Production and Operations Management

Module 5: Materials management

Scope of materials management

1. Amount of materials is high compared to other inputs . and it is increasing year to year.
Proper materials management is key to the survival and growth of the company.
2. Cost of materials could be as high as 70-75% of the cost of the product in engineering
industries. In other industries it could be between 40- 60 % . Hence reduction in the cost
of materials plays an important role in the profitability of a company
3. Materials form a important part of current assets of the organization. Its proper
utilization is vital for ROI ( return on Investment)
4. Added value of a product = Value of produced goods- value of materials purchased. It is
imperative that not only that purchase cost of materials are to be low but also expenses
incurred in purchasing, storing, handling should be as low as possible.
5. Quality of end product depends on quality of input materials. Hence it is important that
right quality of products are to be procured at right time. Giving detailed description of
requirements to supplier in the Purchase order ensures the same.
6. Materials management is one of the Key centers of accountability for performance. It
includes purchasing, handling of materials, maintaining appropriate inventory levels and
ensuring storage conditions.
7. Minimizing the use of scarce resources and finding alternatives
8. Ensuring safety during handling and storage of hazardous materials and compiling with
regulatory requirements
9. Efficiency of business depends on ensuring right quality of materials in right quantity ant
the right time. Otherwise it hampers the production to a great extent. Cost of production
shoots up.

Primary Objective of materials management

1. Low prices- to be lowest - includes transportation: enhances profit
2. High inventory Turnover- value of inventories to be low in relation to sales. Reduces
storage costs
3. Low cost acquisition and possession- reduced handling and storage costs.
4. Continuity of supply- alternative sources, , captive suppliers, flexible suppliers
5. Low payroll costs- Low operating costs of material management personnel
6. Favorable supplier relations- supplier development

Secondary objectives of Materials management

1. New materials and products- working closely with Design and research departments for
development of new materials and products
2. Economic make-buy- Coordinating and assisting other departments in Make-Buy
decisions
3. Standardization- coordinating with Design departments in reducing no. of items.
4. Product improvement- Contribution towards product improvement by giving appropriate
inputs and assisting Design department.
 5. Interdepartmental Harmony- Success of materials management department depends on
the success of other departments . hence relations are to be harmonious
6. Forecasts- Forecasts in terms of prices, availability and general market conditions are to
be regularly monitored towards taking important business decisions.

Functions of Materials Management

1. Purchasing
2. Vendor selection and rating
3. Material storage and handling
4. Inventory management

Purchasing:
Objectives of Purchasing;
1. To pay reasonably low prices for best value of products
2. To keep inventories low
3. To develop satisfactory sources of supply
4. To secure good vendor performance
5. To locate new materials or products as required
6. To develop good purchasing policies and procedures
7. To implement programs like value analysis , cost analysis and make-or-buy decisions
8. To keep overheads of the department Low.
9. To have a high degree of coordination with other departments

Main Functions of Purchasing department

1. Selection of vendors
2. Obtaining quotations/prices
3. Awarding purchase orders
4. Follow-up for delivery
5. Handling complaints , if any
6. Supplier development/ vendor relations
7. Payment of invoices
Other functions of purchase department ( in coordination with other departments)
1. Establishing specifications
2. Scheduling orders
3. Inspection
4. Accounting
5. Market research
6. Inventory policy
7. Sale of scrap
8. Customs clearances ( during import of materials)
9. Transportation
10. Make-or-buy decisions
Steps in Purchasing
1. Receipt of Purchase requests ( qty, delivery, item description)
2. Development Purchase specifications
3. Obtaining quotations from sources
4. Selection of source
5. Release of purchase order and acceptance by supplier ( technical and commercial terms)
6. Follow up for receipt
7. Checking invoice and approval for payment

Vendor / supplier selection is based on the following considerations

1. Availability of Infrastructure ( equipment, building, inspection facilities etc)

2. Availability of human resources ( managerial, workers, Inspectors)
3. Technical capability
4. Meeting delivery requirements
5. Reasonable prices
6. Flexibility to take up variations in demand
7. Willing to work and grow with the company

Normally suppliers are selected on the basis of few trail orders . if the performance is satisfactory
, they are included in approved supplier list and future purchase orders are placed on them.

Single source or Multiple sources

Single source:
1. Quantities may be very small for multiple sources
2. Supplier may be exclusive ( eg patent)
3. Supplier is outstanding in quality and delivery and no need to consider others
4. Ordering and scheduling is very easy and less costly

Multiple sources:
1. Suppliers will be competitive
2. Delivery disruptions cannot be sustained (because of Breakdowns , strike, floods etc)
3. Quantities too huge for one supplier
4. Scheduling flexibility

Vendor rating

Vendor rating is carried out periodically (once in 6 months / 12 months ) to gauge the
performance of the approved supplier and to intimate him regarding improvement if needed.
Suppliers may be classified as( example)
A-good > 80%
B-satisfactory > 60 and < 80%
C-unsatisfactory < 60%
If the performance is not satisfactory , supplier may be given a chance to improve. If the supplier
still falls under not satisfactory category, the supplier may be considered for removal from
approved suppliers list

Some of the criteria for Vendor rating ( weightages may be given for the criteria )
1. Quality of products received
2. Delivery performance
3. Price of product
4. Flexibility in meeting demand fluctuations
5. Assistance in Product development
6. Cost reduction suggestions
7. Implementation of Inventory plans / JIT system
8. Credit terms
9. Management competence
10. Financial position

Problems
Calculate vendor rating with the data below and indicate which supplier is better
Weightages for Quality=50; delivery=25; price =15 : response to suggestions = 10

Supplier data Supplier A Supplier B

Quantity supplied 108 90
Quantity accepted 102 90
Price Rs 1 Rs 1.2
Delivery promised 3 weeks 4 weeks
Actual delivery 2.7 weeks 5 weeks
Response to suggestions 90% 85%
Solution:

# description Supplier A Supplier B

1 Percentage accepted ( quality 102/108 x 100 =94.4% 90/90 x 100 = 100%
ratio)
2 Quality rating 94.4 x 50 /100 =47.2% 100 x 50/100 = 50 %
3 Delivery against promise 3/2.7 x 100=111.11% 4/5 x 100=80%
4 Delivery rating 111.11 x 80 x 25/100 =20%
25/100=27.77%
5 Price ratio ( in percentage )= 1/1 x 100 =100% 1/1.2 x 100=83.33%
lowest price/supplier price X 100
6 Price rating 100 x 15/100= 15% 83.33 x 15/100
=12.50%
7 Response to suggestions rating 90 x 10/100= 9% 85 x 10/100= 8.5%
8 Total 98.97% 91%

Supplier A is better.
Stores management

Functions of stores management

1. To receive materials and account for them
2. To provide adequate and proper storage various materials
3. To ensure proper identification
4. To preserve product from deterioration
5. To receive indents from consuming departments , issue and maintain accounts
6. To minimize obsolescence by stock rotation ( FIFO method) especially shelf life items
7. To highlight stock accumulation, discrepancies and abnormal consumption
8. Ensure good house keeping
9. To ensure efficient material handling
10. To verify stock periodically

Stores layout is critical to good stores management. It should have:

1. Adequate storage areas
2. Good lighting
3. Good material handling equipments
4. Safety provisions
5. Areas marked for receipt of material, inspection areas and area for rejected goods
6. Easy access to all storage areas
7. Storage areas are clearly identified for quick location and fast service
8. Good usage of floor space and heights
9. Secure areas for costly items to prevent theft, pilferage.

Stock verification is conducted to verify the physical stock against book stock. If the
discrepancies are less , it indicates good stores management.
Types of stock verification:
• Periodic verification- stock is verified once in 6 months or 12 months. Receipts and issues
are closed and all materials are checked physically.
• Continuous verification- materials are divided into 52 groups and physical stock is checked
weekly. This will distribute the stock verification burden over the complete year.

Proper classification and codification of various items helps in management of stores in an

efficient way. It reduces duplication and enables reduction in sizes and verities.

Some broad classifications are – raw materials, parts, spares, tools, packing materials, hardware
Inventory Management
Inventory is the materials stocked in order to meet an unexpected demand or distribution in the
future. The materials may include Raw materials, Materials in –process, Finished goods, spares,
Tools and others.

Level of inventories depend on :

1. Nature of product
2. Nature of customer demand
3. Lead times for manufacturing
4. Lead times for procurement
5. Consumption pattern
6. Shelf life of product

Purpose of holding Inventories :

1. Meeting delivery requirements
2. Better utilization of manpower and equipment
3. flexibility in scheduling

Carrying Inventories costs money. It increases production cost.

Inventory costs are :

• Ordering costs - preparation of purchase order, processing payments, Receiving and
inspection
• Carrying costs- deterioration, pilferage, taxes, insurance, storage, Interest
• Capital costs-space, buildings, equipments
• Storage space costs- rent, power, maintenance
• Service costs- salaries of employees, bonus, security, Record keeping, Overtime
• Looses- pilferage, damages, expired products

Inventory carrying costs per year may be 20-30% of the value of Inventory.

Because of high costs involved in inventories proper management and control assumes
importance .
Inventory management involves;
• Development of policies, systems and procedures
• Administration of policies, systems and procedures
• Close interaction with other functions like customer service, production scheduling,
purchasing and transport

Inventory control pertains only to administration of policies, systems and procedures

Factors influencing Inventory management and control:
1. Type of product – if the unit cost is high , closer control is needed. Short supply may have
to be stocked more. custom built products may have to be stocked more. Standard
products may be stocked less.
2. Type of Manufacture - stock out situation should not be allowed to occur. Batch
production and intermittent manufacture allows greater flexibility in inventory control.
3. Volume of production – inventory may not increase with volume of production. If
products have many components then inventory required may be high.
4. Others- objective of the company, supplier capabilities, information systems, capabilities
of personnel

Benefits of Inventory management and control:

1. Ensures adequate supply of materials and minimizes stock out situations
2. Reduces costly interruptions in production
3. Keeps down investment in inventories and inventory costs
4. Bring in purchasing economies by monitoring consumption
5. Better utilization of stocks of common materials for various departments
6. Better accountability
7. enables identification of obsolete items and their disposition
8. enables reliable and consistent financial statements

Steps in inventory management and control:

1. Determination of optimum inventory levels- too much inventory blocks capital. Less
inventory may result in production interruptions. Consumption trends and sales trends
offer inputs for fixing the inventory levels. Inventory levels have to be reviewed
periodically and adjusted as necessary.
2. Determine degree of control – normally based on value of item. ABC analysis is made
and a class items are controlled closely for variations in consumption , stock, record
keeping and review. ( A- high value, low , C- low value, high quantities)
3. Plan and design inventory system-
a. Fixed Quantity system
Maximum
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t level
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Lead time
b Fixed period system Time

Replenishment level
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Fixed periods

4. Organise structure to manage inventory- responsibility for inventory control, monitoring,

keeping records, handling exceptions, raising requests etc ( normally production planning and
control)

Inventory control techniques

• ABC classification- based on identification of “vital few” from ”trivial many”. And
controlling the vital few whose rupee value is high. Steps in classification is as follows;
o List each item carried in inventory
o Determine annual volume and Rupee value of each item
o Calculate product of annual volume and rupee value
o Compute percentage of each item in terms of total inventory in rupees
o Select top 10% of all items which has the highest rupee percentages and
catagorise as ‘A ‘ items
o Select next 20% of all items which has the highest rupee percentages and
catagorise as ‘B‘ items
o Select next 70% of all items which has the highest rupee percentages and
catagorise as ‘C ‘ items

• VED analysis ( effect on production)– V-vital, E- essential, D- desirable

• SDE analysis ( based on availability)- S=scarce, D-Difficult, E-easy
• FSN analysis ( based on consumption)- F-fast moving, S-slow moving, N- non moving
• Economic order quantity- EOQ is based on

TC=DC +D/Q x S + Q/ 2 x H
TC = Total cost
D=Annual demand
 C= purchase cost per unit
Q =quantity to be ordered ( EOQ)
S= cost of placing order
H= holding cost per unit

D/Q x S = Q/ 2 x H : Q= Sq Rt ( 2DS/H )

When wide variations are there in demand or usage EOQ method does not work
satisfactorily. Also inaccurate cost estimates lead to poor calculation of EOQ.
EOQ must be modified with judgment.

• Minimum –maximum technique

Used with manual inventory control systems. Min quantity is and maximum
quantity are established. When withdrawal reduces the qty below min . qty.
order is placed to bring to maximum level.

• Two – Bin Technique-

Normally done for C class items. One bin contains enough to meet the demand
between orders. Other contains enough material to take care of consumption between
placement of order and receipt. When first bin is en=]empty order is placed and
materials are used from other bin.

• Material requirement Planning ( MRP)

For large firms with many different products and products with many components it is accurate
and fast to use a soft ware for material planning purposes. MRP is such a software .
Inputs to MRP are :
• Production plan with products, Quantities and delivery requirements
• Existing stock levels of various components
• Bill of materials ( BOM) – a list of components that make up the product. They may be
brought out, made in house or subcontracted.
• Purchasing information – products , suppliers and agreed prices
• Processing information – Production sequence, equipments, production rates

Outputs from MRP are :

• Purchase orders on suppliers with Quantities and delivery dates
• Production schedule
 Customer orders / production
Plan
Purchase
information Processing
information

Inventory MRP Bill of Materials

Purchase Production
orders Schedules

• Just in time ( JIT)

The concept originated in japan and adopted by many companies in India.

As a concept , JIT means materials arrive on time and no inventories are held at
any time. Either in raw materials, WIP or finished goods. Materials are pulled in
to the system. JIT system ensures great efficiency in production To ensure a good
JIT system the following are essential:
 Reliable suppliers
 Good processes with least rejections
 Break downs of equipment to be very less
 Continuous flow of materials with no bottle necks
 Low set uptimes
Benefits of JIT are:
• Faster through put time
• Less or no storage place
• Visual control and enhanced quality
• Greatly reduced production cost
• Constant flow of Finished goods to customers

Enterprise Resource Planning ( ERP)

Enterprise Resource planning is similar to MRP . It can do what MRP can do and much more.
ERP is very useful for planning and controlling activities in a very large firm with very many
products and operations are carried out in many locations including many countries.
ERP system can handle many functions and comes in modules, each of these can be individually
used or together . normally the modules are:
1. Sales and marketing
2. Materials
3. Production
4. Financial
5. Human resources

Inputs to ERP are :

• Production plan with products, Quantities and delivery requirements
• Existing stock levels of various components
• Bill of materials ( BOM) – a list of components that make up the product. They may be
brought out, made in house or subcontracted.
• Purchasing information – products , suppliers and agreed prices
• Processing information – Production sequence, equipments, production rates
• Sales information
• Human resource information
• Accounting information

Main vendors of ERP are SAP, Oracle, Microsoft.

It may take 1-2 years to put all the inputs and get the ERP online. Once the ERP is on line., all
transactions are input into ERP system on a daily basis and decisions are taken as per
recommendations of the system . With ERP system, the speed of transactions , accuracy and
availability of information to various persons for taking decisions are greatly improved.
Productivity of personnel is greatly improved.

Benefits of ERP are:

Tangible benefits:
• Reduction of lead time for manufacture
• Improvement in delivery performance
• Increased Inventory turn over
Intangible benefits:
• Better customer satisfaction
• Improved supplier performance
• Reduced Quality costs
• Improved resource utilization
• Speed and accuracy of information
• Better decision making capability
Information systems for Material management:
Effectiveness of Materials management function is greatly enhanced if supported by good
information system. Some of the information computer system can provide are :
• Purchasing
o Automatic release of orders on approved parties
o Status of receipt ( dates, Quantities, acceptance details)
o Vendor rating
o Payments to vendors
o Handling of complaints and corrective actions
o Vendor Audit and action taken
• Inventory control
o Number and value of items in inventory
o Trends of consumption
o Fast moving, slow moving, and non-moving items
o FIFO control ( First- in –first-out)
o ABC analysis
o Inventory trends ( weekly, monthly etc)

• Measurements
o Inventory carrying costs
o Inventory turns
o Stock out or incidences of going below safety levels
o Over stock situations

Value Analysis / Value Engineering

Value analysis refers to the managerial activity which deals with study of existing products and
its components with the objective of reducing the cost and retaining its value or function. This is
done by a team of people comprising of , normally, Design, purchase, Methods engineering.
Value analysis is done on products which in market but loosing to competitors on price.
The following are the steps followed;
• Analysis of function of each component to check its contribution
• using less expensive material for same function
• Combining components to reduce cost
• Use of standard parts
• Taking ideas from suppliers

Problem1 : ABC analysis

# Unit price( Rs) Consumption Annual value %

1 1.5 2000 3000 0.335
2 7.5 400 3000 0.335
3 20 3500 70, 000 7.826 A
4 80 800 64,000 7.155 A
5 4 2000 8000 0.894
6 65 500 32, 500 3.633
7 15 750 11, 250 1.257
8 22 800 17, 600 1.967
9 0.5 2000 1000 0.111
10 3 600 1800 0.201
11 2.5 2000 5000 0.559
12 17.5 1500 26250 2.934
13 22 1000 22, 000 2.459
14 45 2500 1, 12, 500 12.578 A
15 350 600 2, 10, 000 23.479 A
16 30 3500 1, 05, 000 11.739 A
17 45 700 31, 500 3.521
18 115 200 23, 000 2.571
19 260 450 1, 17, 000 13.081 A
20 15 2000 30, 000 3.354
8, 94, 400

Problem 2 : computation of EOQ

• No. of tires sold= 9600
• Annual carrying cost is Rs 16
• Ordering cost is Rs 75
Compute EOQ, total cost

EOQ = SQRT (( 2 x D x S )/ H )= SQRT (( 2 x 9600 x 75 ) /16 )= 300 tires

Problem 3 ; inventory carrying cost

• Average inventory = 60 lakhs

• Salaries o stores personnel=Rs 2, 75, 000
• Cost of security =Rs 80, 000
• Taxes and insurance = 1% of inventory
• Interest rate =20% p.a.
• Handling of inventory= Rs 1, 50, 000
• Lost / damage= Rs 20, 000
Compute inventory carrying cost as a percentage of value of inventory

Total cost = 2, 75, 000 + 80, 000 + 60, 000 (1/ 100 x 60,00, 000) + 12, 00, 000 ( 20/100 X
60,00,000) + 1, 50, 000 + 20, 000 = 17, 85, 000.
Inventory carrying cost as a % of Inventory = 17, 85, 000 / 60,00,000 X 100 = 29.75%