1[1]. Introduction of Materials Management & Inventory

8/14/2019 1[1]. Introduction of Materials Management & Inventory

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MATERIALS MANAGEMENT

Importance of materials management :-

1. Materials input is very important as excess material as inventory

causes costs to the company and shortage of material results into

stoppage of conversion process and subsequently shortage of

finished goods leading to customer dissatisfaction

2. Out of 5Ms, that are inputs to a conversion process, material is

substantial in terms of its contribution to product cost, and current

assets.3. 51.1% of product cost is on account of materials. Hence the largest

contributor to product cost. This marks out materials functionas thelargest potential avenue for productivity improvement.

4. Materials account for 70% to 80% of working capital. Effective and

efficient management of materials can reduce substantial burden on

the finances of company.

5. Accounts payable are mostly to materials suppliers. Hence the

importance in management of finance of the company.

6. Quality of the Input and product quality: When the companies

become leaner and leaner, it is crucial that inputs should remain in

the plant only as long as the Through Put Time demands, and the

output product should be Right First Time. The quality of inputs plays

a vital role in this situation.

7. Management of materials is crucial in a Just In Time company.

Production process needs very strong materials management support

to gear up to face challenges of current market


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8. Materials management provides information about availability of

new products and services in the market which leads to cost efficient

changes in the process

Types of materials :-

refer to types of inventory.

Functions of Materials Management :-

[What is a function? Every person , organization or a

distinct part of an organization has to perform a set of tasks

in order to deliver customer expectations satisfactorily. These

sets of tasks are called functions of that particular entity.]

Materials Planning & Control

This is the primary function of Materials Management.

The market forecast is converted into production schedules by

production planning and control. Materials management

prepares the materials plan to meet the production schedule.

The plan is then implemented and controlled.

1. Procurement

Procurement function begins with sourcing the supply after

short listing suppliers. An effective method is to rate the

vendors on the basis of performance and choose the best.

Purchase order is placed on the source and the material isprocured from the source. Procurement activity includes

preparation placement of purchase order, follow up,

transportation and handling.

2. Handling


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The material which reaches the company premise is to be

unloaded, moved and positioned as per the storage plan .

3. Storage & Preservation

The procured material is to be stored and preserved against

internal and external deterioration and theft.Against the

authorized demand the material from the store is retrieved and

issued.

4. Inventory control

Inventory control functioncontrols the inventory levels to

ensure shortage free and excess free stock to check the costs

and ensure customer satisfaction

5. Vendor development

The company makes the chosen vendors effective and

efficient by providing necessary inputs of training and

information. The suppliers systems are audited to ensure

adherence. A good vendor is an asset as he makes hiscustomer more effective and efficient

6. Vendor rating

Vendorrating is used as a tool for narrowing down the

supplier base for productive management of materials function.

The same system is used continuously to assess strengths and

weaknesses of short listed vendors for their effective

development.

7. Waste control

Procuring standard material and continuously trying to

improve yield is waste reduction and control function. When a


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product is processed two types of wastes are generated. One

type of waste is called as standard scrap. This is accepted as

unavoidable. Product that is not right first time is scrap and

thereby waste. Non moving obsolete material is another waste

that cripples organization. Material management should

address these wastes and not only should control but reduce

the wastes.

Value Analysis

Continuously trying to improve the value of the product

mainly by material substitution is a function of the materialsmanagement .

Integrated Materials Management : -

As we have seen earlier, materials management performs

various functions to reach their well-set objectives. These

functions are performed by business organizations since a very

long time as trade and business have been taking place muchbefore scientific management was thought of.


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Traditional Approach -

Traditionally the organizations performed their

functions aiming to achieve excellence in respective areas.

Every function tried to sub-optimize their individual function.

This approach created some excellent buyers, some

excellent movement managers, and some very good

storekeepers, but often this functional excellence was at the

cost of each other. Impact of excellence of one area on other

functions was not taken into account. Performance of this

kind did not bring cost benefits to the parent organizationsthat continued to suffer cost burden. Organizations

wondered why do they struggleunder the cost burden in

spite of such talented managers being their employees, like

some times we wonder why our rivals win the Cricket World

Cup when we have such great individual performers!

Integrated Approach -


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This approach ties all functions together, like a compeers

baton, orchestrated to achieve company goals. Various

functions now come under one control, focus always being

on the final outcome. Initiatives for individual excellence are

undertaken only after ascertaining their favorable impact on

final outcome. The big picture should never be lost sight of,

while trying to solve the jigsaw puzzle. The common thread

that binds various functions into a winning combination is the

focus on the big picture or the organizations gain. Unity of

command balances conflicting interests of individual

functions under integrated approach to materials

management.

Profit Center Approach -

When every integrated function of management works

like a profit center in an organization, entirebecomes a

strong integrated whole forging ahead in business,

maximizing the profits rapidly.

We easily understand concept of profit and its driving

force in business when a product is sold for a price higher

than the cost. One should remember the universal equation,

Price = Cost + Profit. But when sale does not occur,

visualizing profit may become a bit difficult.

Keeping the above equation in mind, as price is

controlled by market, any saving in the cost results into

profit. Every competitor closely follows the above equation

and identifies the resultant cost after keeping the profit

needs of the company intact. This cost is called target cost


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for competitor. Any successful attempt to reduce this cost

without harming the QCD objectives of the company results

into profit. Now split the target cost of the product into its

components developing a fishbone diagram for product cost.

A certain cost package gets attached to every individual

integrated function and any reduction in this package results

into profit for the company. Fix the identified cost package to

materials management and make materials management

accountable for reduction by a percentage. This is the profit

that materials management is responsible for. Make them

earn this profit for justifying their existence in the

organization. Like a business has to earn profit to justify

existence in competition. This approach makes individual

functions accountable for every cost and drives them to

innovate ideas to add value continuously as the competition

pushes the price to new lower levels, thereby making the

company stronger organization .

Case study:-

Acompany with a turn over of Rs.100 crores, makes a

profit of Rs.10 crores [10%] Cost of materials is Rs.60 crores,

Other expenses are Rs.30 crores. How can you increase profit

by 30%? [Rs.3crores]?

To increase the profit by 10% one has to raise the sales

by 30%. The company will have to make and sell 30 crores

worth products in a tough market like the one which exists

today. But keeping the profit center approach in mind, if we


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reduce the materials cost[Rs.60 crores] by just 5% same

objective can be achieved.

Return on Investment: an approach to measure profitability

ROI=

As materials managers if we consciously reduce current

assets companys profits will rise which will be indicated by the

ROI. We should always remember that inventory forms 80% of

current assets of the company.

Benefits of Integration :-

1. Better Accountability

Accountability for materials is now specifically fixed to

one position. No mans lands of cost between various

functions are now addressed effectively by integrated

materials management function.

2. Coordination -

Various functions are now streamlined. The inter

departmental conflicts are balanced. As a result various

functions work like a team under the control ofMaterials

Manager.

3. Better performance

Performance of Materials management improves on

account of the first two results of integration. Accountability

reduces costs and teamwork improves productive

performance.

Profit/Sales Sales/ ca ital assets + current asset


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4. Adaptability to EDP

Computerization requires preparatory work that calls

for integrated efforts where there is no scope for conflicts.

Internal conflicts make computerization untenable

5. Other advantages -

Present & Future: At present industry in our country is

passing through the transition from traditional systems to just

in time like production. Just In Time needs dependable

procurement systems. Only an integrated materials

management function can provide such support to

operations.

Definition and scope :-

Definition

Coordination and planning of all functions for controlling

materials in an optimum manner to meet customer expectations

at minimum cost.

Scope -

Materials management works closely with Production,

Finance, Engineering and Quality control in the process of

performing the functions to meet the objectives of customer

satisfaction.

Materials management and Production

As we saw earlier JIT system needs very reliable

procurement and delivery systems for inputs and outputs.

Production department is the internal customer for Materials

management. Hence very close interaction with production


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department is primary to meet internal customer expectations

and customer delight. Only this ensures unfailing satisfaction

and delight of the external customer.

Scope of materials management function decisions

includes suppliers, subcontractors, production support

warehouses, transportation service providers and internal

departments subordinate to the function.

Materials management and Finance

Timely payment to suppliers is important for the smooth

working of the supply chain which is fundamental for strong anddependable delivery system. Close interaction with finance

function is needed to ensure the above.

Materials management and Engineering

Materials Management in the course of discharge of their

functions plan activities involving change in material inputs.

This obviously has an impact on design of the product and

process of manufacturing. Hence a close working is necessary

between Materials management and Engineering.

Materials management and Quality control

For the same reasons that as above, close working is

necessary between Materials management and Quality control.

Organization & control


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Materials Management is growing in stature on account of

changes in management thought process. Materials function

has moved into board rooms which is an evidence of its

importance in corporate structures.

Materials Management & Corporate Organization structure

A materials director is usually on the board to give overall

directions to the material function in corporate bodies. This

provides unity of command and thereby uniform direction.

Materials Management & Other functions of

Management

Materials Management function is in par with other

functions of corporate management so that it can effectively

interact with other functions for organizational effectiveness.

Some of the conventional structures of materials

organization are discussed below :-

Internal Organization of Materials Management

Internal organization is structured on the need of the

organization keeping in mind the strengths and weaknesses of

individual structures.

Internal Organization based on Commodities -

An organization needs number of inputs[commodities] for

running the conversion process. Materials organization can be

structured internally with focus on the individual commodities. A

sub function can be created for dealing in an individual

commodity in order to provide adequate focus.

Internal Organization based on Location


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An organization with multi plant locations structures its

materials organization with focus on plant level. Every plant will

have a materials function that receives overall direction from

the top management. The materials function in the plant

coordinates materials sub functions of that plant.

Internal Organization based on Function

At the corporate level, materials function is set up with

respective sub functions. These individual functions coordinate

their respective sub functions in various plants or divisions

providing function wise expertise to the entire organization.

Concept of Centralization & De

centralization -

As we were discussing earlier it is the need of the

organization triggered by product, process and market that

ultimately decides how the control should be exercised on the

material function. The control may be centralized or

decentralized fully or in parts keeping in mind overall need.

Management education can provide knowledge about available

options in practice but the choice rests with the corporate

management. New options can be developed to satisfy specific

needs conceptually combining various available options.

Centralized control keeps most of the decision makingat headquarters level delegating only routine level decision

making. Decentralized control delegates decision making to

unit level enabling the units to respond to their respective

environment.


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Advantages of Centralization -

1. Combining the requirements of all units to buy in bulk and

gain benefits of bulk buying.

2. Interplant transfer of material to deal with emergencies in

individual plants. And interplant transfer to utilize surplus

material available at some plant and thereby reduce overall

inventory cost for the company.

3. Benefit of specialized skills of one individual at the corporate

level to all the units or plants. Buying needs specialized skills

specific to the commodity in market specially buying is in large

quantities. Knowledge of the market is essential to anticipate

market trends in terms of price and availability.

4. Benefits of unity of command.

5. Centralized material research resulting in savings for the

company.

Advantages of Decentralization -1. Decentralization overcomes problems posed by significant

physical separation between Plants and Central Office. These

problems can occur due to information flow. They may occur due

to lack of sensitivity to environment due to physical separation

2. Uniqueness of product line requirement of each Plant: When

individual plants areengaged in production of different products,

their requirement is product specific and thereby unique.

Decentralized control can deal with the requirements effectively,

independently.


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3. Better coordination with production & other functions of the

plant: Production is the internal customer of material management

function. Decentralized control enjoys the benefit of being close to

the customer. There is also the need to interact with various other

functions in the plant. Decentralized control can take decisions

based on these interactions effectively.

4. Supportive to the concept of Profit Center: the concept of profit

center as discussed earlier is applicable to each plant and the

management functions within. A decentralized material

management function can effectively work as a profit center and

support the plant as a profit center within the corporate body.

Materials management function for project form of production

Materials need of projects is unique as the features of a project are unique. These are

discussed below to understand the uniqueness of materials needs.

Types of Projects :-

Some of the project types are mentioned below. Most

of these projects are sponsored by Government and

implemented by organizations in public and private sector .

1. Erection of Steel Plants, Refineries

2. Laying of Pipe Lines

3. Building of Bridges, High ways, boring of tunnels

4. Laying of railroads

Features of Project form of

production :-

1.Non repetitive activities

2. Specificand Criticalperformance objectives


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3. Cost objective

4.Time objective, delays invite heavy penalty

5. Projects are monitored and controlled with the help of OR tools

like PERT/CPM

6. Long time spans

Materials Needs of Projects :-

1. Timely Requirement of Materials to meet PERT/CPM

needs .

2. Unconventional Storage, conventional storage

arrangements are not available on most of the project sites .

3. Interchangeability of Materials and equipment between

projects as companies are engaged in similar types of

projects .

4. Ability to forecast Costs within the span of project as materials

are needed at different stages of project. Material budget is to be

prepared taking into account above need. Cost overruns are

unacceptable in commercial projects.

INVENTORY MANAGEMENT :-

What is Inventory? -

1.Inventory is an unused asset, which lies in stock without

participating in value adding process.

2.Unused equipment, raw material, WIP and Finished goods,consumables , spare parts, bought out parts, tools and tackles,

gauge and fixtures etc.


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3.In India 9 to 12 months of sales quantity lies in the form of

Inventory [R/M, WIP, Bought out parts and Finished goods] as

against a few days in Japan and a month in the US and Europe

4.Huge amount of NPAs in our country, Banks, PSUs

5.If we look around in our facilities we find stocks lying unused foryears catching dust and rust in the form of plant and equipment,

raw material, WIP and Finished goods.

6.In our country inventory is always viewed as asset [working

capital], in fact, though it is called an asset, it is a big liability

7.Reluctance to scrap useless inventory in time is one of the

reasons why we carry huge stocks

8.Inventory is biggest source of waste

9.Japanese companies focused their attention on Inventory

through now well known concept of 5S

TYPES OF INVENTORY :-

1. Manufacturing: R/M, components, WIP, F/G.

2. MRO: Maintenance, repairs and operating supplies.

3. Tools and fixtures

4. Inspection gauges and instruments

5. Location inventory: inventory at a fixed location

6. In transit inventory: inventory in the process of transfer or under

going transportation and waiting to be transported. This is also

known as pipeline inventory

FUNCTIONS OF INVENTORY :-

1. Inventory overcomes obstacles due to geographical separation

between suppliers and customers. Manufacturing facilities are


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located at places that make manufacturing economical. This fact

geographically separates manufacturing and market.

2. De coupling from uncertainties of market

3. Overcomes obstacles due to poor infrastructure

4. Balancing supply and demand: seasonal production and year

round consumption [agricultural products], seasonal consumption

and production during some other season [woolen garments and

umbrellas].

5. Buffer uncertainties of lead time and demand

6. De couples internal processes. Two machines running

sequentially are separated by inventory to make them independent

of each other.

Costs of carrying inventories -

1.Capital cost

2.Taxes, insurance

3.Obsolescence4.Storage: handling, space, maintenance, security

5.Opportunity cost

6.Cost of bad quality

INVENTORY CALCULATIONS :-

Economic order quantity

Please , refer to your class notes .

Assumptions of Wilsons lot size formula or Classical EOQ model -

Demand is at a constant rate and continuous

1. Process is continuous


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2. No constraints are imposed on quantities ordered, storage

capacity, budget etc.

3. Replenishment is instantaneous

4. All costs are time invariant

5. No shortages are allowed

6. Quantity discounts are not considered

Limitations of Classical EOQ model -

We have seen that Classical EOQ model made

assumptions that are really not realistic. When the model

is put to practical use we find that so many adjustmentsare needed to be made. Hence EOQ model is formulated

undersome limitations. If we are not conversant with

these limitations, managerial application of this concept

can be counter productive.

Major limitations are some of the assumptions made -

1. The demand or usage is predictable .

2. The demand or usage is constant .

3. The price of the item remains constant through out the

procurement cycle .

4. Materials in many processes are flow controlled ie, materials

move in pipe lines starting and stopping depending on

operational requirements .

If the concept of EOQ is applied without taking into

account the limitations results can be disastrous.

Adjustments to EOQ -

1. Volume transportation rates


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EOQ model does not consider cost of transportation

of goods from vendors place to the purchaser.

Transportation costs are sensitive to weight of consignment.

If the quantity suggested by EOQ model does not get

favorable transportation cost, summation of inventory cost

and transportation cost may be detrimental to the interests of

the organization. Hence we should always evaluate batch

sizes from total cost perspective. In the traditional approach

when inbound logistics are totally vendors responsibility, the

company never used to worry about this aspect. But as the

concept is now enlightened and minimization of the costs in

the supply chain is the focus, this aspect is very significant

Annual demand 2400 U Unit value $ 5.00 Inventory charge 20%Ordering cost $19.00 per order EOQ 302 U

Shipment rate R1 [applicableto EOQ quantity = 300 U]

$1.00

Shipment rate R2 [applicable

to 480 U quantity]

$.75

Alternative 1

Q [EOQ] = 300

Alternative 1

Q = 480Inventory carrying

cost

$150 $240

Ordering cost $152 $95 Transportation

cost @ $1 per U

$2400 $1800

Total cost $2702 $2135


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2. Quantity discount

Impact of quantity discounts is seen if we look at the

costs by doing summation of inventory costs and reliefderived out of quantity discounts. Quantity discounts can

upset the benefit of EOQ if we dont evaluate the situation

from total costs perspective.

3. Other EOQ adjustments -

a) Production lot size

Buyers EOQ and suppliers EBQ some times do notmatch. Then some adjustment will have to be made to the EOQ

to make it practicable.

b) Multiple item purchase

When a combination of several products are sourced from

a supplier, the impact of quantity discounts and transportation

costs will be different from that for individual product. So

adjustment is required to EOQ from the angle of total cost for

the combination of products

c) Limited capital

Budgetary allocations play a significant role in buying. The

budget has to satisfy the requirement of entire product line. So

the EOQ of various items requires adjustment

d) Private trucking

If the company uses private transport for procurement,

getting a full truck becomes significant from cost perspective

e) Standard package


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When a standard package is used for transportation, if

EOQ suggests one and a half package then transporting half

package becomes more expensive than transporting two

packages with enhanced order quantity.

ABC Analysis -

80 20 rule, also known as Paretos rule Pl. refer to

your class notes

Benefits of ABC Analysis -

1. Identification significant 15% to 20%items responsible for 80%

of value for close management control selective management

control

2. Effective management of inventory results in short span of

time

3. Allocation of management resources to significant items,

reduction in clerical work and time.

4. Helps in selection of appropriate inventory control models or

systems. E.g. Q model or P?

5. Helps in formulation of inventory policy

Limitations of ABC Analysis -

1. An exhaustive analysis of all items in the whole organization is

required to make ABC analysis a useful effort. A, B, & C items

should be identified for the whole organization for which data

regarding consumption pattern, lead time and its fluctuation of

all items is necessary. Only then the benefits can be felt. To

carry out this exercise high degree of standardization and


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codification is primary. This exercise is obviously time

consuming.

2. Focus is only on money value, criticality of the item is not taken

into account.

3. Price of an item is assumed to be same through out the year. In

practice it is unlikely to be so.

VED Analysis -

Vital, Essential & Desirable items Pl. refer to your class

notes also pl. refer your notes for the matrix for ABC & VED

items in the store. FSN Analysis

Fast moving, Slow moving & Non moving items Pl. refer to

your class notes

INVENTORY POLICIES :-

P Model, Q Model, Optional replenishment Model Pl. refer

to your class notes .

Comparison of Indian & Global industries -

Comparison

factors

Japanes

e

compani

es

US/Euro

pean co.

General

Indian co.

1.Cycle time

from production

to development

0.5 to 2

years

1 to 2

years

3 to 6 years

2. inventory

level

A few

days of

One

month of

9 t0 12

months of


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sales sales sales3. output per

employee

Rs. 32

Lacs

Rs. 12

Lacs

Rs. 2.5

Lacs4. rejection rate 3 to 4

PPM

30 to 40

PPM

8 TO 20

RPH5. quality cost

with respect to

sale

3% TO

5%

5% TO

10%

35% TO

45%

Documents

1[1]. Introduction of Materials Management & Inventory