of consum ption m aterials. Sources are located by referring p m e to
the m anufacturers' directory, advertisem ents appearing in the trade journals, n t trade
exhibits,discussions with the manufacturers' representatives etc. re q u
C om petitive bidding criterion is applied for selecting suppliers for the purchase ir e s
of r!uadardised equipment. For the purchase of non-standardised equipment, c a p itthe
competitivetiding cannot be used, since suppliers cannot quote unless the detailed al
specifications of fe equipm ent are known. Such purchases, therefore, s arequire nc
shortlisting of tw o or three suppliers, holding detailed technical discussions and tio n
draw ing m utually acceptable specifications of the equipment and finally invitingf rthe om
suppliers to bid for the equipment | with the features they can supply. th e
m an
j Since different suppliers may offer different features, negotiation is the most a g e
appropriatemethod to arrive at the mutual acceptable terms of contract. m ent
.
E c o n o m aicn a ly s is o f th e e q u ip m e n t The
c ap it
E c o n o m ic a n a ly s is o f th e e q u ip m e n t is a l s o c a r r ie d o u t a t th is s ta g e . T h e a n a ly s is is
al
m ade
sa n ct
o n th e b a sis o f in itia l in v e stm e n t a n d s u b s e q u e n t c a s h o u tflo w s n e c e ss a ry in th e
io n
a c q u is itio n
is
o f th e e q u ip m e n t a n d th e e x p e c te d r e tu r n s f r o m th e o p e r a ti o n o f t h e e q u ip m e n t o v e r
re q u i
its
1 e c o n o m ic life . T h e m o s t c o m m o n a p p r o a c h is to p r o je c t th e a n n u a l re d
n e t c a s h in flo w s
to
and
e n su r
• o u tflo w s o v e r th e e c o n o m ic life o f th e e q u ip m e n t a n d v e rify th e p ro p o s a l fo r its
e
e c o n o m ic
th at -
•|
via
bilit
y.
129
(i) the need for the procurem ent is justified.
(ii) economic feasibility of the proposal has been considered and reviewed by the senior
m anagem ent before the requirem ent is authorised.
(in) various options such as new equipment versus old equipment, buying versus leasing
etc. have been considered.
Professional companies make use of a carefully designed form for the sanction of capital
equipment form .
Order raising
The purchase order is raised on the selected supplier. The purchase order for capital
equipment, as compared to routine purchase orders placed for the consumption materials,
is more specific. The purchase order spells out the specifications, time of delivery, mode
of transportation, m ethod of paym ent, post-purchase services etc.
Follow-up
The follow-up function for equipment purchase is distinct from the follow up function for
material purchase. The follow-up function, in case of material purchase, ends with the
receipt and acceptance of materials. It is not so in the case of equipment purchases. Under
equipment purchases, additional activities include -
• Installation of the equipment under the supervision of the technical person of the
supplier. 0 i")
• Trial run of the equipment

ffi)
• Training of workmen
• After-sales-service
Payment w iv)
The mode of payment too, in the case of capital equipment, differs significantly from that
of material purchases. Since the amount involved is very high, paym ents are made in
installments. In case of capital equipment purchased with the financial assistance from the
financial institutions, the payments are made by the financial institutions.
130
Unit 6 Project and Capital Goods Purchasing
^ A ctiv ity A ; ' ' '•''• '• •' • ' • • • - ' ' . - ' • • ' "• ' -
State at least 5 differences between regular item s purchase and capital purchase.
& A ctivity B;
\ W rite the complete specifications and description of a television for purchase.
6.2 E C O N O M IC A N A L Y SIS O F E Q U IP M E N T PU R C H A SE S
Capital equipment purchases are characteristically different from the material
purchasesbecause they involve large initial investments and the benefits accrue over a
long period oftim e. Since such investm ents are usually m ade on borrow ed funds,
the repaym ents are heavy. Capital equipment purchase decisions, therefore, are
carefully taken after detailed
economic feasibility analysis. To do this, the study of the
following components, is necessary:
i) The initial cash outflow
I) The returns (or net cash inflows calculated on yearly basis) over the economic
life ofthe equipment
i) The econom ic life of the equipm ent (to be defined by the m anagem ent).
Economic life represents the m inim um num ber of years that the
m anagem ent assigns to equipm
an ent on the basis of its com petitive use.
Economic life is usually shorter than
durable life due to technological
advancements.
iv) M inimum return desired on such investment, which is called "cutoff point."
i The "cut off point" is an important aspect of the investm ent decision. It
represents theprescribed minimum standard for the purchase of the capital
equipment. 131
If the proposed investment falls above the cut-off point, the proposal is accepted and if it
falls below this point, it is rejected.
The cut-off point under different "methods of evaluating capital investment decisions" is
decided as under:
Method of Cut off point Decision Rule

evaluation
1. Payback period Certain number of years (for The proposal whose payback
(PBP) e.g. 3 years) called "cut-off period is equal to or less than
or acceptable" period. "cut-off point" is considered a
feasible proposal.
The required percentage
2. Accounting rate return on investment (say A proposal whose ARR
of return (ARR) 25%). equals or exceeds the
prescribed return on
investment is considered -a
feasible proposal.
The cost of borrowing
llll) Net present capital. A proposal whose NPV is
value (NPV) positive is considered a
feasible proposal.
The required rate of return as
mmmm)Internal rate determined by the A proposal whose IRR is
of return (IRR) management. equal to or greater than the
required rate of return is
considered a feasible *
proposal. *
132 6.3 PURCHASE OF USED EQUIPMENT

The need for the equipment can be met either by buying a new equipment or by
acquiri is quite a developed market. There are many dealers in this market. They buy the
ng used used equipment, recondition them and sell them offa atbetter price.
equipm
ent. Used equipment can be obtained either directly from owners or from middlemen. f
Used
equipm Directly from the owners
ent At times, business firms dispose off the equipment before the expiry of its specified
market economiclife. Typical reasons for premature disposal of the equipment include -
• replacement of the equipment by a new equipment with innovative technology

I (i.e.
old m achines with sufficient unexpired operational life are discarded to
m aintain
competitive strength).
• sale on completion of the contract (i.e. equipment purchased for a certain
specific
contract may be sold at the end of the contract).
• liq off to pay the creditors).
uid
ati • closure of the firm on a permanent basis.
on
Information regarding the availability of used equipment is obtained through any of the
of
the following means
fir
i advertisements inserted by the seller
m
(i.e • some reliable indirect resource
.
wh • brokers
en • bidding in the auction
the
fir • an open auction by the creditors/liquidators 1 "'."r • • • • . * •
m
•< >
go
es • an intimation by the purchase department of the seller to the likely users
int
o • an offer to sell from the dealers in used equipment
liq
uid A dvantagesof purchasing used equipm ent are:
ati i) Lowacquisition cost: Used equipments are generally cheaper to procure. However,
on, the buyer of the equipment must consider related costs such as cost of dismantling,
the transportation, installation etc., besides price. The cost of repairs, replacem ent of
eq worn out and broken parts, resetting of worn out surfaces, painting etc. should also
uip be taken into account, especially when the used equipment is purchased under "as is
me where is condition."
nt
ma i) Shortlead time:Used equipm ent can be m ade available alm ost in negligible
y lead tim e. On the contrary, in case of new equipm ent, time lag between placing
be of theorder and receiving the new equipment is very long.
dis
po i) On the spot inspection of performance : The performance of the used
se equipmentcan be verified on the spot, if the equipment is in operation. Such a
d facility is usually
not available in the case of new equipment.
13
3
iv) Better integration with existing machines: Old equipment at times are more
suited to the buyer' s requirements if -
• the buyer already has such old models
• such models have been discontinued by the manufacturers.
v) Economy of operations: Old equipments prove economical by operation, if they

are required -
• as standby equipment
• to perform temporary work
• to execute a short-lived project
Disadvantages of purchasing old
equipment
Used equipments suffer from the following disadvantages:
i) Short life expectancy
ii) Technological obsolescence
iii) Higher down time costs: The frequency of breakdowns of used equipment is higher.
iv) Higher maintenance and repairs cost: Maintenance and repair costs in used
equipments are relatively higher. Sometimes, cheaper used machines prove costlier
in real terms.
v) Non-availability of performance guarantee: The seller may hide the limitation oi

the equipment and exaggerate its features to induce the buyer to make a purchase.
Since the sale of the used equipment is usually under "as is where is condition," there
is no operational guarantee.
vi) Non-availability of insurance spares

in
vii) Non-availability of instruction manuals, drawings, diagrams etc. -
viii) Inability of comparison of offers: Since the offers to sell the used equipment are
made on "as is where is" basis, they can never be compared.
ix) Purchases from own funds

m o re P u rc h a se r's " D o L ist" fo r C a p ita l E q u ip m e n t P u rc h a se s

C apital equipm ent purchase is the m ost creative form of purchasing. T he risks to the
buyer's firm are far greater than those with production m aterial. A lso, each equipm
its ent has
own set of considerations and term s and conditions, which the buyer m ust include in his
negotiation schedule and subsequently in the agreem ent. T hough specific term s and
conditions w ill differ in purchases of com puters, plant construction, vehicles, production
, if they
m achinery, office equipm ent, inspection and test facilities etc., the objectives of
arethe exercise
com m on: They (i) to obtain the best value (ii) to avoid heartburns (iii) to reduce the firm 's
risk (iv) to m inim ize life cycle cost. The follow ing "D o list" m ay be typical
considered a
checklist for the purchase of a m ajor capital equipm ent.
Placeof delivery
Place of delivery - the point of transfer of ownership rights from the seller to the the buyer and
responsibility for the cost of transportation depends on the shipping term\\ork, e.g. sellers'
F.O .R . (place of dispatch), F.O .R . (place of destination), B uyer's w Forks, o r h ea
atvy
site.
eq u ip m en t, it is usua lly d esira b le to nego tia te term s o f d elivery
site" aors "Buyer's
"A t
w orks."
P ackin g an d cra ting c osts
Packing and crating costs are generally high in case of bulky and/or heavy equipm ent. A
jnt is higher. suppliers' requests for a flat percentage of 2% 73% tow ards packing cost, especially in
;se of expensive equipm ent, m ay m ean a big expense and, therefore, should be review ed/
o sts in u sed
irove costlier
In sta lla tio n o f e q u ip m e n t
If the equipm ent involves preparation of special foundation, wiring and plum bing work,
> lim itation of
foundation drawings must be requested for, prior to shipment of the equipm ent. helpThe seller's
le a purchase, m ay also be requested for installation and it should appear as a suitable clause in the
ndition," there purchase contract.
Seller's technical assistance during start-up
The new equipm ent can give problems during the initial break in period. Thebesupplier m ay
tc. asked to provide assistance for the first few days of working, so that production
can be losses
avoided.
i equipm ent are
Sp arepa rts a n d su p p ly co n tracts
The buyer is usually in a better position to negotiate for spare parts kits for free or at
reduced price. W hen negotiating/finalising the terms of the machinery. It is equally important
135
Materials Management •
to finalise the long term price of supplies (e.g. paper and toner of a copying
machine), since, in some cases, the cost of supplies over the life of the equipment
represents more than or the investment in the equipment itself.
Service and maintenance contract
In consultation with the maintenance staff, the buyer, wherever possible and
desirable should negotiate with the supplier service and maintenance contract,
thereby making the supplier agree to the contractual obligations to provide
maintenance of the equipment.
Trade-in-value of the old equipment
Negotiation may also be necessary for the trade-in-value of the old equipment to be
adjusted in the price of the new equipment. If the seller is not willing to trade in on the old
equipment, the seller's assistance in the removal of the old machinery should be
sought.
Operator training
Sophisticated equipment - not existing at the company - may require skilled

operators,
Free training at the seller's works or buyer's works by the seller's staff should
be
incorporated into the equipment contract.
M
;
Warranties
>
One of the warranties that relieves the buying firm of the responsibility for the design is
the warranty that the equipment is "fit for the intended use" and that the seller
understands the use to which machinery will be put at site. The buyer may also like to
negotiate an extended warranty for a period of one or two years in place of the
usual 3 months or 6 months warranty.
Buyer's acceptance of the equipment
''
The buyer should negotiate with the supplier the time period for which the equipment
must
136 work satisfactorily at the buyer's works before it is considered to have met the
"acceptance"
criteria and can be considered for payment in full. The buyer should get the seller's
agreement
that VTI (the lowest level being the most favourable and preferred option) are as
the follows:
final
part of
the
payme
nt will
be
availa
ble to
the
seller
only
after
the
equip
ment
passes
the
buyer'
s
accept
ance
criteri
a.
Payme
nt
option
s
Kt
Vario
us
paym
ent
option
s
availa
ble to
the
buyer,
listed
from
level I
to
level
Payment level M eaning
1 Payment in normal terms e.g. 2% -10 days, net - 30 E qui

days. pm e
n Payment after equipment has passed the buyer's nt to
acceptance conf
orm
criteria. stat
11! Payment on proper installation and satisfactory utor
y
performance.
requ
nnnn)Payment on receipt of the equipment. irem
oooo)Some advance (15-30%) with significant portion ent
payable
i The
on successful installation and satisfactory performance.
buyer
V I •; Progressive payment (as it is being built). is not
VH Deferred payment e.g. 20% advance, 70% on proof expect
of ed to
dispatch, 10% on proper installation. know
each
Advancebank guarantee (ABG) and performance bank guarantee (PEG) and
every
The buyer should obtain advance bank guarantee (A BG ), if a significant am ount is to aspect
be •isid to the supplier as an advance. The supplier should also be m ade to provide of the
PEG , thereby assuring successful perform ance of the m achine after the gover
installation andu)mmissioning for the mutually stated period. nm ent
regula
Penalty for the late delivery charges tions ,
and
LD charges should be negotiated and suitable clause should be included in the
specif
contract. Atypical LD clause may read as under:
ic
"D elivery isthe essence of this order. A penalty charge of 0.5% per w eek subject regula
to m axim um of5% shall be levied, if delivery is not effected within the specified tions
period." applic
able
Indem nification of the buyer's com pany to the
m achi
' The seller should be m ade to agree to indem nify the buyer's com pany in the event nery
of any being
• em ployee of the seller or his contractors' m eeting w ith an accident w hile perform ing procur
the ed. To
w ork at buyer's site. The seller m ust have his em ployees covered under the safegu
Em ployee ard,
Insurance Scheme.
the
jll
137
buyer should discuss with the seller and make him agree to include a clause in the
contract guaranting that the equipment shall meet required/essential standards
relating to statutory requirements (e.g. grounding of electrical equipment,
automatic shutdown, hazardous odours and fumes etc.).
Life cycle costing
The equipment selection should be based on life cycle cost (LCC) rather their
installed cost.
JS$ Activity C;
State at least five benefits and five disadvantages of purchasing an old equipment.
Activity D ;
Prepare a list of items that you will check for when purchasing an old used car.
6.4 PROJECT MANAGEMENT
A project, by definition, consists of a set of non-recurring activities that must be performed in

a particular order, w ithin the given period and estimated expenditure, to create a specific
result(i.e. a product or a long term utility). W here output of a project is a product, such
products aregenerally characterised by immobility during transformation. The transformation
of such productsare carried out in "fixed position assem bly type of layout", w hich can
be observed in the production of ships, locom otives and aircraft, construction of roads
and bridges.
Projects have the following basic characteristics
(a) A project is a one-time activity with a well defined set of desired goals.
188
p p p pA) p ro je c t h a s a d e fin ite s ta rt a n d a d e fin ite e n d .

q q q qA) p ro je c t c a n b e d iv id e d in to a n u m b e r o f a c tiv itie s , m a n y o f w h ic h re q u ir e
to b e
p erfo rm ed in a p artic u lar seq u en c e .
rrrr) T h e re q u ire m e n t o f re s o u rc e s fo r th e p ro je c t a re n o t u n ifo rm .
s s s s )A p ro je c t g e n e ra lly in v o lv e s m a n y ta s k s an d a re p e rfo rm e d b y d iffe re n t
a g e n c ie s .
T h e ta s k s u s u a lly h a v e s tr ic t p r e c e d e n c e a n d c o - o rd in a tio n b e tw e e n a g e n c ie s
is o futm o st im p ortan ce.
tttt) P ro jects are u su ally su b jected to u n certain ty . O ften , d elay tak es p lace in th e
co m p letio n
o f th e p ro je cts, re su ltin g in co st o v erru n s.
u u u uS) in ce a site fo r a p ro je ct m ay b e in an u n d erd ev elo p ed reg io n an d it m ay ch an g e
fro m
p ro je c t to p ro je c t, th e re is d islo c a tio n o f n o rm a l life - le a d in g to p e rs o n n e l
p ro b le m s
(e.g . h ig h em p lo y ees tu rn o v er)
( h ) T h e p r o j e c t m a y b e u n d e r t a k e n b y t h e c o m p a n y i t s e l f ( i . e . b y c o m p a n y 's
o w n e n g in e e rin g o r p ro je c t d e p a rtm e n t) o r b y a n o u ts id e a g e n c y
(i) A p ro ject has a defin ite life cy cle.
ivo ject m an ag em en t refers to th e p lann ing an d ex ecu tion of th e pro ject in th e m ost
effectiv me a : e r i.e . m ak in g o p tim u m u se o f re so u rc e s o f tim e , m o n ey an d m e n .
T h e c o s t o f m a n y a m e d iu m s iz e tu rn k e y p ro je c t to d a y ru n s in to c ro re s o f ru p e e s
a n d th erefo re, ev ery d ay 's d elay in co m m issio n in g also resu lts in h eav y p ro p o rtio n ate
lo sses.
D elaysin com pletion of the projects

• tend to increase investment in work-in-process.
• delay in invoicing and therefore reduction in working capital.

» penalise the contracting firms when the completion lags behind the agreed date
(since most of the contracts of the projects contain a penalty clause).
• result in unwelcome additions to the fixed manufacturing cost, as men and 139
machines
are employed beyond the economic time scale.
» delay addition of the product to its related product line.

M a te ria ls M a n a g e m e n t >>•'
All the purchase parameters like quality, delivery, price, place, source etc. are also
applicable in the project purchases and the buyer must assist the project manager in timely
completion of the project, without any time and cost overrun.
Stages in Project Procurement
According to Mehta, Patel and Sood, there are four distinct stages in project procurement -
(i) Detailed engineering stage
(ii) Pre-ordering stage
(iii) Order execution stage s

'
(iv) Dispatch stage
The key activities to be performed in each of these stages are briefly explained below:
1. Detailed engineering stage
This stage involves activities both technical and commercial, which form the inputs
for the next stage and reduce project duration (Fig. 6.1)
Third party inspection agencies Cross verification of technical

specifications
Detailed Engineering
Stage
Long delivery items Finalisation of list of approved
vendors
Finalisation of commercial
terms with approved
vendors
Fig. 6.1: Engineering Stage I
(a) Cross verification of technical specifications
The technical specifications prepared by the consultants should be cross verified

by the project team considering Operation, Maintenance, Safety, Pollution,
Statutory requirement etc.
tfnit 6 Project and Capital Goods Purchasing
(b) Finalisation of the list of approved vendors
A list of approved vendors should be drawn for all items required for
completion of the project. This will save valuable time which is otherwise lost
in locating andselecting vendors at the time of pre-ordering stage (i.e. time that
is lost in selectingvendors for enquiries and/or placing orders). The
suppliers should be selected after thorough analysis of their technical
capability, quality assurance capability, financial capability, managerial
capability, past performance, employer-employeesrelationship, etc.
(c) Finalisation of commercial terms with approved vendors
Commercial terms and supply conditions should be discussed with all

approvedvendors, well before floating the actual enquiry. This would save
a lot of timewhich is otherwise lost at the time of placing the order. The
following commercialterms need to be settled to the satisfaction of the
parties concerned:
• Advance payment , . , . , , , . . .
Advance payments should be linked with the achievement of
important milestones such as submission of drawings, placement of
orders for major raw materials, opening of Letters of Credit for
imported raw materials etc.
to push the vendors for speedy completion
of orders.
• Main payment
Main payments should be made only on receipt, verification and
acceptanceof all required despatch documents and test certificates.
Since bankpayments usually cause delay in receipt of materials at
site and risk ofpayment of demurrage/wharfage charges, the release
of payment throughbank should be discouraged.
r • Retention amount
The last installment of payment (may be 10%) should be released
only after receipt and acceptance of materials at site, to eliminate the
problem of follow-up in the event of short receipt of materials and
non-submission of test certificates by the vendor.
!»
• Delivery period
Delivery may be considered to commence with the date of release
141of
the
order by courier/fax and not linked with the release of any advance
payment. Also, the delivery may be considered completed only on
the receipt of material at site and not on the date of despatch of
material. Such a delivery clause makes the vendor accountable for the
delays in transit. He will exercise care in selecting reliable transporters.
Penalty for delayed delivery
A penalty clause should be incorporated in the purchase order to

exert moral pressure on the supplier to deliver material as per
schedule. The penalty for late delivery should be applied to the total
order value and not to the delayed portion of the order.
Bonus Clause
A Bonus Clause should be inserted in the purchase orders of items

critical to the project to inspire the supplier complete the order
early.
Performance Guarantee Clause
A performance guarantee clause should be discussed and

incorporated into all the purchase orders, making the supplier
responsible for satisfactory performance of the item/product/equipment
supplied by him. The guarantee period should be large enough to
provide
• sufficient time after commissioning to ascertain equipment performance.
• buffer towards unforeseen delays.
A typical performance clause may be as under:
"The supplier shall guarantee satisfactory performance of the equipment

for a period of 12 months from the date of installation or eighteen months
from the date of despatch, whichever is later."
(d) Long delivery items
Long lead time items should be identified and their orders should be placed
on top priority. The dates of other boughtout parts should be finalised,
considering the delivery time of long lead time items, so that they do not
remain in stock unnecessarily.
lit
Unit 6 Project and Capital Goods Purchasing •
(e) Vendor list of bought out items
Tier 1 suppliers should be supplied with a vendor list for all bought out items, so !*-
that the quality of such boughtout parts is ensured.
.4, •
(f) Third party inspection agencies
Third party inspection agencies and their scope of work should be clearly
identified for various project orders to be placed with different vendors.
2. P re-order stage
The Pre-order stage involves activities that help speeding up delivery during actual order
execution (Fig. 6.2) such as:
• Project procurement board/committee
• Pre-bid discussion
• Fixed price bid
• Obtaining offer for spares during the lifetime (say 5 years)
• Personal commitment of Owner/Managing Director

• Selection of the vendor prior to freeze actual specifications
Personal commitment of Formation of project

owner/M.D. procurement board/
committee
Selection of vendors
prior to freezing actual
specifications
Fig. 6.2
143
(a) Project procurement board/committee

Project procurement decisions are usually committee decisions. A committee
consisting of senior staff from Purchase, Finance, Actual user and Project
Manager should be formed to jointly select vendors. However, in case of
a disagreement, the Project Manager's decision is to be considered final.
(b) Pre-bid discussions

Pre-bid discussions are held with all qualified vendors of equipment manufacturers
and high value items, prior to submission of their final offers. The discussions are
intended to provide technical clarifications, so that all the participants are absolutely
clear of the requirements and there is uniformity in their technical offers.
(c) Fixed price bids/No regret price

Fixed price bids (or no regret price bids) are invited to obtain bottom line price.
Under this method of price bidding, the vendors are expected to submit their '
competitive bids from day one as they are not given a second opportunity to
revise their bids later (i.e. there is no price negotiation and suppliers) are selected
on the basis of lowest bid). Vendors are generally informed regarding fixed
price condition during pre-bid-discussions session.
Fixed price bids have the following advantages:

(i) It helps in obtaining the most competitive price since the suppliers, scared
of losing a large value order, tend to submit the lowest bids initially only.
(ii) It helps in speedy fmalisation of orders, at the right price.

(iii) It reflects the buyer's image of integrity and fairness in awarding contracts
to vendors.
(iv) Once the "no price negotiation" policy of the company gets known in the
market, the vendors start submitting their most competitive bids.
(d) Selection of vendors prior to freezing the actual technical specifications

In any project, the specifications of items such as electrical items, instrumentation
items, cables etc. are usually finalised only in the last stage of detailed engineering.
However, in view of long delivery period of such items, the suppliers require to
be selected as early as possible. In order to take care of these two conflicting
situations, the enquiries are floated when hardly 50% of the detailed engineering
has been done. The vendors are given provisional requirements, based on
;» 5 !* estimated bill-of-material, with a clear understanding mat they (the vendors)

will start actual manufacturing only on the receipt of frozen technical
specifications
t
from the owner or their consultant. By this method, the long lead time of
floating enquiry and selecting vendor can be avoided. Since vendors
and prices are already decided, the order for the actual requirement may
be released directly by the consultant, once the technical specifications are
frozen.
(e) Offers for spare parts requirements and annual maintenance

contracts
! Vendors usually quote (or charge) exorbitant prices for spare parts and
maintenance contracts, after the supply of the original equipment. At times,
the cost of spares is higher than the cost of the equipment. The problem
can be avoided by
|c (i) making the vendor quote prices of maintenance spares and services
required during the life time (say 5 years) of the equipment,
alongwith offer/quote for the equipment.
(ii) informing suppliers that their offers (bid prices) will be evaluated in
totality (i.e. total cost of the equipment and spare parts).
This forces the vendors to give competitive prices of the spares, which can
become reference prices for the orders of spares to be released at a later date.
(f) Personal commitment of the owner/M.D.
•*! Since project procurement involves high value purchases, a meeting

should be held with the owner/CEO/MD of the supplier, to seek his
personal commitment for timely delivery.
3. O rder Execution Stage .
The order execution stage involves activities which help speedy execution of
the procurement process (Fig. 6.3). These activities are:
• Interaction with consultant
• Release of a clear techno-commercial order
• Receipt of progress reports from suppliers
• Joint approval of drawings
• Confirmation of statutory approvals 145
• Periodic meetings with the vendors

• Issuance of despatch clearance/material release note.
Periodic meeting with

Issuance of dispatch
vendors
clearance
Interaction with
consultant
Order Execution
Stage
Release of a clear techno-

commercial order
Confirmation of
statutory approvals
Receipt of progress report from suppliers Joint approval of drawings
Fig 6.3
(a) Interaction with the consultants

The consultant's role - preparation and finalisation of technical specifications
-in project purchasing is of vital importance. Timely release of technical
specifications is essential for timely completion of the project. Periodic meetings
should be organised, with the project manager, consultants and suppliers, to
provide clarity and answer queries.
(b) Release of techno-commercial order

Clear and complete techno-commercial purchase orders should be released
immediately on selecting the vendors. The tendency to raise a letter of intent
followed by release of confirmed PO later should be curbed. It is better to issue
technically and commercially clear orders from Day One.
(c) Receipt of progress report from vendors

Vendors should be required to submit a bar chart giving the schedule of major
activities/milestones at the earliest and fortnightly progress reports thereafter.
Vendors should also be required to submit unpriced copies of purchase orders
placed with the suppliers of boughtout items and copies of Letter of Credit for
imported raw materials and components.
Unit 6 Project and Capital Goods Purchasing s
h
o
(d ) Statutory approval by the vendors
u
At times, vendors may have to obtain necessary statutory approvals from various l
government authorities/departments. Target dates should be fixed, after discussion d
with the vendors and progress against these targets should be monitored
Ap periodically. b
e
(e) Dispatch clearance
Vendors should be issued a Material Release Note without loss of time, as a
soon as the materials are accepted by the inspector. Often, it is found that the d
despatch clearance is delayed because the inspector has to report the v
inspection results to the Project Manager at the head office, who has to i
confirm the necessity of materials at site and then give clearance for s
dispatch and/or mode of dispatch. e
d
Good project management demands that the inspector visiting the vendor for '
, inspection should be in the know of the urgency of the material at site and should t
issue a Dispatch Clearance or Material Release Note soon after successful o
completion of inspection.
(f) Solving vendors' supply related problem s s
e
Periodical analysis of vendors' progress reports may suggest that the l
progress It, of work at a particular vendors' place is not satisfactory. The Project e
Management c
team has to analyse the vendor's problems and help the vendor solve them. t
For j£ example, if a vendor is not able to obtain materials from sub-vendors, on t
account r
of shortage of funds, the Project Management team may modify either a
the n
vendor's payment terms or pay the sub-vendors directly. s
p
4. Dispatch Stage o
The Dispatch stage concerns post production activities and includes the r
t
following:
e
• Selection of the transporters r
• Receipt of dispatch s
documents -
t Compliance with • who
requirements hav
e an
(a) Selection of the transporters offi
ce
The vendors should be given a list of approved transporters. The supplier at/n
ear the project site.
• who are on the list of approved transporters.
147
(b) Dispatch documents *

I
The purchase order should spell out clearly the set of documents that
must accompany the equipment/material consignment. Generally, the
following documents together constitute the set:
• Original packing list

• Original lorry receipt
•
• Copy of invoice
'
• Copy of Material Release Note
• Original test certificates
For materials dispatched through a bank, the vendor should be advised to

forward an advance set of non-negotiable dispatch documents through
courier.
(c) Compliance with requirements

For over-dimensional consignments,
• the trailer must comply with safe and road worthy conditions.
• approvals should be taken from the concerned authorities such as
Railways.
Forest Department, Public Works department etc.
£$ Activity E;
State at least 8 differences between regular items purchase and Project purchase.
6.5 SUMMARY ________________________________________
Capital equipment includes production machinery (e.g. machine tools), plant

148 service equipment (e.g. material handling equipment), inspection equipment (e.g. test
rigs, laboratory equipment) and office equipment (e.g. computers, weighbridge).
Capital equipment purchases are significantly different from consumption material

purchases. Capital equipment purchases are non-recurring and involve a large sum
of money. Specification of capital equipment are usually detailed but relatively
flexible. Lead time for procurement is usually large. Capital equipment decisions are
influenced by tax considerations.
Aproject is a one-time activity with a definite start and a definite end. Aproject
usually involves many tasks that are performed by different agencies. Project
purchasing differs from purchases of consumption materials. Since in most of the
projects, almost 70 to 80% of the total cost of the project relates to materials, close
co-ordination between project management group and purchasing is essential.
Project procurement involves four distinct stages: (i) Detailed engineering

stage (ii)Pre-ordering stage (iii) Order execution stage (iv) Dispatch stage.
6.6 KEYWORDS
Capital equipment: Capital equipments are the machines or equipments which we

can use for a long period (more than one year)
Project: Aproject, by definition, consists of a set of non-recurring activities that must

be performed in a particular order within the given period and estimated expenditure
to create
a specific result.
6.7 SELF-ASSESSMENT QUESTIONS_____________________________________
Ql. Describe the sequence of activities involved in making the purchase of a

capital equipment.
Q2. "Various methods are available to ascertain the economic viability of capital
purchase." Discuss any one of these methods, giving the salient features
thereof.
Q3. How does Project Purchasing differ from Consumption Materials Purchases?
Q4. What are the key stages in Project Procurement? Briefly describe the
activities involved in each of these stages.
Q5. Explain the concept of project purchasing. How does it differ from
routine purchasing? What additional precautions should a purchase manager
take in Project
Purchasing? 149
7.1 INTRODUCTION TO TRANSPORTATION

Transportation costs account for a very significant portion (in some cases as high as 40%)
of the material cost. There exists very high potential exists to reduce these costs.
Functions of the Transport/Traffic Department
The functions of the traffic department can be placed under three broad categories:
(i) Functions relating to incoming shipments (i.e. consignments to bring goods from
suppliers).
(ii) Functions relating to outgoing shipments (i.e. consignments to ship goods to the
customers).
(iii) General functions (i.e. records maintenance, claim settlements, co-ordinations etc.)
(a) Functions relating to incoming shipments, which include
(i) Selecting the appropriate mode of transport (i.e. railways, trucks, air, parcel
post or internal waterways).
(ii) Arranging collection of materials from the suppliers. •••••
(iii) Notifying discrepancies (if any) to all concerned,
(iv) Verifying freight bills.
(v) Attending to other miscellaneous transport related matters such as loading,

unloading, weighing, checking etc. as instructed by the purchase department.
(b) Functions relating to outgoing shipments, which include
(i) Getting the consignment prepared (i.e. collecting, packaging and packing), if
instructed by the sales department.
(ii) Selecting the most suitable mode of transport for prompt and economical delivery
to the customer.
(iii) Attending to the customers' instructions, as outlined in customers' orders, and/

or instructed by sales department.
(iv) Prosecuting claims for damages and losses in transit and following up until final
settlement.
U nit 7 T ransport and Traffic M anagem ent
(v) A ttending to custom ers' com plaints relating to transportation.

' (vi)
V erifying freight bills and forw arding them to accounts for paym ents.
(c) G en eral fu n ctio n s, w h ich in clu d e-
-; •*..** -• -"f
(i) M aintenance of up-to-date transportation/traffic records.

(ii) K eeping track of all the papers concerning m ovem ent of goods.
(iii) C o m p ilatio n o f tran sp o rtatio n co sts an d circu latin g th em to th e co n cern ed
departm ents.
(iv) P reparing transport budgets and controlling transport expenses, so to rem ain
within the budgetary lim its.
jiB--
w "' (v) D eterm ination of freight rates and their classification.
(vi) Ensuring safe and speedy m ovem ent of m en and m aterials at m inim um transport
cost.
,.,-'"<
7 .2 C O N S T IT U E N T S O F T R A N S P O R T A T IO N C O S T
ijor constituents of transportation costs are:
(i) Packing cost
(if) Documentation cost
w 'HP'-' 'r''*>'',l *>,"M s -'.'-vf • • •
(i) L o a d in g c h a rg e s
(iv) Freight
(v ) L o c a l c le a ra n c e c h a r g e s
(vi) D em urrages
iv ii) L o s s e s d u e to p ilfe ra g e s , b re a k a g e s e tc .
(v ii) C o s t o f tra c in g m iss in g c o n s ig n m e n ts
(ix) T ransit insurance| | (x ) C o s t in c u rre d in
lo d g in g in s u r a n c e c la im s
I n s p e c tio n c o s t o f d a m a g e d g o o d s
I (xii) Unpacking cost

-ii
(xiii) Unloading charges >.,: •
If the
(xiv) Warehousing charges goods
are to
Factors that determine Transportation Costs be
transp
Major factors that have a bearing on transportation costs are as follows: orted
to a
Value of the product
small
The higher the value of the product to be transported, the higher is the transportation city
or
rate. town
from
Volume of goods moved wher
e
Transportation costs are lower if the volume of goods to be transported is there
more (e.g. A full truck/wagonload would be cheap in comparison to quarter is
wagonload or half wagonload). little
or no
Density chanc
e of
The denser the product, the easier it is to load into a carrier and consequently lower
gettin
are the transportation rates (e.g. cloth is cheaper to transport than cotton bales.)
g a
Space required return
ship
Bulky items cost more to transport, as they require more space and transportation ment,
rates are higher as they are based on space required (e.g. cotton bales). the
rates
The place to which the goods are to be transported are
highe transportation costs.
r.
Packaging requirements
Specia
l The greater the packaging requirements, the higher are the rates. i
servic
es
requir
ed
Speci
al
servic
es
such
as
speci
al
conne
ction
and
stopo
ver
privil
eges
increa
se 7.3
154
Unit 7 Transport and Traffic Management
Competition
The rates also depend on the demand and supply of the carriers. If a large
number of carriers are available, the rates will be lower.
> & A ctiv itv A ;

S ta te a t le a s t 1 0 d if f e r e n t c o m p o n e n ts o f c o s ts a s s o c ia te d w ith a tru c k /te m p o i n
your
region. • .
& A c tiv ity B ;

L ist at least eig h t factors w h ich affect selectio n of tran sp o rt.
7 .3 M O D E S O F T R A N S P O R T
V ariou s m o d es of tran sp o rt serv ices are av ailab le in o u t co u n try , w h ich are u tilised by
the buyer at one tim e or other. T hey are:
(i) Post parcel
(i) P arcel d eliv ery serv ice (o r co u rier serv ices)
(m ) Road service
(iv) Rail service
(v) A ir service
(vi) W ater service
i (vii) Pipeline • ' • . - .
(vi) O verhead ropew ay
155
(a) Post Parcel

Parcel post is suitable for valuable materials that are small in size. Parcels below
one meter in length and weighing less than four kilos are accepted as ordinary
parcels by post offices. Parcels weighing more than 4 kg but up to 20 kg are
accepted as registered parcels. Parcels are also accepted as insured parcels
and VPP parcels.
(b) Parcel Delivery Service (or Courier Service)
Parcel delivery service is offered by private operators wherein a courier
accompanies the parcel, normally by overnight travel.
Courier service is ideal for carrying spare parts, samples, vital life saving
drugs, documents etc. Most of the courier services claim to deliver within 24-48
hours and dutiable goods within 72 hours.
(c) Road Transport
Road transport includes the different means of transport such as motor cars,
trucks, tankers, tramways, annuals and carts and is the most important mode of
transport in the industry. Road transport is the country's second largest internal
transport, which provides the only mechanised transport in hilly, rural and
backward areas which are not connected by rail. It also serves as a feeder to
rail heads.
Advantages/Merits of road transport
Door-to-door service
Road transport provides door-to-door service. Goods can be collected from
the centers of production and carried directly to the destination, if it is full
truck/lorry load. This is perhaps the most important reason for its
popularity. Loading and unloading charges are reduced in road transport if
there is direct transportation of goods to the final destination.
Suitable for short distance
Road transport generally proves to be quicker and cheaper than railway
transport, when the distance involved is small. This is the reason why
perishable goods like vegetables, fish, fruits and flowers are generally sent by
road transport.
Multiple use of roads
Road transport is convenient for carrying goods to the interiors and remote parts of
156 the country, where other means of transport cannot reach easily and quickly.
Flexibility
Road transport is a flexible means of transport as changes can be made easily, quickly
and with limited expenditure. There is no fixed schedule or time table for road transport
Vehicles can move at any time according to the need. Like airways, it is not
tied down to fixed routes and time schedules.
Safety
Road transport is reasonably safe and secure, particularly when goods are door
delivered without any break and loading and unloading in transit. The possibility of
loss due to thefts and breakages is limited.
Disadvantages of road transport:
L ess reliable
Road transport is less reliable than railways. Breakdowns, road congestions, delays
due to road accidents, floods, heavy rainfall etc. make road transport less dependable.
It is also affected by weather conditions.
Absence of uniform rates
Road transport is managed by the private sector. The transport charges are not uniform
and subject to frequent changes.
Not suitable for long distances
Road transport is inconvenient and uneconomical for transporting heavy, bulky and
low value goods over long distance.
Not suitable for bulky goods
Road transport has limited carrying capacity. It is not suitable for carrying heavy and
bulky goods, costly and low grade goods.
(d) Railway Transport
Railway transport is the most important and popular means of transport.
Indian Railways carry almost 75% of the goods and passengers traffic. It is most
suitable for long distances and for bulky goods.
M erits of railw ay transport
Highspeed
Railways have considerable speed because of the use of electricity and automation,
straight railway lines and absence of disturbances on railway tracks. Due to high
speed, a lot of time in transportation is saved. Goods can be taken quickly to

far
away places.
High carrying capacity
Railways have very large carrying capacity and, therefore, bulky goods can be taken
economically from one place to another. Food grains, fertilizers, petrol etc. are carried
conveniently by railway transport.
Regularity of service
Railways offer regular, reliable and dependable service. Railway is a public utility. It
has a fixed time table from which it does not deviate.
Transport charges
Railways are owned and managed by the state. Naturally railway freight rates are
low and also uniform in all parts of the country.
Dependable
A railway network operates regularly and continuously, as per fixed schedule. Railway
is less affected by weather conditions and is a dependable mode of transport.
Limitations of railway transport:
Absence of flexibility
Railway transport is rigid and lacks flexibility. Railway provides transport facilities
only between certain fixed points. It carries goods from one railway station to another
only.
(e) Water Transport
Water transport (rivers, canals, sea and creek) is the oldest, cheapest and the most
natural means of transport. Water transport is suitable for carrying bulky and low
cost goods.
There are two kinds of water transport: . :"
(i) Inland water transport and (ii) Ocean transport

U n it 7 T ran sp o rt an d T ra ffic M a n ag em en t
In lan d w ater tran sp ort
It includes river transport and canal transport. It is useful for internal

transportation of goods.
In river transport, rivers are used for internal transport of passengers and
goods. Small boats and steamers are used for this purpose. This transport
is cheap and convenient. In India, river transport is very common in Kerala
state. It is essential to keep adequate depth in the rivers, so that they will be
available throughout the year for transportation.
Canals are the artificial waterways specially constructed for navigation and
irrigation. The well known Suez canal in Egypt is the finest example of the
use of canal for transportation. This type of transportation is mainly useful for
local transportation. Like river transport, it is cheap and safe.
Inland water transport is not developed much in India. Only a few industrial
sectors like jute, timber etc. make use of this transport.
O cean transport
Ocean transport refers to the transport facilities in the open sea. Big passenger
ships, cargo ships, tankers and tramps are used in ocean transport.
Ocean transport is classified into two categories, namely coastal shipping

and overseas shipping. Coastal shipping is possible in the case of countries where
borders touch the sea shores. Coastal shipping is carried by big ships and
boats. It is an economical means of transport. Coastal transport is generally
restricted to the national shipping companies.
Overseas shipping is the transportation between different
countries. Advantages/Merits of ocean transport
C heapness
t> >
Ocean transport is the cheapest mode of transport. It is the only means of
transport
available for transportation between different countries which are separated by
sea. Ocean transport is economical, as it is a natural means of transport.
t99
Suitability
It is very suitable for carrying bulky goods over a long distance. It is convenient for
transportation of goods between different countries.
Ocean transport is used in India for import of bulky/heavy goods from other countries.
Disadvantages of ocean transport
(i) Cargo carried by sea is subject to deterioration in quality because sea water is
corrosive.
(ii) Sea transport requires strong and much better packing of goods.
(iii) Sea transport runs the risk of losses due to inclement, weather choppy seas and
possibly of shipwreck.
(f) Air Transport
Air transport has made a revolution in the field of transport. It has made the world
smaller.
' • *
Merits of air transport
High speed
Air transport is the speediest of all means of transport. A lot of time is saved due to air
transport.
Suitable for light/valuable articles
Air transport is particularly suitable for movement of delicate and perishable goods.
Low packaging cost
Air transport entails low packaging cost, which partially offsets the higher freight
cost
Lower lead time
Being the fastest mode of transport, it reduces lead time and therefore enables the
firm to operate with smaller inventories.
*
Demerits of air transport
* H igh cost of operation
Freight rates are very high, due to high operational cost.
Unreliable
Air transport is also uncertain and unreliable. Flights are cancelled very often due to
unfavorable weather conditions. Cancellation of flights is very com m on during the
rainy season and in winter due to heavy rainfall, snow, fog etc.
L acks flexibility
Air transport lacks flexibility. It provides service from one airport to the other. As a
result, air transport needs the support of other means of transport.
(g) Pipeline
Pipeline service is used to transport crude hundred of m iles from Assam. Pipelines
are used to bring crude and finished products to and from the refineries.
Major pipelines are as under:
Sr. No. From /To
2. 3. 4. 5. From A nkleshwar to Baroda From B aroda to Ahm edabad

From G auhati to Barauni
From Barauni to Kanpur
From
Salya to Varm gam
(h) O verhead Ropew ays Service
i Steel, cement and similar other sectors use overhead ropeways to transport
materialsfrom the mines to factory. The initial investments are high but the
operating costs are
lower.
Selectionof M ode ofTransport r
Correct n of the mode of transport requires a comparative study of all modes vis-a-vis to merits
selectio and demerits. The following could be the broad points for the comparative analysis:
Value of shipment
Value of shipment is the first factor which influences the selection of the mode of transport.
Costly items require more careful handling and carry greater liability on the part of the
carrier. Usually, high value consignments are transported with lesser concern for
transport cost. Road transport may be preferred over rail transport for expensive
goods.
Nature of consignment
Nature of consignment may restrict the selection of the transport. Bulk liquids, inflammable
liquids, dangerous articles etc. are transported via tankers, tanks and trucks.
Perishable goods are routed through carriers who provide heater or refrigerator
services.
Speed of transport n
Air transport is the speediest among the modes of transport. Railways ranks next for
speed where long distances (over 500 km) are involved, followed by road transport.
However, over short distances, road transport is faster than the rail transport.
Cost of service
Inland waterways is the cheapest method of transport and air transport is the costliest. If
the freight cost of inland waterways is taken as base, then the freight cost is almost twice
the cost of inland waterways.
• Rail transport is two times costlier than inland waterways.
• Road transport is two times costlier than rail transport and four times costlier than
waterways.
•*
• Air transport is 40 times costlier than water transport, 20 times costlier than rail
transport and 10 times costlier than road transport.
Flexibility of service
Road transport provides the maximum flexibility of service compared to any other mode
of transport. Its route and times can be adjusted to the needs of the customers. It offers
door-to-door service, which reduces carting expenses and loading and unloading charges.
Regularity of service
R ailways ranks the first am ong all m odes of transport in term s of regularity of
service.Railway transport is a public utility. It has a fixed time schedule, from
which it does not
deviate.
A ir transport m ay be placed second (next to railw ays), road transport third and
w atertransport fourth, considering regularity of service.
D istance involved
Road transport is generally economical for transporting goods or consignments

weighingbetween 1 to 15 tonnes, within city lim its, over short distances and
medium distances of about 500 km . For longer distances (over 500 km ) rail
transport is usually econom ical.
7.4 TR AN SPO R T D O C UM EN
__________________________________
TS
Transport documents are the receipts issued by the transport organisation to the
consigners(or sender of goods) in acknowledgement of the receipt of goods by them
and acceptance of responsibility for carrying the goods to the destinations, in return
for specified charges
which are called freight.
Transport documents contain:
• Consignor's and consignee's nam es and addresses.
• Nam es of the places of departure and destination.
• Details in respect of the goods such as num ber of packages, their weight, value
and
nature,
• Inform ation as to goods carried at Carrier's risk or O wner's risk.
• Details in respect of freight (paid/to-pay)

• Date on which the document is issued. 163
The main transport documents used by trade are: ' ' n

,,
(a) R a ilw a y R e c eip t (R R )

RR is the acknowledgement of receipt of goods by the Railways authorities
and acceptance of the responsibility to carry goods to the railway station of the
receiver of the goods (consignee). The railway receipt is received by the
consigner (sender of the goods). The consignee takes the delivery of goods
from the station against the railway receipt. Alternatively, the consigner can
route the RR to the consignee through the bank. The bank hands it over to the
consignee against the payment of amount stipulated in the invoice. The
consigner (i.e. the seller) thus is guaranteed of the payments of the goods sold. The
RR is transferable by endorsement.
(b) L orry R eceip t (L R )

LR is the acknowledgement of the receipt of goods by the transport organisation
and acceptance of its responsibility to transport the goods to the consignee (i.e.
the buyer). The consignee obtains the delivery of the goods from the transport
company against the lorry receipt. The consigner can send the lorry receipt to
the consignee through the bank and collect payment for the goods sent.
(c) B ill of L ading

A bill of lading is a contract of affrightment for the carriage of goods from the
port of dispatch to the port of destination. It is either signed by the captain of the
ship or by the ship owners. It is prepared on the basis of the Mate's Receipt,
which is a sort of kutcha receipt given by the ship-owners to the consigner,
when the former hands over the goods on the ship. Then the consigner or the
shipper gets the bill of lading from the ship-owners, against the submission of
the Mate's Receipt. It is issued in triplicate, is transferable by endorsement and
delivery can be sent through a bank to collect payment of goods. A bill of
lading may be qualified or clean. A qualified bill means that the ship-owners have
found the packing unsatisfactory. A clean bill indicates that the packing of goods is
properly done.
(d) T h e A ir C on sign m en t N ote o r A irw ay B ill

It is an acknowledgement of receipt of the cargo and acceptance of the
responsibility , by the airlines for carriage of the goods under the specific
conditions of the carriage. The airway bill is issued in triplicate. One copy is
retained by the carrier, one copy signed by both the carrier and the consigner
accompanies the goods and the third copy is to be kept by the consigner. The
airway bill has the following particulars.
165
• The place and date of issue T
• The places of departure, destination and stoppages
• The names and addresses of the consigner and the consignee
• The particulars of goods

• The numbers of packages, their weight, quantity, volume, dimensions etc.
• The apparent conditions of the goods

• The amount of freight and person liable to pay
g$ Activity C;
List five benefits of road transport
£$ Activity D;
Mention five benefits of railway transport.
7.5 REDUCING TRANSPORTATION COSTS_________________________

(a) A buyer should route the consignment and not leave to the vendor to decide
the routing. This gives the buyer a number of benefits.
(i) Carriers get to know the buyer as an important customer,
(n) Buyer get priority with respect to rates, service claims
etc.
166
Unit 7 Transport and Traffic Management condi
tions
of the
vvvv)C arriers should be selected based on the areas serviced by them , in order
to get carriag
better rates and service. e.
wwww)T he purchase department should prepare a list of preferred carriers and

the same
should be referred, to each time a purchase order is raised.
xxxx)T he number of carriers should be restricted so as to avoid being a general

customer.
yyyy)V endors should be instructed to follow routing instructions rigidly. The vendors
should
be warned that they will be back charged for excess freight, if they do not
follow the
instructions.
7 .6 S U M M A R________________________________________________
Y
Transportation cost forms a significant part of material cost. Land, water and air are
three main forms of transport. Land transport consists of two means of transport
viz. road andrail transport.
Railways is a quick, regular and economical means of transport for carrying bulky
goods over long distance. Railways, however, is unsuitable for short distance, is
inflexible anddoes not provide door to door service.
Road transport is suitable for perishable and delicate goods. Road transport,
however is unsuitable for bulky goods and transportation of goods over long
distances.
Sea transport is a preferred mode of transport to move bulky goods over

enormousdistances. Goods in a sea transport, however, are susceptible to pilferage
and deterioration.
Air transport is the fastest among all the transports and also the costliest. It is best
suited for transport of perishable, light and costly goods.
Besides the above four basic modes of transport, others means of transport include
parcel post, courier service, pipeline, overhead ropeway etc.
7 .7 K E Y W O R D_______________________________________________
S
Airway Bill: It is the acknowledgement of receipt of the cargo and acceptance
of the responsibility by the airlines for carriage of the goods, under specific
167
8.1 INTRODUCTION TO STORES MANAGEMENT____________________
Storekeeping is a service function which deals with the physical storage of goods
under the custodianship of a person called the storekeeper or store-controller.
Goods stored may be either, "Stores" or "Stocks."Unworked material or raw
materials are usually referred to as "Stores" and the place where they are kept is
known as the "store-room." Finished products ready for shipment are usually
called "stocks"and are housed in a place called the "stock-room. "Storekeeping,
therefore, is that aspect of material, which is concerned with the physical storage of
goods.
Store function concerns the receiving, movement, storage and issue of materials
-raw materials, bought out parts, piece parts, tools, spares, consumables etc.
-required for the production, maintenance and operation of the plant, and
finished goods until its dispatch to the customers.
According to Maynard, the responsibilities of Stores Management are "to
receive materials, to protect them, while in storage, from damage or
unauthorised removal, to issue the materials in the right quantities, at the right
time, to the right place and to provide these services at the least cost."
Necessity for Storerooms and Stockrooms

Store rooms and stock rooms would not be necessary, if raw materials are used as
soon as they arrive at the factory and the finished product is shipped as soon as it is
completed. However, this cannot happen because of the following reasons:
-O •:.•.:••
i) Lead time required for procurement
Raw materials, in a majority of the firms, are used in varying amounts and at
varying times, to satisfy the market demand, which is varied. Since it takes a lot
of time to procure materials, they are stocked to meet the production
requirements in the future.
ii) Economy in buying
Purchasing on a day-to-day basis is neither possible nor economical. To effect

economy in buying and reduce the transportation costs, purchases are made in
large quantities, because of which space must be provided for the storing of
materials.
iii) Business constraints
Large purchases are, at times, necessary to satisfy business constraints like

172 the supplier's minimum quantity condition, packing size, seasonal availability,
etc.
Unit 8 The Stores Function
iv) Forward buying
Forward buying - buying large quantities of an item in anticipation of an increase in

its price - is yet another reason why large quantities are purchased and stocked
to be consumed at a later date.
v) Prevention of loss of sale
To prevent loss of sale in a competitive market, it is usually necessary to

ensure a prompt delivery for which products are frequently manufactured in
advance of sales. Provision, therefore, is made for the storage of finished
goods in a "finishedgoods store" or "warehouse."
vi) Economy in manufacturing
Frequent production runs increase manufacturing cost, reduce production

capacity and make the work of production control difficult. Therefore, in
order to perform manufacturing operations economically (i.e. to reduce the set-
up cost) certain parts are produced in large quantities. These parts are stored in
what is known as "finished-parts-stores" and are taken out when required for the
final assembly.
vii) Reduction in the operative's idle time
Cutting tools, hand tools, measuring instruments and gauges required in an

engineering firm are usually issued to the workmen in the beginning of the shift,
which are returned at the end of the shift or on the completion of the job. To
reduce the time for return and the issue of tools, separate stores called "crib
stores" are attached to production shops, each crib store to serving one or more
shops.
/gf Activity A;
State five reasons for the necessary storing of material.
173
8.2 FUNCTIONS OF STORES
The major functions of stores are as follows:
(a) Identification is the process of describing, classifying and codifying all items that
require to be stocked.
(b) Receipt is the process of inwarding all required materials, forwarded by external
sources or internal manufacture, after due verification of quantity and quality. It also
includes the preparation of the appropriate receipt document (called Goods Inward
Note or Goods Receipt Report), which forms the basis for payment of the suppliers'
bills by the company's accounts department.
(c) Inspection is the verification of all incoming materials for quality. Even if a separate
inspection department exists, it is the responsibility of the store to offer materials for
inspection and take them into stock only after they have been verified for quality
against pre-fixed specifications.
zzzz)Storage is the providing for the right and adequate storage and preservation to ensure
that the stocks do not suffer from damage or deterioration because of inefficient
storage. It also includes the operation of handling and storage equipment to facilitate
the easy location and retrieval of materials, keeping the optimum space utilisation.
aaaaa)Identification and location of stock is the process of formulating and updating

a
system of stores and coding, so as ensure efficient identification and location of goods
and services held within the store operation.
bbbbb)Security of stores is the process of providing security cover within the stores
buildings
and stockyards to prevent the theft of stores and damage to the company's property.
The security aspect also covers adequate measures to prevent damage, fire and
spillage.
ccccc)Stock control is the process of recoupment, receipts and issues of stocks, so as

to
ensure adequate stocks to serve the production needs, keeping the inventory
investment within the desired limits.
(h) Issues and dispatch is the process of receiving demands from consumers in the
form of authorised material requisitions/issue slips, selecting the required items and
handing them to the users without loss of time. If external customers are to be served,
this activity may involve packing, loading and dispatch through the appropriate mode
of transport (i.e. rail, road, sea or air).
(i) Stock records is the maintenance of up-to-date records of receipts, issues

and balances, which serves as an efficient basis of stock control.
(j) Stores accounting is the process of recording details of stock movements

and balances in terms of financial value. It involves decisions on the appropriate
method of the pricing of stores issues (e.g. FIFO, LIFO, Weighted Average,
etc.), so that money spent on materials is properly allocated and the product is
correctly costed.
(k) Stock verification is the process of physically verifying the quantities of

materials and their condition at specified intervals, to see if they tally with the
quantities shown in the stock records. It includes the investigation of
discrepancies and adjustments in the records thereof.
Q) Surplus management is the process of minimising the surplus and obsolescent

stock through proper inventory control and the effective disposal of surplus and
obsolete items.
(m) Administrative control is keeping a vigil on the discrepancies, abnormal
consumption, deterioration, accumulation of stocks, etc. and enforcing the
appropriate control measures.
(n) Co-ordination and co-operation involves interfacing with other departments

such as engineering, purchasing, production planning and control,
manufacturing, quality control, accounts, etc.
& Activity B;
Mention at least seven functions being carried out in a nearby industry/factory.
S ystem s of S to ra g e
Basically, there are two systems of storage: (i) a closed stores system and (ii) an
open
stores system.
(i) Closed Stores System: In such a system, materials are physically stored in a
closed area. Except stores personnel, no other person is permitted into the area.
Movement of materials in and out of the store is permitted only when 175
accompanied by the authorised documents.
Closed stores system allows a tight security arrangement and rigid material
accounting.
(ii) Open Stores System: In such a system, materials are stored as close to the
point of consumption/use (there are no store room) as possible.
An Open Stores System allows little or no security and is useful when
• Materials are too heavy/bulky to handle (for example, heavy castings).
• There is little or no chance of pilferage or theft.
• Materials have a negligible chance of spoilage/deterioration.
Such stores systems are suitable in mass production units, wherein I\

materials are arranged at the work stations as per the requirement and the
available space. The storage facilities have a direct access for the workmen.
No authorised document is needed for issuing materials.
The responsibility of Stores in this system is to move material to production

areas, arrange for physical storage, in consultation with production supervisors,
and obtain the necessary issue documents. Further, the responsibility of the
materials stored in these production areas lies with the production
supervisors.
The open stores system cuts down paper work considerably, as the material is
issued in bulk and not against individual work orders. No perpetual inventory
records are kept. The actual consumption is ascertained by finding the
difference between the stock at the beginning and at the end of the period.
8.3 TYPES OF STORES________________________________________________
Functionally, there are the following types of Stores:
1. Receiving store performs activities necessary to exercise control on the

quality and quantity of purchased materials, before they are accepted and
taken into stock.
Receiving store may be sub-divided as under:
(i) In ward store to keep incoming materials until they are accepted and taken
into stock.
176
It- (ii) Quarantine store to temporarily stock materials which are under dispute and
require suppliers' (or transporters') certification (for example, quantity
discrepancy in the consignment, transit damage to the goods, etc.)
(iii) Rejection store to stock defective (non-conforming) goods, until they are sent
back to their suppliers.
2. Main Store performs activities concerning the storage and issue of accepted
materials and the maintenance of records. Main store may be either centralised
and housed in a large godown or decentralised and located near the point of use.
Main store may be divided as under:
i) Crib store to stock cutting tools, hand tools, measuring instruments and gauges
s. etc. to be issued to the workmen in the beginning of the shift and to be received at
the end of the shift (or job).
ii) Finish part store to stock components and parts produced in lot sizes in the
company's own plant.
t*(
^ iii) Plant (or maintenance) store to stock spares of plant and machinery.
iv) Sub-stores (Raw materials stores) to stock bar stocks, castings and forgings
etc. which require a lot of space and can be stocked in areas open to the sky.
ddddd)Warehouses (Finish Product Store) to perform activities concerning receipt,

packaging and packing, dispatch of finished goods to different destinations
and the handling of connected papers and documents.
eeeee)Special Stores to perform activities of receipt, storage and issues of special

materials. Typical examples of special stores are:
fffff) Bonded Store to stock materials "hypothecated with banks" and to stock
"excisable goods."
ggggg)Statutory Store to stock materials, namely kerosene, diesel and other petroleum
products requiring a strict conformance to safely precautions which have been
stipulated as statutory regulations.
hhhhh)Temperature Controlled Store to stock perishable items such as meat, fish,

mil etables and fruits or goods like rubber and rubber parts, active
k, ingredients like antibiotics and vitamins and others which require a temperature
veg controlled store-room.
17
7
5. Scrap Yard to perform activities of receipt, segregation and the storage of

different types of scrap.
8.4 STORE LOCATION

"Store location is the process of selecting the appropriate site for the store building in
the organisation and deciding how materials are to be placed inside the store (i.e.
decidingthe spot in which an item is to be placed) so as to provide efficient and
prompt service to the user departments. "
Store location to a large extent influences the efficiency of the

manufacturing/service departments and it is a function of higher management. The
location of the store must be based on the activity relationships between Store and
the different departments.
Principles of a good store location are as follows:
1. Economy in cost of transportation
The store location should be such that unnecessary material handling is

avoided. Store building/store should be located close to the place of work,
where materials are required.
2. Approachability by rail/road transport
Raw material like coal, coke, manganese and ores should be stored in the open
and in such a way that they can be easily removed by trucks, cranes and
conveyors.
Also, the location of the store should be approachable by rail or road transport.
3. Efficient Service
Location of the store should result in efficient service to the user departments
for which activity relationships between the store and the user departments
must be given due consideration. II
As a general rule
• raw material store - forgings, castings, bar-stocks, etc. - should be

located
near the shops where the initial operations are performed.
• finished parts store should be placed closer to the assembly bays.

Unit 8 The Stores Function d
e
p
• finished goods store should be located in the proximity of the shipping
ar
area. t
m
4
• jigs and fixtures should be stored near the machines at which they are e
nt
used. to
pr
• tools and supplies required on day-to-day basis should be stored near e
the v
production shops. e
nt
4. R educed fire risks
cr
Materials should be stored in locations which minimise fire hazards. For o
w
example, di
n
• Inflammable materials like petrol should be separately stored. g/
c
• Combustible materials such as paints, oils, greases, diesel, kerosene, etc.
o
should
n
be kept away from each other and from general stores.
g
• Oxidising agents should be kept away from combustible materials. es
ti
5. Security o
n
For security reasons a
n
• The Storeroom should be away from the main gate of the premises. d
to
• The Storeroom should not be located near the factory wall, where it is likely
a
to
v
be broken into by outsiders.
oi
• The Main Store should be placed in such a way that suppliers' d
representatives, th
drivers and others do not have easy access. e
n
6. M inim isation of risk of spoilage and deterioration e
e
While selecting a suitable site for the store, due consideration should be given to d
the requirements of temperature, humidity and light. to
s
7. Flexibility (for future expansion) hi
ft
While selecting the Store site, future expansion needs must be considered.
th
Sufficient space should be available for future expansion of the store
e Store to another location at a later date.
£79
8. Overall integration of factors
Since it is almost impossible to satisfy each and every factor, store location should be
such that it results in an overall integration of factors.
JS$ Activity C:
List the factors that you will consider when locating a store for the storage of material for
deliveries to the retail outlets in your city.
8.5 LAYOUT OF STORES
Store layout means the physical arrangement of space for storage, materials movement,
material handling equipment, office and its records, and thereby providing for the most
efficient receipt, storage and issue of materials.
The main criteria for store layout are .• :
i) Easy receipt, storage and issue of materials
ii) Sufficient space for the easy movement of men and of the material-handling equipment
in) Optimum utilisation of storage space ,
iv) Clear identification of materials
v) Quick location of items
vi) Ease in physical stocking
vii) Protection against fire risk to the store and the rest of the establishment
viii) Easier and efficient supervision of store
ix) Adequate capacity and provision for future expansion

The general principles of locating materials within the Store are given below:
Characteristics of the material Preferred location in the store
iiiii) High usage items As close to the issue counter as possible

jjjjj) Heavy items that are difficult Near the point of use, or near broad to
transport gangways, or near the gate, or in the
open
kkkkk)Oils, greases, paints or messy items In a separate store
lllll) Inflammable and dangerous items In an isolated fireproof place, with a
sprinkler system
mmmmm)Rubber and rubber parts In an air-conditioned store
nnnnn)Costly items like bearings, etc. In locked cupboard and away from the
entrance to the store
7. Bulky items impervious to weather hi the outside yard

1,2,3...
L ocation N um ber .
In small factories, where there is one small store, the storekeeper generally will
remember the location of material but in large industrial units, where several thousand
items are handled, the storekeeper can't bank on his memory. To assist the
storekeeper in the easy location of the item, some sort of system of the location of
materials is necessary.
Location number of an item implies the precise spot in the Store, where the
requisitioned material can be found. Proper locationing
i) provides convenience in the receiving and issuing of stock.
ii) helps to know where each and every item is kept. This avoids the need to
remember. In any case, with thousands of items in store, it is impossible to
remember the place in the store where the item is kept.
in) eliminates the possibility of wrong issue of the item.
iv) improves housekeeping and renders a neat and orderly appearance to the
store.
v) reduces the possibility of misplacement of items.
vi) makes the task of physical stock taking simple and efficient.
One of the most popular locationing systems in Indian industries is described below:
• All the racks from one end of the store to the other are serially numbered as
181
• In each rank, the shelves are alphabetically numbered from top to bottom as A,B,C,
etc.
• The pigeon holes in each shelf are numbered numerically from left to right.
For example, the location number 03-D-02 will represent
• third rack in the store
• fourth shelf from the top (denoted by D) in the third rack
• second pigeon hole from left.
j
Where materials are located on the floor or in open yards (as in the case of open
storage system), the storage area is marked off by painting the floor area into blocks
and codified in a similar manner.
Activity D ;
Analyse and write how the layout is done for the storage of material in any nearby retail
outlet.
8.6 IDENTIFICATION OF MATERIALS

Identification of materials is the tracing of the part description or part number
including size, material of construction, source of supply, batch number, etc. Proper
identification is necessary to
• ensure the issue of the correct items.
• sort out the mix-up of materials of the same size but of different specifications.
• track the identity of the batch number through the different stages of operations.
Different methods of identifying materials are given below:
ooooo)Tagging: Identification tags, made of paper board or tin plate, giving the
necessary
information, can be either kept along with items or tied to the item itself.
182 ppppp)Labelling: A label may be fixed with a cellophone tape on the item or its
container.
qqqqq)Writing or plating: Identification details can be written on the cartons /
drums /
ite
m
s
in
in
k,
gl
as
s
m
ar
ki
ng
cr
ay
on
s,
pa
in
ts,
et
c.
rrrrr)E ngraving:Vibrating m arking tools can be used to engrave identification details.
sssss)Embossing:The part number or any other details such as the material of construction,
, batch num ber, date of m anufacture, supplier's nam e / code, direction of flow, etc.
; may be cast on the item.
ttttt)Stamping:M etal punches can be used to stam p the code on the metal com ponents.
7. E tching:Stam ping operation m ay not be desirable on certain com ponents (for

example, on bearing surfaces). Code number in such items may be etched by chemicals.
. L.
8 . C olour coding:R aw m aterials/rubber parts in different specifications m ay be
identified by colour codes.
14 Typical Layout Plans
A few typical store layouts are given below:

1.
A layout of a small store in a

small scale industrial unit is
shown in Fig 8.1. The seating
arrangement, filing cabinet,
storage equipment and the#
arrangement of the equipment
to form aisles is shown in the
figure. Numerals in the figure
represent the following:
1. Entrance
a) Storekeeper
b) Issue clerk
c) Filing
cabinet
d) Storage Fig. 8.1: Layout of a Small Store
racks
Layout of a sm all store
18
8
8.7 P R E SE R V A T IO N O F ST O R E S
Industries use various types of stores like hardw are, fragile glassw are, rubber parts,
paintsand colours, m achinery parts, etc. T hey are m ade of m aterials, som e of w hich
deteriorateby nature. T he storek eep er m u st ensure th at they are free from dam ag e
an d deterioration a n d m a in ta in th e ir re q u ir e d p ro p ePrtie
re ses.rv a tio n , te c h n ic a lly ,
is th e p ro te c tio n sto
o f re s fro m h e a t, m o istu re , d u st, c o rro sio n , ru st, fire , e tc . so
a s to m a in ta in m a te riain lsiheir original form .
D eterio ra tio n an d ca u ses o f deterio ration
D eterioration im plies reduction in the value of an item (i.e. drop in ability of the
item ) to fulfill the functions (i.e. specific purposes) for w hich it w as
purchased /fabricated. M any
factor
a contributes to stock deterioration. T he follow ing
are the im portant ones:
uuuuu)F a u lty sto r a g e a r ethaas t a llo w d a m p to e n te r v ia b ro k e n w in d o w s ,

v e n tila to rs ,
leaking roofs and badly fitted doors.
vvvvv)F a ilu r e to fo llo w su p p lie rs' sto ra g e in strausctio

p ronv sid ed o n th e
p ac k ag es o r
delivery docum ents.
w w w w wF)au lty tem p eratu re an d h u m id ity con dition s of sto rag e.
xxxxx)F au lty or careless hand ling of m aterials

that cause breakages, leakages,
scratches,
dents, dam ages, etc.
yyyyy)C o n ta m in a t io n o f m a te roia
n lsa c c o u n t o f th e sto ra g e o f d iff e re n t
m a te r ia ls in
close proxim ity (for exam ple, storage of oil drum along w ith food item s).
(f) F ailu re to ob serve first-in -first-ou

that causes
t old stock to be left unused
thereby
m aking the item (s) to becom e useless on acco unt of the expiry of shelf life.
Agents of deterioration .
T he agents of deterioration are as per the figure given below :
ass
Agents of Deterioration
f Physical and
1
Biological
Climate and chemical agents agents
environment * 1 1 1
• Rainfall Physical i
Chemical Micro r
Insects Rodents
• Humidity agents agents organisms
• Wind (low • Sunlight • Moisture
air pressure) • Heat • Salts
• Wind • Acids
• Dust • Alkalies
• Gases
Fig. 8.4: Agents of Deterioration
These agents cause deterioration as detailed below:
zzzzz)Sunlight (ultra-violet rays) causes chemical reaction in materials, either

acting
alone or in company with other agents like moisture or oxygen (for example,
textiles, plastics).
aaaaaa)Heat causes oxidation, making the materials brittle and in extreme cases
causes
fire.
bbbbbb)Wind assists the movement of contaminants such as CO2, SO2, H2S, etc.,
which
adversely affect the leather and textile goods.
cccccc)Dirt, dust and grit being hygroscopic, absorb moisture from the humid
atmosphere
and cause deterioration in some materials.
(e) Salts accelerate the corrosion of ferrous metals.
Biological agents are the living organisms which may be classified as
(a) Micro organisms, which can be further divided into:
(i) micro-organism of vegetable origin (called fungus)
(ii) micro-organism of animal origin (called bacteria)
Both categories thrive on food, oxygen, moisture and humidity. Their effect can
be eliminated by using air tight containers, storing materials on proper dunnage,
186
U nit 8 T he Stores Function
I covering stocks by tarpaulin, exposing damp stores to the sun to remove moisture
i (for example, textile, leather etc.).
(b) Insects include termites, bamboo-borers, woole bears, cloth moths, etc.
Deterioration due to insects can be prevented by using insect-proof packing,

;
spray of D.D.T., inserting napathalene balls between layers of cloth, inspecting
articles at regular intervals, treating materials with insecticides like creosote,
DDT, Gammaxin, aldrin, chlorodine etc., treating the ground with insecticide
before erecting the building, stacking materials on anti-termite products.
(c) Rodents. Their effect can be minimised by
• using floor of bricks or concrete.

• fixing tin sheets at the edges of doors and windows,
locating windows at least one meter above the floor level,
covering open ends of wipes with barbed wire,
trapping and killing rodents.
offering poison baits to rodents to destroy them,
fumigating rat holes.
Preservation Measures
Preservation measures depend upon:
i) the nature of the items
ii) the duration for which an item is to be preserved.
General rules for Preservation
A few common rules for preservation are:
i) Materials should not be allowed to have direct contact with the floor. They should be
kept on raised platforms called dunnage. This prevents moisture from ground, dust,
insects, etc., from attacking materials.
n) All items, particularly those with a limited life, should be issued on "first-in-first-out"
principle.
18
7
iii) The user department should be informed of the expiry date in advance.
iv) Store should also be given periodically a spray of suitable pesticides or fungicides
to get rid of termites, white ants and fungi.
v) Items should be kept as far as possible in the suppliers' original packing provided
by the manufacturers (for example, roller bearings are greased and wrapped in
impregnated papers).
vi) High precision and high value components, spares and instruments should be
stored in temperature-controlled stores.
&Z Activity E;
Visit a nearby retail outlet and list down the preservation methods used by them in
the store.
8.8 SECURITY OF STORES

Security of stores includes measures against (i) theft by outsiders (ii) pilferage by
employees (iii) malpractices by stores staff (iv) precautions against fire protection and
(v) pest control measures to contain rodents and termite menace. Adequate
precautionary measures against these must be worked out in advance and
implemented. The measure should include:
• Daily closing of stores and custody of keys.

• Marking of stores.
• Storage of expensive and scarce materials.

• Movement control of incoming/outgoing vehicles.
• Indemnity bonds or bank security from store employees.

• Enquiry and disciplinary action against defaulters.
• Fire fighting equipment

• Pest control measures.
188
Unit 8 The Stores Function ggggg
g) A
ll
S e c u r ity o f In sta lla tio n s d
.•, u
•>.- p
li
The Store manager has to ensure that all installations, which include the following, c
are a
secure: t
e
i. Store buildings. All doors, windows, skylights, entrances, shutters and other k
possible means of entry are secured, so that unauthorised persons are prevented e
from entering store buildings. y
s
i Store offices. All cupboards, cabinets, filing systems, desks etc. must be secure s
and kept locked. No valuables should be left in the office. The office must be h
kept locked when not in use. o
u
ffi. Stockyards. The entire stockyard should be security fenced. The fencing should l
be checked daily. Any breakages or damage to the fencing must be d
repaired. The stockyard gates and stockyard office and all locks must be b
secure. e
k
iv. Marshalling areas. Normally marshalling areas are difficult to secure e
because of the high degree of access by the other departments such as p
materials handling, production control, etc. However, mobile stocks can be t
secured by use of lockable pallets i.e., pallets with metal cages fitted on the top u
with a lockable entrance. n
d
v. Work-in-process. All stocks held as work-in-process must be secured and e
correctly recorded. r
t
vi General. Regular inspection of all installations is essential to ensure h
e
security. Daily closing of stores and Custody of keys c
u
dddddd)Daily closing of stores should be properly supervised. s
t
eeeeee)Stores' keys must be numbered and registered. Written instructions should be o
issued, d
nominating the persons responsible for the maintenance of the keys. During off y
duty o
hours, keys should be kept in a locked key safe under the supervision of a f
responsible t
* person of watch and ward. h
e
ffffff)"Key movement" register should be maintained. Any one collecting and s
depositing a e
key, particularly after the factory hours, should be required to sign the n
register. i
or officer.
hhhhhh)Loss or misplacement of a key on each occasion should be thoroughly
investigated.
Old locks should be replaced in case of even the slightest doubt.
189
Marking of items
Items of high value and which can be easily pilfered should be marked in some way
to identify their ownership and origin. Marking is desirable because
• it discourages theft as marked stock cannot be easily sold to outsiders.
• ownership of the stocks, in the event of theft and subsequently the recovery, by
the
police or the investigating agencies, can easily be established.
Marking of stocks can be achieved in different ways as follows:
• Colour marking by paint.
• Embossing or engraving trade mark
• Marking by dye (this method allows the dye to get transferred to the hands of
the
thief when touched by hand).
Control of entry into store installations
No unauthorised person should be permitted to enter the Store area. This can be
achieved by
i. Constructing counters so that unauthorised persons cannot easily enter the

stores.
ii. Adopting a system of pass cards, wherein passes are issued by the management
only to those persons who should be in the Store at any given time.
iiL Installing electronic sensors, which ensure entry to only holders of specially
coded pass-cards issued by the management.
Prevention of theft by outsiders
To check theft by outsiders, the following measures should be taken:
iiiiii) The entire factory should have a high compound wall or a high barbed wire
fencing.
jjjjjj)The number of windows, glass shutters and open ventilators should be

190 the
minimum possible.
kkkkkk)All windows and skylights should be capable of being securely

fastened. They
m
us
t
al
so
be
fit
te
d
wi
th
ba
rs
an
d
ir
on
-
m
es
h.
Unit 8 The Stores Function and
oxygen
llllll)Security guards should be put on duty at strategic points. .
mmmmmm)O utsidersshould not be permitted to enter the store beyond the
serving counters.
Prevention of pilferage by employees
The following steps should be taken to check pilferage by the employees:
nnnnnn)O nly authorised personnel should be allowed to enter the store.
oooooo)N o personal property should be allowed to be kept inside the store.
pppppp)Items liable for pilferage should be monogrammed with the company's

name or
marked for some kind of identification
qqqqqq)Fresh materials may be issued against return of old ones.
rrrrrr)Surprise checks of a section of Store items should be done every now and
then.
ssssss)Immediate enquiry should be conducted, as soon as any case of malpractice is

brought
to light, and punishment for pilferage should be given adequate publicity.
tttttt)Store staff should be searched before they are allowed to leave the main gate
after
the day's work.
Prevention of M alpractices by Store Staff '

M alpracticesare the manipulations by store personnel with the active
help of outsiders.The following steps help in checking malpractices by store staff:
uuuuuu)O utgoing trucks, trolleys, parcels etc. should be thoroughly checked.
vvvvvv)G ate passes should be issued for taking any material out of the company.
wwwwww)Indemnity bonds or bank security must be taken from store
employees.
Prevention of fire
Fire isan accident caused by the chem ical reaction between com bustible
materials
191
M a teria ls M an ag em e n t re •< •<
The following precautions should be taken towards fire prevention in Stores:
xxxxxx)Doors and staircase should be made of fire resistant materials
yyyyyy)Smoking should be prohibited in and around the store houses.
zzzzzz)Adequate earthing should be provided to the external and internal wiring of

store
buildings.
aaaaaaa)Leakage of inflammable oils, greases and fluids should be prevented.
bbbbbbb)Combustible materials should be stored in covered metal bins
ccccccc)Defective wiring should be immediately replaced to eliminate the possibility of

fire
due short circuit.
ddddddd)Since inflammable materials can undergo spontaneous ignition on account of

slow
oxidation coupled with inadequate ventilation to remove the resulting heat, they should
be stored appropriately.
eeeeeee)Those parts of buildings where inflammable materials are kept should be well
insulated
to reduce the risk of fire spread.
fffffff)Exits should be provided with panic bolts and should open outwards.
ggggggg)Telephone should be provided at strategic locations, with a ready access to

the
telephone numbers of the fire brigade.
hhhhhhh)Material inside the stores should be stocked keeping a fire hazard in mind:
Enough clearance (around half a meter) between the wall and the storage rack should
be provided.
iiiiiii)Appropriate fire fighting equipment (e.g. fire extinguishers, sand and water-buckets,
water sprinklers etc.) should be provided at strategic places.
jjjjjjj)Smoke detectors should be installed in all Storehouses, to detect an outbreak of fire.
kkkkkkk)Fire alarms should be provided at appropriate places, to sound

emergency
communication to all.
U n it 8 T he Sto res Function
8.9 SUM M ARY

Storekeeping is that function of M aterials M anagem ent, w hich deals w ith
receiving,movement, storage and the issue of material under the custodianship of a
person called the
storekeeper or store-controller. Store room s and stock room s are
necessary because m aterials are not used as soon as they arrive at the factory and
the finished productshipped
is as soon as it is completed.
There are two system s of storage: (i) a closed stores system and (ii) an open stores
system .Stores are of five types: Receiving store, M ain store, Finished parts store,
Special storeand Scrap yard.
The m ain function of a store are: classification and codification of item s to be

stored,inwarding materials forwarded by external and internal sources, verification of
the quantityand quality of incoming materials, storage and preservation, issue and
dispatch, maintenance
of stock records, stock verification, exercising control on
surplus and obsolete stock,
stores accounting and the adm inistrative control on stock
discrepancies, deterioration and
accumulation of stocks and co-ordination and co-
operation with interfacing departments.
Store location is the process of selecting an appropriate site for the store building in
the com pany's prem ises. It also includes decisions on how m aterials are to be
placed insidethe store.
Principles of a good store location include econom y in the cost of

transportation,approachability by rail/road transport, efficient service to the user
departments, minimization of fire hazards, security of stocks, minimization of the risk of
spoilage/deterioration, flexibility
(for future expansion) and the overall integration of
factors.
Preservation refers to protection of the materials against any functional degradation.

Threekey agents that cause deterioration are i) climate and environment ii) physical and
chemicalagents iii) biological agents.
Security m easures are intended to prevent theft by outsiders, pilferage by

em ployees,m alpractices by stores staff, destruction of stores by fire, loss due to
m enance of rodent
andtennite.
193
9.1 INTRODUCTION TO STORES OPERATIONS_______________________
Receiving concerns on the control on the quantity and quality of materials from the
time they are received until they are accepted and taken into stock is an important
aspact. Its importance can be gauged from the following:
Errors in purchase transactions can be detected more easily at the time of the
receipt of materials rather than later.
Correctly performed receiving function can prevent malpractices.
The receiving department can assist the purchase department in improving the
effectiveness of the vendors.
Responsibilities of Receiving Store
The receiving store has the following responsibilities:

L Verification of the correctness of paperwork and the appropriateness of supply
before accepting the goods.
il Unloading of material.
iiL In w a rd in g o f th e c o n s ig n m e n t.
iv. V e rific a tio n o f q u a n titie s.
v. I n f o r m in g p u r c h a s e / in d e n to r / P P C r e g a r d in g r e c e ip t o f g o o d s .
vl P re p a rin g th e n e c e ssa ry d o cu m e n ts su c h a s th e d isc re p a n c y n o te , g o o d s
i n w a r dn o te e t c .
vii. A rra n g in g th e in s p e c tio n o f m a te ria ls .
viii. R e tu r n in g a ll r e je c te d g o o d s b a c k to th e s u p p li e r s .
ix. F o r w a r d i n g t h e a c c e p t e d m a t e r ia l s t o t h e a p p r o p r i a te s t o r e s f o r s t o r a g e .
x. R e tu r n in g a ll c h a r g e a b le e m p tie s b a c k to s u p p lie r s .
Nature of Material Receipts
Material in the receiving store are received from the following

sources: i. Purchased materials received from suppliers.
198
Unit 9 Stores Operations
ii. Materials received from customers for processing.
iiL Materials returned by customers as defectives.
iv. Materials returned by customers on account of excess supply
v. Tooling, gauges etc. received from customers "on loan" to be returned.
v i S em i-fin ish ed o r fin ish e d jo b s received fro m ven d o rs.

vi "On Joanmaterials "returned by the vendors.
vffi. M aterial received from forwarding agents against imports.
k. Petty cash purchases by the purchase personnel.
Documents used in Receiving
The following docum ents are received/raised for receipt transactions:
lllllll)D elivery challan, also called dispatch m em o, delivery note or delivery advice is
a
docum ent sent by the local supplier/m anufacturer, trader, dealer with the m aterial. It
lists the item details and the number of packages being sent by the carrier.
m m m m m m mRailw
) ay Receipt (RR )/Lorry Receipt (LR) issued by the
railways/transporter is a
docum ent that acts as an authorization slip for getting the delivery of goods by the
purchaser from the railways or transporters.
nnnnnnn)Bill of entry is a document received from the clearing agent against imports.
ooooooo)Cash memo is a document which is used in connection with a cash purchase/sale

and
constitutes a receipt for the money which the buyer has paid to the seller.
9.2 RECEIVING OF MATERIALS

___________________________________
The following are the main steps to be followed when receiving1.material:
In warding at the security gate
Security aspects of materials requires that each incoming consignment is entered in a

register at the security gate and the original copy of the document accompanying the
material is stam ped for the security seal. Inwarding the consignment at the security
gate.
i guards against malpractices by the stores personnel.
iL makes it possible to trace the consignments in case of a dispute by the
supplier.
2. Verification of correctness of paperwork and appropriateness of supply
Materials in the receiving department on receipt, before being unloaded, are

checked for the correctness of the paperwork and the appropriateness of the supply.
A supplier's note accompanying the consignment provides the necessary
identification and procurement details of the items which helps the receiving
personnel retrieve the necessary documents - purchase order and delivery
schedule - received earlier from their own buying department.
3. Inwarding of the consignment in the receiving stores

Inwarding of the consignment involves the following clerical activities:
i) Verifying the number of packets/cases as per the accompanying note.
ii) Observing apparent damages to the packages (if any).
iii) Obtaining certificate/signature from the carrier confirming the

shortage/damages to the packages.
iv) Guiding the carrier to unload material at the appropriate place.

v) Entering the details of the consignment into a Goods Receipt Register
(GRR).
Every incoming consignment is assigned a GRR number and the details of
the consignment are entered in the GRR register against this number. Only a
summary of the items contained in each consignment is written in the
register.
vi) Stamping the accompanying document (on front) for the inward details.
vii) Giving acknowledgement to the carrier. The carrier copy is also stamped
and updated for receipt details.
4. Verification of quantities
This function comprises of unpacking and inspecting the general condition of

the goods inside the packages for transit damages, verifying quantities against the
supplier's packing slips and notifying discrepancies (if any). As soon as the
1200
discrepancy is detected, appropriate action should be taken.
er. U n it 9 S to re s O p eratio n s '•••< ^•••'
4 Claims should be lodged with

the insurance agency since, normally, all incoming goods
:ed are insured against damage or loss either by the consignor or by the consignee.
;r's
md A certificate for the shortages in packages/cases should be obtained from the
the transporter (railways, steamer agent or carrier's agency) to that effect.
om
Materials along with the packages/cases require to be moved to a separate enclosed
store called "Quarantine Store" until negotiation and scrutiny by the concerned
authorities relating to the observed discrepancies are settled.
Shortages and discrepancies in the consignment mentioned in the contents of the

packages require to be communicated to the supplier using a form known as
"Discrepancy note."
5. Notifying indentor and purchase regarding the receipt of materials

lages
Goods received in the department must be cleared in the shortest possible time since
it adds to the procurement lead time without adding any value to the goods. Usually,
it takes three to four days time until the GRR reaches the indentor. Until the GRR
reaches the concerned department, the indentor may be ignorant of the receipt and
RR). perform unnecessary follow-ups with the purchase department. To obviate these
of the difficulties, the receiving department should notify indentors and the purchase
unary department of the receipt of materials at the earliest.
6. Preparation of Goods Receipt Report
For each consignment, a Goods Receipt Report (GRR) is prepared by the receiving
edand : tore on completion of physical verification of the quantities. Goods receipt also
known as GIN (Goods Inward Note), M RR (Material Receipt Report), MIN
(Material Inward Note), RCIA (Receipt-cum-Inspection Advice) etc. is an important
linking document between the supplier, store, inspection, Purchase and the accounts
i of the department.
ipplier's
Goods receipt report(GRR) in a company, is generally distributed as under:
ancy is
L Original copy (Supplier's copy) to acknowledge receipt of the indicated quantity
and communicate the inspection results.
il Accounts copy to confirm the quantity actually received and the quantity accepted
for payment. It provides a check on the quantity invoiced by the supplier.
2
0
1
in. Indentor's copy to intimate the receipt and inspection results of the materials
received.
iv. Main Stores copy to give custody of the accepted materials, post stock cards
etc.
v. Purchaser's copy to enable the buyer to record receipt materials on the follow-
up copy of the P.O.
vi. Receipt-cum-inspection copy to maintain records of the GRRs.
7. Inspection of materials
After the materials have been uncrated and verified for quantity, it is offered to the
Quality Control department for quality certification. The Inspection department, on
receipt of the GRR, carries out the necessary inspection and enters the inspection
results (quantity accepted/rejected) including causes for non-conformance (if any) in
the GRR. Afew companies use a document called "Rejection Note" to report inspection
results.
8. Delivery of inspected materials to the appropriate store
Accepted/rejected materials after inspection are forwarded to their respective store

accompanied by a copy of Goods Receipt Report (GRR). Accepted materials are
moved to the main store, while non-confirming materials are sent to the rejection
store.
9. Return of defective materials to the suppliers
Defective materials are kept in the rejection store. A separate register called "Rejection
Register" is maintained, wherein each rejected consignment is logged in. Local suppliers
are asked to collect rejected materials. Outstation suppliers are notified and defective
materials are sent back to suppliers, usually on a "freight to pay" basis.
10. Returning all chargeable empties to suppliers
All empties such as empty gas cylinders, empty oil barrels, empty chemical tanks,
steel pallets, etc., not charged to the buyer's company, are returned to the supplier as
per the terms of the purchase order.
U n it 9 S to res
O p e ra t io n s
^ A ctiv ity A ;
Prepare a check list for checking the received material for any small scale organisation.
93 ISSUE O F M ATERIALS
Issue function is the key activity of Store, which concerns the issue of materials of the right
quality (as specified in the material requisition), in the right quantities and at the right time.
Material is issued to
(i) production for the manufacture of goods against customers' orders or for manufacture
to stock" purposes.
fri) the maintenance departm ent for plant repairs and m aintenance of m achinery.
(iii) the tool room for manufacturer of jigs and fixtures.
i i '- i the contractors for conversion into finished products/materials.
(v) the suppliers "on loan" to be returned (for exam ple, m easuring instruments, gauges,
jigs and fixtures etc.)
(vi) the sister companies "on loan" from the stock held.
(vii) the contractors to manufacture products/items against contracts, wherein it is agreed
to supply certain materials free of cost.
(viii) the crib store/sub-store to replenish the stock con sumed by them.
fix) the laboratory to re-evaluate quality of material (when material is stocked beyond its
shelflife).
(x) the repairers against repair contracts (for exam ple, rew inding of m otors, repairs of
instruments).
(xi) the em ployees or scrap contractors (for example, sale of scrap materials).
(xii)
the customers as sale of finished products.
(xiii) the com pany's departm ents operating under im prest system , to periodically issue
quantities equal to the difference betw een the sanctioned im prest and the current
stock, to recoup the quantities consumed.
(xiv) the cost centers/departments to issue the quantity budgeted (or fixed) per
period (maybe a month or a quarter). Typical examples of the items issued under
this category are consumable items like lubricants, cotton waste, soap,
stationerym, etc.
Control stock of issues
The stock held by the company represent money and it needs to be treated like
money. Some control on issue of stock therefore is essential to avoid losses. Every
employee in the organisation cannot be allowed to authorise issues. Store
administration should be given a list of designated persons who can authorise the
requests for the issue of materials. The list of authorised persons requires to be
periodically updated. Their number should be just adequate. If too few numbers of staff
are authorised, it can cause delays in the issue of stock and if too many are given
authority, then control is likely to be weakened.
Document to authorise issues
The basic document to authorise issue of stock is known as "Store Issue Note" or
Material Requisition. Although the design of the requisition varies slightly from
organisation to organisation, a typical material requisition is as shown below:
PRODUCTIVITY MATERIAL Material

SERVICES EC. REQUISITION Requisition No. :
Road, Pune 411 Work Order No.:
004 Indenting
Department :
Sr. Part Name/Part No. Qty. Unit Unit Remarks

No. demanded issued price
Authorized by Issued by Date of issue Entered by
Fig. 9.1 : Typical Format of a Material Requisition

204
T im in g of issu e s
M aterial should be issued only during specified hours of the day. This enables the storekeeper
to attend to other duties outside these hours. H ow ever, if urgent dem ands are presented
outside the stipulated hours, they m ust be m et w illingly and happily.
Issu e p ro ced u re
The following are the steps that occur between the origin of the need for aparticularitem
of stock and its final issue by the store departm ent.
(a) P re p ara tio n o f M aterial Issu e N o te /M ateria l R eq u isition
The requisitioner needs to prepare a M aterial Requisition giving com plete details of
the goods required.
(b) A u th o risa tio n
The requisitioner must next locate a designated official or a member of staff to authorise
the issue of the stock and request him for his approval and signature.
(c) Presentation of M R to Store
O nce the M aterial R equisition or Issue N ote has been authorised, it needs to be
presented to store for delivery. Store staff is obliged to check all details concerning
the item requisitioned such as description, code num ber, quantity etc. and verify the
reliability of authorisation.
M aterial requisition found acceptable should be logged in the Requisition Register,

needs which
to be mentioned datewise, like a diary.
S e ria l Material Date of Actual Indentor Brief Qty. Qty. Issue Note
No. Requisition raising date of description demanded issued No.and date
No. material receipt
requisition
F ig . 9 .2 : R e q u is itio n R e g is te r
205
(d) Identification of required items(s) •

Stores then identifies the item(s) required, using the code number/description contained
in the issue note/MR and the codification system held in the store vacabulary.
(e) Issue of required items

Stores keeper should next check the availability of the indented material, whether
available in full or in part.
If the material of the exact specifications is not available, the store should check for
the availability of the substitute material or an alternate material. The indentor should
be informed of the availability of the alternate or substitute material and the same
should be issued if it is acceptable to the indentor. If the exact material or substitute
material is not available, the requisition may be returned, to be presented later on
receipt of material.
Where the material is to be taken out of the company (for example, issues to vendors/
sub-contractors/customers), a gate pass should be prepared, giving the following
details:
• Description/code no. of the material

• Number of packages
• Issue voucher no. and date
• To whom sent
(f) Collection /delivery

Material should be collected by the requisitioner from the issue counter after signing
the issue voucher. However, where the material is bulky/heavy, it may be delivered
by the store on door-delivery basis.
(g) Cost Allocation

To enable the costing department to determine true cost of the job, the issue note
must be priced. This is done by entering the value of each issue on the issue note,
before forwarding it to costing.
(h) Updation of stock records and stock control

Once the materials have been issued, both stock records and stock control are updated
for the issued quantity.
U n it 9 S to res O p eratio n s
Essentials of Correct Issues
The essentials of correct issues are as follows:

• Material should be issued against written requisitions.
• Material should be issued only against authorised requisitions.
• Material should be issued only in a pre-fixed quantity, especially for C-class of items.
« Material requisitions should be received preferably a day in advance.
• Material should be issued on the basis of FIFO (first-in-first-out), particularly for the
itfiiis of low shelf life. However, suppliers' approved sample piece(s) should be issued
last.
• Material should be issued in bags/cartons, so that they do not get damaged/dented/
chipped during movement.
t Issued materials must be accompanied by an identification tag/sticker to avoid mix-
up (except when the identification details are engraved/etched on the components/
cartons),
^ Activity B;
Prepare a checklist for ensuring the correct issue of material.
kdger). Physical stock, in an actual situation, never tellies withthe book

*4&i
207
Why Physical Counts are Necessary
Physical count is essential not simply because we want our records to be accurate. There
are other reasons as well too.
(a) Production control ;
Accurate stock records are essential for the proper working of the production control
system. If the stock records show too high a balance, the requirements will not be
indented and thus a shortage will be created. And shortages, if not corrected in time,
could lead to production stoppages. Alternatively, if the stock records show too low
a balance, an item will be unnecessarily re-ordered.
(b) Financial statements

Physical count is the prime requirement for the certification of financial statements.
This is because the corporate tax depends on the volume of profit and profit in turn
depends on the cost of materials used. And material cost equals the sum of value of
stocks held at the beginning of the year (i.e. opening stock), plus the cost of materials
bought during the year minus the value of stocks at the end of the year. The statutory
regulations therefore demand that the stock shown in the balance sheet must be
verified physically during the financial year and all discrepancies must be properly
adjusted and accounted for in the books of account.
(c) Early detection of obsolete and dormant stocks

Stocktaking helps early detection of obsolete and dormant stocks, thereby enabling
the purchase department to take timely action on their disposal and release the
company's scarce capital for productive use.
(d) Moral check on the stores personnel

Stocktaking provides a moral deterrent to stores personnel against fraud, malpractices
and pilferage. It also provides shows as to whether stock records are being maintained
properly and accurately and whether the procedures laid down are being followed
meticulously.
(e) Stores audit

Stocktaking provides an opportunity to audit Stores procedures. It helps to reveal
weaknesses in the existing system and review stock control procedures, to know
whether they are operating satisfactorily and effectively or not.
U nit 9 Stores O perations
W hy Physical Stock does not Tally w ith the Stock Balance
Stock records never stay accurate all the tim e. Errors creep in occasionally,
because ofvarious reasons. Som e of the com m on sources of errors are:
(a) Clerical errors
Inventory control is manned by people and people occasionally m ake m istakes:
• They receive or issue materials but forget to m ake entries.
• They issue incorrect quantities (i.e. over issue and under issue)
• They m ake errors in copying and posting receipt quantities.
• They post on the wrong cards.
• They m ake errors in addition and subtraction w hile posting.
(b) Incorrect location of parts
A part m ay get lost due to incorrect location. Physically, the part m ay be
lying som ew here under different nom enclature, but discrepancy w ill be
show n duringstocktaking.
(c) M aterials handling
C a r e l e s s n e s s in h a n d l i n g o f m a t e r i a l s o f te n c a u s e s b r e a k a g e s , d a m a g e s , o r
l e a k a g eosf m a te ria l s , w h ic h le a d to d is c re p a n c ie s .
(d) S h rin k a g e
Discrepancies result w hen m aterials are purchased in one unit and are issued
in a different unit. W ires, for exam ple, m ay be bought by w eight (kgs) but
issued bylength, sheets may be procured by weight but issued by numbers. The
discrepancy insuch situations arises because of two reasons - firstly, the issue
clerks usually give liberal
a m easure and secondly, there is alw ays som e
wastage w hile m easuring and
cutting to requirements.
(e) Atmospheric conditions
C ertain item s alw ays end up w ith surplus or sho rtag es, because of th e
basic characteristics of the m aterials. Item s such as caustic soda being
hygroscopic gain weight, while item s such as spirits, inks etc. show shortage
due to evaporation.
209
(f) Theft, pilferage and malpractice
Discrepancies generally result if there are no adequate measures against theft, pilferage
or malpractices.
(g) Incorrect stocktaking
Discrepancy - surplus or shortages - is also caused due to mistakes made by those

responsible for the ascertainment of physical balance. Mistakes are made due to
hurried working or accumulated fatigue, if a large number of items are to be verified
within a limited time, as in the case of annual stocktaking.
(h) Unaccounted materials being destroyed in destructive tests
Materials/components destroyed to verify quality of conformance, if not accounted

properly, cause discrepancies. To avoid this, stock cards should not be posted for
suppliers' challan quantities but for net quantities received in the stores. And pieces
destroyed in metallurgical checks should be shown as consumption.
(i) Misplacement of papers and vouchers
Misplacement of Goods Receipt Reports, Materials Return Notes, Material

Requisitions, etc. cause discrepancies.
(j) Material issued to line because of urgency
Often materials on receipt from suppliers are issued directly to line because of urgency.
The failure to obtain issue vouchers cause discrepancies.
(k) Poor storage conditions
Spoilage/wastage resulting from damages caused by worms, moths, rodents, etc. is

yet another reason for discrepancies.
Methods of taking inventory
The physical inventory can be conducted by one of the three methods:
ppppppp)Once a year count, called annual stocktaking

qqqqqqq)Rotating counts, called continuous stocktaking
rrrrrrr)Low point counts, called re-order point stocktaking
Annual Stocktaking ' "r
Annual stocktaking is the process of making a complete count once a year, of all
materials, finished parts (bought out as well as piece parts) work-in-process,
finished goods and supplies. The stocktaking is generally undertaken at or near the
close of the financial year. This necessitates shutting down the production
operations.
Advantages of Annual Stocktaking
The advantages of annual stocktaking are as follows:
sssssss)The method is simple, less costlier and satisfactory.
ttttttt)Stock figures in the balance sheet are more correct, since stock taking is
carried out
at the time of preparation of balance sheet.
uuuuuuu)Annual stocktaking does not require permanent staff, since personnel

from other
departments can be called to assist the stores staff.
Disadvantages of the Annual Stocktaking

i) Finalisation of accounts at times gets delayed if the stocktaking activity is not
completed within the stipulated period.
a) Since all movements from and into the stores is suspended for the period of
stocktaking, there is accumulation of pending work right in the beginning of the
financial year.
in) Staff called from other departments to assist the stores personnel in stocktaking
are not conversant with the stocktaking work and are not accountable for
discrepancies ' which affects the accuracy and effectiveness of stocktaking.
iv) As the activity is conducted only once a year, discrepancies due to

pilferage, i malpractices and misappropriation by the conniving staff cannot
be effectively : minimised.
Essentials for Efficient Annual Stocktaking
The following arrangements are essential for efficient annual stock-taking:
(a) All local purchases should be suspended close to the period of stocktaking, so
that physical stock is comparatively less. Distance suppliers should be instructed in 211
advance not to supply goods during the days of stocktaking.
I Materials Management
vvvvvvv)The movements of goods in and out of stores should be stopped until the
stocktaking
is over. Sufficient quantity should be issued in advance to meet production requirement
and thereby avoid loss of production during the period of stocktaking.
wwwwwww)All relevant documents - inventory tags, inventory sheets etc. - should be

kept ready
sufficiently in advance of the stocktaking. Inventory sheets, similarly, should be
prepared in such a way that the clerical work during stocktaking is the barest minimum.
Inventory tags should be attached to the respective parts, components, bins or
containers in advance.
xxxxxxx)Each individual forming the crew should be instructed in writing, with respect
to his
responsibilities.
yyyyyyy)The stores should be divided into sections. Each section may be entrusted to a
supervisor
or to a foreman.
Continuous Stocktaking
Continuous stock taking, also called perpetual stocktaking, is the process of taking physical
counts of a few items daily and thus covering each item in storeroom at least once a year,
more important ones twice, thrice, six times or even twelve times a year. A more rational
approach is to relate the frequency of counts to the usage value classification - ABC
analysis - under which items of high usage value are verified more often than those of low
usage value.
Advan stocktaking can be planned and worked into scheduled activities, without
tages dislocation of either Stores or Production. The need to verify every item at the end of
of the fiscal year is avoided.
Contin
uous aaaaaaaa)The work can be conducted in a more orderly and relaxed manner, two
Stockt conditions
aking that are vital for accurate work, as a few items are checked every day.
zzzzzzz bbbbbbbb)Discrepancies are detected and corrected early and frequently. This eliminates
) Co the
nti possibility of last minute production hold-up.
nu
ou cccccccc)Interim profit and loss account can be complied quickly, as correct stock figures
s are
readily available.
212
U n it 9 S tOo pr eesr a t i o n s
(e) It costs relatively little because regular store-room clerks can be utili sed to assist
the counting and in m aking entries in the relevant stock records during the
tim e w henwithdrawals are few.
Continuous stocktaking is suitable for large factories. The annual inventory

statem ents under this m ethod are prepared on the basis of stock balances on the
bin cards or stock
cards on the last day of the financial year.
Reorder Point Stocktaking
Reorder-point stocktaking is the process of taking physical count of an item ,

w hen itsstock falls below the re-order level (or w hen the first bin is exhausted).
The storekeeper orthe stock controller, when working with this system , has the
responsibility of notifying
this to the auditing departm ent. C loser co-operation
betw een the store records-section
id the auditing department, is, therefore, a m ust to
operate this method of physical count.
H ie advantages of re-order point stocktaking are the sam e as those of the

continuous
sid verification method.
V fC h e c k in g '
Sp;ii cads are conducted to verify stock held, w ithout prior notice, thereby
providing 10 tim e to stores personnel to replace stocks illegally. A spot-check
system acts asdeterrent
a against those intend to pilfer or commit fraud, as a sudden
check could herald an
Spot checking provides the following advantages:
ii It acts a strong deterrent to theft, pilferage and fraud.
•ii It is easy to conduct, as it is carried out on a lim ited scale.
Since spot-check is lim ited in operation, com pared to the other form s of stock
taking, itrtprovide data for financial calculations.
| ipcy for Stocktaking
cy for stocktaking depends on the type of industry, size of the firm and the
m ethodM oved for stocktaking. Three basic agencies are:
213
(i) Stocktaking by Store Staff
Stocktaking under this arrangement is conducted by the store staff without

obtaining help from outside the department. Such a practice is obviously
undesirable, since it does not provide any check against malpractices, fraud and
misappropriation by the staff.
Even genuine mistakes are unlikely to be exposed, since those charged with
the responsibility are tempted to hide facts for fear of criticism of their work
by their seniors. Nevertheless, this practice is followed in small units.
(ii) Stocktaking by Outsiders
Stocktaking under this arrangement is done by an outside agency -

professional auditors - retained for the specific stocktaking assignment. The
agency is given the information on the codification system and location
reference of the items. The information on quantity on the stock card,
however, is withheld. Support staff is provided to assist the team.
(Hi) Stocktaking by Company's Specialist Staff
Under this arrangement, the company's internal auditing department is given

the responsibility of stocktaking.
J& Activity C;
Visit a nearby retail outlet and list the methodology used for stock checking.
9.5 SUMMARY__________________________________________________
Receiving store exercises control on the quantity and quality of materials, from the
time that they are received until they are accepted and taken into stock. The receipt
procedure comprises ten steps, namely:
214
U n it 9 S toOrepse r a tio n s
d d d d d d dIn
d )w a rd in g a t th e s e c u rity g a te .
e e e e e e eVe )e r if i c a tio n o f th e c o r r e c tn e s s o f p a p e r w o r k .
ff ff f ff In
f ) w a r d in g o f c o n s ig n m e n t in th e r e c e iv in g s to re . ,
g g g g g g gVg )erificatio n o f q u an tities.
hhhhhhhh)
N otifying indentor. ,
ii ii i i i iP)r e p a r a ti o n o f G o o d s R e c e i p t R e p o r t .
jjjjjjjj)
In sp e c tio n o t m a te ria ls.
8) D e li v e r y o f in s p e c te d m a te r ia l s to a p p r o p r ia te s to r e s .
i) R ear of defective m aterials to the suppliers.
:
10) Return of all chargeable em pties to the suppliers.
The function of issue is a key activity of the Store, which concerns the issue of materials of
the right quality (as specified in the m aterial requisition), in the right quantities and at the
righttime.
Physical inventories, also called stock verification, is a must for an efficient scientific inventory
control system besides being a statutory requirem ent, no inventory control system can
• ork unless stock records stay correct and the quantities show n as book balance tally
;•; the physical balance. The different m ethods of stocktaking are: annual stocktaking,
continuous stocktaking and re-order point stocktaking. A nnual stocktaking is generally
les Jtfa'five than the other two m ethods of stocktaking.
A surplus item is one whose existing stock is likely to last longer than its norm al period of
consumpi ion. Various causes for surplus stocks are over-buying, reduction in the production
program me, product sim plification, lack of control on the quantity of incom ing materials,
forward buying, etc.
9.6 KEYW ORDS

________________________________________________
Cash M em o: C ash m em o is a docum ent which is used in connection w ith cash purchase/
sale and constitutes a receipt for the m oney, which the buyer has paid to the seller.
Delivery chaflan: A delivery challan is a document sent by the local supplier/manufacturer,

trader, dealer w ith the m aterial. It lists the item details and the num ber of packages being
sent by the carrier.
Obsolete stock: An item is said to be obsolete when it is superceded by another

item due to change in design, modification or due to the process of substitution.
Railway Receipt (RR)/Lorry Receipt :(LR) Railway Receipt (RR)/Lorry

Receipt (LR) issued by the railways/transporter is a document that acts as an
authorisation slip for
getting the delivery of goods by the purchaser from the
railways or transporters.
in
Store Issue Note or M aterial Requisition

: This is the basic document to
authoriseissue of stock.
V "
Stock verification
: Stock verification, also called physical inventories or stocktaking,
is the process of ascertaining - by counting, weighing, or measuring - whether the
physicalstock of materials tallies with the balance shown in the stock records.
Surplus stock: An item is said to be in surplus when its existing stock is likely to
last
longer than the normal period of consumption.
'<". ''r-
9.7 SELF-ASSESSMENT QUESTIONS______________ _
________________________________________________^
Q1. W hat are receiving stores? Describe briefly the functions of receiving stores,
v
Q2. What are the major activities performed by the receiving store from the time
materialsare inwarded at the security gate until they are accepted and taken
into stock?
Q3. For what purpose are materials issued from stores? List the main types of
issuesthat a typical store generally handles.
Q4. Describe briefly the basic procedure to be followed for issuing materials.
Q5. W hat is physical stocktaking? W hy is it necessary?
Q6. "While comparing physical stock with the balance shown in the stock cards,
surplus and deficiencies are often found." Why do these discrepancies occur
and state themethods you would consider employing to reduce them?
216
wiatenais management
10.1 UNDERSTANDING THE INVENTORIES
Inventories represent the aggregate of those items which are either held for sale in the
ordinary course of business or are in the process of production for sale (i.e. work-in-
process) or are yet to be utilised/consumed in the production of goods and services.
The principal items of inventories are as follows:
1. Raw materials
Raw materials are those basic unfabricated materials which have undergone no conversion
whatsoever, since their receipt from the suppliers. They include items like steel (angles,
channels, tees, flats, tubes, plates, shafts etc.) copper, lead, tin, cotton, rubber, leather,
timber etc. Raw materials, in other words, are those basic materials from which components,
parts and products are manufactured by the company.
2. Finished parts ,
Finished parts are either bought-outparts or piece parts (also called works made parts).
Bought-outparts are those finished parts, sub-assemblies or assemblies that are purchased
from outside suppliers. These include standard parts as well as parts produced by suppliers
to the buyer's design. Piece-parts (or work-made-parts) are those parts which are
manufactured at the company's own plant, from the basic raw materials.
3. Work-in-process
Work-in-process comprises items that are in a partially completed condition of manufacture.
Raw materials become work-in-progress at the end of first operation and remain in that
classification until they become finished parts or finished goods. Work-in-process can be
found on the conveyors, trucks, pallets, in and around the machines and in temporary
areas of storage, waiting to be worked upon or assembled.
4. Finished goods
Finished goods are the final products, ready to be shipped. Products usually leave work-
in-process classification and enter the classification of finished goods at the point of final
inspection, when they are ready for delivery to the customer or to the finished goods store.
5. Tools
a) Standard tools used on machines such as saws, drills, reamers, taps, chasers,
milling cutters, hobs, broaches, form tools, inserts etc.
U nit 10 F undam entals of Inventory
M an agem e n t fa cto
ry,
a
b) H a n d to o ls su c h a s h a n d -sa w s, d rill g u n s, h a m m e rs, m a lle ts, n e e d le s,
g rin
p l i e r sp, u n c h e s , s p a n n e r s , w r e n c h e s , e t c .
der
6 . S u p p lie s in a
cem e
S u p p l i e r s t h a t i n c l u d e m a t e r i a l s t h a t u s e d i n r u n n i n g t h e p l a n t n ot r i n m a k i n g
t h e c o m p a n y 's p r o d u c t s b u t n o t m a k i n g t h e p r o d u c t . S u p p l i e s , t h e fr ae cf ot or e ,
in clu d e ry
and
k k k k k k kM k )i s c e l l a n e o u s c o n s u m a b l e s t o r e s s u c h a s b r o o m s , c o t t o n w a s t e ,
so
c lo th w a ste ,
on.
t o i le t p a p e r , w a s h i n g p o w d e r , j u t e t w i n e e tc .
llllllll)
W e l d in g , s o ld e r in g a n d tin n in g m a te ria ls s u c h a s e le c tr o d e s , w e ld in g ro d s ,
s o ld e r ,
sp elte r etc.
m m m m m m mAmb )r a s i v e m a t e r i a l s s u c h a s e m e r y c l o t h , e m e r y b e lt s , s a n d p a p e r ,
la p p in g p a ste ,
la p p in g p o w d e r, e tc .
n n n n n n nOn )ils a n d g re a s e s s u c h a s k e ro s e n e o il, tra n s fo rm e r o il, p e tro l, d ie s e l o il,

lu b ric a tin g
and cu ttin g oils.
e) P r i n t e d f o r m s s u c h a s e n v e l o p e s , l e t t e r h e a d s , e n q u i r y f o r m s , o r d e r
a c c e p ta n c e
fo rm s, p u rc h a se o rd er fo rm s, o rd e r a m en d m en t fo rm s, g o o d s rec e ip t
rep o rts,
• • etc .
f> Electric supplies such as cables, clips, cut-outs, fuses, lamps, lamp-
holders, plugs, hoses, shades, switches, etc.
*•
I M a ch in e ry
sp a re s in c lu d in g
o o o o o o oc o )n s u m a b l e s p a r e s s u c h a s b e l t s , b e a r i n g s , o i l s e a l s , o - r i n g s , g a s k e t s ,
sp rin g s,
h y d ra u lic /p n e u m a tic p ip e s, e tc .
p p p p p p pr ep p) l a c e m e n t s p a r e s s u c h a s p u l l e y s , w e d g e s , g e a r s , w o r m w h e e l s ,
w orm shafts,
c o u p lin g s , e tc .
q q q q q q qr aq t) a b l e s p a r e s s u c h a s m o t o r s , p u m p s , l a r g e m e c h a n i c a l s e a l s , e t c .
r r r r r r rirn) s u r a n c e s p a r e s s u c h a s p r o p e l l e r o f a s h i p , a c o m p r e s s o r i n a f e r t i l i z e r
221
M a te rials M a n ag e m e n t , ,,/r -!
;,>ij
Why does a firm carry inventories?
There are seven major reasons why firms carry inventories:
1. To economise on buying/manufacturing cost
A certain amount of fixed cost - ordering cost or set up cost - is incurred, whether
an item is purchased from outside suppliers or manufactured at the
company's own plant. To buy or to manufacture goods on a day-to-day basis is
both, impracticable and uneconomical. The firm, therefore, may order
(manufacture) beyond the immediate needs of the company to distribute (i.e.
prorate) the fixed cost over a large number of units.
Manufacturers of certain items (made to order or standard) offer discounts if

more units are purchased. The buyer, therefore, may buy quantities beyond
the current requirements, to take advantage of the price discounts.
2. To keep pace with changing market conditions
Inventories are created when large quantities of items are purchased and
stocked, in anticipation of their non-availability in the future or in anticipation of
a spurt in their prices.
3. To take care of contingencies (i.e. prevent stock-outs)
A company may suffer a substantial loss on account of an item going out of

stock. The stock out of a critical item may result in one or more of the
following:
• to do certain operations second time.

• to cannablise parts from one assembly to finish another assembly.
• to shut down the complete operation.
A stockout results when the rate of consumption is more than the estimated
usage rate or when there is a delay in delivery. To prevent the occurrence of
stockouts, certain extra stock called as safety stock, is maintained. This forms a
fixed portion of inventories.
5. To stabilise production
A product is produced to meet the customer's orders. Rarely does a company

222 have a continuous stream of orders. Usually orders and the shipment of orders are
subjected
Unit 10 Fundamentals of Inventory Management
to fluctuations. But the production has to be done at a uniform rate throughout the
year. The inventory will gradually increase and reach a peak before the season, after
which the products will start moving to the market and the inventory will decline.
6. To prevent loss of sale
Finished goods inventory is maintained to match the requirements of the customers

for prompt execution of their orders. The need for maintaining the finished goods
inventory assumes greater importance when the products are competitive. The failure
of fhe company to make such products available immediately may result in a loss of
sale or even the in loss of a customer.
7. To satisfy other business constraints
Sometimes the company is forced to buy quantities more than the current requirements
and lock-up its productive capital under certain situations. A few such situations are
mentionedbelow:
a) S u p p l i e r ' s c o n d i t i o n o f m i n i m u m q u a n t i t y
T h e su p p lie r m a y in sist o n a c e rta in m in im u m q u a n tity .
b) G o v e r n m e n t r e g u la t i o, ,n,s ,•.« .-< ••• . , , , - , • ' • . . .
T o o m u c h c a p ita l g e ts lo c k e d in c rea tin g in v en to rie s o f ite m s th a t are su b je c te d

to g o v e rn m en t reg u la tio n s, m o re so in th e c a se o f im p o rte d ite m s. T h e c o m p a n y ,
h e re fo re , b u y s q u a n titie s a llo tte d b y th e g o v e rn m e n t, b e c a u se it is e c o n o m ic a l.
c) S e a s o n a l a v a ila b ility :
T h e re a re c e rta in ite m s w h ic h :
i) a re a v a ila b le in p le n ty a n d h e n c e c h e a p ly d u rin g c e rta in m o n th s (fo r e x a m p le ,

c o c o n u t, so y a b e a n s )
i) are not available during certain months (for example, sand for foundry in
the monsoon). The company is thus forced to buy a large quantity and
create inventories.
^Activity A;
List down at least five reasons for keeping an inventory.
10.2 COSTS FOR INVENTORY DECISIONS

Establishing the most economical quantity to order from vendors or the size of the lots to
be processed at the company's own production facilities involves a search for minimum
i total cost resulting from effects of individual costs. This requires knowledge of the various
* costs that influence inventory decisions.
Inventory carrying cost
Inventory carrying cost refers to the cost of holding stocks. The following elements constitute
inventory carrying cost:
a) Capital cost is an important element of the inventory of carrying cost. Capital cost
is either the cost of borrowing capital or the cost of diverting the company's funds
for investing in inventories. The former means the interest rate, the latter
implies the foregone opportunity cost. There are thus two methods of
determining the capital cost. The first method is to use the bank lending rate if the
money were to be borrowed. The other method is to consider the opportunity cost
of the money (the rate that the money will yield if invested elsewhere) if the
company were to use its own funds.
The opportunity cost of money represents loss of opportunity to obtain return on

the value of stocks and it equals R.O.R. (i.e. company's rate of return on its
investment).
R.O.R. = Net profit before taxes
Total capital
b) Storage cost includes cost of storage space, cost of maintenance and repairs, cost
of storage facilities, cost of preservation, cost of record keeping, and cost of periodic/
annual stock verification etc.
U nit 10 F undam entals of Inventory M anagem ent
,f the lots to S o m e o f t h e e le m e n ts o f th e s t o r a g e c o s t a r e f ix e d , a s t h e y a r e in coufr r e d ir r e s p e c t iv e

r minimum t h e i n v e n to r y v a lu e . A c e r t a i n a m o u n t o f s p a c e i s r e q u ir e d a n d m u s t b e l i g h te d
'the various m a in ta in e d . T h e w a g e s o f th e p e rso n n e l c a n n e v e r b e c u rta ile d e v e n w h e n th e ir
w o rk lo a d is re d u c e d . S im ila rly , n o sa v in g s c a n re su lt if th e sp a c e re le a se d fro m
r e d u c tio n in in v e n to r y is n o t u tilis e d f o r o th e r p u r p o s e s. O n e m a y , th theere fo re , q u e s tio n
v a lid ity o f u s in g s to r a g e c o s t a s a c o n tr o l to o l w h e n m o s t o f th ec oe slet ma re
e n ts o f th is
f ix e d .T h e s o lu tio n lie s in c o n s id e r in g o n ly th e v a r ia b le e x p e n s e s , th o se w h ic h in c re a s e o r
nts constitute
r e d u c e w ith r ise o r f a ll in in v e n to ry in v e s tm e n t.
c ) D e t e r i o r a t iaonnd o b s o l e s c e n c e
Capital cost is
iy's funds for D e te r io r a tio n is th e lo s s f r o m r e d u c tio n in th e in v e n to r y v a lu e d u e to o n e o r m o r e o f
;r implies the the follow ing reasons:
rig the capital
, be borrowed. i) T h e p a r t/ite m /m a te r ia l m a y h a v e a lim ite d s h e lf lif e a n d m a y d efteo r ioa r a te if s to r e d
ie rate that the lo n g t im e . F o r e x a m p l e , r u b b e r p a r t s m a y c r a c k a n d a m m osnp ia
o il s ifh e e ts m a y
own funds. s to c k e d b e y o n d th e ir s h e lf lif e .
n return on the B h ) I t e m s a l s o d e t e r i o r a te w h e n s t o r a g e c o n d i t i o n s a r e i n a d e q u a toer, u n s a t i s f a c t o r y
investment). b o th . S o m e o f th e p a r ts m a y g e t d a m p , d r ie d , o r s p o ile d ( f o r emxaaym p le , c e m e n t
g e t d a m p a n d s o l id i f y ; s te e l m a y b e c o m e r u s t y ; s p ir it m a ymeavya pd or yr a te ; in k
u p ; o r s ta ti o n e r y m a y b e c o m e d ir t y ) .
iiij D e te rio r a tio n c a n a lso re su lt fro m p o o r h a n d lin g in th e s to re s. S o m e o f th e f ra g ile

ite m s , ( e le c tr ic b u lb s , f lu o re s c e n t tu b e s e tc .) m a y c o llid e w ith o th e r s a n d b r e a k .
nd repairs, cost
:ost of periodic/ • m p r o c e s s o f d e te r io r a tio n th u s r e d u c e s th e v a lu e o f th e s to c k s a n d hthi e y m a y n o t n o w
i > r t h th e v a lu e a t w h ic h th e y s ta n d r e c o r d e d in th e a c c o u n ts b o o k th s . eAn nt a d ju s t m e n t,
'e, ha s to b e m a d e to av o id fic titio u s sto ck va lu e s to ap p e ar in th e finTahnisc ialis do cu m en ts.
d o n e b y w ritin g o ff a c e rta in a m o u n t (e q u a l to th e d iffe re n c e b e twtheee nitethmes vaaslu e o f
p e r th e a c c o u n ts b o o k s m in u s th e v a lu e to b e r e a lis e d f r o m suthceh diteismp os)s aalt othf e
tim e o f p re p a ra tio n o f fin a n c ia l sta te m e n ts. It is th is a m o u w n tritte
- thne oa fmf o-u th
n t a t is
c o n s id e re d to c o m p u te d e te r io r a tio n a s a n e le m e n t o f c a r ry in g c o s t.
O b s o le s c e n c e is th e lo s s fro m r e d u c tio n in in v e n to r y v a lu e o f th e ite masre/c o m p o n e n ts th a t

ren d e re d un u sa b le b y th e c o m p a n y , d u e to ch an ge s in d esig n o r d u e toinththe ed e v e lop m en ts
fie ld . T h e s te p s c o m p u tin g d e te r io ra tio n a n d o b s o le sc e n c e c o s t a re a s
in v o lv e d in under:
22
1
i) Prepare a list of obsolete and non-moving items by going through their stock cards.
The following details are extracted from the stock card of each item:
• Part Name/Part No.

• Stock on hand
• Price per unit
• Last date of issue
if) Determine the value (Ai) of each obsolete and non-moving item by multiplying the
quantity on hand with its unit price.
in) Determine the number of years (n) over which the item has not moved. *'*
iv) Establish the proportionate amount that can be realised if the items were to be disposed
off(p) v) Calculate average annual obsolescence and
deterioration.
ThiswiUbe ZAi
i) Compute deterioration and obsolescence element of inventory carrying cost by

dividing the above figure by average inventory investment.
(1-p) I Ai *
Deterioration and Obsolescence = . - ; - ; -

Average Inventory Investment
d) Insurance cost
Inventories, like other assets, are covered by insurance. Insurance cost is thus the
premium paid or payable to cover the company against loss due to unforeseen acts
such as fire, theft, etc. An illustration on inventory carrying cost
The balance sheet of M/s. ABC Co. shows an opening and closing stock of inventory
at Rs. 55 ,000 and 65 ,000 respectively. The profit and loss account for the same year
indicates Rs. 20,000 as the net profit before taxes. The company's total capital deployed
during the year was Rs. 1 ,00,000. The study carried out in the area of inventory
management revealed
I
that the com pany had accum ulated a considerable num ber of obsolete and non-m oving
item s, which had locked-up the com pany's productive capital to the tune of Rs. 6000.
The last issue of certain item was found to be as late as 3 years. The discussion with the
propnetorof the company revealed that the disposal of such items is likely to fetch 40% of
the original value of the items. Lastly, the insurance paid for the stock held during the year
was 0.25%.
Calculate the inventory carrying cost for this company assuming that the prevailing interest
rate is 12%
Solution:
a) Capital Cost equals either the bank's interest rate or company's R.O.R., whichever is
Bank's interest rate = 12% (given)

Opportunity cost = R.O.R.
= P /C x lO O
2 0 ,0 0 0
xiO O
1,00,000
= 20%
Since opportunity cost is higher than the bank's interest rate, 20% figure is selected
as the capital cost.
b ) Storage Cost = 0 % (Storage cost was not considered since the system w as to be
introduced)
c) D e t e r i o r a t i o n a n d o b s o l e s c e n c e , a s e s t a b l i s h e d i n t h e p r o c e e d i n g f e w p a r a g r a p h s , i s
g iv e n b y th e fo llo w in g re la tio n :
(l-p)A i
Deterioration and Obsolescence (%) = - n
A verage Inventory Investm ent
lere A i = T otal value of the obsolete item s as per books (R s.6,000) p =

Proportionate value like to be realised on disposal (0.40)
n = Number of years over which the items have been accumulated (3

years)
(l-p)IAi Rs. 6,000 x 0.60

= Rs.
Average inventory investment = Rs. 1,200
Opening stock + Closing stock

2
55,000 + 65,000 2 1,20,000
= Rs. 60,000 (l-p)ZAi

Deterioration and Obsolescence =
Average Inventory Investment 1,200 x 100 = 2.0%

60,000
d) Insurance cost
= 0.25 %
/. Inventory carrying cost
= 20 % + 0 % + 2.0 % + 0.25 %
= 22.25 %
10.3 PROCUREMENT COST
Procurement cost also called ordering cost, replenishment cost or recoupment cost is the
i cost incurred to replenish the stock of an item. It is, in fact, the cost incurred at different
stages of the procurement function and is obtained by dividing the cost of activities like
requisitioning, order writing, order follow up, receiving and inspection, record keeping
and bill payment per period by the number of orders processed during that period. I
Procurement cost, therefore, represents the average cost to be expended to place an
order and execute the delivery once.
The basic elements of procurement cost are as under:
a) Paper work cost
The procurement function is built around the pyramid of paper work, since all orders -
small or big, need paper work. Purchasing function sets out with paper work
U nit 10 F undam entals of Inventory M anagem e nt
(materials requisitions), pushes through paper work (inquiry forms, purchase

order forms, good receipt notes, inspection notes, stores receipt notes) and
ends up with paperwork (cheques to pay the supplier's invoices). The
requirement of paper work vfiries directly with the order frequently and its cost
is considered one of the elements
of procurement cost.
b ) P o s ta g e c o s t
Postage cost is the cost expended to mail the documents necessary for the
business transactions. Purchase orders are sent to authorise vendors to
supply the goods; delivery schedules are mailed to communicate
immediate as well as future requirements; amendments to purchase orders
are issued to alter/modify quantity, price or other terms; goods inspection
notes are posted to acknowledge receipts of mat, ials and communicate the
inspection results; discrepancy notes are sent to highlight shortages in the
quantities received; cheques are dispatched to settle the supplier's bill, etc.
Postage cost is also incurred for the exchange of statement of accounts, debit
notes, credit notes and other documents required in the transactions.
c) Follow up cost .
Follow up is the function of seeing that the suppliers effect the deliveries on
time. Telephones, trunkcalls, telegrams, telexes and faxes are the aids
commonly used by buyers for pre-delivery follow up as well as for shortage
chasing. The cost of such communication media is yet another major element
of procurement cost.
Cost of visits to the vendor's plants
Follow up with the vendors at times requires visits by purchase personnel and
therefore the costs of such visits are considered towards procurement cost.
e ) O p e ra tin g c o st o f th e v e h ic le s
Vehicles are employed for collection and delivery of materials from/and to the
vendors, collection of materials from transporters'/railways' godowns, etc. The
operating cost of such vehicles should be considered (if the vehicle is exclusively
used by the materials department for buying materials from the local market, to
chase vendors, and/or to bring goods to the plant) as an element of procurement
cost.
Inspection and testing costs
Inspection and testing costs include the cost of destructive tests. Too-
frequent 229
purchases increase inspection costs.
h) Administrative costs
Purchase is a major function and it requires performing of a number of

activities. Indents are raised to inform the purchase department of the impending
need; inquiries are floated; quotations are received; rates are compared; terms of
payment are looked into; and then an order is placed with a supplier whose terms
are attractive; progress on the order reviewed and follow up with suppliers is
done wherever necessary; materials on arrival are checked for quantity and
inspected for quality; supplier's invoices are received, verified and paid for. All
these activities add-up to a big expense, salaries being the main expense. Other
related expenses of these activities are: indirect wages, gratuity, bonus, ESIC,
provident fund, depreciation on office equipment, etc.
Bulk of the above referred administrative costs are fixed as the company has to incur
them irrespective of the increase or decrease in the number of orders. Ordering costs,
therefore, should include all costs to the extent they vary with the order frequency
Activity B ;
Write down the activities which contribute towards the cost of purchasing.
10.4 STOCKOUT COST
Stockout cost represents the cost of going out-of-stock (i.e. loss incurred due to
nonavailability of the item when it is required).
r
f'..;S t o c k o u t r e s u l t s w h e n t h e s t o c k o f t h e i t e m g e t s d e p l e t e d b e f o r e t h e r e
fresh
s u p p ly . O n e o r m o re o f th e fo llo w in g o c c u rre n c e s m a y c a u se S to c k o u t:
i) U n u s u a l h ig h e r d e m a n d ra te d u rin g th e p ro c u re m e n t le a d tim e
i) Delay in delivery
SO T r a n s p o r t a t i o n d e l a y s
V
iv ) R e j e c t i o n i n t h e i n c o m i n g c o n s i g n m e n t
230
110 Fundam entals of Inventory M anagem ent
The stockout of a key material or boughtout component may cause production

stoppage and therefore render a group of workmen and machines idle. Similarly,
stockout of a consumable, replacement or an insurance category of the spare of a
vital machine may renderagroup of machines idle, leaving a wide gap of
unabsorbed overheads.
The following
are the major elem ents of the stockout cost:
i) C o st of m en and m ach in es ren d ered id le.
••t*- ' '
'
i) C o s t d u e to lo s s o f p ro fit o n p ro d u c tio n w h ic h d id n o t ta k e p la c e .
I) C o st o f em erg en cy actio n s su ch as air freig h tin g ch arg es.
iv) C ost due to prem ium price paid. It equals the price difference w hen the item is
procuredfrom an alternate source of supply.
v ) C o st d u e to p en alty p aid fo r the d elay ed sh ip m en ts.
\i) C o st d ue to th e ov ertim e paid to w orkm en em p loy ed in in w ard in spection ,

prod uctionsh o p s, etc. an d to in d ire ct sta ff to co m p le te th e targ e ts o f p ro d u ctio n .
v i) C o st d u e to cu sto m er's d issatisfactio n resu ltin g fro m a d elay ed sh ip m en t.
i) C o st d u e to lo ss o f b u sin ess sin ce th e irate cu sto m er m ay n o t p lac e rep e at

o rd ers ohr e m a y te ll o th e r c u s to m e rs h o w u n p re d ic ta b le th e s u p p lie r s ' firm
is in d e liv e ry
commitments.
T hu s, sto cko u t is m u lti-sid ed an d it d iffers from on e o rg an isatio n to an o th er. N eith er

is it possible to estim ate this cost for all its elem ents nor it is possible to specify the
range of this cost. A nd yet, estim ating stockout costs for inventory decisions. The
estim ate helps decide th e ex ten t o f th e safety sto ck fo r item s o f reg u lar p ro du ctio n
an d th e sto ck in g p o licy o f
insurance spares.
Stockout cost, in general, depends on a particular situation and it equals any of the
follow ing:
i) Back-order cost
B a ck -o rd e r c o st re su lts w h en a n o rd er fo r g o o d s fro m a cu sto m er is k ep t
p e n d in gap p ro v al an d it eq u als th e co st o f p ap er w o rk an d re co rd -k eep in g
u n til th e o rd er is m
ii) Down-time cost

Down-time cost occurs in case of spares and it equals the unabsorbed cost per hour
(i.e. machine hour rate) multiplied by the down time of the equipment.
iii) Foregone profit on lost sale
This occurs in case of goods which are easily available in the market, since the
prospective customer may shop elsewhere.
iv) Additional cost due to premium price
This occurs when the items are available with another supplier at a higher price.
v) Cost of expedited routing
This equals the difference between the cost of expedited routing and the cost of
normal routing.
10.5 SELECTIVE CONTROL OF INVENTORIES______________________

Selective treatment of inventories is based on the following basic philosophy of business:
"No one can control everything nor should one try to do so (even if one can). Uniforn
control is rarely effective. Effectiveness results when important aspects of a problem are
pursued more rigorously than others. A major portion of managerial time should be spent
in performing more important jobs. Less important tasks - those involving routine decisions
and which involve less risk - should be delegated to a lower level."
This law can be effectively applied in inventory function to identify items that are more
important than the others. The classification enables managerial time being spent according
to the importance of the item. Selective control is essential since uniform control of all
items
(i) is expensive
(ii) gives a diffused effect
Selective control means variations in the method of control of various items, based on a
selective basis. The criterion used for the purpose may be the cost of the item, criticality.
lead time, consumption, procurement difficulties and so on. Various classifications are
employed to render selective treatment to different types of materials. Each classification
emphasises a particular aspect. Selective control can be divided into eight types, as illustrated
in Table 10.1.
I
Fundam entals of Inventory M anagem ent
Table 10.1 : Types of Classification

t per ur ho , Classification C r i te r i o n e m p l o y e d
1. ABC analysis U sag e va lue (i.e . co nsu m ptio n per
p erio d x p ric e p er u n it)
HML analysis
(High- U nit price (i.e. it does no t tak e
since the M edium-Low) co n sum p tio n in to a cc ou nt)
VED analysis (Vital- C riticality of the item (i.e. loss of
Essential -Desirable) pro du ctio n)
;r price. I the SDE analysis
(Scarce-Difficult-Easy) <! " Procurem ent difficulties
G ( Fanalysis(G overnm ent-O rdinary-
cost of S o u rce of pro cu rem en t
Local-Foreign)
S-OS analysis (Seasonal- *•
OffSeasonal) S easonality
MNG analysis
1 of business: S toc k tu rn o v er ra te Issu es
F SN analysis (Fast-S low -(Non-
' ""
an). Uniform a moving) fro m sto res
problem are XYZanalysis
iould be spent Inven to ry investm ent
atine decisions
\BCAnalysis
s that are more \BC analysis underlines a very important principle "Vital few: trivial many." Statistics reveal
spent according H i;;! just a handful of item s account for the bulk of the annual expenditure on m aterials.
Hi control of all The i few item s, called 'A ' item s, therefore, hold the key to business. The other item s,
town as 'B' and 'C item s, are numerous in number but their contribution is less significant.
A BC analysis thus tends to segregate all item s into three categories: A , B , and C on the
basis of their annual usage.
A-Items: It is usually found that hardly 5-10% of the total items account for 70-75% of the
total money spent on the materials. These items require detailed and rigid control and need
terns, based on a to be stocked in smaller quantities. These items should be procured frequently, the quantity
;item,criticality,
per occasion being small.
lassificationsare
ach classification B -ltem s: These item s are generally 10-15 % of the total item s and represent
J 10-15 % of
ypes, as illustrated ' 'al expenditure on the m aterials. These are interm ediate item s. The control on these i
not be as detailed and as rigid as applied to A item s.
23
3
C-Items: These are numerous (as many as 70-80% of the total items), inexpensive (represent
hardly 5-10% of the total annual expenditure on materials) and hence insignificant (do not
require close control) items. The procurement policy of these items is exactly the reverse
of A items. C items should be procured infrequently and in sufficient quantities. This enables
the buyer to avail price discounts and reduces the work load of the concerned departments.
Conducting ABC analysis
The following steps are necessary to conduct ABC analysis:
(i) Prepare the list of the items and estim ate their annual consum ption (units).
(U) Determ ine unit price (or cost) of each item.
(iii) M ultiply each annual consumption by its unit price (or cost) to obtain its annual
consum ption in rupees (annual usage).
(iv) Arrange items in the descending order of their annual usage, starting with the highest
annual usage down to the sm allest usage.
(v) Calculate cum ulative annual usages and express the sam e as cum ulative usage
percentages. Also express the number of items in the cumulative items percentages.
(vi) Graph cumulative usage percentages against cumulative item percentages and segregate
the item s into A, B, and C categories.
(vii) Decide the policies of control for the three categories.
An illustration of ABC analysis:
Table 10,2 below, gives the description, annual consumption and price per unit of 20
items. This information is enlisted in the first three columns of the table. The fourth column
gives the annual usage (annual consumption in rupee value) obtained by multiplication of
annual consumption and unit cost of each item.
U nit 10 Fundam entals of Inventory M anagem ent
Table 10.4: Summary of ABC Analysis
No. of % o f R ange of T o tal an n ual P e r c e n t a g e ., ..

i'ems items an n u a l u sa g e u s a g e a n n u a l u s a g e -C a t e g o r y
3 15% A boveR s 1,08,000 7 4 .5 % A

30,000
3 15% B etw een 2 2,20 0 15.4% B

4 ,000 -30,0 00
14 70% Below 14,800 10.1% C

R s. 4,000
Im portant considerations in A BC analysis
\ few important points to considered in connection with ABC analysis are:
1. The ABC curve is a lopsided distribution, wherein a small percentage of items

accountfor a major expenditure on materials. Therefore, the ABC curve is similar
in shape for
different industries.
I All items that the company consum es should be considered together, while
makingABC analysis. It would be meaningless to have separate classifications
for materials,1 "'lished parts, tools, supplies, spares, etc. Similarly, a company
manufacturing morethan one product should also make only one ABC
analysis. Separate ABC analysis ;'or each product is error prone. This is
because, quite likely, an "A" item in product-v ise ABC analysis may become a
"C" item in the total ABC analysis.
3, Tho1: ± annual consumption figures are generally considered for ABC analysis,
it is
not necessary. If convenient, quarterly or six monthly consumption figures can
be
considered.
4. Though classification of items into three categories A, B and C is adequate for

control,
the items may be classified into more than three categories, if required. At
times, to
rationalize control, the author has classified "C" items into sub groups; Cl,237C2
and
C 3.
Policies of control for A, B and C categories:
Any sound stock control system should ensure that each item gets the right amount
of attention at the right time. ABC analysis makes this possible with considerably less
effort, due to its selective approach. There are a number of ways in which ABC
classification can be made use of:
1. Degree of control
A items, as discussed earlier, account for the bulk of the annual usage value and
hence must be given the utmost attention. Someone at the senior level should
be made responsible for the regular reviewing of these items. Up-to-date and
accurate records should be maintained for these items. The inventory should be
kept at a minimum, by placing open orders (or orders covering annual requirement) and
arranging supplies in staggered lots. Every attempt should made to reduce both,
internal and external lead time by closer follow-up at the home plant, better vendor-
vendee relations and market research for alternate sources of supply.
"B" items should be brought under normal control made possible by good record
keeping and periodic attention.
Little control is required for "C" items. Replenishment work should be delegated
to the lower level staff, who may be directly incharge of stores. Large inventories
should be maintained to avoid stockouts. Individual postings should be replaced
by group postings.
Quite a number of inexpensive "C" items can be placed in a convenient spot in

the stock-room or on the shop floor, to enable the shops to help themselves. This
may look like encouraging pilferage and wastage, but the cost of wastage will be
much less as compared to the saving in time and effort otherwise spent by the
stores personnel.
2. Ordering procedure
5.
"A" items require careful and accurate determination of order quantities and
order points based on exact requirements. They should be subjected to frequent
reviews to reduce unwarranted stockouts and the possibility of overstocking.
Areasonably good analysis for order points is required for "B" items, but the
stocks may be reviewed less frequently.
238
It Of No such computations are necessary for "C" items. These items should be bought in
fort, bulk. Their stock may be reviewed only when major changes occur.
ican
3 , S to c k r e c o r d s
Detailed records of goods ordered, received, issued and goods on hand should be
maintained for "A" category of items. Tight control and accurate records are also
icand required for scrap, loss and rejection of such items.
uldbe
xurate No such detailed records are necessary for "C" items. Normal office procedure
;pt at a should suffice, provided that it can give a fairly reasonable estimate of annual
ranging consumption for the year and the indication when replenishment should be happen.
maland Two-bin-system is most suitable for these items.
relations
Any routine method that ensures good and accurate records (not as detailed as "A"
items and also not as loose as "C" items) is enough for "B" category of items.
>d record
4. Safety stock
legated to All items of consumption are equally important from the production point of view.
ies should Shortage of a bolt worth a few paise can be as damaging as the shortage of a casing
iby group worth afew hundred rupees, if both are production items. Shortages do occur even
when accurate and realistic order points have been computed. Safety stock is provided to
safeguard against these shortages.
t spot in the
s. This Safety stock should be less for "A" items. The possibility of stockouts can be
may /ill be onsiderably be cut down by closer forecasting, frequent reviewing and more i
much ,y the Dressing. "C" items, on the contrary, should have sufficient safety stock to eliminate
stores progressing and to reduce the probability of stockouts.
A moderate policy is required for "B" items, safety stock being neither too high nor
toolow.
ties and order 5 . S t o r e s la y o u t

tent reviews to
asonably good ABC analysis can be efficiently utilised for the stores layout as well. Quite a bit of
iy be reviewed time and effort can be saved, which otherwise would be lost in locating fast moving
items near the point of issue. Most of these items will belong to "A" category. "B"
items which are active can be put slightly farther.
23
9
I • Materials Management
i. Most of the "C"

items can be
put in the
less
accessible
areas except
those few
which might
have fallen in
to the "C"
category
because of
their low unit
price and not
because of
their low
consumption
. Such items
may also be
located in
readily
accessible
areas.
6. Physical
stock-taking
"A" items
may be
checked
more often
and "C"
items, on
the contrary,
least often.
One of the
decisions
can be to
check "A"
items every
two months,
"B" items
every three
months and
"C" items
every six
months.
The process
of stock-
taking can be
further
simplified by
verifying the
stock of "A"
items at the
time that they
are ordered,
since their
physical stock
is then low.
Afurther
modification
will be to
verify "A"
items by
units and
"C" items by
boxes, tins,
weight, etc.
7. Value
analysis
To secure
the
maximum
benefits, it is
essential to
select those
items for
value
analysis
which offer
the highest
scope for
cost
reduction.
The usage
value
classification
(ABC
Analysis) is
a useful step
in this
direction.
Only "A"
and "B"
items are
selectedfor
detailed
value
analysis and
the former is
given
priority over
the latter.
"C" items
should not
be value
analysed.
HML Analysis
H-M-L analysis is
similar to ABC
analysis, except
that instead of
"usage value," the
"price" criterion
is used. The
items under this
analysis are
classified into
three groups
which are called
"High",
"Medium" and
"Low". To
classify, the
items are listed in
the descending
order of their unit
price. The cut-
offlines are then
fixed by the
management for
deciding the three
categories. For
example, the
management
may decide that
all items of unit
price above Rs.
1000 will be of
"H" category,
those with unit
price between
Rs. 100 and Rs.
1000 will be of
"M" category and
those having unit
price below Rs.
100 will be of "L"
category.
HML analysis
helps to :
i assess storage
and security
requirements
(for example,
high priced
items like
bearings.
worm shafts,
worm
wheels, etc.
require to be
kept in the
cupboards).
n. to keep control over

consumption at the
departmental head i
level (for example,
indents of high and
medium priced items
are authorised by the
departmental head
after careful scrutiny
of the consumption
figures).
240
:
ew which ft determine the frequency of stock verification. For example, high priced items are
,ot because checked more frequently than low priced items.
iible areas.
iv. to evolve buying policies to control purchases. For example, excess supply other
than the order quantity may not be accepted for "H" and "M" groups while it may be
accepted for "L" group.
least often,
items every v. to delegate authorities to different buyers to make petty cash purchases. For example, "H"
and "M" category of items may be purchased by senior buyers and "L" category
• of items by junior buyers.
.of "A" items r
modification VED Analysis
YEP 'i;tlysis represents classification of items based on their criticality. The analysis classifies the
Hi ;as into three groups called Vital, Essential and Desirable.
value analysis "Vital" category encompasses those items for want of which production would come to
[fication (ABC halt. "Essential" group includes items whose stockouts cost is very high. And "Desirable"
ire selected for group comprises items which do not cause any immediate loss of production or their
2" items should stockout entail nominal expenditure and cause minor disruptions for a short duration.
VED (Vital-Essential-Desirable) analysis is carried out to identify critical items. An item

which usagewise belongs to the C-category may be critical from the production point of
view, if it's stockout can cause a heavy production loss.
due," the "price"
iroups which are n S-D-E Analysis
the descending vt
for deciding the S-D-E analysis is based on the problems of procurement, namely: i
ems of unit price non-availability « scarcity
reen Rs. 100 and
• longer lead time
100 will be of "L"
,.-
i;.,-
.-
-, .
• geographical location suppliers, and
• reliability of suppliers, etc.
items like bearings, S-D-E analysis classifies the items into three groups called "Scarce", "Difficult" and "Easy". The
ards). information so developed is then used to decide the purchasing strategies.
for example, indents "Scare" classification comprises of items which are in short supply, imported or cannalised
ital head after careful through government agencies. Such items are best procured a limited number of times in ;he
year, considering the effort and expenditure involved in the procedure for import.
24
1
"Difficult" classification includes those items which are available indigenously but are not easy
to procure. Also items which come from a long distance and for which reliable sources do not
exist, fall into this category. Even those items that are difficult to manufacture and are
manufactured by only one or two sources only belong to this group. Suppliers of such items
require several weeks of advance notice.
"Easy" classification covers those items which are readily available. Items produced to
commercial standards, items where the supply exceeds demand and others which are
locally available fall into this group.
S-D-E analysis is employed by the purchase department:
(i) to decide on the method of buying
For example, Forward buying method may be followed for some of the items in the
"Scarce" group, "scheduled buying" and "contract buying" for the "Easy" group.
(ii) to fix responsibility of buyers
For example, Senior buyers may be given the responsibility of "S" and "D" groups
while items in "E" group may be handled by junior buyers or even directly by the
storekeeper.
G-NG-LFAnalysis/GOLF Analysis
G-NG-LF analysis (or GOLF analysis) like S-D-E analysis, is based on the nature of the
suppliers. The analysis classifies the items into four groups, namely, G-NG-LandF.
"G" group covers items procured from "Government" suppliers such as the STC, the
MMTC and the public sector undertakings. Transactions with this category of suppliers
involve long lead time and payments in advance or against delivery. *
The "NG" (O in GOLF analysis) group comprises items procured from "Non-Governmen"
f
(or Ordinary) suppliers. Transactions with this category of suppliers involve moderate
delivery time and availability of credit, usually in the range of 30 to 60 days.
"L" group contains items bought from "Local suppliers." The items bought from local suppliers * are
those which are cash purchased or purchased on blanket orders.
I
"F" group contains those items which are purchased from "Foreign" suppliers. The
transactions with such suppliers:
242
• involve a lot of adm inistrative and procedural w ork. ' "

• necessitate a search of foreign
suppliers.
i require the opening of letter of credit.
« require the m aking of arrangem ents for shipping and port clearance.
S-OS Analysis
S-03 analysis is based on the seasonality of the item s and it classifies the item s into
tw o groups-S (seasonal) and O S (i.e. O ff S easonal). T he analysis identifies item s
w hich are:
i »asonal and are available only for a lim ited period. F or exam ple, agriculture
producelike raw m angoes, raw m aterials for cigarette and paper industries, etc.
are available for a lim ited tim e and therefore such item s are procured to last the
full year.
i seasonal but are available throughout the year. T heir prices, how ever, are low er
duringthe harvest tim e. T he quantity of such item s requires to be fixed after
com paring the
cost savings due to low er prices if purchased during season against
the higher cost of carrying inventories if purchased throughout the year.
i no n-seaso nal item s, w hose quantity is decided on different con sid eration s.
F-S-N Analysis
F-S-N analysis is based on the transaction frequency of the item s. T he item s under
this anaH s are classified into three groups: F (fast m oving), S (slow m oving) and
N (non-
moviiis).
Toconduct the analysis, the last date of receipt or the last date of issue, w hichever is
later, is taken into account and the period, usually in term s of the num ber of
m onths that has
elapsed since the last m ovem ent, is recorded.
Such an analysis helps to identify:
i active item s w hich require to be review ed regularly.
i surplu s item s w ho se stocks are high er th an their rate of con sum p tion ; and
i non-m oving item s w hich are not being consum ed. The last tw o categories
243 are
review edfurther to decide on th e dispo sal action to deplete th eir sto cks and
thereby release
>' Com pany's productive capital.
Further detailed analysis is made of the third category, with regard to yearwise stocks.
Items can be sub-classified as non-moving for 2 years, non-moving for 3 years,
non-moving for 5 years and so on.
X-Y-Z Analysis
X-Y-Z analysis is based on value of the stocks on hand (i.e. inventory investment). Items
whose inventory values are high are called X items while those inventory values are low
are called Z items. And Y items are those which have moderate inventory stocks.
Usually, X-Y-Z analysis is used in conjunction with either ABC analysis or HML analysis.
XYZ analysis when combined with ABC analysis is used as under:
Class of items B
X Efforts to be made Efforts to be made Steps to be taken to

to reduce stocks to to convert them to dispose of surplus
Z category Y category stocks
Efforts to be made * Control may be
to convert these to further tightened
Z category
Stock levels may be *
reviewed twice a year
XYZ analysis when combined with F S N analysis helps to formulate specific strategies,
as mentioned below:
Class of F items N
X Tighten control Deplete stocks to a Dispose of

very low level immediately at an
optimum price.
Y Deplete the stocks Dispose of as early

further at good price as possible
Liberalise control * (to reduce Dispose of as early * as

clerical cost) possible even at ' lower prices.
244 * Items are within control. No further action is necessary

deterioration, obsolescence and, above all, the cost of the capital required in
financing stocks. On the other hand, it costs money to run out of stock-idle wages, loss
of production, loss of profit, loss of goodwill, premium shipments and expediting
to overcome the disorganisation following a shortage.
Inventory control helps to strike an optimal balance between these opposing costs
and thereby ensures the availability of the required items at a minimum total cost to the
company.
Inventory carrying cost, procurement cost, set-up cost and stockout cost are the
four major costs for the inventory decisions. Inventory carrying costs are the costs
incurred in connection with the holding of stocks and they include capital cost (interest
or opportunity cost on the capital invested in stocks), loss due to obsolescence and
deterioration, taxes and insurance, and storage and handling expenses. Procurement
costs are the costs incurred in connection with the replenishment of stocks and they
include costs of printing and stationery, telephone and trunkcalls, telexes and
telegrams, postage and travelling, fuel and maintenance expenses of the vehicles
employed to collect/deliver materials from/to vendor's/transporter's
plants/gowdowns, etc. Stock-out cost is the cost incurred in the event of the non-
availability of the item when required. Stock-out costs are usually difficult to estimate
and they are situation dependent.
Selective control advocates control-by-exception. Uniform treatment of all items

gives diffused effect, besides being expensive. Items should be classified so that a
major portion of effective managerial time is spent on those materials which are
more important than others. Various methods of classifications are available.
Each method emphasises a particular aspect. For example, ABC analysis
emphasises annual usage; V E D analysis employs the criticality of the part, H M L
classification utilises price criterion; F S N categorisation considers consumption
pattern; S D E analysis relies on problems faced in procurement, and so on. At times, it
may be advantageous to use more than one criterion, in conjunction with each other.
For example, A B C and V E D classification may be used
for spares; X Y Z and F S N classification may by utilised to reduce obsolescence.
£
10.7 KEYWORDS______________________________________________
Capital Cost: Capital cost is either the cost of borrowing capital or the cost of
diverting the company's funds to invest in inventories.
Deterioration and Obsolescence: Deterioration is the loss from reduction in the

inventor* value due to keeping it beyond the life of the stock. Obsolescence is the loss
246 from reduction in inventory value of the items/components that are rendered
unusable by the company due to changes in design or due to the developments in
the field.
U n it 1 0 F u n d a m e n taInlsvoe fn to r y M a n a g e m e n t
Finished Parts: Finished parts are those parts, sub-assem blies or assem blies which
are purchased from outside suppliers or those parts which are manufactured at the
com pany'sown plant from the basic raw materials to be used for the final product.
Finished G oods: Finished goods are the final products ready to be shipped.
Inventories: Inventories represent the aggregate of those item s which are either
held for sale in the ordinary course of business or are in the process of production
for sale (i.e.work-in-process) or are yet to be utilised/consumed in the production of
goods and services.
Inventory Carrying Cost: Inventory carrying cost refers to the cost of holding
stocks.
Insurance Cost: Insurance cost is the prem ium paid or payable to cover the
com pany
against loss due to unforeseen acts such as fire, theft, etc.
R aw M aterials : R aw m aterials are those basic unfabricated m aterials w hich

have undergone no conversion whatsoever, since receipt from the suppliers.
I Storage C ost: Storage cost includes cost of storage space, cost of m aintenance
and repairs, cost of storage facilities, cost of preservation, cost of record keeping and
cost of1 periodic/annual stock verification, etc.
Stockout Cost: Stockout cost represents the cost of going out of-stock (i.e. loss
incurreddue to the non-availability of the item when it is required). Stockout results
when the stock of the itt-1 gets depleted before the receipt of fresh supply.
W ork-in-Process: W ork-in-process com prises item s that are in a partially

com pleted
condition of manufacture.
10,8 SELF-ASSESSM ENT QUESTIONS
Ql. W hat are inventories? State and define the various types of inventories
found in amanufacturing firm.
Q2 W hy is inventory control important for every business firm? W hat are the
objectivesof a scientific inventory control?
Q3. W hat are the different types of costs that require to be considered in the
S47
inventorydecisions? W hat elements constitute these costs? How are these
elements assessed?
Q4, a) What are inventory carrying costs? What elements constitute inventory carrying
cost?
b) The data extracted from the financial and other statements of a company are
revealed the following:
Capital deployed Rs. 4,29,57,212

(Share capital + Reserves +Secured Loans etc.)
Profit before tax Rs. 77,32,298Rs.
Average inventory investment 1,10,66,270 Rs.
Value of obsolete & dormant stock 31,048
written off during the year
Insurance on stock held during the Year. Rs. 42,574
Storage area: Raw material store 10'x 20'
Components store 20'x 20'
+
64' x 20'
Receipt & Despatch 32' x 12'
2264 eq. ft.
Construction cost Rs. 90 per sq.ft.
Life of building 50 years
Expenses by way of maintenance Rs. 90 per sq.ft.
248 Life of building : 50 years

jj
Expenses by way of maintenance : Rs. 33,084
of stores including cost of
preservation, stock records etc.
Ba %
nk t
len Calculate inventory carrying cost for the company.
di
ng 2
rat
Q5. What do you understand by procurement cost ? What are the major elements
of
e procurement cost?
:
Q6. What is meant by the selective control of inventories? What different methods are
14
used for selective control of inventory items?
11.1 INTRODUCTION TO EOQ

One of the basic decisions that must be made in any stock control system is that
of determining the quantity to order, since investment in inventories largely depends
upon the quantities in which the items are ordered for replenishment.
Ordering large lots infrequently reduces the administrative work but increases
investment in stocks. Ordering small lots frequently keeps the investment low
but increases the administrative work. Therefore, a rational approach is needed for
determining the order quantity of an item.
As a general rule, items of C-category can be procured in bulk, without capital

being locked. The stock of A-category of items, on the contrary, should be kept low
by ordering frequently. This will keep the inventory investment low and will not
increase administrative work (because of their limited number).
Graphical analysis of economic lot
size Cost to be optimised
There are two major costs associated with any order quantity (i) procurement cost and
(ii; inventory carrying cost. The annual procurement cost varies with the number of
orders. This implies that this cost will be high if the item is procured frequently in
small lots. This has been graphically demonstrated in Fig. 13.1.
The annual inventory carrying cost (the product of average inventory investment and
inventor}' carrying cost), on the contrary, falls when the quantity ordered per occasion is
small because of low capital investment. The two costs, therefore, are diametrically
opposite to each other. The right quantity to order will be the one that strikes an
optimal balance between these two opposing costs. When these costs have been
properly balanced, the total cost is minimum and the resultant quantity is termed as
the economic order quantity, and is commonly abbreviated as EOQ. Further, it may
be observed from the graph in Fig. 13.1 that the lowest total cost occurs at the
intersection of the procurement cost curve and the carrying cost curve.
An illustration on the graphical method

The monthly consumption of an item costing Rs. 3/- per unit has been estimated at
1(X units.
252
U nit 11 E conom ic L ot Size
Inventory carrying cost and the procurement cost for the company have been computed
at
15% and Rs. 30 per order respectively.
s s s s s s sCs a) l c u l a t e t h e a n n u a l p r o c u r e m e n t c o s t f o r t h e a b o v e i t e m , a s s u m i n g d i f f e r e n t v a l
o f o rd e r q u an titie s (sa y in ste p s o f 1 0 0 ) a n d c o n stru c t a g ra p h fo r a n n u al p ro c u re m e n
c o s t v e rsu s o rd e r q u a n titie s.
t t t t t t tCt )a l c u l a t e t h e a n n u a l i n v e n t o r y c a r r y i n g c o s t f o r t h e a b o v e i t e m , f o r t h e d i f f e r e n t v a l u e
of order quantities and construct a graph for annual inventory carrying cost versus
order quantities.
uuuuuuuu)Determine the quantity to be purchased to optimise the total cost.
Solution:
•' ' i
i o costs are affected by the size of the order quantities: annual procurement cost and
annual inventory carrying cost.
Table 11.1 is developed for these costs for different values of order quantities (in steps of
100units). Asample calculation for an order quantity of 400 units is shown below:
Annual procurement cost = [No. of orders per year] x [procurement cost per year]
_ [ A n n u a l c o n s u m p t io n procurement 1cost
X
I o rd e r q u a n tity per order J
=
[ 1 0 0 x 1 2 x 3 0400
L
Annual inventory cost

= R s.90
= [ Average
_ n_ order price peri T Inventory
L2 quantity J inventory
unit
investment] x
[Inventory carrying cost]
L carrying cost1
= x 4 0 0 * 3 x 0 .1 5 = R s.9 0
253
I'n ii 1 1 E co n o m icS ize
Lot
A s ev id en t fro m th e g rap h , to ta l co st is m in im u m w h en th e o rd er q u an tity is 4 0 0 u n its.

T h erefo re, eco n o m ic o rd er q u an tity o f th e su b ject item is 4 0 0 u n its.
1 1 .2 B A S IC (O R W IL S O N ) E O Q M
______________________________
ODEL
A s s u m p tio n s u n d e rly in g th e E O Q m o d e l:
i. T h e d em an d fo r th e item o ccu rs u n ifo rm ly o v er th e p erio d a t th?..e k n o w n rate.
T he rep len ishm en t o f th e sto ck is in stantan eo u s.
ii T h e tim e th a t ela p se s b e tw e en p la c in g a re p len ish m en t o rd e r an d rec e iv in g th e item
into stock, called lead tim e, is zero.
iv . T h e p rice p er u n it is fix ed an d is in d ep en d en t o f th e o rd er size.
T h e co st fo r p lacin g an o rd er an d p ro c essin g th e d eliv ery is fix ed an d d o es n o t v ary
with the lot size.
vi. T he inventory carrying charges vary directly and linearly, w ith the size of the inventory,
an d is ex p re ssed as a p ercen tag e o f th e av erag e in v en to ry in v e stm en t.
\i T h e ite m can b e p ro cu red in th e q u an titie s d esired , th ere b ein g n o restric tio n o f an y
kind.
\IL i h e item h as a fairly lo n g sh elf life, th ere b ein g n o fear o f d eterio ratio n o r sp o ilag e.
Symbols used:
A m y consum ption of the item (units) : S
Price per unit (Rs.) : Cu
Procurem ent cost per order (Rs.) : Cp
Inventory carrying cost as a percentage

ot average
inventory investm ent (decim al) Order: i
quantity (units)
q
q
Economic order quantity o
2
5
5
U nit 11 Econom ic Lot Size
Proof of optim al buying:

To give proof of optim al buying, w e m ust calculate the annual procurem ent cost and annual
inventory carrying cost w hen the quantity ordered per occasion equals the econom ic order
quantity.
>;COSt
Annual procurement cost -xCp
q
S x Cp
/2 .S .C u (S in c e a t E O Q le v e l q =C qu.io )
S .C p .C u .i .(5)
Annual inventory carrying . x Cu x i
'2 . S . C pC u . i C u .i
x
S .C p .C u i
.(6)
;ost, we must
alive to zero. It is evident from the above tw o equations, (5) and (6), that the best buyingte results w hen
annual procurem ent cost equals annual inventory carrying cost.
Using the form ula: illustration

An
\, o m p a n y u se s 7 5 n u m b e rs o f a n ite m p e r m o n th . E a c h u n it c o s ts Rs,
th e c o m p a n y
25/-. The cost of putting through each order and inventory carrying charges are per m onth
com puted atR s. 36 and 1.5% of the average inventory investm ent respectively.
.....(4) In w hat econom ic lots should the item be purchased to m inim ise the annual
Solution:
total cost?
Economic order quantity is given by the formula,
qo =
er order]
25
7
Annual consumption (units)

where S 75X12
900 numbers.
Cp =
procurement cost per order (Rs.)
Rs. 367-
Cu =
Price or cost per unit (Rs.)
Rs. 257-
Inventory carrying cost per year (decimals)
x 12 = 0.18
100 Substituting the values in the EOQ formula, we
get
'1 x 900 x
Sq. Rt.,
qo =
25XQ.18
An alternate formula 120 numbers. for EOQ when consumption is specified in
Rupees
The basic formula for the EOQ (equation 4) suggests the quantity (in terms of units) to be
purchased to optimise the costs involved. In this formula, consumption figure (s) is
considered in units (i.e. numbers, kgs, meters etc.). At times, however, it is desirable to
calculate order quantity in rupees instead in units. (This being so when the annual
consumption of the items are specified in terms of monetary values.) The formula for
"economic order quantity in rupees" can be obtained as under:
Let A = Annual consumption in rupees (called annual usage)

Qo =
Economic order quantity (Rs.)
Multiplying both sides of the equation (4) by unit price, Cu, we get:
2.S.Cp
qo x Cu = Qo =
x C u Cu.i
2.A.Cp.Cu2Cu2.i
S=
A
258
£$ Activity B ;
List all the costs to be considered for EOQ.
g$ Activity C;
List the factors because of which the EOQ is required to be modified in practice.
11.3 EOQ WITH QUANTITY DISCOUNTS
Rational of quantity discount
Basic economic order quantity formula is based on the assumption that price per unit
is fixed, irrespective of the order quantity. This is not always true. Often, suppliers
offer a discount if higher quantities are purchased.
Quantity discounts reduce the material cost and the procurement cost but
increases investment in inventories (i.e. increase inventory carrying cost). A decision,
therefore, is to be made whether the buyer should stick to the economic order
quantity or to raise the same to take advantage of the price break.
When quantity discounts are offered, the management needs to decide whether they
should buy a quantity larger than determined by the EOQ formula to take advantage of
the discount If the price per unit is variable (as in case of a quantity discount
situation, the total cost function no longer remains uniformly continuous but becomes
stepwise continuous. This implies that in order to establish the optimum quantity, we
must investigate all local minima (global minima), some of which may occur at price
break level while others may occur within a price range.
260
U n it 1 1 E c o n o m ic L o t S iz e
Considering the step-wise continuous nature of the total cost function, we must also consider
the annual material cost (S x Cu) in the cost calculations, while making a comparison on the
basis of annual total cost. Therefore, the general formula for the annual total cost becomes:
'4
ATC = SxC u+xS x Cp + qx Cuxi ' ......(9 )
q 2 , ,
Procedural steps
I) Calculate EOQ at
different price levels.
1} D ecide the quantity to be purchased at each price level. This equals EO Q or the
p ice break quantity. The latter being necessary if EO Q at a particular price level
w orks out to be lower than the corresponding price break quantity.
Calculate the annual total cost including the annual material cost at the quantities fixed
under step (2).
\] Select an optim al purchase quantity, this being one w hich entails the low est annual
total cost.
An illustration
Acheraical firm buys 2500 units of a particular item annually from a vendor,Rs,
at a cost of
per unit. It has now received price schedule from the vendor, which is as follows:
Order Quantity Price Per Unit

Less than 500 units
500 to 1250 units
1250 R s. 3.00 R s. 2.9R0s. 2.85
units or more
The cost of placing an order and executing the delivery once = Rs. 25
Inventory carrying cost as a percentage of average inventory = 20%
investment
Determine economic order quantity of the item.
261
Assumptions underlying the model:

vvvvvvvv)The item is consumed at the known demand rate, which is constant.
wwwwwwww)The cost to set up a machine (or a group of machines) and order writing is
fixed and
does not vary with the lot size.
xxxxxxxx)The inventory carrying charges vary directly and linearly with the size of the
inventory
and are generally expressed as a percentage of the average inventory investment.
yyyyyyyy)The inventory does not increase by the quantity on the shop order but rather
gradually
at a rate (p-d) where 'p' is the production rate and 'd' is the demand rate or the
production rate is finite (i.e. stock replenishment is gradual)
e) The item can be manufactured in the desired quantity free from restrictions of any
kind such as tool stand up time, risk of obsolescence, space restrictions, etc.
Graphical representation of the model:

Replenishment of inventory under this system, as mentioned earlier, occurs over the period
't' while the usage occurs over entire cycle T. This gives two effects:
i. It increases the economic lot size since average inventory is no longer—but less than
IL
qo Mathematical treatment of the

2
= S
Annual total cost for the same annual requirement is less than the annual total cost
= Cu
under the instantaneous receipt method. = C p
= P
model: Symbols used: = d
Annual requirement of the item (units) = t
Manufacturing cost per unit Setup cost
per production run Daily production rate
(units) Daily demand rate (units) Duration
of production run (days)
U n it 1 1 E c o n o m ic L o t S iz e
and Inventory carrying cost as a percentage of

average inventory in vestment = i
rentory Quantity per production run = q
nent.
Economic manufacturing quantity = qo
ad u ally
5 o r th e P reparation of the m odel:
In v en to ry u n d er th is sy stem b u ild s u p at th e rate (p -d ) an d is m ax im u m a t th e en d o f

production run.
M axim um inventory at the end of production run = ( p-d)t
is of any :. Average inventory (units) = (P-d) \
= i (P-d) x <L
iie p erio dit
('.') q =quantity produced during a production run
= p x t)
less than
al to tal co st
- -1 C u.i S
2 P
:. Vinual inventory carrying cost
.
And annual set-up cost C

= [No. of production runs]
p
x [Set-up cost per production run]
= - xCp
q +
Annual total cost (ATC)
= A nnual set-up cost+A nnual inventory carrying cost, q

/ -C u .i
(10)
!
\
(11)
26
5
Optimisation of the model:
Optimisation of the inventory model implies fixation of batch quantity that minimises annual
total cost (ATC).
To minimise annual total cost, we must differentiate ATC with respect to the decision of the
variable q and equate the first derivate to zero.
.- . d (A T C ) _ - S . Q .C u .i = 0
dq q2
or S.Cp _ 1_ =0
qo2 2 When d(ATC) = 0 then q > qo
J
dq
qo2 = 2.S.Cp
(j.dlCu.i 1
Pj
orqo =
' 2.S.Cp ....(1 2 )
d_\ .
An illustration: '("I) Cu.i
P'
266 A company uses 12,000 units of a particular time, the average usage being 40 units
per working day. The production process is such that the company can produce 60
units perday. Each item made in the plant costs the company Rs. 8. The cost of set-up
and orderwriting works out to be Rs. 96/-. The inventory carrying cost is estimated at
15% of theaverage inventory investment.
I
,
zzzzzzzz)W hat quantity should be produced in each run?
J
aaaaaaaaa)H ow frequently should production runs be made?

Materials
t
Management
11.5
SUMMARY
Investment in inventories, to a large extent depends on the quantities in which the items are
ordered for replenishment. Ordering bigger lots infrequently reduces the procurement cost
but increases investment in stocks, while ordering small lots frequently keeps investment in
inventories low, but increases the procurement cost. The two costs - procurement cost
and inventory carrying cost - are diametrically opposite to each other. The right quantity to
order, therefore, is the one that strikes an optimal balance between these two opposing
costs. When these costs have been properly balanced, the total cost is minimum and the
resultant quantity is called "economic order quantity" for which the formula is as under:
Economic order quantity (qo) = SQ. RT. 2 . S . Cp C u . i
The formula above represents the basic EOQ model, which may be extended to cover
many other situations.
11.6 KEYWORDS____________. _________ ^ _ _ _ _ _______________
EOQ : Economic Order Quantity is that quantity where the total cost of ordering and
inventory is optimised to give the minimum cost.
Inventories: Inventories represent the aggregate of those items which are either held for
sale in the ordinary course of business or are in the process of production for sale (i.e.
work-in-process) or are yet to be utilised/consumed in the production of goods and services.
Inventory Carrying Cost: Inventory carrying cost refers to the cost of holding stocks.
Ordering/Procurement Cost: All the costs associated with preparation of order and
purchasing the item is termed ordering cost.
Storage Cost: Storage cost includes cost of storage space, cost of maintenance and
repairs, cost of storage facilities cost of preservation cost of record keeping, and cost of
periodic/annual stock verification etc.
11.7 SELF-ASSESSMENT QUESTIONS_____________________________
Q1. What is economic order quantity? Describe the development of EOQ formula, step by
step.
U nit 11 E conom ic L ot S ize
.sure Q 2. W hat is the im portance of EO Q in inventory control? W hat are the lim itations of
I cost EO Q concept?
e n tin
Q 3 A trading com pany buys and sells 10,000 bottles of pain balm every year. p e r T he cost
it cost
b o ttle is R s.2 a n d th e co st o f p lac in g an o rd e r is R s. 1 0 0 . T h e co standard
m p an y 's
itity to
rate of return on w orking capital funds is 11/3 % per m onth. Tphysical he cost of
Dosing
storage of pain balm is fixed.
incline
nder. (a) D eterm ine the optim al order quantity and inventory cycle duration for the pain
balm.
(b) H ow m an y orders are placed each year?
vc) W hat is the m inim um yearly inventory cost?
to c o v er
A ns. (a ) q o = 2 5 0 0 ,3 m o n th s (b ) 4
(c ) R s.8 0 0
Q 4. A co m p an y requ ires 20 00 k gs o f" 1, E n 8, cold d raw n b ar stock" m aterial per

m o n th w h ic h c o sts R s. 1 2 .5 0 p e r k g . T h e c o m p a n y h a s to sp e n d R s. 1 5 0 fo r
ie rin g a n d
processing and executing an order for the supply of raw material. Interestcosts and storage
total 20%.
herheldfor .......? *v>? \
for sale (i.e. bbbbbbbbb)
W hat is the approxim ate econom ic order quantity?
and services.
ccccccccc)
W hat is the annual total cost
Iding stocks,
i
(i) excluding purchase price.
of order and
(ii) including purchase price. '
A ns.: (a ) qo= 1697 kgs.
in te n a n e e a n d
ng, and cost of (b ) (i)A T C = R s.4 24 2
(ii)A T C = R s. 3 ,0 4 ,2 4 2
Q 5. The m anagem ent of a com pany has established a policy of turning inventory four
tim es a year. T he unit price is R s. 24 per unit. O rdering cost is R s. 48 per order.
3Q form ula, step U sage rate is 300 nos. per m onth. A nd inventory carrying charges areper 16 percent
annum.
(a) W hat is the total annual cost of existing inventory policy ?
26
9
12.1 LEAD TIME AND ITS ELEMENTS

Lead time is the time that elapses between the realisation of the need for the item until
the fulfillment of the need. It is, therefore, the total time necessary to replenish the
stock of an item.
Several distinct elements comprise lead time. They are discussed below:
1. Time required by the indenting department to convey requirements

to
Purchase
Materials may be required as a routine replenishment or for a specific use.

Purchase indents for regular items are generally raised by the store as soon as
their stock falls to or below a pre-fixed level. Purchase indents for non-stock
items are generally initiated by the user department. The duration of this element
depends on the channels through which a purchase indent is made to pass.
Purchase indents of 'C items may be initiated and sent directly to the purchase
department by the store keeper. One day is usually considered enough for such
indents. Purchase indents of A and B items may be initiated by the stores
department but reviewed by someone at the senior level. Therefore, the time
considered is maybe two days for all such indents.
2. Time required by the purchase department to convert a purchase indent

into
a purchase order
When an indent is received, the purchase department invites quotations. The

request for quotations, is mailed to certain selected vendors, samples (wherever
asked for) are tested to ascertain quality and terms of delivery are looked into.
Such a procedure enables the purchase department to select a supplier, who can
supply the goods of right quality, at the right price, and at the right time. The
purchase order is then raised on the supplier whose terms are better than those
of others.
It is a general practice to mail requests for quotation (tenders) simultaneously to

all suppliers and indicate therein the specific date and time up to which their
offers will be considered. This sets the duration of this time element. This activity
is usually not performed for the standard items and for those procured from
established suppliers.
3. Time required by the supplier to route the buyer's order through his
274 administrative channels and fill the same
The duration of this time element depends largely on the conditions of

manufacture. Manufacturers of standard items such as hinges, handwheels, bolts,
nuts, washers :
U nit 12 R eplenishm ent S ystem s
etc., do not require longer lead time, as they can be supplied by the vendor from
his ready stock. Comparatively longer delivery period is quoted when the item is
a non-standard one and needs to be manufactured to the buyer's design. An
even longer delivery period is quoted, if the manufacture involves the
procurement of special materials. The duration of this element equals the delivery
period quoted by the supplier.
4. Transit tim e for the goods to reach the buyer's works

The transit time which depends on two major factors - the distance and the
mode of transport - has the greatest bearing on the lead time of an item.
Transportation time is less if the vendor is located nearby. Similarly, materials
dispatched by road transport generally take lesser time than by rail transport.
5. Tim e required by the receiving departm ent to inward goods

Incoming goods are received and verified for quantity by the receiving
department. The department verifies the markings on the packages before
accepting the delivery, unpacks and verifies contents to ensure that the quantity
on the challans and quantity actually received tallies before inspection and
prepares the necessary documents like Goods Receipt Report, etc.
(i, Tim e required for inspection to verify the quality of goods

Time for this activity depends on the criticality of the item and its quality
description. Items procured to commercial standards and brand names
require less time than those procured to performance standards. Similarly,
items requiring dimensional checks require less time to inspect than those
requiring metallurgical and/or performance checks.
I Tim erequired by the store departm ent to take goods into stock and
updates to c k re c o rd s
T h e tim e o f th is e le m e n ts in c lu d e s tim e to
d d d d d d d vd ed r) i f y t h e q u a n t i t y o f m a t e r i a l s r e c e i v e d a g a i n s t G R . R .
e e e e e e e er e )c o r d r e c e i p t q u a n t i t y o n s t o c k - c a r d a n d w o r k o u t t h e b a l a n c e .
f f f f f f f fafr)r a n g e f o r s t o r a g e o f m a t e r i a l s i n t h e i r r e s p e c t i v e b i n s o r c o n t a i n e r s .
S ffS
Control of Lead Time
Lead time of an item has a major influence on the investment in inventories. The longer the
lead time, the higher is the working as well as the safety stock. Therefore, the management
must make a deliberate and determined effort to reduce lead time.
Internal lead time of an item can be reduced by the following actions of the management:
i Selectively delegating powers
ii. Better paper work procedures
iii. Fixed targets for individual activities of lead time
External lead time can be reduced by the following activities of the management:
L Developing local suppliers

ii. Negotiating annual contacts with staggered deliveries
iii. Selecting efficient and faster mode of transport to achieve overall economy
iv. Making suppliers carry inventory at their plants
Estimation of Lead Time
General rules for estimation of lead time are as under:
i. Lead time for C-category of items should be estimated item group-wise (say drills,
taps, inserts, broaches, standard hobs, non-standard hobs, milling cutters etc.) while
lead time for A and B category of items should be assessed individual itemwise.
ii. SDE (Scarce-Difficult-Easy) analysis should be carried out prior to the estimation of
lead time. SDE analysis may be made for item groups of C-category and for individual
items of A and B category.
iii. Lead time should be reviewed periodically especially that of A and B category and
adjustments in stock levels should be made accordingly.
How lead time information is utilised for inventory control?
Under ideal conditions, the fresh supply shall be received as soon as the stock of an itei
drops to zero. This is possible only if-
U nit 1 2 R eplenishm en t System s
1 the replenishment action is taken at the right ti

tme.
i there is no increase in dem and during the lead tim e.
i there is no delay in getting the supplies (delivery).
The first condition is satisfied by fixing a trigger point called as the re-order level. Trigg
point is that level of stock at which the store keeper is authorised to raise an er indent
for replenishment of an item . Re-order level under ideal situations therefore equals lead
time'
consumption.
Sym bolically, Re-order level (P) = Lx C w here L = lead tim e in days/w eeks/m onths.
And C = daily/ weekly/ monthly consum ption.The process of replenishment is shown in
figure 12.1
Lead tim e consum ption

0
L time
Fig. 12.1: Replenishment Process under Ideal Conditions
It is clear from the above discussion that to fix up the re-order level, we m ust have
information on lead time.
Let os now analyse the other two assumptions. Both these assumptions are unrealistic and
almost 180° apart from the true situation. Demand does increase! Lead time, of course, is
tardy adhered to! This gives rise to stockouts and production stoppages as show n in
Fare 12.2.
! U n it 12 R eplen ish m en t S ystem s
1 J
'
\ &A ctivity B ; ' • > . . . - -' < -
M ention the steps that you can take to reduce the lead tim e.
1 12 R E P L E N IS H M E N
SYT S T E M S
A replenishm ent system is a m eans to decide w hen to order and how m uch to order.
The form er ^presents "tim e of ordering" and the latter represents "quantity to be
ordered."The tim e of ordering can either be according to "stock level" (i.e.
replenishm ent actionbeto initiated w hen stock level drops to a pre-fixed level) or
it can be according to "pre
fixed tim e scale" (i.e. every w eek or every m onth). A nd
the quantity to be ordered either
can be "fixed" or it can be "variable." Different
systems differ in these tw o aspects only.
s The tw o m ain replenishm ent system s are: (i) fixed-order-quantity system and (ii)
fixed-
'. order-interval system.
113 FIX ED -O R D EQRU A N T IT Y SY ST E M

I Fixed rder quantity system is also called fixed-order system or m in-m ax system
or re-j orderpoint system. The salient characteristics of this system are:
in Re-order quantity is alw ays the sam e, w hich is usually the econom ic order
quantity(or econom ic order quantity m odified in the light of constraints).
!
b) R eplenishm ent action is initiated w hen the stock on hand is just sufficient to
m eet; demand during lead time.
k] Safety stock is kept to take care of any increase in dem and during lead tim e as
w ellas to m eet dem and w hen the lead tim e is extended.
d| Re-order level equals safety stock plus average consum ption during lead
tim e.Working of the system:
Under this system, the stock of an item is replenished when it approaches or falls
279
below a
He-fixed i • el called re-order level.
Re-order level, which is commonly abbreviated as R.O.L., is the sum of safety stock and
the average lead time consumption. The stock equal to lead time consumption is intended
to satisfy average demand during lead time. The safety stock is meant to absorb other
contingencies such as delay in delivery, increase in consumption, and rejection in the incoming
consignments. (Ref. Fig. 12.4). Re-order levels is located somewhat above the minimum
level. The quantity ordered (re-order quantity) in his system is fixed and is usually
the economic order quantity (or the same might have been modified to suit business
constraints).
1 t I
o
\ Lead time
cons. Re-order
Level
Safety Stock
t
280 Fig. 12.4 : Graphical Representation of Re-order Level System
The system is very simple and easy to operate. The daily issues of the item are posted on
its n practice to write re-order level of the item on its stock card for ready reference).
stock Replenishment action is initiated if the sum of stock on hand and quantity on pipeline
card falls to or below its re-order level, otherwise the decision is postponed until the next
and issue.
stock &.
balance To operate the system efficiently, stock cards must be kept correct and should be
is posted regularly for receipts and issues. The essentials of this system are:
worked (i) Incoming materials and materials returned from shops must be deposited in
out, appropriate bins and their stock cards must be posted for goods inward notes and
which material return notes for the quantities physically received.
is
compar (ii) Items should be issued in correct quantities.
ed with (iii) The balance on the stock cards should be periodically tallied with the physical stock.
its re-
(iv) Entries must be made on the correct cards.
order
level (it (v) Arithmetical errors should be avoided.
is a -
commo
(vi) Individual issues and receipts should be posted.
U nit 12 R eplenishm ent S ystem s
.and Basic parameters to operate the system

nded There are two basic parameters required to operate the system. t* (a) Re-order level, as
mentioned earlier, equals the sum of mi nimum stock and average
rther
lead time consumption.
ming
mum \ Symbolically, •
ly the Re-order level = m + LxC ......................... (A)
aints).
Where m = minimum stock or safety stock (units) 1 «

L = lead time (days/weeks/months)
I ix J '., C = daily/weekly/monthly consumption
(units)
)ostedon (b) Re-order quantity (q) under this system is fixed and is normally the economic order
rder level for quantity (EOQ) or modified economic order quantity (MOQ).
ready nantity
on d until the M a x im u m sto ck (M ) u n d er th e sy stem :
U n d er th e re-o rd er lev el sy stem , th e m ax im u m lev el is th e su m o f m in im u m sto ck an d th e

1 be posted re-order quantity.
If ra=rninim um stock and ~r

appropriate
terial return qo =;v -nornic order quantity, then
.'. M ax im u m sto ck (M ) = m + q o ........ (B )
j A verag e in v en to ry u n d er th e sy stem :
ysical stock.
' Average inventory, in general, is either half of the sum of minimum stock and maximum «k
or merely the sum of minimum stock and the half of the re-order quantity, i.e.
Average inventory (I) = V&(m

= l
/2 (m + m + qo)
= m + qo/2 -,,, v .... ..... ,;..,
.\n illustration on the working of the system :
UKmonthly consumption of an item whose unit price of Re. 1 has been estimated at 300 its,
The 'pventory carrying cost and the procurement cost for the company have been
28
1
computed at 18% and Rs. 36 per order respectively. Stock records show that this item
can normally be procured within a period of one month. If the company adheres to the
policy of one month safety stock,
Calculate
ggggggggg)re-order quantity
hhhhhhhhh)minimum level
iiiiiiiii)re-order level
jjjjjjjjj)maximum level, and '
kkkkkkkkk)average inventory,
assuming re-order level system of replenishment
Solution:
(a) Re-order quantity under re-order level system is fixed and is generally the economic j
order quantity (which might have been modified in the light of constraints) and is
given by the relation
qo Cu.i = 2.S.Cp
Where S
= Annual consumption (units)
= 300x12
= 3,600 units
= Procurement cost per order
= Rs. 36 per order.
= Inventory carrying cost as a percentage of average inventory

investment (decimals)
= 0.18
282
U nit 12 R eplenish m ent System s
Substituting the values in the above relation, we

2 xget -
3600 x 36
qo =
1 x 0 .1 8
1200 units
llllllllM l ) i n i m u m l e v e r ( m ) w h i c h a l s o k n o w n a s s a f e t y - s t o c k i s g i v e(i)n t o b e e q u a l
to o n e The
m o n th 's c o n s u m p t io n , ( 3 0 0 u n i ts ) m = 3 0 0 u n i ts . replen
ishme
m m m m m m m mRme -)o rd e r le v e l ( P ) , w h ic h is th e su m o f s a f e ty s to c k a n d a vnt e ra g e le a d
tim e c o n s u m p tio n , orders
w ill be are
IV .
raised
R. 0. L. = Safety-stock+Lead time consumption at
irregu
= 300 + lar
300 interv
als,
$< = 600 units. which
(d) Maximum level (M) which is the sum of minimum stock and re-order quantity may will
be
be incon
venie
M = Safety-stock + R e-order quantity nt
= 300+1200 to
the
= 1500 units. sup
plie
*
!
• |
,
*.
•'"; rs.
( e ) Average inventory (I) which is the sum of minimum stock plus half the re-order(i) In
quantity cas
will be - e
of
1 = m + qo/2 ite
= 3 0 0 + 1 2 00 /2 ms
wit
= 3 00 + 6 0 0 ha
= 90 0u nits lon
g
D isadvantages
of the fixed-order quantity system : lea
d
tim e, more than one order will be pending with
supplier
the and there is every
possibility that he m ay fill up all pending orders at one
time.
283
M ate rials M an ag em e nt ': ' ,-'••.-.y
(m) Since re-order points in different items occur at different times, they cannot be ordered
at one time and as such for each item group, a large number of orders would be
raised which increases purchasing, clerical and freight costs.
(iv) There is always a possibility that the stock level of an item has approached or dropped
below the re-order level but the store clerk has failed to take note of it, in which case
a stockout may occur.
Basic requirements to operate the system :
(i) The cycle time of consumption should be more than the lead time.
(ii) The consumption rate should be fairly uniform.
(iii) Individual receipts and issues must be posted. ,
(iv) Stock records must be accurate, which can be made possible through continuous
stock verification.
Suitability of the system:
Fixed order quantity system is generally suitable for:
(i) B-class of items.
(ii) Low-value items ordered infrequently in large quantities )J
g$ Activity C;
Mention the factors which will affect the parameters for operating the fixed order quantity
system.
U nit 12 Replenishm ent System s
12.4 TW O -BIN SYSTEM

W orking of the system:
The two-bin system, which operates on the principle of re-order level, physically segregates
the entire stock of any item into two bins. The second bin contains stocks equivalent
- to re
order level (minimum stock plus lead time consumption) and is deemed to be sufficient to
satisfy probable demand during the period necessary for replenishment.
The fust bin contains enough stock (order quantity-lead time consum ption) to satisfy the
demand between the receipt of materials and the placing of the next order.
To start with, the stock from the first bin is consumed. The emptying of the first bin indicates
that the stock has reached the re-order level and the same is to be replenished. The stock
in the second bin is then utilised until the receipt of fresh supply.
I
a
a fc
Lead Time Consumption
S afety S tocJk
Time
Fig. 12.5 : Graphical Representation of Two-bin System
j Hie fresh supply, when received, is once again physically distributed between the two bins
j asperapre-fixedratio.
j Is system has a number of advantages over the conventional paper work systems. M any
j atim e, the inventory clerk fails to report when the stock falls to or below the re-order
| level. Situations are not uncommon when they fail to make entries or make errors while
1 posting. Two bin-system safeguards against these errors. The issue clerk is less likely to
j w iookthe fact that the first bin is empty and thus the item needs to be re-ordered.
The system also drastically cuts down the work involved in keeping the records. The need
for maintaining perpetual inventory records is avoided, since the system ensures a high
degree of automaticity.
Basic parameters for operating the two-bin system:
There are basic parameters required to operate the two bin system:
nnnnnnnnn)Re-order quantity in the two-bin system is fixed and is generally the economic
order
quantity.
ooooooooo)Second-bin quantity which is equivalent to a re-order level, equals minimum

stock
plus average lead time consumption,
Second bin quantity = m + LxC .(Q
(c) First-bin quantity as mentioned earlier, contains enough stock to satisfy the demand
between the receipt of material and the placing of the next order. This implies that the
first bin will have stocks equivalent to order quantity minus the lead time consumption,
/. First bin-quantity = Order quantity - Lead time consumption
= qo-LxC ........(D )
Maximum stock in two-bin system:
Maximum stock (M) in two bin system equals the sum of quantities in both the bins,
M i.e.
= (m + LxC ) + (qo-L xC )
= m + qo ........(E)
Average Inventory in two-bin system:

I*
Average inventory, which is the average of minimum plus maximum stock, equals:
I
= V4(m + M)
= Vi (m + m + qo) ,M
= m + qo/2
U n it 1 2 R ep lenish m en t S yste m s
Tie need An illustration of two-bin system :

jsahigh
The annual consumption of an item called 'Xylene' is 60 Kgs. And its unit price is Rs. 8 per
kg. The item can norm ally be procured w ithin a period of tw o m onths. The inventory
carrying cost and the procurement cost, computed from financial documents and information
su pplied by the purchasing departm ent, w orks out to be 15% and R s. 12 per order
respectively. The managem ent during the study, agreed to have the safety-stock at tw o
months consumption.
me order
fi) Calculate different param eters necessary to operate the two-bin
(li)system .
aim stock Calculate the m axim um stock and average inventory from the param
Solution:
eters.
u'j The basic param eters necessary to operate the two-bin system are re-order quantity,
..........( Q second-bin quantity and first-bin-quantity.
ie demand Thesecan be calculated as under:

ies that the
isumption, (a) Re-order quantity in this system is fixed. It is normally the economic order quantity
and is given by the following relation
qo =k 2.S.Cp
.............(D) C u.i
where S = A nnual consum ption (units)
tK = 60kgs.
ie bins, i.e.
Cp = P rocu rem en t co st per o rde r
t = Rs. 12 per order.
.............(E) i = Inventory carrying cost as a percentage of average inventory
, investment (decimals)
tib = 0.15Substituting the values in the above
luals: relation, we get
qo = j2x60xl2
V 8x0.15
= 35
12 Replenishment Systems
12.5 FIXED-ORDER INTERVAL SYSTEM
I Fked order interval system is also called the "periodic ordering system" or "periodic review
1 system" or "order cycling system."
, The salient characteristics of the system are :
(') The order-interval is fixed either for each individual item or for a group of item s.
in) A forecast is m ade of the average consum ption during review period (R x C ) and
, lead tim e (L xC )
liii) Safety stock (m ) is added to the above stock to take care of contingencies like
variations in consum ption during the review period and the lead tim e. The total, m+ „
(R+L)C, so obtained sets the m axim um level (M ) of the stock to be maintained.
fiv) Stock of the item is reviewed at periodic interval and quantity (q) which will bring the
stock on order up to the m axim um level (M ) is ordered.
Basicparam eters for operating the system :

I Basic parameters to operate fixed-order interval system are the review period (R), maximum
levels (M) and reorder quantity (q).
in Review period (R), also called order interval, is fixed either for each individual item
or for a group of item s. R eview period, like the EO Q in the fixed order quantity
system, can either be determined (economic review period being the one that minimises
the sum of annual procurement cost and annual inventory carrying cost) or it can be
fixed by judgment.
M aximum Level (M ) is meant to put the maximum ceiling on the inventory level. A
forecast is made of the average demand during the review period (R x C) and during
lead time (LxC). Safety stock (m) is added to the above to take care of variations in
demand during the review period and lead time as well as to meet demand when lead
tim e is extended. The total, m + (R + L)C, so obtained, sets the maxim um level of
stock to be maintained.
Symbolically, M = m + (R + L)C .(F)

Re-order-quantity (q) depends on the relationship between the review period and
the lead time. W hen the lead time is less than the review period, the re-order quantity
equals maxim um stock minus the stock actually held at the time of review.
Unit 12 Replenishment Systems
M inim um level under fixed-order interval system : *

Minimum stock, also called safety stock, under fixed-order interval time is meant to provide
for variations in demand (i.e. increase in the rate of consumption) during the review period
and the average lead time plus average consumption during an increase in lead time.
A verageinventory under the system :

Average Inventory (I) in any replenishm ent system is equal to the minim um stock plus
m aximum stock. M aximum inventory under fixed order interval system is attained just
after the receipt of fresh supply and is equal to the maximum stock level (M ) minus lead
time consumption. M aximum inventory (M ) is attained if there is no consumption during
lead time.
!/2 (M inimum stock + M aximum stock)

1/2(m
+ m + (R(R + L )C
(H)
An illustrationon the system :
M onthly consum ption of an item costing Rs. 12 each is estim ated at an average of
400 nos. per month. Procurement cost per order and the inventory carrying cost are
estimatedatRs. 36 per order and 1.5% per month respectively. The above said item
can normallybepra ired within a period of one month. Safety stock equivalent to
half of the lead time
consumption is considered sufficient to take care of any increase in
demand and/or extensionof lead time. Assuming review period of one month,
(a) Fix up necessary param eters to operate the fixed-order interval system
• (b) W hat would be the re-order quantity if the stock on hand at the time of first
review isi 650 numbers?
c) And what would be the re-order quantity at the time of second review, if the stock
on hand is 200 nos. and the quantity ordered previously (i.e. at the time of first
review)is yet to be received?
291
Solution:
'H i (a) Fixed-order interval system requires two basic parameters: (i)
review period (R) and (ii) maximum level (M): Review period
n (R) = 1 month (Given) Maximum level (M) (equation 40.7) =
m + (R + L) C
where m Safety stock
half of lead time consumption
'72x400
l
/2 x Lead time consumption
200 nos.
R Review period (months)
1
Lead time (months)
1
C
Average monthly consumption (units)
M
200 + (1+1) 400
1000
(b) Re-order quantity at the time of first review:
Re-order quantity (Equation 40.9) (q) = M - (Ih + Ip)
Where M = Maximum level

1000 units
fli = stock on hand at the time of review
650
Ip = quantity on the pipe line (i.e. quantity ordered previously but not
received yet)
= 0
q = 1000-650 ;
350 nos.
(c) Re-order quantity at the time of second review:
Re-order quantity (q) = M - (Ih + Ip)
where Ih = stock on hand at the time of review (2nd review)
200
292
IP
q u an tity o n th e p ip elin e - . : * - . ; • -
3 5 0 n o s . (i.e . q u a n tity o rd e r e d a t th e tim e o f f irs t re v ie w )
q 10 00 - (2 00 + 35 0)
450 nos.
S u it a b ili ty o f t h e f ix e d - o r d e r in t e r v a l s y s t e m :
T he fix ed o rd er in terv al sy stem is u sed fo r,
(i) h ig h -v a lu e ite m s (a c a teg o ry o f item s) req u irin g stric t c o n tro l o n sto ck le v e ls.
F ix edo- rd e r in te rv a l s y s te m g e n e ra lly g iv e s h ig h e r c o n tro l th a n th e fix e d - o rd e r
q u a n titysy ste m , p ro v id e d th a t th e re -o rd e r p e rio d (o r re v ie w p e rio d ) is s h o rt. A
lo n g re v ie w p e rio d , o n th e c o n tra ry , te n d s to p u sh u p in v e n to ry in v e stm e n t.
fit) item s w h ic h are req u ire d in d iffere n t siz e s (fo r ex am p le , d rills, re am e rs, tap s,
h o b s, g rin d in g w h e e ls, in se rts e tc .) an d p ro c u re d fro m a sin g le so u rc e .
(i) estab lish m en ts (e.g . retail sto res) procu rin g a w id e rang e o f item s from a sin g le
su pp lier,w h e re a w e e k ly o r m o n th ly re -o rd e r p e rio d is u se fu l. E c o n o m y in
p u rc h a s in g in th e
I fo rm o f q u a n tity d is c o u n ts a n d re d u c e d w o r k lo a d c a n b e r e a lis e d b y re v ie w in g
th e sto ck s o f all item s in th e ran g e at th e sam e tim e.
# A ctiv ity D :
L ist d ow n th e facto rs w h ich w ill affect th e p aram eters for op erating th e fix ed order
in terv al
system.
116 SUMMARY
_________________________________
L ead tim e is th e to tal tim e n ecessary to rep len ish th e sto ck of an item an d it can b e
d iv id ed in to tw o parts, nam ely th e in ternal lead tim e and th e ex tern al lead tim e.
In ternal lead tim coen sists o f th e serv icin g tim e w h ich in clu d es th e tim e req u ired fo r
o b tain in g q u o tationegotiating
n s, price, entering into contracts etc. and the receiving
tim e w hich includes the tim e
293
needed for uncrating and inspecting goods, moving them between stores and making
entries in stock records. External lead time comprises administrative, manufacturing
and delivery times required by the supplier. Lead time information is required to fix
the reorder point, safety stock and modify the economic order quantities. Lead time
can be shortened through a determined and deliberate effort by the management.
A replenishment method helps to determine the time when a replenishment order is

to be raised and the quantity that should be ordered on each occasion. Two basic
methods for the purpose are: (i) fixed-order quantity system and (ii) fixed-order
interval system. The fixed-order quantity system is suitable for the B-class of items
and low-value items ordered infrequently in large quantities. The fixed-order
interval system is useful for high-value items (the A category of items) requiring
a strict control on stock levels. Fixed-order interval system generally gives greater
control than the fixed-order quantity system, provided that the review is kept short. A
long review period, on the contrary, tends to push up the inventory investment.
The other method, which is a modification of the basic method, is "the two-bin-
system." The two-bin system is best suited for the C-class of items.
iI
12.7 KEYWORDS______________.________________________________
Fixed Order Quantity System: Under this system, the stock of an item is
replenished when it approaches or falls below a pre-fixed level, called the re-order
level .The quantity ordered (re-order quantity) in this system is fixed and is usually the
economic order quantity (or the same might have been modified to suit business
constraints).
Fixed Order Interval System : Under this system, the orders are placed at
predetermined intervals and the order quantity is equal to the difference between the
maximum stock and the actual stock.
Lead Time: Lead time is the time that elapses between the realisation of the need
for the item and the fulfillment of the need. It is, therefore, the total time necessary to
replenish the stock of an item.
Replenishment System: A replenishment system is a means to decide when to

order and how much to order. The former represents the "time of ordering"
and the latter represents the "quantity to be ordered."
Re-order Level: Re-order level is the sum of safety stock and the average lead
time consumption.
-xu
naking entries U nit 12 R eplenishm ent System s
g and delivery
reorder point,
Two Bin System: Two-bin system operates on the principle of re-order level. It physically
rtened through
segregates the entire stock of any item into two bins. The second bin contains stocks
equivalent to the re-order level. The first bin contains enough stock (order quantity-lead
it order is to be time consumption) to satisfy demand between the receipt of materials and the placing of
ic methods for the next order.
al system. The
e items ordered 12.8 SELF-ASSESSM ENT QUESTIONS
___________________
for high-value
is. Fixed-order Ql. What is lead time? Which activities are considered in the making of lead time? How
Astern, provided and where is this information used in inventory control?
5 to push up the
Q2. Lead time can be shortened by deliberate and determined effort by the management."
>asic method, is
Do you agree? Justify your answer with examples.
if items.
Q3. W hat is fixed-order quantity system (or re-order level system )? W hat are its
parameters? How are they determined?
n is replenished Q4. W hat is fixed-order interval system (or review system)? W hat parameters are
vel.The quantity necessary to operate this system? How are these parameters calculated?
tic order quantity
Q5. The monthly consumption of an item costing Rs. 3 is estimated at an average of 100
nos. per month. Procurement cost per order and the inventory carrying cost are
j placed at pre
- calculated at Rs. 36 and 18% respectively. The above said item can be procured
en the maximum within aperiod of two months. Safety stock equivalent to one month's consumption
is desirable to take care of contingencies.
if the need for the Assuming re-order level system of replenishment,
•y to replenish the
ppppppppp)
Calculate the necessary parameters.
de when to order qqqqqqqqq)

Using the parameters calculated above, explain the working of the
ig" and the latter
system.
iverage lead time (Ans.: (a) Re-order level = 300. re-order qty = 400. (b) Item to be issued until
stock approaches/drops below level of 300, when it is re-ordered for 400 nos.)
Q6. (a) W hat is the re-order level system of replenishment? W hich parameters are
necessary to operate this system? How are they calculated?
| (b) Establish the param eters for the re-order level system from the data given
below:
Monthly consumption (units) = 1 00

Price per units (Rs.) = 3

Inventory carrying cost as a percentage = 16%
of average inventory investment
Cost of order writing and processing of a = Rs. 32
delivery (Rs.)
Lead time = One month
• . • • . . IB
Safety stock = One month consumption
Using the parameters computed above, explain the working of the system. t
(Ans: Re-order level = 300, Re-order qty. = 400)
Q7. An electronic firm utilizes the 'Two-bin system" to replenish the stock of its various
items. According to the system: ^
(i) The quantity equal to the second-bin quantity is put into a plastic bag which in
turn is sealed and placed in the rack in which the left over quantity in loose
form is stocked.
(ii) The issues are made out of loose quantity, until the same is exhausted and the
store clerk is forced to issue from the quantity kept in the plastic bag.
An indent is then raised to authorise the purchase department to procure a

fresh supply of the item.
fiii) The item, in the meanwhile, is issued from the plastic bag until receipt of the
fresh supply.
Considering the above features of replenishment system, determine the quantity to

be kept in the first and second bin (quantity to be kept free and in the plastic bag)
and the quantity to be ordered for an item for which the following details are available:
Item A resistor part number 051183

Average monthly consumption 200 n
Price per unit Rs.3/-
consumption
Lead time One month
;
system. Safety stock to be maintained to One month
meet contingencies
Procurement cost per order
Rs.48/-
tock of its various 20%
Inventory carrying cost :
»•
astic bag which in [Ans.: Re-order qty. = 620 nos., Qty. in the second bin = 400, Qty. in the first bin =
quantity in loose Balance (i.e. 620-400 = 200)]
. The monthly consumption of an item costing Re. I/- is estimated at an average of

exhausted and the 300 nos. per month. Procurement cost per order and the inventory carrying
cost are calculated to be Rs. 48 and 2 % per month respectively. The said item
)lasticbag.
can normally be procured within a period of two months. Minimum stock
tment to procure a equivalent to half of the lead time consumption is desirable to take care of possible
contingencies such as delay in deliveries, increase in consumption or rejection in
the incoming consignment
(i) Calculate the economic review period of this item.
' (ii) Fix up necessary parameters to operate: fixed-order interval (review period)
system.
fiii) What will be the re-brdefquantity If the stock on hand at the time of review is
800 units?
(Ans.: (i) R = 4 months (ii) R = 4 months and M = 2100 nos. (iii) 1300 nos.)
> until receipt of the
mine the quantity to

id in the plastic bag)
-details are available:
ber 051183
im
Materials
Management
N
O
T
E
S
Object
™
A fte r
con
<*"
state
•*•
usetl
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disci
discu
orgar
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Struct
ure
13.1
Intro
1^3.2 Tech
rrrrrrrrr)JTTP
sssssssss)S um
ttttttttt)K ey1
uuuuuuuuu)S
elf-a
JUST-IN-TIME (JIT)
•#
Objectives
After completing this unit, you will be able to: ,
*" state the m eaning of JIT.
r use the techniques of JIT.
"" discuss the Kanban system .

r discuss the push pull system .
r organise JIT purchasing.
^ d is c u s s th e d if fe r e n c e b e tw e e n J I T
p u r c h a s in g a n traditional
d purchasing.
Structure
fI
B.I Introduction
to JIT•\2
Techniques of
JIT
v v v v v v vJvI vT )P u r c h a s i n g
w w w w w w wSwu m
w )m a r y
x x x x x x x xKxe)y w o r d s
y y y y y y y yS ye )l f - a s s e s s m e n t Q u e s t i o n s
13.1 INTRODUCTION TO JIT
II Just-in-Time refers to the concept of producing and delivering finished goods just in time
to be sold, making sub-assemblies just in time to be assembled into finished goods,
fabricating/purchasing parts just in time to go into sub-assemblies and procuring raw
1 materials just in time to be transformed into fabricated parts. JIT drastically cuts down the
inventory at different stages, yet it is not just a way to reduce the inventory; rather, it is a
means of solving problems that block the building of an excellent manufacturing organisation.
JIT, in fact, is a complete business philosophy and process of thinking, working and
managing to eliminate waste.
Toyota, the originator of the JIT concept, defines waste as "anything other than the minimum
amount of equipment, materials, parts and working time absolutely essential to the production."
Edward Hay, an authority on JIT, defines waste as "anything other than the absolute minimum
resource of material, machine and manpower required to add value to the product."
JIT, therefore, is not just an inventory control or inventory reduction technique. It is a

philosophy or an approach to productivity which is applicable to all facets of manufacturing
process, including material. The JIT approach, when applied systematically, reduces or
eliminates waste from purchasing, manufacturing, distribution and all other support activities
of a manufacturing enterprise. Further, it is not restricted to the manufacturing activity
alone but can be successfully applied to an office system as well.
13.2 TECHNIQUES OF JIT__________ ' _____________

Techniques used to reduce non-value added activities include:
• Set up time reduction
• Autonomous or modular cells
• JIT layout
• The pull system (the Kanban system of production control)
• Continuous improvement
• Buffer Stock removal
• Total productive maintenance
• Qu at-source
ali • Just-In-Time purchasing
ty- • Employee involvement
ds just in time U n it 13 Just-In-T im e (JIT )
lished goods,
ttocuring raw ,1
cuts down the
y; rather, it is a Here we will mainly discuss the JIT techniques used in the materials department.
ig organisation. ^ A ctiv ity A ;
;, w orking and
Visit a nearby m anufacturing facility and list the JIT activities being carried on there.
m the # A ctivity B ; Kan

minimum ban
the Visit a nearby bank and and list the JIT activities being signa
production." carried on there. ls are
solute requi
minimum red
product." whe
n:
echnique.lt
is a rf i
manufacturin asse
g cally, The Kanban system (The m bl
reduces or y
support Pull SystemW
) hatis the wor
activities k,
acturing pull system? sub-
activity asse
An ideal JTT system is a one-at-a-time production flow, wherein each m bl
y
operation pulls the
PRIMUS<3^c«<*~~^J~«x»_^^ ,,^^^^^ ^^^ n
wor
mJ te
. k
not require any signals. Since it is usually not possible to sbTve and
M $fiM f&ra4S&™ vov^f perfect one-at-a-time flow, Kanban signals are the
used as a com promise (i.e. pull system to m an
ufac
link operation). ture
Sf:
of
W hen isthe pull system (K anban system ) necessary? parts
are carried locations (for example, at different buildings) and it is impractical to
out at move a
different product one at a tim e over long distances.
ii set up time on the feeding operation is higher than the receiving (or using)
I operation.
iiL one or more machines are common to various work cells and needs to be
linked to the cells with Kanban signals. Linking makes the common machines
an integral part of each cell on account of the frequent signals from the cell, on
what to produce and when.
iv. there are bottlenecks or quality or capacity problems which do not allow a
smooth flow.
1 What is the Kanban system?
1 The working of the Kanban system can be compared to a supermarket shelf

which is continuously monitored and refilled as the customers help themselves. At the
supermarket, the customers pick up the quantities of the goods they need. At
periodic intervals, an employee checks up to see what has been taken and he
replaces the stock. There is no paper work generated to instruct the employee on
what items and in what quantities he should put the stock on the shelves. Quantities
picked up by the customers are the quantities put on the shelves by the employee.
The Kanban system does exactly this.
Kanban is a simple but effective control that helps the JIT production work. Kanban
is a Japanese word for card and the use of cards is central to many Japanese control
systems, including the one at Toyota whose Kanban system has received much
attention. Kanban signals may be one of the following:
i A card on which is written the part number, the size of the container, the
number of pieces to be held by the container and the number of this card in
the system.
ii. a containers. Metal plates are useful in an oily environment and they display
M f the same kind of information as on the cards.
e f
t i iii. The containers themselves.
- ••"''! -: '"'
a x
l e iv. Computer-to-computer Kanban signals. -'
p d
Two types of Kanban systems exist - the single card Kanban system and the double
l t
card Kanban system. In a double card Kanban system, two cards are used: a
a o
withdrawal Kanban (C-Kanban) and a production Kanban (P-Kanban). A withdrawal
t t
Kanban specifies the kind and the quantity which the subsequent process should
e h
withdraw from the preceding process while a production Kanban specifies the kind
s e
and the quantity of the product which the preceding process must produce.
Unit 13 Just-In-Time (JIT)
,ir 2) operation. The contents of the Kanban are:

i to be linked • Partname ,
to an integral • Part No.
part to
produce and • Kanban No.
» Work Station (From)
allow a smooth . Work Station (To)

• Quantity
• Container No. (or Box)
t shelf which is TV'ira l rules concerning the double-card Kanban system are:
he supermarket, • The subsequent process can withdraw the parts from the preceding process in
lie intervals, an the
xk. There is no right quantity (required quantity), at the right time (required time). Any
lat quantities he withdrawal
are the quantities without a Kanban (C-Kanban) is not permitted.
is.
• The preceding process may produce the parts in the quantities withdrawn by
ork. Kanban is a the
coiitrol systems, subsequent process.
lention. Kanban
i Production greater than the quantity withdrawn (in case of the single card
Kanban system) is not permitted. In case of the double card Kanban system, no
jr, the number of parts can be made unless there is production Kanban (P-Kanban) authorising
e system. production.
jily environment • Defective parts must be removed/corrected but not sent to the subsequent
process.
However, if some defectives parts are discovered by the subsequent process,
they
should be returned to the preceeding process to prevent the reoccurrence of
such
defects.
d the double card
jd: a withdrawal • Only standard containers are to be used and they are filled with the prescribed
Kanban specifies small
rom the preceding quantity.
ty of the product
From the above discussions, it can be concluded that:
The key to the "Kanban System" does not lie in the Kanban cards but in the philosophy
imbibed in it. Cards are the mere mechanism for establishing a pre-determined inventory
buffer between consecutive work centres. Apre-determined buffer equals the number of
Kanban cards, one card for each container of parts. The buffer advises the workman at
the preceding when to work and when not to work. When the buffer is i!i, the preceding workman
work centre as to stops work and when buffer is not full, he works.
• If1 Drawbacks of the System: delive

rs a
Any significant disruption at any work center results in the stoppage of work flow bad
and thus idling of the succeeding work centres. That is why a lot of attention is batch,
paid, and measures like productive maintenance, setup time reduction, quality the
improvement, suppliers' self certification etc are adopted. This reduces the whole
incidence of disruptions. produ
ction
Continuous Improvements
line
JTT is not a one-time effort. It embodies the concept of continuous improvement, will
supported at all levels of the staff. JIT seeks plant-wide involvement in the work stop.
improvement projects. A key element of JIT is continuous improvement; it is This
never good enough and it never stops. Suggestion schemes are therefore fear
strongly encouraged and supported. of line
stopp
Buffer Stock Removal age in
the
1 event
of
Buffer (inventories) in a conventional system is considered necessary for smooth rejecti
production. But in a JIT concept, inventories are considered an inefficiency and a on in
mechanism to hide problems. JIT advocates that there should be an attempt to the
let problems surface so that they attract the attention of the management. Just as purch
one cannot see the rocks if the water is deep, so also the supply, suppliers' ased/s
quality, transportation, procurement system, etc. cannot be seen if there is too ub-
much of a buffer (i.e. excess inventories). If smooth production is to take place, the contra
water (buffer) in the production stream must be lowered to expose the hidden cted
rocks (problems). materi
al and
Continuous elimination of buffer stock is recommended to highlight the
production/purchase problems previously shielded by high inventory levels. lack
Immediate solution to the problems, no sooner they are identified, is necessary to of
maintain the smoothness in production (or smoothen in-flow of purchased confid
material). ence
in
"Low buffer" (low inventory), however, does not necessarily mean "Zero"
handli
inventory. Zero inventory is a goal which may or may not be attained. Also, it
ng
must be remembered that JIT is not possible for each and every item held as
such
inventory. One has to appreciate the difference between planned and
contin
unplanned inventory.
genci
Quality at Source es has
been
JIT's success depends on the high quality of incoming materials. If a supplier one of
the
major
hurdle
s in
the
imple
menta
tion of
JIT.
The
,*•
aru
U nit 13 Just-In-T im e (JIT )
rk flow and traditional approach to leave the quality to inspectors (i.e. inspecting every State
thus d, and consignment, getting bad pieces segregated/rectified and expediting replacements) is at
measures it, too expensive to practise in a competitive situation. JIT, on the contrary, underlines least
suppliers' self the concept of "Quality• at source" which eliminates wastes at all stages of five
procurement. Through its "Do it right the first time" concept, JIT helps to eliminate action
s that
waste by
you
can
zzzzzzzzz)eliminating the incoming inspection
jment, take
supported a a a a a a a a a va )o i d i n g t h e n e e d t o p a c k a n d r e t u r n a n y d e t e c t i v e s t o t h e s u p p ltoi e r f o r
re ctific a tio n / motiv
ivement ate
projects, ugh rep la c em en t.
the
and it never J IT Q u a lity a t so u rc e in v o lv e s e ig h t b a s ic p rin c ip le s , n a m e ly : suppli
Drted. ers of
D S e l e c t i n g s u p p l i e r s b a s e d o n t h e i r c a p a b i l i t y f o r q u a l i t y a s s u r a n c e . JIT
suppl
b b b b b b b b bE bd)u c a t i n g a n d t r a i n i n g s u p p l i e r s o n t h e v a r i o u s a s p e c t s o f q u y.a lity
nooth req u irem en ts,
production, se le c tio n o f m e a su rin g in s tru m e n ts a n d g au g e s a n d th e m e th o d s o f in sp e c tio n .
echanismtohid
e us surface so c c c c c c c c cWc )o r k i n g c l o s e l y w i t h t h e s u p p l i e r r i g h t f r o m t h e s t a g e o f a s s e s s i n g
that rocks if the th e te c h n ic a l
water nent c a p a b ility o f th e su p p lie rs , th ro u g h th e v e n d o r d e v e lo p m e n t s ta g e , s a m p le
system, etc. v a lid a tio n
mooth a n d p ilo t/b u lk s u p p ly s ta g e a n d u p to e s ta b lis h in g re g u la r s u p p lie s .
production jred
to expose the d d d d d d d d dLde )n d i n g t h e m s p e c i a l g a u g e s a n d t o o l s .
e e e e e e e e eEen) c o u r a g i n g s u p p l i e r s t o i n t r o d u c e a p r e - s h i p m e n t q u a l i t y a u d i t .
)
duction/purchas f f f f f f f f fPf r) o v i d i n g f e e d b a c k o n t h e n a t u r e o f d e f e c t s a n d h e l p i n g t o r e d u c e / e l i m i n a t e
e >n to the
re je c tio n .
problems, , in
production (or g g g g g g g g gEgn)c o u r a g i n g s u p p l i e r s t o i m p r o v e t h e p r o d u c t i v i t y a n d q u a l i t y b y
ad o p tin g th e JIT
c o n c e p t a t th e i r p l a n t s .
o" inventory.
Zero ; 8 A d o p tin g T Q M a s th e p h ilo so p h y o f co n tro l a n d re p la c in g e rro r-d e te c tio n
remembered that b a s e ds y s t e m b y a n e r r o r - p r e v e n t i o n b a s e d s y s t e m .
5 to appreciate
the £ f A c tiv ity C ;
it
supplier delivers a
age in the event of
idence in handling
ntationofJIT.The
13.3 JIT PURCHASING

JTT purchasing is wrongly perceived as the activity of pushing inventory on the suppliers. It
is, in fact, a technique for eliminating waste in the purchase function by developing long
term, mutually beneficial relationships with fewer but better suppliers. It aims at:
i eliminating waste in the purchase process (for example, order processing costs, follow-
up costs, stock-out costs, packaging and packing costs, freight costs, costs of handing
defects, etc.
iL eliminating waste at the supplier's end (transport costs, rejection costs, etc.)
in. eliminating purchased inventory.
JIT purchasing is based on the following fundamental principles:
L The supplier's facilities are an extension of the buyer's own facilities.
iL Long term (since it takes a long time to solve the problems) and mutually beneficial
relationships (since only mutual beneficial relationships can be long term) with fewer
(as no company has the resources to solve long-term problems with many suppliers)
but better suppliers are necessary to eliminate the waste of incoming inspection.
iiL Delivery lot size should be just enough to satisfy the immediate higher level requirement,
iv. Rejections interrupt supply chain and hence must be eliminated.
v. Buyer and seller should jointly identify problems and activities which do not add
value and initiate the actions to achieve continuous improvements.
The major elements of JIT purchasing are as follows:

'J,
i. Locating, selecting and developing suppliers of high quality assurance so that
line rejection do not take place. The entire JIT purchasing hinges on the suppliers'
quality.
iL Problem solving: The key to the successful application of JTT lies in solving problems.
For example, if the firm carries higher spare inventory to guard against machine
breakdowns, then JIT recommends the organisation to analyse/take steps to prevent
the occurrence of machine breakdowns. This will eliminate the need to carry
inventories. Thus, inventory reduction results as a by-product of JIT.
Unit 13 Just-In-Time (JIT)
nthesuppliers.lt
developing long
Early supplier involvement: The supplier should be involved in the decision stage of
aims at:
the product, as early as possible. Close co-ordination must take place between the
iing costs, buyer's design department and the prospective supplier, while finalising
follow-, costs of specifications. Emphasis should be more on performance rather on design
handing specifications, thereby permitting suppliers loose specifications without compromising
!
'» on quality. Loose specifications enable suppliers to be more cost effective, since they
f get more flexibility in taking decisions. In JIT purchasing, value analysis forms an
;osts, etc.) "•''- integral part of the purchasing system and the supplier gets the status of member of
& the value analysis syndicate.
iv Long term contracts: One of the most important requirements of the JIT
implementation is to enter into long contracts covering 18 to 36 months renegotiable
every 6-12 months. This drastically cuts down the lead time. System contracting is an
ies. important step towards successful JIT purchasing. Long term relationships are
necessary, since it takes a long time to solve the problems. The aim should be to
mutually beneficial * progressively move from Blanket orders, to System contracting, to Requirements
ng term) with fewer contracts, to JIT Contracts and to the extreme-handshake.
/ith many suppliers)
ning inspection. v. Pricing: The success of JIT hinges on mutual trust and confidence in each other.
Both, buyer and seller must open their books. The buyer should provide the supplier
nerlevelrequirement. information on the market demand and trend of growth or the decline of business,
and share information on product prices and the company's development plans.
The supplier, on his part, must share the cost information with the buyer. The supplier
ies which do not add should also commit to quality and cost improvements over the foreseeable future. If
nts. the buyer has price constraints, the supplier should be prepared to reconsider cost.
The buyer, on the other hand must protect the supplier from competition and guarantee
worthwhile return on the suppliers' investments of time and capital.
assurance so that line Both are, however, morally bound to protect the confidentiality of the information
n the suppliers'quality. provided to him.
ies in solving problems. vi. Fewer suppliers: The number of suppliers of any component or material should be
;uard against machine restricted to one or two. Fewer suppliers are necessary because no company has the
se/take steps to prevent 1 resources to mutually develop mutually beneficial relationships with thousand of
suppliers.
aate the need to carry
ctofJIT. vil Self certification of quality: True JIT purchasing requires an effective supplier
self-I certification programme which guarantees that quality specifications are met
before I the components leave the suppliers' works. Self certification by the supplier
eliminates
receiving inspection at the buyer's plant and last minute running to replace/rework/
return defectives.
viii. Delivery to the point of use: Since the suppliers are totally responsible for the 3)
delivered quality of the product, they usually deliver directly to the point of use on the
production line.(i.e. direct supply line-DSL basis). This eliminates the added handling,
packaging and packing, transportation, counting, inspection and so on.
4)
ix. Process control to improve and maintain quality: Manufacturing operations
at both, the supplier's and the buyer's plant should be under process control,
thereby improving the quality of products or components with time. Targets must
be set for quality measured in parts-per-million and the supplier himself having
the ultimate responsibility of measuring quality.
x. Use of standard containers to protect product and simplify counting of goods:

Both buyer's as well as supplier's manufacturing operations should make use of
standardised containers or packages. An ideal container will have a standard number
of spaces, similar to an egg carton, which, in addition to protecting the
product, makes it easy to count the quantity. The benefits to be realised from
the use of standardised containers are:
• Elimination/minimisation of transit damages.
• Ease in verification of the quantity of part/component.

• Automatic signal to the supplier to replenish stock
• Better co-ordination between departments/firms
XL Mutual dependence: Both, the buyer and the seller must appreciate and subscribe
to the concept of mutual dependence. The buyer must look upon suppliers as partners
in the buyer's company performance. The buyer's company needs them as much as
they need the buyer's company. The buyer's company, at times, may require to provide
anything from techniques and quality inputs to machines, buildings, funds, workers'
training and other support including quality management of their processes, which
will enable the suppliers to reach a stage where they can self certify their products.
13.5
Suitability of JIT purchasing:
hhhhhhhhhh)JIT is more suitable for flow production. Batch production units may require
change
from batch to flow methods, with consequent changes in systems to support the new
methods.
iiiiiiiiii)JIT is not suitable for low cost'C class bought out items.
[isibleforthe Unit 13 Just-In-Time (JIT)
,t of use on the
Ided handling, j j j j j j j j jJj I) T i s a l s o n o t s u i t a b l e f o r i t e m s w h i c h e x p e r i e n c e p e a k s a n d v a l l e y s i n d e m a n d
and
; operations at m a n u f a c t u r e r s o f s u c h i t e m s h a v e t h e m o n o p o l i s t ic s i t u a t i o n o r i n s i s t o n l o n g d e l i v e
ntrol, thereby le a d tim e .
nustbesetfor
k k k k k k k k kJ IkT) c a n b e p r a c ti s e d o n ly i n t h o s e o r g a n i s a ti o n s t h a t h a v e r e m o v e d th e b a r r i e r s
ig the ultimate
b e tw e e n
its d iffe re n t fu n c tio n s, sin c e JIT re q u ire s th e in v o lv e m e n t o f p e o p le fro m a ll t
ting of goods: d is c ip lin e s in th e o rg a n is a tio n . S u b sta n tia l tra in in g to b r in g in a c h a n g e o f c u ltu
d make use of (a d o p tio n o f JIT c u ltu re ) is a m u st fo r th e su c c es s o f JIT p u rc h a sin g .
mdard number
J& A ctivity D ;
ig the product,
•om the use of State five benefits of JIT purchasing.
13.4SU M M A R Y
e and subscribe Many a business executive carries the wrong impression that JIT is a means of reducing
diers as partners inventory. This is not true. Inventories are indeed reduced significantly as a result of applying
hem as much as JIT yet this is not its primary focus. Inventory reduction is a by-product of JIT. In fact, JIT
squire to provide is a scientific approach to productivity and is applicable to all facets of manufacturing
funds, workers' processes including materials. The JIT approach, when applied systematically, reduces
rocesses, which waste from purchasing, manufacturing, distribution and all other support activities of a
their products. manufacturing enterprise. Since it aims at reduction/elimination of non-value added activities
(called wasteful activities), even the service organisations can benefit from the use of the
technique.
y require
change support 1.5 KEYWORDS__________________________________________________
the new
JIT: Just-in-Time is to produce and deliver finished goods, just in time to be sold, make
sub-assemblies just in time to be assembled into finished goods, fabricate/purchase parts
Justin time to go into sub-assemblies and procure raw materials just in time to be transformed
into fabricated parts.
Fanban/Pull system: An ideal JTT system is a one-at-a-time production flow, wherein

acii operation pulls the previous operation and makes it produce at the rate needed.
Materials Unii
Management
13.6 SELF-ASSESSMENT QUESTIONS
Q1. What do you understand by Just-In-Time (JIT)? What benefits can occur to the
company from the application of the JIT technique?
Q2. "Just-In-Time is much more than an inventory control or inventory reduction

technique." Do you agree? If yes, justify your stand with suitable examples.
Q3. What are the techniques of JIT? Name each technique and discuss it briefly.
.1
NOTE
S
xurtothe
•y reduction
tiples.
briefly .
COMPUTERISATION OF
MATERIALS MANAGEMENT
i
O bjectives
After completing this unit, you will be able to:
®° discuss the concept of computerisation.
^ discuss the process of computerisation.
'•s make use of computerisation for various materials activities.
®° computerise the materials process.
^ generate reports for materials management.
"" address the queries related to the materials department

using computers.
Structure
l l l l l l l l l Il n) t r o d u c t i o n t o C o m p u t e r i s a t i o n
m m m m m m m m mS tme p) s i n C o m p u t e r i s a t i o n
m
n n n n n n n n nCno) m p u t e r A p p l i c a t i o n s i n M a t e r i a l s
M anagem ent
o o o o o o o o oMo )a n a g e m e n t R e p o r t s o n
M a te ria ls
| 1 4 .5 S u m m ary
j 1 4 .6 K e y w o r d s ~
s
1 4 .7 S e lf- a s s e s s m e n t Q u e s tio n s
14.1 INTRODUCTION TO COMPUTERISTION
Information is the essential ingredient of management control and a continuous flow of

information is of the utmost importance to the company. The traditional methods do not
serve the purpose, as quick availability of data according to the requirements, cannot be
made available. The computer, on the contrary, helps in a great measure to quickly process
the information in accordance with the needs of the various levels of the management. The
importance of the computer control system lies in the ability to acquire and assimilate a
large amount of information with speed, accuracy and flexibility.
Computers are finding increasing acceptance in Materials Management, in view of the

enormous amount of administrative work involving thousands of requisitions, purchase
enquiries, purchase orders, order amendments, expediting communications, goods receipt
reports and other documents. A bulk of this work being of a routine nature, they can safely
be performed by the machine, thus leaving enough time to the Materials Manager / buyers
to concentrate on more a productive activities like vendor development, cost-price analysis,
value analysis, make-or-buy decisions, wastage reduction, etc.
Benefits of Computer Systems

Benefits of computer system include:
(i) freeing lower and middle management from filling, non-productive clerical functions
common to manual systems.
(ii) standardising pertinent data and terminology.

(iii) providing instant availability of information from records.
(iv) improving communication and report within the materials department and with other
departments of the plant (for example, pending GRRs with Q.C. accounts payable,
ete,)
(v) ensuring adaptability and fast response to a change in priorities, prices and
other variables.
(vi) saving in equipment and floor because of the virtual elimination of filing.
(vii) eliminating duplicate data files (each department can use the same computerised files).
(viii) reducing inventory investment due to speed and more accurate response time.
(ix) enabling better control over operation because of timely availability of information for
sound decision-making as well as the flexibility of handling vast quantities of details.
Unit 14 Computerisation of Materials Management
14.2 STEPS IN COMPUTERISATION
Since procurement procedures and their requirements vary widely, there is no

single universally applicable computerised system for a materials department.
Each company needs to have a computer system tailor-made to suit their needs.
The steps involved in the installation of a computerized system may be

summarised as under
(i) Analyse an existing manual system and identify weak spots (if any).
(ri) Define the objective(s) of the system.
(in) Constitute a project team (also called steering committee).
(iv) Collect information for a preliminary system design.
(v) Develop a conceptual design.
(vi) List alternatives (buying vs. leasing, buying vs. hiring capacity etc.) and
conduct a cost benefit analysis of each alternative.
(vii) Prepare a project report on justification and obtain management approval for
the proposal.
(vii) Design the necessary
system. (ix) Develop system
specifications.
Obtain quotations, prepare comparative statement, evaluate alternatives and

select the best supplier.
(id) Train employees.
(HI) Install the system.
(i) Audit output reports.
(HV) Rehabilitate the employees affected by the introduction of the computerised
system.
315
JS^ Activity A; •
List ten areas where computers are useful in your daily life.
JS$ Activity B ;
State five reasons why computerisation must be done for Materials Management.
Database for Materials Management System
A database is a collection of information processed by the computer. The database to be

created for the materials management system include:
F o r p u rc h a sin g 4 ,. , .
Supplier database, offer database, standard text passage database, statistics database,
receiving department database and invoice database.
For inventory
Item master database, lead time database, unit of measurement database, group code
database, receiving department database and invoice database.
14.3 COMPUTER APPLICATIONS IN MATERIALS MANAGEMENT
Applications of computers in Materials Management can be classified into three groups:
(i) Operating systems

Operating systems process data for the routine operations of the department such as
maintaining status of purchasing actions, typing request for quotations and purchase
orders, filing and sorting vendor lists, and maintaining commodity price and vendor
history files.
R eporting system s
Reporting systems process data, often drawing on data files set up for operating
systems and report these data to the management. Some typical examples include
purchased part history, vendor delivery record, purchased material price variance,
inventory transactions, analysis of purchase orders, vendorwise purchases, items below
re-order levels and above maximum level.
(iii) Decision support systems

Decision support systems incorporate data into an analytical framework, utilising
f scientific techniques such as regression analysis, simulation, etc. and present data in
the form of select alternative actions and thereby assisting materials people to select
from among the alternatives. Some typical examples include quotation analysis, price
discount analysis, forecasting, forward buying, ABC/XYZ/FSN analysis, etc.
Activitiesof M aterials M anagem ent Covered by Com puterisation

The various activities of Materials Management that are frequently covered by
computerisation are detailed below:
1 , P u r c h a sin g
Computer system can be applied to the purchase activities for:
(i) preparing forecasts of materials, based on their past usage.

(ii) providing historical information on suppliers, prices, past purchase orders, etc.
(I) selecting the most efficient source of supply, based on the analysis of suppliers'
quotations for variables such as quantity discount, payment terms, freight, excise,
sales tax, geographical location of the supplier, multiple plants to be served, etc.
(iv) typing of purchase orders and delivery schedules.

(v) providing control on receipt of quantities higher than the order quantity and/or
the delivery schedule.
(vi) comparing actual receipts against the delivery schedule and producing memos
and reminders to the vendors for the pending delivery of materials.
(vii) keeping up-to-date record of receipts of materials and providing information on

outstanding orders.
(viii) matching suppliers' invoices with purchase orders and goods receipt reports,
auditing price, discount, freight, taxes, etc. and performing the monotonous activity
of bill passing.
(ix) verifying payment terms, printing out cheques and holding onto them until payment
on the due date.
2. Stores Management
Computers can be programmed to:
(i) verify that quantities received from suppliers are strictly according to the delivery
schedule/purchase order.
(ii) prepare goods receipt reports (GRR) for the materials received from suppliers.
(iii) update inspection results and compute pending quantities against a

purchase order.
(iv) analyse the number of GRRs pending with the Quality Control department,
awaiting inspection.
(v) find the status of the GRRs awaiting updation in the stock ledger.
(vi) compute stock on hand, compare against the re-order level and generate
purchase indents.
(vii) prepare consumption statements and month-end stock ledger (inventory reports),
(viii) effect stock adjustments based on physical stocktaking.
3. Inventory control and material planning:
Based on the regular updating of the stock ledger, computers can be programmed to
do the following:
(i) Replace manual inventory valuation by the machine.
(ii) Carry out inventory planning and materials budgeting activities.

(iii) Fix operating levels of inventory such as minimum, maximum and re-orderand
levels
initiate purchase indents based on these levels.
(iv) Generate exception reports, consumption reports and stock reports. r
(v) Carry out ABC, FSN and XYZ analysis on a periodical basis, for example,
once
or twice a year.
(vi) Anaylse the consumption data and project future requirements based past
on the
data.
(vii) Study past data on prices to forecast future trends.
& Activity C;
List the activities that you would like to computerise for a large scale manufacturing
company.
& A ctivity D ;
Visit a bank nearby and list the output reports that it generates from computers.
14.4 MANAGEMENT REPORTS ON MATERIALS

_____________________
To keep track of the various operations in the materials department, different types of
reports are required. The computer can produce all these reports at a very high speed and
accuracy. Typical reports usually required for management control are:
• Vendor delivery record -;

• Purchase material price variance
319
Materials Management • is low
and
therefo
• Analysis of purchase order re
• 'Vendorwise purchases require
s to be
• Items below re-order levels and above maximum levels expedi
ted,
• Materials consumption for the period failing
which
• Expenditure due to materials used by various departments
they
• Inventory transactions and stock status are
likely
• Accounts payable (agewise) to
cause
Specific Reports stocko
ut/prod
pppppppppp)Pending purchases indent report to highlight indents which are uction
yet to be converted stoppa
into purchase orders. ges.
Low
qqqqqqqqqq)Pending purchase order report to highlight purchase orders stock
against which supplies statem
are yet to be received or partly received. ents
require
rrrrrrrrrr)Purchase orders released during the current month report. The to be
statement is generated prepare
every month to know the financial commitment made during the d more
current month. freque
ntly
ssssssssss)Pending GRRs report to indicate number of GRRs against which the
(for
material is yet to
exampl
be taken into stock. These GRRs may be pending for QA clearance
e,
and/or stores
weekly
updation.
).
tttttttttt)Price variance report to highlight the variance in the price of an
h) High
item ordered on
stock item
different suppliers. Another type of price variance report is to find the
report
price variance
provides
of the items procured in different periods.
information
uuuuuuuuuu)Stock transaction report provides information on the on items
consumption of the items in the whose stock
previous periods and stock-on-hand. The statement is prepared monthly. is more than
The data is their
useful for the purpose of inventory planning of indirect materials and
review of the
stock levels of regular production items.
vvvvvvvvvv)Low stock item report provides information on items whose stock

Unit 14
rateo is usu;
1) List oi perioc
arepn
Listl List 2 List3

List 4
Thelii
j) Listoi last loi listed i cancel materi
k) Physic physic stock a after tii contim accura
D ABCc
on con; on inve
Prepare the 1 of your com]

rate of consumption, (i.e. disproportionate to their rate of consumption). The report

is usually prepared annually or six monthly.
i) List of inactive items provides information on items which have not moved over the
period. The list is prepared in the descending order of the inventory value. The lists
are prepared agewise:
List 1 to record items not moved for over 5 years.

List 2 to record items not moved for over 3 to 5 years.
List 3 to record items not moved for over 1 to 3 years.
List 4 to record items not moved for over six months to one year.
The lists are prepared periodically - six monthly or yearly. The lists are scrutinised by
the team and disposal action is decided to reduce inventory.
List of surplus items provides information on items whose stock-on-hand is likely to

last longer than the normal period of consumption (usually six months). The items are
listed in the descending order of their value. The list is scrutinised and the decision to
cancel/modify/ suspend the supplies of the items on the list is taken. This helps the
materials manager/purchase manager to keep the inventory investment under control.
k) Physical inventory slips (PIS) report is a document used to correct discrepancy in the
physical stock and in the book balance of an item. A positive value of PIS means
stock addition and negative value means stock reduction. The list is prepared annually,
after the stock verification (in case of annual stock taking) or periodically (in case of
continuous stock taking). The statement provides the management an insight into the
accuracy of stock records and the quality of store transactions.
' ABC classification categorises the store items into three groups A, B and C, based
i on consumption value of the items. The classification helps to exercise selective control
I
on inventories. The report is prepared annually.
& A ctivity E;
Prepare the list of reports which you would like to generate for the materials management
of your company.
M aterials M an ag em en t ' '( f ( - • K-
\
Queries
The computerised system also offers the facility of querying on various aspects. Typical
queries which are frequently raised, are as follows:
• Location of the item
• Stock-on-hand
• Quantity required for the order
• Weighted average price
• Pending quantity with QC for inspection
• Alternate material
• Transactions of the item during the period
• Consumption during the month till date
• Yearly total consumption till date
• Quantity requested by the indenter
• Quantity pending to be procured.
14.5 SUMMARY__________________________________________________
The Materials function provides an excellent scope for computer applications, as the bulk
of the work is routine in nature and can be easily performed by the machine. Applications
of computers in Materials Management can be classified into three groups: operating
systems, reporting systems and decision support systems. Anumber of activities concerning
purchase, stores, inventory control, materials planning, etc. can easily be computerised.
Also, computers can produce a large number of reports with high speed and efficiency.
14.6 KEYWORDS_________________________________________________
Database: A database is a collection of information processed by the computer.
Decision support systems: Decision support systems incorporate data into an analytical
frame work, utilising scientific techniques such as regression analysis, simulation, etc. and
present data in the form of select alternative actions, thereby assisting materials people to
select from alternatives.
15.1 INTRODUCTION TO EVALUATION SYSTEM ___________

Material cost, in most of the manufacturing units, constitutes a large and significant
portion of a company's total expenditure. Depending upon the nature of the industry,
this could be anywhere between 50 to 60% and, in some, cases as high as 70-80%.
Even if 1% of this expenditure is reduced, the gross profit of the company could
increase by 8 to 10%. Hence, the success or failure of an organisation largely depends
upon the effectiveness (or performance) of its materials function. It is, therefore,
essential to measure this performance and analyse it at periodic intervals, so that
corrective action, wherever necessary, can be taken.
Salient Features of the Evaluation System
A good performance appraisal system should evolve performance parameters which

will help to measure the contribution of the department in achieving the set
objectives. The performance parameters must have the following characteristics:
(i) Measurability
The indicator must be measurable. The constraint on measurability includes
availability of data, people's willingness to provide information, skills available in
the machinery for collecting and analysing data.
(ii) Accuracy
The evaluation system should be accurate. This is as important as it is obvious.
(iii) Timely
The indicator should correspond to a suitable time
span, (iv) Action oriented
It should be possible to use the indicator for analysis. It should highlight the
areas requiring remedial action.
(v) Verifiable
Record keeping, method of obtaining information and method of recording
information should be such that, if necessary, it should be possible to confirm
the value of the indicator through an independent check.
(vi) Stability
Each indicator must be defined properly and precisely. The data elements
used in definition should retain their meaning over a wide span of time.
326
U n it 1 5 E v alu atio n o f M ate rials D ep artm en t •< •'.'•
(vii) Easy to understand

The indicator must be easy to understand. The lower the understandability, the lesser is
the practical utility of the indicator.
(viii) Cost effectiveness ~ ~
The indicator should be such that it will not cost much to collect the data.
Steps in the Measurement Process
Fig. 15.1 gives a flow chart of the steps in the measurement process.
List down key activities
Decide measurements
Assess current level

(Collect data)
Set targets
Decide corrections Prepare action plan
Analyse cause Implement
Review performance
erformance as
desired?
Fig. 15.1 Revise targets

327
Unit 15 Evaluation of Materials Department
• Efficiency in return of defective material.
• Administrative cost effectiveness.
How to measure?
(a) Efficiency of materials inwarding analyses the
• Efficiency and cost consciousness exercised in the collection of materials.
• Speed and efficiency in taking materials in stock.
• Quality of control on quantities.
Three indicators employed for the

Demurrage paid during the period
purpose are:i Demurrage
index =
Value of purchases made from outstation suppliers
during the period
i Collection index = Transport cost incurred in collection of materials

from
godown per period
Value of purchases made from outstation suppliers

during the period
E Processing time of a GRR = Average time to clear a GRR
(b) Effectiveness of control on suppliers' quantities

measures the care exercised on
physical receipt of quantities. Two indices used for the purpose are:
% deliveries not No. of GRRs where quantities are excess than schedule
L as per schedule ~ Total number of GRRs
% defectivedeliveries No. of GRRs with discrepancies

Total number of
GRRs
(c) Effectiveness of "return of defective material" function measures

the effectiveness of "timely return of defective material" and "completeness of
accounting."Two basic indicators for the purpose are given as under:
329
(i) Average period of returning defective material back to supplier:

No. of rejected GRRs wherein material returned is partial or nil •
(ii) Defective material
accounting index = Total number of GRRs
(d) Administrative cost effectiveness measures the ability of the department to keep the
expenses within limits which can be measured by analysing the "clerical cost per GRR."
(i) Clerical cost per GRR = Expenses (per period) of the receiving stores No. of GRRs
(per period)
15.3 EVALUATION OF PURCHASE FUNCTION
What to measure?
The purchase department requires to be assessed for the effectiveness in the following
areas:
(i) Effectiveness of administrative controls.
(ii) Quality and delivery performance of the vendors.
(iii) Promptness in return of defective materials.
(iv) "Administrative cost" effectiveness.
(v) "Cost improvement" effectiveness.
How to measure?
The performance criteria to be used are given below:
1. Effectiveness of administrative control mainly concerns analysis of the orders.

Rush orders and cash purchase orders should reduce while contract orders and
blanket orders should increase. Administrative effectiveness also considers the function
of selection, development and retention of suppliers.
Rush order percentage = No. of rush orders

Total number of purchase orders x 100
330
Every organisation must attempt to reach as high an indigenous content as possible,

as early as possible. Effectiveness of efforts of indigenisation can be measured by the
following ratio:
Import substitution Index = Value of stores purchases indigenously Total

value of purchase
or
Value of imported stores

Total value of purchase
2. Delivery and quality performance measures the effectiveness of purchase follow-

up, quality of vendor development and maintenance of relations with the vendors to
ensure that they effect delivery of right materials at the right time:
(i) Vendors' Quality Index = No. of zero defect suppliers Total no.
or of suppliers
No. of lots accepted Total no. of

lots supplied
(ii) Vendor Delivery
% Deliveries on time
No. of lots delivered on schedule Total

no. of lots delivered
(iii) Vendor's overall rating =
% Suppliers with over 95% rating
3. "Return of defective material "function effectiveness
This aspect measures effectiveness in timely return of defectives materials and also
the 'completeness of accounting.'
Two basic indicators sufficient for the purpose of measurement are:
(i) Average period of returning rejected material back to the supplier:

No. of rejected GRRs where material returned in partial or nil
(ii) Effectiveness in=
Total number of rejected GRRs
accounting of rejection
4. Administrative cost effectiveness

Administrative cost effectiveness measures the ability of the department to keep the
expense within limits, which can be measured by analysing purchase order cost.
Total purchase department expenses per period

Cost per purchase order =
No. of orders placed during the year
5. "Cost improvement" Analysis

The purchase department is a profit centre. Buying function, if handled effectively,
can result in improvement in purchase cost. Cost savings may be achieved by
• Substitution of materials
• Reduction in inventory investment
• Economic scrap disposal
• Value analysis . ,- . .
• Make-or-buy decisions
• Import substitution
• Better price negotiations
• Better credit terms
• Quantity discounts (Bulking of orders)
• Transport charges
• Development of new vendors
• Change of suppliers
Various indices to measure "cost improvement" by purchase department are:
Annual savings by purchase department

(i) Purchase cost saving index =
Total value of purchases
Savings due to value analysis project

(ii) Value analysis index
Total material cost
(iii) Standardisation effectiveness index = No. of items after standardisation

No. of items before standardisation
(iv) Codification index No. of items codified

Total number of items
15.4 EVALUATION OF INVENTORY FUNCTION
What to measure?
Inventory function requires to be assessed for effectiveness in the following areas:
(i) Optimisation of capital lock-up
(ii) Continuity in availability of materials for production
How to measure?
The performance criteria to be used is an under:
1. Optimisation of capital lock up measures the effectiveness of inventory control

techniques measured in terms of inventory turns.
Material consumed during the period

Inventory turns Average inventory during the period
Opening stock + Purchases - Closing Stock l/2

(Opening stock + Closing stock)
For better control, inventory turns may be studied for total inventory and separately for
• Raw materials + Bought-outs + Works-made parts
• Finished goods
• Work-in-process
• Spares
• Vendors' stock
(i) Finished goods inventory turns =
Average Annual sales finished goods investment
= Average number of days of sale (or
business)
(ii) Raw materials + Bought-out (Cost of materials + Bought-out parts +

parts+Works-made parts Works-made parts consumed during the year)
inventory turns = Average inventory of raw material + Bought-out parts +
Works-made parts.
(iii) Work-in-process Value of production during the year Average

inventory turns work-in-process inventory investment
(iv) Spare parts inventory Cost of spares consumed during the year Average
turns spare parts inventory investment
OR
Spare parts inventory investment Value
Spare parts index (v)
of capital goods
Annual value of purchases of parts /

components on labour charge basis.
Vendor's inventory turns
Average inventory of company's material
with the vendors
2. Continuity in availability of materials for production measures the

effectiveness of the inventory control techniques in avoiding or in minimizing
stockouts. The effectiveness can be measured by calculating either "out of stock
index" or "production loss due to stock-outs."
No. of times out of stock

(i) Out-of-stock No. of times requisitioned
The analysis needs to be made for A and B class of items
(ii) Production loss due to Hours of production lost due

stock-outs to non availability of material
Total scheduled production time
334
15.5 EVALUATION OF STORES FUNCTION

What to measure?
Stores function requires to be assessed for effectiveness in the following areas: (i)
Effectiveness of administrative control (ii) Effectiveness of cost control
1. Effectiveness of administrative control concerns analysis of —

• loss due to obsolescence, deterioration, pilferage etc.
• lock up of money in obsolescent and dormant stock
• value of discrepancies between the physical stock and book balance.
The different ratios used for the purpose are as under:

Obsolescence (value)
(i) Value of non-moving items in inventory
index Average inventory investment
OR
Obsolescence (items) No. of non-moving items Total
index ~~ number of items
Obsolescence and pilferage
Average
(ii) Storage loss index = inventory investment
Average inventory investment

2.
"Effectiveness of cost control" criterion
Effectiveness of cost control measures the ability of the department to keep the
expenses per item within limits which can be measured by analysing the "stores cost"
index.
_________Expenses of store
___________
Value of discrepancies
Total value of materials received and issued
(1) Stock verification index = Area used for storage Total
storage area available
(i) Stores cost index =
(ii) Space utilisation index =

J& liA ctiv ity E ;

State the parameters that should be considered for the evaluation of performance in
the materials department of a medium scale manufacturing company.
15.6 SUM M ARY_________________________________________________

Evaluation of Materials Management forms an integral part of the material function.
It helps to identify weak spots, determine training needs, measure contribution of
quantitativetechniques, perform inter-firm comparison and induce individuals to
improve their performance. Evaluation involves deciding measures, collection and
analysis of data finding
the current level, setting targets, finding gaps, deciding on counter
measures and performance appraisal and corrections.
Evaluation may be carried out separately for five main sub-functions of

M aterials Management, namely, receiving and inspection, purchasing, inventory
management andstores.
15.7 KEYWORDS________________________________________________
Evaluation: Evaluation is the process designed to measure the performance and
analyseit at periodic intervals, so that corrective action, wherever necessary, can be
taken.
15.8 SELF-ASSESSMENT QUESTIONS________________________________

Q1. What do you understand by performance appraisal? Why is it needed? What
shouldbe the salient features of a good performance appraisal system?
Q2. W hat performance parameters would you recomm end to ensure the
efficientfunctioning of materials department? Suggest your recommendations
with reasons.
.-336

Materials Management

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Materials Management

1.1 INTRODUCTION TO MATERIALS MANAGEMENT________________

Material Management according to Bethel and others, is a term used to connote

Rate of Return on investment

P = Profit C = Capital S = Sales

Fig. 1.2: R.O.R. and its constituents

Two basic ways to improve R.O.R. are

(a) Increasing profit keeping the capital constant

Unit Unit Unit Unit cost

Fig. 1.3: Profit and its constituents

The duplication of resources requires extra capital, which depends on the

(b) Reducing Capital '

An alternative to increasing profit to improve ROR is to reduce capital. Capital can

Costs involved in the Management of Materials

The various costs involved in the management of materials are as follows:

• Basic cost of materials - cost paid to the supplier as price of goods.

• Ordering costs - cost incurred in effecting purchasing, such as cost of tendering,

• Inventory carrying costs - cost incurred in maintaining inventory such as interest

• Freight cost - cost incurred in movement of materials from suppliers' works to

• Wastage during receipt, storage, production etc. - cost of losses due to

Objectives of Materials Management

There are ten objectives of Materials Management:

a) To maintain a steady flow of materials to ensure uninterrupted production. Any

b) To achieve economy in cost of materials by adopting cost reduction techniques

c) To ensure consistency of quality by providing right materials, of the right quality,

d) To reduce inventory investment through scientific inventory control techniques.

e) To improve corporate image by maintaining good buyer-seller relations.

g) To preserve/conserve materials in stock so that losses due to pilferage,

h) To reduce operating cost by minimising/eliminating wastage and improving

Fig. 1.4 below lists the objectives of Materials Management.

Fig. 1.4: Objectives of Materials Management

Integrated approach to Materials Management

Purchasing -Arranging uninterrupted supply of raw materials, parts, components

Developing new sources of supply - Locating, selecting and developing new

Ancillarisation - Developing small scale captive sources to manufacture parts and

Status of the department

Fig. 1.5: Material department being considered top management function

iv) Economy in maintenance of records in the purchase (few purchase indents),

receiving and inspection (fewer receipts) and accounts (fewer

v) Low inventory investment.

vi) Reduction in handling and storage costs due to centralisation of receiving

vii) Performance of specialist functions by non-specialists.

viii) Avoidance of irritation of the vendors at having a number of contacts

Decentralised arrangement refers to the system of procurement of requirements

(i) Decentralisation enables individual buyers to react rapidly to changes in

i) Complexity of operations (i.e. quantity and variety of items to be purchased)

in) Single or multi-plant/multi division.

A . Internal structure in a sin gle p lan organisation

The general rules are as follow s:

Fig.1.6: Organisation showing receiving, store keeping and traffic

Decentralised set up is preferred in organisations having more than one plant

A semi-centralised setup is shown in Fig. 1.8.

Materials Materials Materials

Receiving & Inventory Purchasing Traffic Materials

Buyer I Buyer II Buyer III

Fig. 1.8: Semi centralised set up

Responsibilities of different divisions of Materials Department.

The respective functions of the materials department of a medium-sized firm are

1) The Material Planning division is mainly concerned with assurance of materials

• Determining net requirement of materials by considering sales budget

1.6 SELF-ASSESSMENT QUESTIONS__ ,