3 - inventory control

1

INVENTORY MANAGEMENT

INVENTORY CONTROL

2


• THE CONTROL OF INVENTORIES IS ONE OF THE MOST COMPLEX, YET CRUCIAL OF ALL BUSINESS ACTIVITIES.

• IT HAS WIDE ORGANISATIONAL IMPLICATIONS AND IS THE FOCAL POINT OF MANY SEEMINGLY CONFLICTING OBJECTIVES - BOTH LONG TERM AND SHORT TERM.

• IT’S PLANNING AND EXECUTION INVOLVES PARTICIPATION FROM FUNCTIONAL DEPARTMENTS.

• INVENTORY CONTROL IS VITALLY IMPORTANT TO ALMOST EVERY TYPE OF BUSINESS, WHETHER PRODUCT OR SERVICE ORIENTED. INVENTORY CONTROL TOUCHES ALMOST EVERY FACET OF ORGANIZATIONS.

• PRODUCTION MANAGERS AND MATERIALS MANAGERS ARE RESPONSIBLE FOR CONTROLLING COSTS OF OPERATIONS.

• ONE CRITICAL COST OF OPERATIONS IS INVESTMENT IN RAW MATERIALS, SUPPLIES, WORK – IN – PROCESS AND FINISHED PRODUCTS NOT YET SHIPPED.

3


• IF THIS INVESTMENT BECOMES EXCESSIVE, THE RESULTS ARE HIGH CAPITAL COSTS, HIGH OPERATING COSTS, AND DECREASED PRODUCTION EFFICIENCY WHEN TOO MUCH SPACE IS USED FOR INVENTORY.

• ALTHOUGH THESE COSTS ARE APPARENT FOR MANUFACTURING, IT IS EASY TO BELIEVE THAT SERVICE ORGANIZATIONS DO NOT HAVE SUCH INVENTORY COSTS.

• INVENTORY CONTROL IS CRUCIAL TO BOTH EFFICIENCY AND COST CONTROL.

• IN MANUFACTURING, IT IS COMMON FOR MATERIALS TO ABSORB OVER HALF OF TOTAL EXPENDITURES.

• IN WHOLESALING AND RETAILING, THE FIGURE IS MUCH HIGHER. CONTROLING INVENTORIES THEREFORE MEANS CONTROL OF A MAJOR COST.

4


• CONTROLLING INVENTORIES DOES NOT MEAN ELIMINATING THEM.

• AT TIME, IT WAS THOUGHT PROFESSIONAL INVENTORY MANAGERS COULD CONTROL THE “DRY – UP” AND “FLOODING” COSTS OF INVENTORY.

• THEY CANNOT BE.

• THE MAIN JOBS OF INVENTORY MANAGERS ARE TO KEEP TRACK OF MATERIALS AND TO COLLECT, STORE, AND DELIVER THEM.

• THEY ARE INVENTORY CARETAKERS, NOT CONTROLLERS OF SLACKS AND GLUTS.

• SLACKS AND GLUT PROBLEMS ARE OPERATIONAL PROBLEMS, NOT INVENTORY PROBLEMS AND THEY REQUIRE JOINT ACTION.

5


• INVENTORY CONTROL CANNOT BE TREATED IN ISOLATION.

• INVENTORIES GROW BECAUSE OF LARGE LEAD TIMES, LONG SETUP TIMES, ERRACTIC OUTPUT, ETC.

• INVENTORY MANAGERS HAVE AN UNENVIABLE TASK ON THEIR HANDS.

• THEY ARE BLAMED AT THE DROP OF A HAT.• HOWEVER THE NATURE OF THE PROBLEM IS SUCH

THAT, THEY ON THEIR OWN CAN DO VERY LITTLE ABOUT THE INVENTORY ON HAND.

• INVENTORY MANAGEMENT IS BUT A PART OF THE GREATER SYSTEM THAT WE MAY WELL AS THE PRODUCTION - MATERIALS MANAGEMENT SYSTEM.

6


• TRADITIONALLY, INVENTORY CONTROL SYSTEMS HAVE BEEN REACTIVE IN NATURE.

• THE RULE HAS BEEN TO PROVIDE FOR EXTRA INVENTORY AS A MEANS TO TACKLE THE WIDE RANGE OF VARIABILITY THAT CONFRONT ANY ORGANIZATION.

• INVENTORY MUST FLOW. THIS BECOMES ALL THE MORE IMPORTANT WHEN COST IS CONSIDERED, FOR COST IS LIKE DUST - IT HAS A TENDENCY TO SETTLE ON ANYTHING SITTING AROUND.

• RAPID FLOW OF MATERIALS ALLOW LITTLE TIME FOR COST TO ACCUMULATE.

7

WHAT ARE INVENTORIES

• INVENTORIES REPRESENT AGGREGATE OF THOSE ITEMS WHICH ARE

• EITHER HELD FOR SALE IN THE ORDINARY COURSE OF BUSINESS

• OR• IN THE PROCESS OF PRODUCTION FOR

SALE ( I.E. WORK IN PROCESS ) • OR • ARE YET TO BE UTILIZED / CONSUMED

IN THE PRODUCTION OF GOODS AND SERVICES.

8


• INVENTORIES CAN BE CLASSIFIED IN VARIOUS WAYS DEPENDING ON THE SPECIFIC PURPOSE.

• MANUFACTURING COMPANIES HAVE BROADLY TWO CATEGORIES OF INVENTORIES:

1. MANUFACTURING INVENTORY

2. DISTRIBUTION INVENTORY

9

WHAT ARE INVENTORIES• MANUFACTURING INVENTORY :

• THE PRINCIPAL ITEMS OF INVENTORIES ARE AS FOLLOWS:

1. RAW MATERIALS: ARE THOSE BASIC UNFABRICATED MATERIALS WHICH HAVE UNDERGONE NO CONVERSION WHATSEVER SINCE THEIR RECEIPT FROM THE SUPPLIERS.

THEY ARE THE BASIC MATERIALS FROM WHICH COMPANY’S PARTS OR PRODUCTS ARE MANUFACTURED.

RAW MATERIALS ARE DIFFERENT FOR DIFFERENT INDUSTRIES.

• FOR EXAMPLE, • COTTON FOR TEXTILE MILLS, • CLOTH FOR DRESS MAKERS, • FRUITS FOR CANNING INDUSTRIES, • TURPENTINE AND SPIRIT FOR PAINT MANUFACTURERS, • STEEL FOR AUTOMOBILE FIRMS ARE THE RAW MATERIALS.

10

WHAT ARE INVENTORIES2. FINISHED COMPONENTS – WHICH MAY EITHER BE BOUGHT –

OUT PARTS OR PIECE PARTS. BOUGHT – OUT – PARTS ARE THOSE FINISHED PARTS OR

SUB-ASSEMBLIES OR ASSEMBLIES WHICH ARE PURCHASED FROM OUTSIDE SUPPLIERS AND GENERALLY INCLUDE STANDARD PARTS AND PARTS MANUFACTURED AT SUPPLIER’S PLANT TO BUYER’S DESIGN.

PIECE PARTS ARE THE PARTS MANUFACTURED AT THE FIRM’S OWN PLANT FROM THE BASIC RAW MATERIALS.

3. SEMI – FINISHED COMPONENTS - THESE REFER TO MATERIAL COMPONENTS THAT HAVE BEEN WORKED UPON PARTIALLY BUT REQUIRE FURTHER PROCESSING BEFORE THEY CAN BE USED IN THE ASSEMBLY OF THE FINISHED PRODUCT, E.G. FORGING FOR AN AUTOMOBILE ENGINE SHAFT.

4. SUB – ASSEMBLIES - THESE REFER TO SUBSTANTIALLY LARGE AND IMPORTANT PART OF THE COMPLETE PRODUCT. E.G. GEARBOX ASSEMBLY FOR AN AUTOMOBILE.

11


5. WORK – IN – PROGRESS - COMPRISES ITEMS OR MATERIALS IN PARTIALLY COMPLETED CONDITION OF MANUFACTURE.

RAW MATERIALS BECOMES WORK – IN – PROGRESS AT THE END OF FIRST OPERATION AND REMAIN IN THAT CLASSIFICATION UNTIL THEY BECOME PIECE PARTS OR FINISHED GOODS.

WORK – IN – PROGRESS CAN BE FOUND ON CONVEYERS, TRUCKS, PALLETS, OR IN TEMPORARY AREAS OF STORAGE WAITING TO BE WORKED UPON OR ASSEMBLED.

12


6. TOOLS - COMPRISES• STANDARD TOOLS - TO BE USED ON

MACHINES SUCH AS SAWS, DRILLS,REAMERS, TAPS, CHASERS, DIES, INSERTS, CUT – OFF TOOLS, MILLING CUTTERS, GEAR SHAPER

CUTTERS, HOBS, AND MANY MORE LIKE THAT.

• HAND TOOLS - SUCH AS HAND-SAWS CHISEL DRILL-GUNS, HAMMERS, MALLETS, NEEDLES, PLIERS, PUNCHES,

SPANNERS, WRENCHES ETC.

13


7. SUPPLIES – THIS INCLUDE MATERIALS USED IN RUNNING OF THE PLANT

OR IN THE MAKING OF COMPANY’S PRODUCTS BUT DO NOT THEMSELVES GO INTO THE PRODUCT.

SUPPLIES THEREFORE INCLUDE :-• MISCELLANEOUS CONSUMABLES STORES SUCH AS BROOMS,

COTTON WASTE, CLOTHE WASTE, TOILET PAPERS, CLEANING POWDERS, JUTE TWINE ETC.

• WELDING, SOLDERING AND TINNING MATERIALS SUCH AS ELECTRODES, WELDING RODS, SOLDER, SPELTER, ETC.

• ABRASIVE MATERIALS SUCH AS EMERY CLOTH, EMERY BELTS, SAND PAPERS, LAPPING PASTE, LAPPING POWDERS, ETC.

• BRUSHES, MOPS, BOBS SUCH AS ARTIST’S BRUSHES, PAINT BRUSHES, ETC.

• EMPTIES SUCH AS BAGS, GLASS BOTTLES, CARDBOARD BOXES, DRUMS, JARS, TIN ETC.

• OIL AND GREASES SUCH AS KEROSENE OIL, TRANSFORMER OIL, PETROL, DESEL OIL, LUBRICANTS, AND CUTTING OILS ETC.

14

WHAT ARE INVENTORIESSUPPLIES –• GENERAL OFFICE SUPPLIES SUCH AS BLOTTERS, CANDLES,

SEALING WAS, INK AND INK-PADS, PENCILS, REFILLS, FILES, PINS, CLIPS, CARBON PAPERS, STENCIL PAPERS, TRACING PAPERS, ERASERS ETC.

• PRINTED FORMS SUCH AS LETTER HEADS, ENQUIRY FORMS, ORDER ACCEPTANCE FORMS, PURCHASE ORDER FORMS, REQUISITION FORMS, ORDER AMENDMENT FORMS, GOODS RECEIPT REPORTS DISCREPANCY NOTES, CASH VOUCHERS, DEBIT NOTES, CREDIT NOTES, INVOICES, ETC.

• LEDGERS AND JOURNALS SUCH AS GOODS INWARD REGISTER, GOODS RECEIPT REGISTER, SALES REGISTER, SUNDRY CREDITORS REGISTER, SUNDRY DEBTORS REGISTER, CASH BOOK, LOAN REGISTER, SALES JOURNALS, PURCHASE JOURNALS, GENERAL LADGERS. ETC.

• ELECTRIC SUPPLIES SUCH AS CABLES, CLIPS, CUT – OUTS, FUSES, LAMPS, HOLDERS HOSES, SHADES, SWITCHES, ETC.

15

WHAT ARE INVENTORIES8. MACHINERY SPARES INCLUDE – • CONSUMABLE SPARES SUCH AS BELTS,

BEARINGS, OIL SEALS, O-RINGS, GASKETS, SPRINGS, HYDRAULIC / PNEUMATIC PIPES, ETC.

• REPLACEMENT SPARES SUCH AS PULLEYS, WEDGES, GEARS, WORM WHEELS, WORM SHAFTS, COUPLINGS, ETC.

• ROTABLE SPARES SUCH AS MOTORS, PUMPS, LARGE MECHANICAL SEALS, ETC.

• INSURANCE SPARES SUCH AS PROPELLER OF A SHIP, A COMPRESOR IN A FERTILISER FACTORY, A GRINDER IN A CEMENT FACTORY, A CRANK SHAFT IN A TRANSPORT WORKSHOP, ETC.

16


• DISTRIBUTION INVENTORY

9. FINISHED GOODS – ARE THE FINAL PRODUCTS READY TO BE SHIPPED TO THE CUSTOMERS.

PRODUCTS USUALLY LEAVE “WORK – IN – PROGRESS” CLASSIFICATION AND ENTER “FINISHED GOODS” CATEGORY AT THE POINT OF FINAL INSPECTION WHEN THEY ARE READY FOR DELIVERY TO THE CUSTOMER OR FINISHED STOCK ROOM.

10. FINISHED PRODUCTS - IN TRANSIT : PRODUCTS IN TRANSPORTATION TO WAREHOUSES,

STOCKISTS, DEALERS, CUSTOMERS ETC.

17

WHY DO WE CARRY INVENTORY

• INVENTORIES IN GENERAL ARE BUILT UP TO PROVIDE A CUSHION BETWEEN SUPPLY AND DEMAND.

THEY ARE MEANT TO TAKE CARE OF REQUIREMENTS OF DEMAND:

• TILL NEXT ARRIVAL,

• PROBABLE DELAY IN DELIVERY

• SUDDEN INCREASE IN DEMAND

18


• A MANUFACTURING FIRM CARRIES INVENTORIES BECAUSE OF FOLLOWING SEVEN MAJOR REASONS:

1. TO GAIN ECONOMY IN BUYING:• 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 DAY – TO – DAY BASIS IS BOTH IMPRACTICABLE AND UNECONOMICAL.

• THE FIRM, THEREFORE, MAY ORDER {MANUFACTURE} BEYOND ITS IMMEDIATE NEEDS – THEREBY CREATE INVENTORIES – IN ORDER TO PRORATE THE FIXED COST AMONG A LARGE NUMBER OF UNITS.

• MANUFACTURERS OF CERTAIN ITEMS OFFER DISCOUNTS IF MORE UNITS ARE PURCHASED.

• THE PURCHASE OFFICER MAY, THEREFORE BUY QUANTITIES

BEYOND THE CURRENT REQUIREMENTS TO TAKE ADVANTAGE OF PRICE DISCOUNT.

19


2. TO KEEP PACE WITH CHANGING MARKET CONDITIONS :• INVENTORIES ARE CREATED WHEN LARGE QUANTITIES ARE

PURCHASED OR MANUFACTURED AND STOCKED IN ANTICIPATION OF THEIR NON-AVAILABILITY IN FUTURE AT THE TIME OF NEED OR ANTICIPATION OF SPURT IN PRICES.

3. TO SATISFY DEMAND DURING PERIOD OF REPLENISHMENT :• IF PRODUCTION AND DELIVERY OF GOODS COULD BE

INSTANTANEOUS, THERE WOULD BE NO NEED OR ATLEAST A VERY LITTLE NEED FOR INVENTORIES.

• NO FIRM CAN OBTAIN ITEMS THAT IT REQUIRE - WHETHER PURCHASED OR MANUFACTURED - WITHIN ZERO TIME LAG.

• IT GENERALLY TAKES FEW DAYS OR FEW WEEKS TO PUSH THROUGH EACHWORK ORDER AND MAKE THE COMPONENT AVAILABLE FOR ASSEMBLY.

• THE COMPANY, THEREFORE, MUST MAINTAIN SUFFICIENT INVENTORY OF PIECE PARTS TO ENSURE THEIR SMOOTH OUTFLOW FOR ASSEMBLY.

• SIMILARLY, A VENDOR MAY QUOTE A DELIVERY PERIOD OF FEW DAYS, FEW WEEKS OR FEW MONTHS. INVENTORIES, THEREFORE, NEED TO BE MAINTAINED TO SATISFY DEMAND DURING PERIOD OF REPLENISHMENT.

20


4. TO CARRY RESERVE STOCKS TO AVOID STOCK OUT:• A COMPANY MAY SUFFER SUBSTANTIAL LOSS FOR BEING OUT OF

STOCK. A STOCKOUT OF A CRITICAL ITEM MAY NECESSITATE ONE OR MORE OF THE FOLLOWING –

- TO DO CERTAIN OPERATION SECOND TIME.

- TO TRANSFER A PART 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 DELAY IN DELIVERY.

• TO PREVENT THE OCCURRENCE OF STOCKOUT AND PROTECT THE COMPANY AGAINST AN INTERRUPTION OF THE SCHEDULED FLOW OF DELIVERIES, CERTAIN EXTRA STOCK CALLED SAFETY STOCK IS MAINTAINED FOR EACH ITEM.

• THIS CREATES CONSTANT PORTION OF INVENTORIES.

21


5. TO STABLIZE PRODUCTION :• A PRODUCT IS CREATED TO MEET CUSTOMER’S

ORDERS. RARELY, A COMPANY HAS A CONTINUOUS STREAM OF ORDERS.

• USUALLY, THE ORDERS AND SHIPMENT OF ORDERS ARE SUBJECTED TO FLUCTUATIONS.

• THE PROBLEM IS VERY SEVERE IN CASE OF SEASONAL PRODUCTS E.G. AIR CONDITIONING UNITS, REFRIGERATORS, UMBRELLAS ETC.

• HOW SHOULD THE PEAKS AND VALLEYS OF THE DEMAND BE SATISFIED ?

• ONE METHOD OF ADJUSTING TO CHANGES IN BUSINESS VOLUME IS TO ADOPT THE POLICY OF “HIRING AND FIRING” PEOPLE.

• WILL SUCH A POLICY BE ACCETABLE TO THE LABOUR UNIONS ?

22


• TO STABLIZE PRODUCTION…………• WILL SUCH A POLICY BE CONDUCIVE TO THE

MORALE OF WORKERS ? • NO LABOUR UNION WOULD ACCEPT SUCH A

POLICY.• WORKERS CANNOT BE EXPECTED TO GIVE

THEIR BEST IF THEY ARE CONSTANTLY REMINDED OF THE UNEMPLOYMENT WHICH AWAITS THEM.

• MOREOVER, POLICY OF HIRING AND FIRING PUTS AN ADDITIONAL COST BURDEN ON THE COMPANY - THE COST OF TRAINING NEW WORKERS WHEN BUSINESS EXPANDS

23


• TO STABLIZE PRODUCTION CONT…….• THE ALTERNATIVE METHOD - A RATIONAL APPROACH - WOULD BE

TO PRODUCE AT A UNIFORM RATE THROUGH OUT THE YEAR. • FINISHED GOODS INVENTORY WILL INCREASE GRADUALLY AND

REACH AT ITS PEAK BEFORE THE SEASON, AFTER WHICH THE PRODUCTS WILL START MOVING TO THE MARKET AND INVENTORY WILL DECLINE.

6. TO PREVENT LOSS OF SALES :

FINISH GOODS INVENTORY IS MAINTAINED TO MEET REASONABLE REQUIREMENTS OF THE CUSTOMERS FOR PROMPT EXECUTION OF THEIR ORDERS.

• THE NEED FOR MAINTAINING THE FINISH GOODS INVENTORY ATTAINS GREATER IMPORTANCE WHEN THE PRODUCTS ARE VERY COMPETITIVE, E.G. REFRIGERATORS, SEWING MACHINES, FANS, SCOOTERS, CARS, TELEVISION SETS ETC.

• THE FAILURE OF THE COMPANY TO MAKE SUCH PRODUCTS AVAILABLE MAY RESULT IN LOSS OF SALE OR EVEN THE LOSS OF CUSTOMERS.

24


7. TO SATISFY OTHER BUSINESS CONSTRAINTS :

• SOMETIMES, THE COMPANY IS FORCED TO BUY QUANTITIES MORE THAN THE CURRENT REQUREMENTS AND LOCK UP ITS PRODUCTIVE CAPITAL. FEW OF SUCH SITUATIONS ARE :

a. SUPPLIER’S CONDITION OF MINIMUM QUANTITY

MANY A TIMES, THE SUPPLIER INSISTS ON CERTAIN MINIMUM QUANTITY. THIS CAN HAPPEN UNDER ONE OF THE FOLLOWING CONDITIONS:

- THE SUPPLIER HAS THE MONOPOLY AND HENCE

ORDER QUANTITIES ARE DICTATED TO BY THE

SELLER.

- THE SET UP COST IS VERY HIGH AS IN CASE OF

MANUFACTURE OF FORGINGS, HEAVY PRESS PARTS

ETC.

25


• TO SATISFY OTHER BUSINESS CONSTRAINTS……….

b. GOVERNMENT REGULATIONS.

TOO MUCH CAPITAL GETS LOCKED IN CREATING INVENTORIES OF ITEMS THAT ARE SUBJECTED TO GOVERNMENT REGULATIONS, E.G. IMPORTED ITEMS

c. SEASONAL AVAILABILITY

THERE ARE CERTAIN ITEMS WHICH ARE AVAILABLE IN PLENTY AND HENCE CHEAPLY ONLY DURING CERTAIN MONTHS E.G. COCONUTS, SOYABEANS, MANGOS

OR AND ARE NOT AVAILABLE DURING CERTAIN MONTHS E.G. SAND FOR FOUNDRY IN MONSOON,

THE COMPANY IS THUS FORCED TO BUY LARGE QUANTITY AND HENCE CREATE INVENTORIES.

26

CONFLICTING PRESSURES ON

INVENTORY LEVELS

PRESSURES FOR

SMALL INVENTORIES

PRESSURES FOR

LARGE INVENTORIES

1. INTEREST OR OPPORTUNITY COST

2. STORAGE AND HANDLING COST

3. PROPERTY TAX

4. INSURANCE PREMIUMS

5. SHRINKAGE COSTS : PILFERAGE,

OBSOLESCENCE AND DETERIORATION

1. CUSTOMER SERVICE

2. ORDERING OR SETUP COST

3. LABOUR AND FACILITY UTILISATION

4. TRANSPORTATION COST

5. COST OF PURCHASED ITEMS

27

SELECTIVE CONTROL OF INVENTORIES

28


• SELECTIVE TREATMENT OF INVENTORIES IS BASED ON THE FOLLOWING BASIC PHILOSOPHY OF BUSINESS:

“ NEITHER ONE CAN CONTROL EVERYTHING NOR ONE SHOULD TRY TO DO SO (EVEN IF ONE CAN).

UNIFORM 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 EFFECTIVELY APPLIED IN INVENTORY FUNCTION SO TO IDENTIFY ITEMS WHICH ARE MORE IMPORTANT THAN OTHERS.

• THE CLASSIFICATION ENABLES MANAGERIAL TIME BEING SPENT ACCORDING TO THE IMPORTANCE OF THE ITEM.

29


• SELECTIVE CONTROL IS ESSENTIAL SINCE UNIFORM CONTROL OF ALL ITEMS : -

1. IS EXPENSIVE

2. GIVES DIFFUSEED EFFECT

• SELECTIVE CONTROL MEANS VARIATIONS IN METHOD OF CONTROL FROM ITEM TO ITEM BASED ON SELECTIVE BASIS.

• THE CRITERION USED FOR THE PURPOSE MAY BE -

- COST OF THE ITEM

- CRITICALITY

- LEAD TIME

- CONSUMPTION

- PROCUREMENT DIFFICULTIES,

- OR SOMETHING ELSE.

30


• VARIOUS CLASSIFICATIONS ARE EMPLOYED TO RENDER SELECTIVE TREATMENT TO DIFFERENT TYPES OF MATERIALS, EACH CLASSIFICATION EMPHASIZES ON A PARTICULAR ASPECT.

CLASSIFICATION CRITERION EMPLOYED

1 ABC ANALYSIS USAGE VALUE (I.E. CONSUMPTION PER PERIOD X PRICE PER UNIT)

2 HML ANALYSIS

(HIGH – MEDIUM – LOW)

UNIT PRICE (I.E. IT DOES NOT TAKE CONSUMPTION INTO ACCOUNT)

3 VED ANALYSIS (VITAL – ESSENTIAL – DESIRABLE)

CRITICALITY OF THE ITEM (I.E. LOSS OF PRODUCTION)

4 SDE ANALYSIS (SCARCE – DIFFICULT – EASY) PROCUREMENT DIFFICULTIES

5 GOLF ANALYSIS

(GOVERNMENT – ORDINARY – LOCAL – FOREIGN)

SOURCE OF PROCUREMENT

6 S - OS ANALYSIS

(SEASONAL – OFF SEASONAL)

SEASONALITY

7 FSN ANALYSIS (FAST – SLOW – NON MOVING) ISSUES FROM STORES

8 XYZ ANALYSIS INVENTORY INVESTMENT

31

SELECTIVE INVENTORY CONTROLPARETO – “ABC ANALYSIS”

• ABC ANALYSIS - ALWAYS BETTER CONTROL :

• THE ITALIAN ECONOMIST VILFREDO PARETO OBSERVED THAT REGARDLESS OF THE COUNTRY STUDIED, A SMALL PROPORTION OF THE POPULATION CONTROLLED MOST OF THE WEALTH..

• THIS OBSERVATION OF HIS, LED TO THE FORMULATION OF THE

80 / 20 PRINCIPLE, OR ABC ANALYSIS WHOSE PRINCIPLES HOLD TRUE IN WIDE RANGING CIRCUMSTANCES I. E. IN ANY GROUP ONLY A FEW OF ITS MEMBERS WILL BE OF ANY REAL SIGNIFICANCE.

• THE CONTRIBUTION OF THIS RULE TO THE MANAGEMENT IS THAT IT FACILITATES SELECTIVE CONTROL.

• IT HELPS MANAGEMENT TO CONCENTRATE ON WHAT IS IMPORTANT.

• IT FOLLOWS THE GUIDANCE OF VILFREDO PARETO, THAT

“A RELATIVELY SMALL NUMBER OF PRODUCTS ( THE CRITICAL FEW ) HAS VERY IMPORTANT IMPACT ON TOTAL INVENTORY COSTS”.

32


• MATERIALS MANAGEMENT INVOLVES THOUSANDS OF TRANSACTIONS PER ANNUM.

• TO DO THIS JOB EFFECTIVELY, IT IS IMPORTANT THAT THE MATERIALS MANAGER IS NOT DISTRACTED BY TRIVIAL ELEMENTS AND HE MUST NOT GO INTO UNIMPORTANT DETAILS, BUT CONCENTRATE ON IMPORTANT ITEMS.

• THEREFORE, MANAGEMENT SHOULD FOCUS MOST ATTENTION ON CONTROLLING THOSE ITEMS.

• IN PRACTICE, LESS THAN 20 PERCENT OF ALL ITEMS REPRESENTS OVER 80 PERCENT OF INVENTORY INVESTMENT.

• THESE ARE THE ‘A’ ITEMS, WHICH ARE TYPICALLY HIGH – PRICE, HIGH – VOLUME ITEMS WORTHY OF MANAGEMENT’S SCARCE DECISION – MAKING TIME.• ON THE OPPOSITE END ARE ‘C’ ITEMS (TRIVIAL MANY), WHICH ARE

TYPICALLY LOW – VALUE, LOW – VOLUME.• THEY MAY COMPRISE 80 PERCENT OF TOTAL ITEMS BUT ONLY A

SMALL FRACTION OF INVENTORY INVESTMENT.• IN BETWEEN ARE THE ‘B’ ITEMS.

33


• THE TYPICAL ABC ANALYSIS USES “DATA BASE MANAGER” OR A ‘SPREAD SHEET’ TO RANK ALL INVENTORY ITEMS BY ANNUAL RUPEE VALUES.

• MANAGEMENT THEN SEARCHS FOR NATURAL DIVIDING POINTS FOR THE THREE CLASSES OF ITEMS.

• OFTEN, ABOUT 10 PERCENT OF ALL ITEMS WILL BE CLASSIFIED ‘A’, 20 PERCENT AS ‘B’, AND 70 PERCENT AS ‘C’.

• IT CAN BE HOWEVER BE ARGUED THAT WITH RAPID DEVELOPMENT OF THE INFORMATION TECHNOLOGY SECTOR AND FALLING HARDWARE COSTS, ALL ITEMS CAN BE EASILY CONTROLLED. THERE IS SOME MERIT IN THE POINT.

• HOWEVER, TODAY,S ORGANIZATION DEAL WITH THOUSANDS OF ITEMS MOVING IN DIFFERENT DIRECTIONS.

• EVEN TODAY IT MAKES SENSE TO FOLLOW THE ABC TECHNIQUE.

34

ABC CLASSIFICATION OF INVENTORY ITEMS VERSUS RUPEE VALUE

CLASS B

20 %00

100

80

60

40

20

20 40 60 80 100

PERCENTAGE IN INVENTORY

PE

RC

EN

TA

GE

O

F

TO

TA

L

RU

PE

E

VA

LU

E

CLASS A 10 %

CLASS C 70 %

35

ABC INVENTORY CLASSIFICATIONPERCENT INVENTORY VALUE VERSUS PERCENT OF ITEMS

AITEMS

B ITEMS

0 10 30 1000

15

70

100

C ITEMS

PE

RC

EN

T

OF

T

OT

AL

R

UP

EE

U

SA

GE

CUMULATIVE PERCENT OF TOTAL NUMBER ITEMS

36


GROUP A ( SAY 10 % OF ITEMS )

1. THESE FREQUENTLY ACCOUNT FOR 70 % OF USAGE VALUE AND COULD BE CONTROLLED WITH CONTINUOUS MONITORING.

2. TIGHT CONTROL HAVE GREAT IMPACT OVER THE COST OF INVENTORY.

3. “A” ITEMS ARE TIGHTLY CONTROLLED, HAVE ACCURATE RECORDS, AND RECEIVE REGULAR REVIEW BY MAJOR DECISION – MAKERS.

4. THE PURCHASE DEPARTMENT MAY ENTER INTO CONTRACTS WITH SUPPLIERS FOR CONTINUOUS SUPPLY OF THESE MATERIALS AT RATES THAT MATCH USAGE VOLUMES.

5. BECAUSE OF CLOSE SURVEILLANCE THE RISK OF PROLONGED STOCKOUT IS SMALL.

37


GROUP B ( SAY 20 % OF ITEMS )

1. A REORDER CYCLE SYSTEM COULD CONTROL GROUP B (THE NEXT, SAY 20 % OF ITEMS AND 15 % OF VALUE).

2. “B” ITEMS ARE LESS CONTROLLED, HAVE GOOD RECORDS AND REGULAR REVIEW.

3. THESE ITEMS CAN BE EFFECTIVELY MANAGED BY COMPUTERIZED SYSTEM AND PERIODICALLY REVIEWED BY A MANAGER.

4. STOCKOUT COSTS FOR ‘B’ ITEMS WILL BE MODERATE TO LOW. GROUP C (SAY 70 % OF ITEMS )

1. A TWO – BIN OR ANNUAL DEMAND SYSTEM COULD MANAGE THE FINAL 70 % OF ITEMS (15 % BY VALUE ).

2. “C” ITEMS HAVE MINIMAL RECORDS, PERIODIC REVIEW, AND SIMPLE CONTROLS.

3. CAREFULLY DESIGNED BUT RUTINE CONTROLS PROVE TO BE ADEQUATE.

4. FOR EACH ITEM, ACTION IS TRIGGERED WHEN INVENTORIES FALL TO A REORDER LEVEL.

5. SEMI – ANNUAL OR ANNUAL REVIEW OF THE SYSTEM PARAMETERS OF LEAD – TIME, USAGE RATES, COST WILL SUFFICE.

38


• IMPLICATIONS ;• THE ANALYSIS POINTS THE WAY TO WHERE CONTROL

EFFORTS ARE BEST DIRECTED.• JUDGEMENT IS NEEDED ON CRITICAL ITEMS OR

SECURITY MATTERS THAT PARETO ANALYSIS IN ITSELF DOES NOT REVEAL.

• IN ASSEMBLY SITUATION WHERE ITEMS A, B, AND C ARE COMBINED IN AN ASSEMBLY, A C ITEM, OUT OF STOCK, CAN DELAY PRODUCTION JUST AS MUCH AS AN ITEM A OR B ITEM.

• THE ANALYSIS REQUIRES ITEMS TO BE LISTED WITH THEIR UNIT COSTS AND AVERAGE RATE OF USAGE.

39

STEPS IN ABC ANALYSIS TO CONDUCT ABC ANALYSIS, FOLLOWING STEPS ARE NECESSARY;

a) PREPARE THE LIST OF THE ITEMS AND ESTIMATE THEIR ANNUAL CONSUMPTION (UNITS)

b) DETERMINE UNIT PRICE (OR COST) OF EACH ITEM.

c) MULTIPLY EACH ANNUAL CONSUMPTION BY ITS UNIT PRICE (OR COST) TO OBTAINED ITS ANNUAL CONSUMPTION IN RUPEES (ANNUAL USAGE)

d) ARRANGE ITEMS IN THE DESCENDING ORDER OF THEIR ANNUAL USAGE STARTING WITH THE HIGHEST ANNUAL USAGE DOWN TO THE SMALLEST USAGE.

e) CALCULATE CUMULATIVE ANNUAL USAGES AND EXPRESS THE SAME AS CUMULATIVE USAGE PERCENTAGES. ALSO EXPRESS THE NUMBER OF ITEMS INTO CUMULATIVE ITEMS PERCENTAGES.

f) GRAPH CUMULATIVE USAGE PERCENTAGES AGAINST CUMULATIVE ITEM PERCENTAGES AND SEGREGATE THE ITEMS INTO A, B, AND C CATEGORIES.

g) DECIDE THE POLICIES OF CONTROL FOR THE THREE CATEGORIES.

40

STEPS IN ABC ANALYSIS ‘ A ‘ ITEMS

1. MAINTAIN TIGHT CONTROL

2. PROCUREMENT QUANTITY BASED ON CALCULATION.

3. NUMBER OF SOURCES - MANY.

4. PROPER RECEIPTS AND ISSUE RECORDS MAINTAINED.

5. LEAD TIME MINIMUM.

6. FREQUENCY OF ORDERING - HIGH.

7. CONTINUOUS EXPEDITING REQUIRED.

8. ACCURACY OF FORECASTS – HIGH.

9. SAFETY STOCK - ABOUT 2 WEEKS.

10. CENTRALIZED PURCHASING.

11. RIGOROUS VALUE ANALYSIS.

12. PURCHASED JUST BEFORE USE.

13. HIGH CONSUMPTION VALUE.

41

STEPS IN ABC ANALYSIS ‘ B ‘ ITEMS

1. MAINTAIN MODERATE CONTROL.

2. PROCUREMENT QUANTITY BASED ON USAGE.

3. NUMBER OF SOURCES - TWO OR THREE.

4. PROPER RECEIPTS AND ISSUE RECORDS MAINTAINED.

5. LEAD TIME MODERATE.

6. FREQUENCY OF ORDERING – LESS FREQUENT.

7. EXPEDITING REQUIRED TO AVOID POTENTIAL SHORTAGE.

8. ACCURACY OF FORECASTS - MODERATE.

9. SAFETY STOCKS - ABOUT 6 TO 8 WEEKS.

10. CENTRALIZED AND DECENTRALIZED PURCHASING.

11. MODERATE VALUE ANALYSIS.

12. WELL IN ADVANCE PURCHASE.

13. AVERAGE CONSUMPTION VALUE.

42

STEPS IN ABC ANALYSIS ‘ C ‘ ITEMS

1. MAINTAIN LOOSE CONTROL.

2. PROCUREMENT QUANTITY BASED ON INVENTORY LEVEL.

3. NUMBER OF SOURCES – MAXIMUM TWO.

4. ADHOC RECEIPTS AND ISSUE RECORDS MAINTAIN.

5. LEAD TIME - FLEXIBLE

6. FREQUENCY OF ORDERING - BULK ORDERING, VERY LOW FREQUENCY.

7. NO EXPEDITING.

8. ACCURACY OF FORECASTS - LOW.

9. SAFETY STOCK - MORE THAN 12 TO 15 WEEKS.

10. DECENTRALIZED PURCHASING.

11. MINIMUM VALUE ANALYSIS.

12. WELL ADVANCED PURCHASE.

13. LOW CONSUMPTION VALUES.

43

USES OF ABC ANALYSIS

1. HELPS MAINTAIN AN EFFECTIVE MIS OF HIGH VALUE ITEMS.

2. HELPS EVOLVE AN INFORMED PURCHASING AND RESCHEDULING POLICY.

3. HELPS MAINTAIN ACCURATE STOCK RECORDS.

4. PRIORITY TREATMENTS TO ITEMS AS PER THEIR ANNUAL USAGE VALUES.

5. DETERMINATION OF SAFETY STOCKS

6. VALUE ANALYSIS.

44

ILLUSTRATION ON ABC ANALYSIS

• PERFORM AN ABC ANALYSIS ON THE FOLLOWING DATA;

ITEM ANNUAL CONSUMPTION

(UNITS)

UNIT PRICE (RS)

1 7000 5.00

2 24000 3.00

3 1500 10.00

4 600 22.00

5 3800 1.50

6 40000 0.50

7 60000 0.20

8 3000 3.50

9 300 8.00

10 29000 0.40

11 11500 7.10

12 4100 6.20

45

SOLUTION FOR ABC ANALYSIS

• USAGE VALUE = ( ANNUAL CONSUMPTION ) X (PER UNIT PRICE )• CALCULATE ANNUAL USAGE VALUES AND RANK THE ITEMS IN DESCENDING ORDER OF USAGE VALUES

ITEMS ANNUAL VOLUME

UNIT PRICE RS.

ANNUAL USAGE RS.

% OF

TOTAL COST

RANK

1 7000 5.00 35000 9.8 4

2 24000 3.00 72000 20.2 2

3 1500 10.00 15000 4.2 7

4 600 22.00 13200 3.7 8

5 3800 1.50 57000 16.0 3

6 40000 0.50 20000 5.6 6

7 60000 0.20 12000 3.4 9

8 3000 3.50 10500 3.0 11

9 300 8.00 2400 0.7 12

10 29000 0.40 11600 3.3 10

11 11500 7.10 81650 23.0 1

12 4100 6.20 25420 7.1 5

355770 100.00

46

ABC PLANITEMS IN ORDER

OF RANKING

ITEM NUMBERS

% OF

TOTAL

ITEMS

VALUE

(RS)

CUMULATIVE VALUE

CUMULATIVE

%

% OF

TOTAL

VALUE

CATEGORY

1

3 25

81650 81650 23.0

69 A2 72000 153650 43.2

3 57000 210650 59.2

4

4 33.3

35000 245650 69.0

20.7 B5 25420 271070 76.2

6 20000 291070 81.8

7 5000 306070 86.0

8

5 41.7

13200 319270 89.7

10.3 C

9 12000 331270 93.1

10 11600 342870 96.4

11 10500 353370 99.3

12 2400 355770 100.0

100 355770 100

47

ABC PLAN

0

50000

100000

150000

200000

250000

300000

350000

400000

1 2 3 4 5 6 7 8 9 10 11 12

48

VED ANALYSIS• THE ITEMS ARE CLASSIFIED ON THE BASIS OF THEIR

CRITICALITY TO PRODUCTION PROCESS OR OTHER SERVICES.• ‘V’ STANDS FOR “VITAL” ITEMS WITHOUT WHICH THE

PRODUCTION PROCESS WOULD COME TO A STANDSTILL.• ‘E’ IN THE SYSTEM DENOTES “ESSENTIAL” ITEMS WHOSE

STOCKOUT WOULD ADVERSELY AFFECT THE EFFICIENCY OF THE PRODUCTION SYSTEM.ALTHOUGH THE SYSTEM WOULD NOT ALTOGETHER STOP FOR WANT OF THESE ITEMS, YET THEIR NON – AVAILABILITY MIGHT CAUSE TEMPORARY LOSSES IN, OR DISLOCATION OF PRODUCTION.

• ‘D’ ITEMS ARE THE “DESIRABLE” ITEMS, WHICH ARE REQUIRED BUT DO NOT IMMEDIATELY CAUSE A LOSS OF PRODUCTION.

• APPLICATION - THE VED ANALYSIS IS DONE MAINLY IN RESPECT OF SPARE PARTS.

49

VED ANALYSIS

• VED (VITAL – ESSENTIAL – DESIRABLE ) ANALYSIS IS CARRIED OUT TO IDENTIFY CRITICAL ITEMS.

• AN ITEM WHICH USAGEWISE BELONGS TO C – CATEGORY MAY BE CRITICAL FROM PRODUCTION POINT OF VIEW IF ITS STOCKOUT CAN CAUSE HEAVY PRODUCTION LOSS.

AN ITEM MAY BE VITAL FOR A NUMBER OF REASONS, NAMELY –

IF THE NON – AVAILABILITY OF THE ITEM CAN CAUSE SERIOUS PRODUCTION LOSSES.

LEAD TIME FOR PROCUREMENT IS VERY LARGE. IT IS NON – STANDARD ITEM AND IS PROCURED TO BUYER’S

DESIGN. THE SOURCE OF SUPPLY IS ONLY ONE AND IS LOCATED FAR

OFF THE BUYER’S PLANT.

50

VED ANALYSIS

• STEPS INVOLVED IN MAKING VED ANALYSIS ARE AS UNDER ;

1. IDENTIFY THE FACTORS TO BE CONSIDERED FOR VED ANALYSIS. THE COMMONLY CONSIDERED FACTORS ARE : EFFECT ON PRODUCTION (I.E. STOCKOUT COST IN THE EVENT OF NON – AVAILABILITY), LEAD TIME, NATURE OF ITEM AND SOURCE OF SUPPLY.

2. ASSIGN POINTS / WEIGHTAGES TO THE FACTORS ACCORDING TO THEIR IMPORTANCE TO THE COMPANY. TYPICAL EXAMPLES OF THE WEIGHTAGES TO THE ABOVE FACTORS MAY BE 30, 30, 20, AND 20 POINTS.

3. DIVIDE EACH FACTOR INTO THREE DEGREES AND ALLOCATE POINTS TO EACH DEGREE. USUALLY, THE FIRST DEGREE IS ASSIGNED POINTS EQUAL TO THE WEIGHTAGE OF ITS FACTOR; SECOND DEGREE IS ALLOCATED POINTS EQUAL TO TWICE THE WEIGHTAGE OF THE FACTOR AND THIRD DEGREE IS ASSIGNED POINTS EQUAL TO THRICE THE WEIGHTAGE OF THE FACTOR.

51

VED ANALYSIS

4. PREPARE CATEGORISATION PLAN WHICH PROVIDES THE BASIS OF CLASSIFICATION OF ITEMS INTO VITAL, ESSENTIAL, AND DESIRABLE CATEGORIES.

5. EVALUATE ITEMS ONE BY ONE AGAINST EACH FACTOR AND ASSIGN POINTS TO THE ITEM DEPENDING UPON THE EXTENT OF PRESENCE OF THE FACTOR IN THE ITEM.

6. PLACE THE ITEM INTO V, E, AND D CATEGORIES DEPENDING UPON THE POINTS SCORED BY THEM AND BASIS OF CLASSIFICATION SET UNDER STEP 4

52

TYPICAL VED ANALYSIS CATEGORISATION PLAN

S.NO. FACTOR FIRST DEGREE

SECOND DEGREE

THIRD DEGREE

1 STOCK OUT COST IN THE EVENT OF NON – AVAILABILITY

(30)

ABOVE RS. X

(30)

BETWEEN

RS. X TO Y (60)

ABOVE

RS. Y (90)

2 LEAD TIME FOR PROCUREMENT (30)

1 – 4 WEEKS

(30)

4 – 8 WEEKS

(60)

OVER

8 WEEKS (90)

3 NATURE OF THE ITEM

(20)

PRODUCED TO COMMERCIAL STANDARD, OR OFF THE SHELF AVAILABILITY (20)

PRODUCED TO SUPPLIERS’ DESIGN

(40)

PRODUCED TO BUYER’S DESIGN OR PROPRIETORY ITEMS (60)

4 SOURCE OF SUPPLY

(20)

LOCAL

(20)

OUTSTATION

(40)

IMPORTED, QUOTA ITEMS I.E. CONTROLLED SUPPLY (60)

53

TYPICAL VED ANALYSIS CATEGORISATION PLAN

POINTS CLASSIFICATION

100 - 160 DESIRABLE

161 - 230 ESSENTIAL

231 - 300 VITAL

VED ANALYSIS IS BEST SUITED FOR SPARES INVENTORY.IN FACT, IT IS ADVANTAGEOUS TO USE MORE THAN ONE METOD.E.G. ABC AND VED ANALYSIS TOGETHER WOULD BE HELPFUL FOR INVENTORY CONTROL OF SPARES.

54

HML ANALYSIS• THE ITEMS ARE CLASSIFIED ON THE BASIS OF ‘UNIT COST’

RATHER THAN THEIR USAGE VALUE.

• THE ITEMS ARE CLASSIFIED ACCORDINGLY, AS THEIR COST PER UNIT IS ‘ H – HIGH’, ‘M – MEDIUM’, OR ‘L – LOW’

• THIS TYPE OF ANALYSIS IS USEFUL FOR KEEPING CONTROL OVER MATERIALS CONSUMPTION AT THE DEPARTMENTAL LEVEL.

• IN A WAY THIS IS SIMILAR TO THE ABC ANALYSIS.

• TO CLASSIFY, THE ITEMS ARE LISTED IN THE DECENDING ORDER OF THEIR UNIT PRICE. THE CUT – OFF LINES ARE THEN FIXED BY THE MANAGEMENT FOR DECIDING 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/- TO RS. 1000/- WILL BE OF ‘M’ CATEGORY AND THOSE HAVING UNIT PRICE BELOW RS. 100 WILL BE OF ‘L’ CATEGORY.

55

HML ANALYSIS HML ANALYSIS HELPS TO - ASSESS STORAGE AND SECURITY REQUIREMENTS (E.G. HIGH PRICED

ITEMS LIKE BEARING, WORM SHAFTS, WORM WHEELS, ETC, REQUIRE TO BE KEPT IN THE CUPBOARDS).

TO KEEP CONTROL OVER CONSUMPTION AT THE DEPARTMENTAL HEAD LEVEL (E.G. INDENTS OF HIGH AND MEDIUM PRICED ITEMS ARE AUTHORISED BY THE DEPARTMENTAL HEAD AFTER CAREFUL SCRUTINY OF THE CONSUMPTION FIGURES)

DETERMINE THE FREQUENCY OF STOCK VERIFICATION, E.G. HIGH PRICED ITEMS ARE CHECKED MORE FREQUENTLY THAN LOW PRICED ITEMS.

TO EVOLVE BUYING POLICIES TO CONTROL PURCHASES E.G. EXCESS SUPPLY THAN THE ORDER QUANTITY MAY NOT BE ACCEPTED FOR “H” AND “M” GROUPS WHILE IT MAY BE ACCEPTED FOR “L” GROUP.

TO DELEGATE AUTHORITIES TO DIFFERENT BUYERS TO MAKE PETTY CASH PURCHASE E.G. “H” AND “M” CATEGORY OF ITEMS MAY BE PURCHASED BY SENIOR BUYERS AND “L” CATEGORY OF ITEMS BY JUNIOR BUYERS.

56

SDE ANALYSIS

• S – D – E ANALYSIS IS BASED ON THE PROBLEMS OF PROCUREMENT NAMELY ;

• NON - AVAILABILITY• SCARCITY• LONGER LEAD TIME• GEOGRAPHICAL LOCATION OF

SUPPLIERS• RELIABILITY OF SUPPLIERS ETC.

57

SDE ANALYSIS • THIS USES THE “CRITERIAN OF THE AVAILABILITY” OF ITEMS.• ‘S’ STANDS FOR “SCARCE” ITEMS WHICH ARE IN SHORT

SUPPLY, IMPORTED OR CANNALISED THROUGH GOVERNMENT AGENCIES.

SUCH ITEMS ARE BEST TO PROCURE LIMITED NUMBER OF TIMES A YEAR IN LIEU OF EFFORT AND EXPENDITURE INVOLVED IN THE PROCEDURE FOR IMPORT.

• ‘D’ REFERS TO THE “DIFFICULT” ITEMS - MEANING THE ITEMS THAT MIGHT BE AVAILABLE IN THE INDIGENOUS MARKET BUT CANNOT BE PROCURED EASILY; ALSO ITEMS WHICH COME FROM LONG DISTANCE AND FOR WHICH RELIABLE SOURCES DO NOT EXIST FALL INTO THIS CATEGORY .EVEN THE ITEMS WHICH ARE DIFFICULT TO MANUFACTURE AND ONLY ONE OR TWO MANUFACTURERS ARE AVAILABILE BELONG TO THIS GROUP.SUPPLIERS OF SUCH ITEMS REQUIRE SEVERAL WEEKS OF ADVANCE NOTICE.

58

SDE ANALYSIS• ‘E’ REPRESENT “EASILY AVAILABLE” ITEMS, FROM THE

LOCAL MARKETS MAY BE.ITEM PRODUCED TO COMMERCIAL STANDARDS, ITEMS WHERE SUPPLY EXCEEDS DEMAND AND OTHERS WHICH ARE LOCALLY AVAILABLE FALL INTO THIS GROUP.

• S – D – E ANALYSIS IS EMPLOYED BY THE PURCHASE DEPARTMENT ;

1. TO DECIDE ON THE METHOD OF BUYING.E.G. FORWARD BUYING METHOD MAY BE FOLLOWED FOR SOME OF THE ITEMS IN THE ‘ SCARCE’ GROUP; ‘SCHEDULE BUYING’ AND ‘ CONTRACT BUYING ‘ FOR “EASY” GROUP.

2. TO FIX RESPONSIBILITY OF BUYERS.E.G. 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.

59

S-OS ANALYSIS• THIS ANALYSIS IS BASED ON THE NATURE OF SUPPLIES.• ‘S’ REPRESENTS THE “SEASONAL” ITEMS ,• ‘OS’ REPRESENTS THE “OFF – SEASONAL” ITEMS.• APPLICATION - THIS CLASSIFICATION OF ITEMS IS DONE WITH THE AIM

OF DETERMINING PROPER PROCUREMENT STRATEGIES AND DECIDE STOCK LEVELS.

• THE ANALYSIS IDENTIFIES ITEMS WHICH ARE ;1. SEASONAL AND ARE AVAILABLE ONLY FOR A LIMITED PERIOD.

FOR EXAMPLE, AGRICULTURE PRODUCE LIKE RAW MANGOES, RAW MATERIALS FOR CIGARETTE AND PAPER INDUSTRIES ETC. ARE AVAILABLE FOR LIMITED TIME AND THEREFORE SUCH ITEMS ARE PROCURED TO LAST THE FULL YEAR.

2. SEASONAL BUT ARE AVAILABLE THROUGHOUT THE YEAR.THE PRICES HOWEVER, ARE LOWER DURING THE HARVEST TIME.THE QUANTITY OF SUCH ITEMS REQUIRE TO BE FIXED AFTER COMPARING THE COST SAVINGS DUE TO LOWER PRICES IF PURCHASED DURING SEASON AGAINST HIGHER COST OF CARRYING INVENTORIES IF PURCHASED THROUGHOUT THE YEAR.

3. NON – SEASONAL ITEMS WHOSE QUANTITY IS DECIDED ON DIFFERENT CONSIDERATIONS.

60

F – S – N ANALYSIS

• FSN ANALYSIS : FNSD ANALYSIS;

• BASED ON CONSUMPTION PATTERN OF THE ITEMS, THE FSN CLASSIFICATION CALLS FOR CLASSIFICATION OF ITEMS,

AS “ FAST – MOVING, SLOW – MOVING, AND NON – MOVING”.

• ANOTHER SIMILAR CLASSIFICATION IS AS FNSD : FAST – MOVING, SLOW – MOVING AND DEAD (OR NON – MOVING).

• THIS ‘SPEED’ CLASSIFICATION HELPS IN THE STORES AND IN DETERMINING THE DISTRIBUTION AND HANDLING PATTERNS.

• TO CONDUCT THE ANALYSIS, THE LAST DATE OF RECEIPT OR THE LAST DATE OF ISSUE WHICHEVER IS LATER IS TAKEN INTO ACCOUNT AND THE PERIOD, USALLY IN TERMS OF NUMBER OF MONTHS, THAT HAS ELAPSED SINCE THE LAST MOVEMENT IS RECORDED.

61

F – S – N ANALYSIS

• SUCH AN ANALYSIS HELPS TO IDENTIFY :

1. ACTIVE ITEMS WHICH REQUIRE TO BE REVIEWED REGULARLY.

2. SURPLUS ITEMS WHOSE STOCKS ARE HIGHER THAN THEIR RATE OF CONSUMPTION

3. NON – MOVING ITEMS WHICH ARE NOT BEING CONSUMED. MAY BE CALLED OBSOLETE ITEMS.

THE LAST TWO CATEGORIES ARE REVIEWED FURTHER TO DECIDE ON DISPOSAL ACTION TO DEPLETE THEIR STOCKS AND THEREBY RELEASE COMPANY’S PRODUCTIVE CAPITAL.

FURTHE DETAILED ANALYSIS IS MADE OF THE THIRD CATEGORY IN REGARDS TO THEIR YEAR – WISE STOCKS AND ITEMS CAN BE SUB – CLASSIFIED AS NON – MOVING FOR 2 YEARS, NON – MOVING FOR 3 YEARS, NON – MOVING FOR 5 YEARS AND SO ON.

62

GOLF ANALYSIS / VEIN ANALYSIS

• GOLF ANALYSIS :• IT IS BASED ON SOURCE OF ORIGIN OF MATERIAL.• G – GOVERNMENT• O – ORDINARY • L – LOCAL• F – FOREIGN• APPLICATION HELPS TO DECIDE PURCHASE STRATEGY.

• VEIN ANALYSIS :• V – VITAL

• E – ESSENTIAL

• I – IMPORTANT

• N – NORMAL

• APPLICATION ; MAINTENANCE

63

GUS ANALYSIS

• A CLASSIFICATION OF PRODUCTS INTO THREE CATEGORIES FOR THE BENEFIT OF GOODS FLOW CONTROL AND STOCK CONTROL, BASED ON A PRODUCTS AREA OF APPLICATION WITHIN A PRODUCT DIVISION.

• ‘G’ = “GENERAL PRODUCTS” THAT MAY BE REQUIRED IN

SEVERAL MAIN ARTICLE GROUPS OR OPERATIONS CENTERS

AND ARE ADMINISTERED CENTRALLY IN THE DIVISION.

• ‘U’ = “UNIQUE PRODUCTS” THAT ARE USED UNIQUELY IN ONE

MAIN ARTICLE GROUP OR OPERATIONS CENTRE BUT

SEVERAL OF ITS PRODUCTS, AND ADMINISTERED LOCALLY

IN THE DIVISION.

• ‘S’ = “SPECIFIC PRODUCTS” THAT ARE USED EXCLUSIVELY IN

ONE HIGHER LEVEL PRODUCT, AND WHOSE PROCUREMENT

IS EFFECTED PER INDIVIDUAL ORDER.

64

XYZ ANALYSIS

• IT IS BASED ON THE CLOSING INVENTORY VALUE OF DIFFERENT ITEMS.

• ‘X’ ITEMS ARE ITEMS WHOSE INVENTORY VALUES ARE HIGH.

• THOSE WITH LOW INVESTMENT IN THEM ARE TERMED AS ‘Z’ ITEMS.

• OTHER ITEMS ARE THE ‘Y’ ITEMS WHOSE INVENTORY VALUE IS NEITHER TOO HIGH NOR TOO LOW.

• APPLICATION - TO DEVICE PROPER INVENTORY STRATEGY.

• FAILURE ANALYSIS.• DESIGN AND ISSUE OF SPARES.• APPLICATION - RELIABILITY ENGINEERING.

66

ELEMENTS OF INVENTORY COSTS

• THE TYPES OF COSTS THAT USALLY AFFECT THE INVENTORY DECISION ARE :

1. THE COST TO PLACE REPLENISHMENT ORDER.

• THESE ARE ALSO REFERRED TO AS REPLENISHMENT COSTS OR PROCUREMENT OR INDENTING COSTS.

• THESE ARE ESSENTIALLY COSTS INCURRED IN PROCURING AN ITEM.

• THEY ARE INCURRED EACH TIME AN ORDER IS PLACED.

IN THE SIMPLEST MODEL THIS IS TREATED AS FIXED REGARDLESS OF THE SIZE OR AMOUNT OF THE ORDER.

• IN MORE COMPLEX MODELS IT MAY BE COMPOSED OF A HEADER COST PLUS A LINE COST FOR EACH ITEM BEING ORDERED.

67


• THE ORDERING COST VARIES AS PER THE NATURE OF THE MATERIAL PROCURED AND INCLUDES:

• COST OF PAPER WORK, TYPING, AND DISPATCHING AN ORDER.

• COSTS INCURRED IN FOLLOWING UP TIMELY DELIVERIES, TRAVELLING COSTS, PURCHASE FOLLOW UP COSTS, TELEPHONES, TELEGRAMES, TELEXES, POSTAL, E-MAIL, AND OTHER CORRESPONDANCE COSTS.

• COSTS INVOLVED IN RECEIVING THE ORDER, INCOMING INSPECTION, CHECKING, PHYSICAL HANDING OVER TO STORES.

• ANY SET – UP MACHINE COST, IF ANY, DIRECTLY CHARGED BY THE SUPPLIER TO THE BATCH SIZE.

• SALARY AND WAGES OF THE PURCHASE DEPARTMENT.

68


• THE FOLLOWING TASKS MIGHT BE PERFORMED IN CONNECTION WITH MATERIAL ORDERING:

1. SEARCH FOR A SUPPLIER

2. SELECTION OF A SUPPLIER

3. NEGOTIATIONS WITH A SUPPLIER

4. ISSUING OF ORDERS

5. RECEIVING OF GOODS

6. INSPECTION OF GOODS

7. RETURNING OF DEFECTIVE ITEMS

8. TRANSFERING OF GOODS TO STORES

9. HANDLING OF INFORMATION SYSTEM TRANSACTIONS RELATED TO THE ACTIVITIES ABOVE.

69


• IN CASE OF A MANUFACTURED MATERIAL THE COMPONENTS OF ORDERING COST- WHICH IS CALLED AS SETUP COST IN THIS CONTEXT – ARE AS UNDER :

1. COST OF SETUP - ADJUSTMENT OF MACHINE TOOLS, EQUIPMENT IN PREPARATION OF NEXT OPERATIONS,

2. COST OF SUPPORTING MATERIALS – FIXTURE, TOOLS, ETC.3. COST OF MATERIAL HANDLING – LOCATING AND HANDLING

MATERIALS IN THE STORES AND MOVING IT TO THE WORK CENTRE.

4. COST OF PRODUCTIVITY – THIS IS A PENALTY COST IN RELATION TO ACHIEVING LONGER PRODUCTION RUNS WHICH CAN YIELD LOWER UNIT COST BECAUSE OF LEARNING CURVE EFFECTS

5. COST OF INSPECTION6. COST OF SCRAP7. COST OF IDLE TIME OF THE MACHINE8. COST OF STATIONARY UTILIZED.

70


2. THE COST TO HOLD INVENTORY:• THESE COSTS INCLUDE ALL EXPENSES INCURRED

BECAUSE OF THE VOLUME OF INVENTORY CARRIED.• THESE ARE ALSO CALLED AS INVENTORY CARRYING

COSTS.• THIS MAY BE A FIXED SUM PER UNIT PER TIME

PERIOD,• IT MAY BE FIXED PERCENTAGE OF VALUE PER TIME

PERIOD.• IN MORE COMPLEX MODELS IT MAY CONSIST OF

MORE THAN ONE ELEMENT I.E. HOLDING COSTS MAY CONSIST OF BOTH PHYSICAL STORAGE AND CAPITAL COSTS (FOREGONE EARNINGS)

71


• AMONG THE RELEVANT COSTS ARE -• WAREHOUSE RENTAL (IMPLICIT OR EXPLICIT)• CLERICAL COSTS OF COUNTING INVENTORY,• INSURANCE FOR GOODS AND WAREHOUSE,• SECURITY• TAXES ON INVENTORY,• OBSOLESCENCE,• DAMAGE• PILFERAGE,• THEFTS• REDUCED ITEM LIFE• SPOILAGE,• THE VALUE ASSOCIATED WITH FUNDS TIED UP IN INVENTORY- THIS COST OF CAPITAL MAY BE THE ACTUAL COST OF FUNDS BORROWED TO PURCHASE INVENTORY,- THE INTEREST THAT COULD BE SAVED IF THAT MONEY WERE USED TO RETIRE DEBT,- THE INTEREST THAT COULD HAVE BEEN EARNED BY DEPOSITING THE FUNDS,- AN INTERNAL RATE OF RETURN- REPRESENTING GAINS MADE FROM USING THE SAME FUNDS ON E.G. PLANT EXPANSION • THE COMPONENTS OF THIS COST ARE - CYCLE STOCK COSTS AND BUFFER STOCK COSTS.

72


• THE INVENTORY HOLDING COST PER TIME UNIT IS A RESULT OF TWO MULTIPLICATIVE COMPONENTS:

• ‘I’ - CARRYING CHARGE FACTOR EXPRESSED IN PERCENT PER

UNIT TIME.

• ‘C’ - THE COST OF THE ITEM PER UNIT

• THE REASON FOR HAVING THE TWO COMPONENTS ARE –

1. THE COST OF CARRYING INVENTORY PER UNIT OF TIME IS ASSUMED TO BE IN DIRECT PROPORTION TO THE UNIT COST OF THE ITEM.

2. IF ‘I’ IS CONSTANT , THEN ‘IXC’ IMPLIES THAT THE CARRYING COST REFLECTS EACH INDIVIDUAL ITEM

3. ONE CAN ASSUME SAFELY THAT ‘I’ IS CONSTANT FOR ALL ITEMS BECAUSE THE COST OF CAPITAL IS CONSTANT

4. A CHANGE IN CARRYING COST CAN BE EASILY ADJUSTED FOR ALL ITEMS BY CHANGING ‘I’.

• THE COST OF CAPITAL IS THE MOST SUBJECTIVE FACTOR IN THE HOLDING / CARRYING COST.

• THE PREVALENT PRACTICE IS THAT THIS VARIABLE IS SET BY MANAGEMENT TO REFLECT SACRIFICES MADE WHILE INVESTING CAPITAL.

• IN ESSENCE IT IS THE OPPORTUNITY COST OF CAPITAL.

73


3. THE COST OF MANAGING SHORTAGES OR BACK ORDERS :

• IF A POTENTIAL CUSTOMER APPROACHES A COMPANY AND ASKS FOR DELIVERY OF A CERTAIN PRODUCT, WHICH THE COMPANY CAN NOT DELIVER. TWO POSSIBILITIES EXIST.

• THE CUSTOMER ACCEPTS WHATEVER HE GETS, IF ANY, AND AGREES TO GET THE BALANCE DELIVERY AT A LATER POINT OF TIME.

• THE SECOND POSSIBILITY IS THAT THE CUSTOMER TURNS TO A COMPETETOR FOR BALANCE DELIVERY OR MAY ENTIRELY CANCEL THE ORDER AND GET IT FROM OTHER COMPANY.

• IN BOTH THE SITUATIONS SHORTAGE OCCUR.

• THE FIRST CASE, WHERE THE CUSTOMER STAYS WITH THE COMPANY, IS A BACK ORDER SITUATION.

• THE SECOND CASE IMPLISE A SHORTAGE THAT EVANTUALLY LEADS TO LOSS OF SALES.

74


3. THE COST OF MANAGING SHORTAGES OR BACKORDERS…………

• THE LOST SALES DUE TO SUCH CONDITIONS SIMPLY CAN NOT BE QUANTIFIED.

• APART FROM THE LOSS OF REVENUE, THE FIRM ALSO SUFFERS A LOSS OF GOODWILL OR REPUTATION.

• IF CUSTOMER NEVER RETURNS ALL FUTURE SALES SHOULD THEORETICALLY FORMS A PART AND PARCEL OF THE SHORTAGE COST.

• A FIRM, WHICH RUNS OUT OF A PRODUCT, MAY INITIATE A SPECIAL ORDER, OR TAKE ADDITIONAL SPECIAL STEPS TO SATISFY THE CUSTOMER OR ELSE IT MAY RISK LOOSING THE CUSTOMER.

• THE LABOUR AND THE PAPERWORK ASSOCIATED WITH BACKORDERS ENTAILS USUALLY HIGHER COSTS.

• THE COSTS MAY ALSO INCLUDE HIGHER FREIGHT PREMIUM BECAUSE OF SMALLER QUANTITY OF MATERIAL BEING DELIVERED

• THE ELEMENTS OF THIS COST ARE - LOST SALES AND BACKORDERS.

75


4. THE COST OF ACQUIRING THE ITEMS THEMSELVES:• THIS IS RELEVANT IN ANY QUANTITY DISCOUNT

MODEL.• THE COST OR VALUE OF AN ITEM IS USUALLY ITS

PURCHASE PRICE. IN SOME INSTANCES, THE COST OF TRANSPORTATION, INSURANCE, RECEIVING OR INSPECTION MAY BE INCLUDED AS PART OF THE COST.

• IF ANY PLANT MANUFACTURES THE ITEM IN – HOUSE THE DIRECT MANUFACTURING COST IS THE COST OF THE ITEM.

76

THE CHALLENGES OF INVENTORY MANAGEMENT

• THERE ARE TWO MAJOR OBJECTIVES OF INVENTORY CONTROL, WHICH USUALLY ARE IN CONFLICT.

• THE OPERATION MANAGER’S PROBLEM IS IN STRIKING A FINE BALANCE BETWEEN THE TWO. THESE OBJECTIVES ARE;

• MAXIMIZE THE LEVEL OF CUSTOMER SERVICE, AND• MINIMIZING THE COST OF PROVIDING AN ADEQUATE LEVEL OF

CUSTOMER SERVICE, PROMOTING EFFICIENCY IN PRODUCTION OR PURCHASING.

• THE ORGANIZATION’S INVENTORY MANAGEMENT SYSTEM MUST CARRY OUT OBJECTIVES SET BY UPPER MANAGEMENT. IT MUST PERFORM IN SUCH A WAY TO ENHANCE THE ORGANIZATION’S PROFIT OR PERFORMANCE.

• THE OBJECTIVES SET BY MANAGEMENT WILL FREQUENTLY FALL INTO EITHER OF TWO CATEGORIES;

1. CUSTOMER SERVICE OBJECTIVES

2. INVENTORY INVESTMENT OBJECTIVES• THE FIRST CATEGORY INCLUDES SUCH CONCEPTS AS SERVICE LEVEL

AND STOCK – OUT RATE; THE SECOND, SUCH ITEMS AS NUMBER OF INVENTORY TURNOVERS PER TIME PERIOD.

77

THE CHALLENGES OF INVENTORY MANAGEMENT

• GENERALLY, THE ACHIEVEMENT OF HIGHER LEVELS OF CUSTOMER SERVICE, HOWEVER DEFINED, IS ACCOMPLISHED WITH LARGER AMOUNTS OF INVENTORY, AND IS SUBJECT TO DIMINISHING RETURNS.

• THE ACHIEVEMENT OF HIGHER LEVELS OF THE INVESTMENT OBJECTIVES IS GENERALLY MET WITH SMALLER INVENTORIES.

• THUS WE SEE THE BASIC CONFLICT OF INVENTORY MANAGEMENT:

• SOME OBJECTIVES CALL FOR ECONOMIZING ON INVENTORY LEVELS, WHILE OTHER OBJECTIVES CALL FOR INCREASING INVENTORIES.

• THESE OBJECTIVES MAY CREATE CONFLICT ALONG DEPARTMENTAL LINES; FINANCE WANTS SMALLER SUMS TIED UP IN INVENTORY, WHILE MARKETING WANTS LARGER AMOUNTS SO THAT CUSTOMERS ORDERS CAN BE MORE PROMPTLY SATISFIED.

78

INVENTORY DECISIONS

• INVENTORY PROBLEMS ARE ENCOUNTERED IN MANY PHASES OF PRODUCTION – MARKETING PROCESS.

• A MANUFACTURER MUST DETERMINE THE AMOUNT OF RAW MATERIALS TO ORDER.

• A MANUFACTURER MUST DETERMINE THE QUANTITY OF IN – PROCESS INVENTORY TO ‘SHIP’ TO ANOTHER STAGE OF PRODUCTION. THE PROCESSING SPEED AT ONE DEPARTMENT OR WORKSTATION MAY DIFFER FROM THE SPEED OF ANOTHER (LINE BALANCING PROBLEM). AN IN – PROCESS INVENTORY WILL ALLOW EACH STATION TO OPERATE AT ITS OWN OPTIMAL RATE. THE INVENTORY THEREFORE DECOUPLES THE TWO PRODUCTION RATES.

• A DISTRIBUTOR OR MANUFACTURER MUST DETERMINE THE QUANTITY OF FINISHED GOODS TO SHIP TO A CUSTOMER. (WILL THE CUSTOMER’S ORDER BE SHIPPED AS A SINGLE SHIPMENT OR WILL IT BE SUBDIVIDED INTO SVERAL SMALLER SHIPMENTS?)

79

INVENTORY DECISIONS• A RETAILER OR WHOLESALER MUST DETERMINE THE

QUANTITY OF GOODS TO ORDER FOR RESALE. AN INDIVIDUAL OR A CORPORATION MUST DETERMINE THE QUANTITY OF FUNDS TO BE TRANSFERRED FROM ONE ACCOUNT TO ANOTHER ACCOUNT.

• A MANUFACTURER MAY NEED TO PROTECT HIMSELF FROM SUPPLIER SHORTAGES OR DISRUPTIONS. A BUFFER STOCK OR SAFETY STOCK OF RAW MATERIALS CAN PROVIDE THIS PROTECTION.

• SIMILARLY A RETAILER MAY NEED TO KEEP SAFETY STOCKS OF PRODUCTS IN ORDER TO MANAGE UNCERTAINTY IN THE LEVEL OF CUSTOMER DEMAND FOR PRODUCTS.

• THE EXAMPLES OF DECISIONS ABOVE INDICATE THAT INVENTORY PERFORMS A VARIETY OF FUNCTIONS, MOST OF WHICH ARE RELATED TO PRIMARY PURPOSE OF INVENTORY, WHICH IS BUFFERING OR DECOUPLING.

80

INVENTORY DECISIONS

• TRADE OFFS INVOLVED IN INVENTORY COSTS ARE AN IMPORTANT ASPECT IN DESIGNING AN INVENTORY CONTROL SYSTEM.

• VARIOUS COSTS OF INVENTORY BEHAVE IN OPPOSITE FASHIONS.

• THE ANNUAL PROCUREMENT COSTS DECREASE WITH THE AMOUNT OF INVENTORY CARRIED,

• WHEREAS THE INVENTORY CARRYING COST INCREASE WITH INCREASE IN AVERAGE INVENTORY CARRIED.

• IT IS THE TASK OF THE INVENTORY CONTROL MANAGER TO STRIKE A FINE BALANCE BETWEEN THE TWO, SO AS TO OPTIMIZE THE TOTAL INVENTORY COST.

81

DEPENDENT AND INDEPENDENT DEMAND

• THE NATURE OF DEMAND OF AN ITEM IS A DETERMINING FACTOR IN THE SELECTION OF AN APPROPRIATE INVENTORY CONTROL TECHNIQUE.

• AN ITEM EXHIBITS DEPENDENT DEMAND WHEN IT IS TO GO INTO ONE OR BECOME A PART OF ANOTHER ITEM.

• COMPONENT ITEMS GO INTO PARANT ITEMS.

• THE REASON FOR THIS CLASSIFICATION IS AS FOLLOWS;

• THE PROCUREMENT OR DELIVERY SCHEDULE OF A DEPENDENT DEMAND ITEM FOLLOWS THE DEMAND OF ITS PARENT,

• PRODUCTION OF THE PARENT, AND THE COMPONENT CAN BE TIGHTLY COORDINATED WITH LITTLE OR NO DIFFICULTY.

• THE SCHEDULE FOR THE COMPONENT ITEM IS DEAD ACCURATE RELATIVE TO THE SCHEDULE OF THE PARENT ITEM.

82

DEPENDENT AND INDEPENDENT DEMAND

• SCHEDULING THE INDEPENDENT DEMAND ITEM IS NOT SO SIMPLE.• DUE TO THE ELEMENT OF GUESSWORK IN THE FORECAST

FIGURES, THE COSTS OF CARRYING INVENTORY ARE PROMINENT.• TO BE ON SAFER SIDE, AND TO TAKE CARE OF CUSTOMER

SERVICE LEVELS, THE BUFFER STOCK IS CARRIED.• THE DEPENDENT / INDEPENDENT DEMAND PRINCIPLE STATES

THAT END ITEMS WHOSE DEMAND IS INDEPENDENT OF OTHER ITEMS IN THE INVENTORY SYSTEMS SHOULD BE CONTROLLED BY STATISTICAL REORDER POINT TECHNIQUES, WHEREAS ALL PARTS THAT MAKE UP THE END ITEMS AND ARE THEREFORE SUBJECT TO DEPENDENT DEMAND ARE MORE SUITABLE FOR CONTROL BY MATERIALS REQUIREMENT PLANNING (MRP) SYSTEMS.

• THERE ARE ALWAYS EXCEPTIONS TO THE ABOVE THUMB RULE.• A SPARE PART IS A COMPONENT OF BOTH DEPENDENT AS WELL

AS INDEPENDENT DEMAND, BECAUSE AS A PART OF DEPENDENT DEMAND IT IS A COMPONENT OF AN END ITEM CURRENTLY BEING MANUFACTURED AND ITS DEMAND MUST BE FORECASTED.

• SO MRP SYSTEM WILL BE SUITABLE.• AT TIMES SPARES MAY BE REQUIRED FOR ITEMS THAT ARE NO

LONGER SOLD BY THE ORGANIZATION.• THESE WILL REQUIRE REORDER POINT TECHNIQUES.

83

INDEPENDENT DEMAND

84

INDEPENDENT DEMAND INVENTORY MODELS

• THE MODELS CONCERN PRODUCTS WHOSE DEMAND IS INDEPENDENT OF THE DEMAND FOR OTHER ITEMS SOLD OR USED BY THE SAME FIRM.

• 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 ADMINISTRATIVE WORK BUT INCREASES INVESTMENT IN STOCKS.

85


ORDERING SMALL LOTS FREQUENTLY KEEPS THE INVESTMENT LOW BUT INCREASES ADMINISTRATIVE WORK. THIS IS BECAUSE SMALL LOTS REQUIRE HIGH ORDER FREQUENCY -

MORE PURCHASE REQUISITIONS REQUIRE TO BE RAISED, MORE FREQUENTLY INQUIRES MUST BE SENT, MORE FREQUENTLY THE COMPARATIVE STATEMENTS MUST BE

PREPARED, MORE FREQUENTLY THE PURCHASE ORDERS MUST BE

RAISED, MORE FREQUENTLY THE MATERIALS MUST BE RECEIVED, MORE PROGRESSING MUST BE DONE, MORE POSTING MUST BE DONE, MORE BILLING MUST BE HANDLED. ALL THESE INCREASED ACTIVITIES CALL FOR MORE STAFF

AND HENCE MORE ADMINISTRATIVE COSTS AND OVERHEADS. THEREFORE, A RATIONAL APPROACH IS NEEDED FOR FIXING

THE ORDER QUANTITY OF AN ITEM.

86


• AS A GENERAL RULE, ITEMS OF C- CATEGORY CAN BE PROCURED IN BULK WITHOUT TYING UP MUCH CAPITAL.

• STOCK OF A – CATEGORY OF ITEMS, ON THE CONTRARY, SHOULD BE KEPT LOW BY ORDERING FREQUENTLY.

• THIS WILL KEEP INVENTORY INVESTMENT LOW AND WILL NOT INCREASE ADMINISTRATIVE WORK BECAUSE OF THEIR LIMITED NUMBER

87

GRAPHICAL REPRESENTATION OF EFFECT OF ORDER QUANTITY ON COST

• COST TO BE OPTIMISED :• THERE ARE TWO MAJOR COSTS ASSOCIATED WITH ANY

ORDER QUANTITY;

1. PROCUREMENT COST

2. INVENTORY CARRYING COST

• THE ANNUAL PROCUREMENT COST (THE PRODUCT OF NUMBER OF ORDERS AND THE PROCUREMENT COST PER ORDER) 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 ILLUSTRATED IN THE GRAPH BELOW.

• THE ANNUAL INVENTORY CARRYING COST (THE PRODUCT OF AVERAGE INVENTORY INVESTMENT AND INVENTORY CARRYING COST) ON THE CONTRARY FALLS WHEN THE QUANTITY ORDERED PER OCCASION IS SMALL BECAUSE OF LOW CAPITAL INVESTMENT

88


• 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 THAT THE LOWEST TOTAL COST OCCURS AT THE INTERSECTION OF PROCUREMENT COST CURVE AND THE CARRYING COST CURVE.

89

AN ILLUSTRATION ON THE GRAPHICAL METHOD

• MONTHLY CONSUMPTION OF AN ITEM COSTING RS. 3/- PER UNIT HAS BEEN ESTIMATED AT 100 UNITS. INVENTORY CARRYING COST AND THE PROCUREMENT COST FOR THE COMPANY HAVE BEEN COMPUTED AT 15 % AND RS. 30 PER ORDER RESPECTIVELY.

a) CALCULATE ANNUAL PROCUREMENT COST FOR THE ABOVE ITEM, ASSUMING DIFFERENT VALUES OF ORDER QUANTITIES (SAY IN STEPS OF 100) AND CONSTRUCT A GRAPH FOR ANNUAL PROCUREMENT COST VERSUS ORDER QUANTITIES.

b) CALCULATE ANNUAL INVENTORY CARRYING COST FOR THE ABOVE ITEM FOR THE DIFFERENT VALUES OF ORDER QUANTITIES AND CONSTRUCT A GRAPH FOR ANNUAL INVENTORY CARRYING COST VERSUS ORDER QUANTITIES.

c) DETERMINE THE QUANTITY TO BE PURCHASED TO OPTIMISE THE TOTAL COST.

90

AN ILLUSTRATION ON THE GRAPHICAL METHODSOLUTION

• TWO COSTS ARE AFFECTED BY THE SIZE OF THE ORDER QUANTITIES: ANNUAL PROCUREMENT COST AND ANNUAL INVENTORY CARRYING COST.

• TABLE BELOW IS DEVELOPED FOR THESE COSTS FOR DIFFERENT VALUES OF ORDER QUANTITITES (IN STEPS OF 100 UNITS).

• A SAMPLE CALCULATION FOR AN ORDER QUANTITY OF 400 UNITS IS GIVEN BELOW;

• ANNUAL PROCUREMENT COST = NO. OF ORDERS/YEAR X PROCUREMENT COST / YEAR = ANNUAL CONSUMPTION / ORDER QUANTITY X PROCUREMENT COST / ORDER = 100 X 12 / 400 X 30 = RS. 90 /- • ANNUAL INVENTORY COST

= AVERAGE INVENTORY INVESTMENT X INVENTORY CARRYING COST= 1/2 X ORDER QUANTITY X PRICE / UNIT X INVENTORY CARRYING COST = 1/2 X 400 X 3 X 0.15 = RS. 90 / -

• AS EVIDENT FROM THE GRAPH, TOTAL COST IS MINIMUM WHEN ORDER QUANTITY IS 400 UNITS. THEREFORE EOQ OF THIS ITEM IS 400 UNITS.

91

GRAPHICAL ANALYSIS OF ECONOMIC LOT SIZE

ORDER QUANTITY

(UNITS)

ANNUAL PROCUREMENT

COST

(RS.)

ANNUAL INVENTORY

CARRYING COST (RS.)

ANNUAL TOTAL COST

(RS.)

100 360.00 22.50 382.50

200 180.00 45.00 225.00

300 120.00 67.50 187.50

400 90.00 90.00 180.00

500 72.00 112.50 184.50

600 60.00 135.00 195.00

700 51.43 157.50 208.93

800 45.00 180.00 225.00

900 40.00 202.50 242.50

1000 36.00 225.00 261.00

1100 32.73 247.50 280.23

1200 30.00 270.00 300.00

92


0.00

25.00

50.00

75.00

100.00

125.00

150.00

175.00

200.00

225.00

250.00

275.00

300.00

325.00

350.00

375.00

400.00

0 100 200 300 400 500 600 700 800 900 1000 1100 1200

AN

NU

AL

IN

VE

NT

OR

Y

CA

RR

YIN

G

CO

ST

&

AN

NU

AL

P

RO

CU

RE

ME

NT

C

OS

T

ORDERING QUANTITY

A

B

C

A – ANNUAL TOTAL COST, B - ANNUAL INVENTORY CARRYING COST, C - ANNUAL PROCUREMENT COST

EOQ

93

TYPES OF EOQ MODELS

• THERE ARE DIFFERENT TYPE OF EOQ MODELS AS SHOWN BELOW -

ECONOMIC ORDER QUANTITY MODELS

BASIC (OR WILSON)EOQ MODEL

(WITH INFINITEREPLENISHMENT

RATE

EOQ MODELWITH PLANNEDBACKLOGGING

EOQ MODELWITH FINITE

REPLENISMENTRATE

EOQ MODELWITH

QUANTITYDISCOUNTS

94

TYPES OF EOQ MODELS

• THERE ARE DIFFERENT EOQ MODELS.

• THE MOST CLASSICAL MODEL WAS FIRST PROPOSED BY WILSON IN 1928.

• IT IS POPULARLY KNOWN AS ‘EOQ’ (ECONOMICAL ORDER QUANTITY) MODEL OR ‘WILSON’S LOT SIZE FORMULA’ .

• THREE BASIC ASSUMPTIONS OF WILSON FORMULA ARE ;

1. THE REPLENISHMENT OF STOCK IS INSTANTANEOUS

2. NO SHORTAGE (OR NO BACK ORDERING) IS ALLOWED.

3. PRICE PER UNIT IS FIXED AND IS INDEPENDENT OF THE ORDER QUANTITY.

• GRAPHICALLY, THIS MODEL CAN BE PORTRAYED AS FOLLOW ;

EO

Q

TIMEINSTANTANEOUS REPLENISHMENT OF STOCK

95

BASIC (OR WILSON) EOQ MODEL WITH INFINITE REPLENISHMENT RATE

• ASSUMPTIONS UNDERLINING THE EOQ MODEL:

i. IT IS APPLICABLE TO A SINGLE PRODUCT THAT IS CONTINUOUSLY REVIEWED.

ii. THE DEMAND RATE FOR THE ITEM IS KNOWN, AND IS CONSTANT OVER TIME, AND INDEPENDENT.

iii. THE ITEM IS PRODUCED IN LOTS, OR PURCHASED IN ORDERS.

iv. EACH ORDER IS RECEIVED IN A SINGLE DELIVERY.

v. THE LEAD – TIME IS KNOWN AND CONSTANT.

vi. INVENTORY HOLDING COST IS BASED ON AVERAGE INVENTORY.

vii. ORDERING COSTS OR SETUP COSTS ARE CONSTANT.

viii. NO BACKORDERS ARE ALLOWED.

ix. THERE ARE NO QUANTITY DISCOUNTS.

96

BASIC (OR WILSON) EOQ MODEL WITH INFINITE REPLENISHMENT RATE

• THE BASIC EOQ PROBLEM IS SOLVED AS A COST – MINIMISING PROBLEM: “ WHAT VALUE OF ORDER QUANTITY PRODUCES THE LOWEST ANNUAL SUM OF ORDERING COSTS AND HOLDING COSTS?”

• THESE TWO COSTS ARE OPPOSING; THAT IS, AS THE DECISION VARIABLE CHANGES, ONE COST RISES WHILE OTHER FALLS.

0

Q/2

Q

TIME

INVENTORY LEVEL AND ORDER POINT FOR REPLENISHMENT

97

BASIC (OR WILSON) EOQ MODEL WITH INFINITE REPLENISHMENT RATE• THE SYMBOLS USED ;• D - BE TOTAL ANNUAL DEMAND (IN UNITS)• Q - BE QUANTITY ORDERED (IN UNITS)• Q* - BE OPTIMAL ORDER QUANTITY (IN UNITS)• R - BE REORDER POINT (IN UNITS)• R* - BE OPTIMAL REORDERPOINT (IN UNITS)• L - BE LEAD TIME (IN TIME UNITS)• S - BE SETUP OR PROCUREMENT COST (PER ORDER)• C - BE UNIT PURCHASE COST OF AN INDIVIDUAL ITEM (IN RUPEES).• I - BE CARRYING COST PER UNIT CARRIED, EXPRESSED IN TERMS OF UNIT COST AND AS A PERCENTAGE.• K - BE STOCKOUT COST PER UNIT OUT OF STOCK.• P - BE PRODUCTION RATE; OUTPUT PER UNIT TIME ( IN UNITS) OR DELIVERY RATE. • d1 - BE DEMAND PER UNIT TIME DURING LEAD TIME (IN UNITS)• D1 - BE TOTAL DEMAND DURING LEAD TIME (IN UNITS)• TC - BE TOTAL ANNUAL INVENTORY COSTS• TCmin - BE MINIMUM TOTAL ANNUAL INVENTORY COSTS

98

BASIC EOQ MODEL WITH INFINITE REPLENISHMENT RATE

• THE SIMPLE EOQ FORMULA IN ITS EARLIEST FORM WAS INITIALLY PUTFORTH AND DEVELOPED BY FORD HARRIS IN THE YEAR 1915.

• TOTAL ANNUAL INVENTORY COSTS = PROCUREMENT COST + CARRYING COSTS

• PROCUREMENT COSTS; • D IS TOTAL ANNUAL DEMAND (IN UNITS) AND Q IS QUANTITY

ORDERED (IN UNITS) THEN, THE NUMBER OF ORDERS PER ANNUM IS GIVEN BY TOTAL ANNUAL DEMAND DIVIDED BY QUANTITY ORDERED PER OCCASION I.E D / Q.

• S IS SETUP OR PROCUREMENT COST PER ORDER, THEN TOTAL ANNUAL PROCUREMENT COST IS GIVEN BY NUMBER OF ORDERS PER ANNUM MULTIPLIED BY PER OCCASION PROCUREMENT COST I.E. D/Q X S

• THUS, PROCUREMENT COSTS = D/Q X S

99


• CARRYING COSTS ;• TOTAL ANNUAL CARRYING COST = COST OF CARRYING ONE UNIT

MULTIPLIED BY AVERAGE NUMBER OF UNITS CARRIED PER ANNUM =

= IC X (MAXIMUM INVENTORY + MINIMUM INVENTORY ) /2

TOTAL ANNUAL CARRYING COST = IC X Q /2• TOTAL INVENTORY COSTS TC = PROCUREMENT COSTS+ CARRYING COSTS

TOTAL INVENTORY COSTS TC = D / Q X S + I C X Q / 2• FROM THE ABOVE EQUATION WE DERIVE THE FORMULA FOR EOQ I.E. Q*• GETTING THE FIRST DERIVATIVE OF TC WITH RESPECT TO Q AND

EQUATING IT TO ZERO FOR MINIMUM VALUE OF TC WE HAVE,

• 0 = - D S /Q*² + I C / 2 FROM THIS WE GET D S / Q*² = I C / 2 • Q*² = 2 D S / I C Q* = (2DS /IC) THEREFORE ECONOMIC ORDER QUANTITY

= 2 X ANNUAL CONSUMPTION (UNITS) X PROCUREMENT COST /ORDER

PRICE PER UNIT X INVENTORY CARRYING COST

EOQ

100


• PROOF OF ECONOMIC BUYING ;

• TO GIVE PROOF OF OPTIMAL BUYING, WE MUST CALCULATE ANNUAL PROCUREMENT COST AND ANNUAL INVENTORY CARRYING COST WHEN QUANTITY ORDERED PER OCCASION EQUALS ECONOMIC ORDER QUANTITY.

• ANNUAL PROCUREMENT COST = D / Q X S

= D X S / 2 D S / I C

= D . S . I . C / 2

• ANNUAL INVENTORY CARRYING

COST = Q / 2 X C X I

= 2 . D . S / C . I X C. I / 2

= D. S. I. C / 2

• IT IS EVIDENT FROM THE ABOVE TWO EQUATIONS THAT THE BEST BUYING RESULTS WHEN ANNUAL PROCUREMENT COST EQUALS ANNUAL INVENTORY CARRYING COST.

=

101

AN ALTERNATIVE FORMULA FOR EOQ WHEN CONSUMPTION IS SPECIFIED IN RUPEES

• THE BASIC FORMULA FOR THE EOQ SUGGEST THE QUANTITY (IN TERMS OF UNITS) TO BE PURCHASED TO OPTIMISE THE COSTS INVOLVED. IN THIS FORMULA CONSUMPTION FIGURE 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 ANNUAL CONSUMPTION OF THE ITEMS ARE SPECIFIED IN TERMS OF MONETARY VALUES).

• THE FORMULA FOR “ECONOMIC ORDER QUANTITY IN RUPEES” CAN BE OBTAINED AS UBDER ;

• LET A = ANNUAL CONSUMPTION IN RUPEES (CALLED ANNUAL USAGE )• Qo = ECONOMIC ORDER QUANTITY IN RUPEES• MULTIPLYING BOTH SIDES OF THE EQUATION BY UNIT PRICE ‘C’ • Q* X C = Qo = 2 . D . S / C . I X C = 2 . A . S . C² / C² . I (AS D = A/C)

• Qo = 2 . A . S / I

102

WHEN INVENTORY CARRYING COST IS SPECIFIED IN “RUPEES PER UNIT”

• SOME FIRMS PREFER TO SPECIFY THE INVENTORY CARRYING COST IN “RUPEES PER UNIT” IN PLACE OF “ PERCENTAGE FIGURE”.

• IN FACT, FOR CERTAIN ITEMS (THOSE WHICH ARE BULKY, EXPENSIVE OR REQUIRE SPECIAL STORAGE ARRANGEMENTS), IT IS DESIRABLE TO DO SO.

• THE ECONOMIC LOT SIZE FORMULA, IN SUCH A SITUATION, UNDERGOES A SMALL CHANGE AS UNDER –

• Q* = 2 . D . S / C . I

• Ir = INVENTORY HOLDING COST (INVENTORY CARRYING COST

PER UNIT PER YEAR ) = C X I

• SO Q* = 2 . D . S / Ir

103

EOQ MODEL UNDER FINITE (OR NON – INSTANTANEOUS) REPLENISHMENT RATE

• ONE OF THE MAJOR ASSUMPTION OF WILSON FORMULA, AS MENTIONED ABOVE, IS THAT REPLENISHMENT IS INSTANTANEOUS (I.E. ENTIRE ORDER QUANTITY IS DELIVERED AS SOON AS ORDER IS RELEASED WHICH ALSO IMPLIES THAT REPLENISHMENT RATE IS INFINITE).

• IF THIS ASSUMPTION OF CLASSICAL EOQ MODEL IS RELAXED AND REPLENISHMENT RATE IS CONSIDERED TO BE FINITE (STAGGERED DELIVERIES WITH PRODUCTION RATE ‘p’ AND DEMAND RATE ‘d’), IT GIVES RISE TO INVENTORY BUILD UP AS SHOWN BELOW -

ST

OC

K

ORDERQTY

TIME

THIS MODEL IS POPULARLY KNOWN AS“ EOQ MODEL UNDER FINITE ( OR NON – INSTANTANEOUS REPLENISHMENT RATE”

104


• MANY A TIMES, PRODUCTION BATCHES TAKE CONSIDERABLE TIME TO COMPLETE.

• WE MAY NOT, THEREFORE, WAIT FOR THE ENTIRE QUANTITY TO BE COMPLETED BUT TRY TO MEET THE DEMAND WHEN THE BATCH IS BEING PROCESSED.

• A FEW ILLUSTRATIONS ON THE ABOVE ASPECT ARE GIVEN BELOW;

1. A COMPANY MANUFACTURING AUTOMOTIVE WHEELS (EACH AUTOMOTIVE WHEEL CONSISTS OF FOUR COMPONENTS - A RIM, A DISC, A FLANGE AND A LOCK RING ) CAN OPERATE IN EITHER OF THE FOLLOWING TWO WAYS:

a) FIX UP OPERATING LEVELS OF THE DISCS, RIM, FLANGES, AND LOCK RING, WITHDRAW THESE COMPONENTS FROM STORES AS PER NEED, ASSEMBLE COMPONENTS, AND DISPATCH FINISHED PRODUCT TO CUSTOMERS. INVENTORY INVESTMENT UNDER SUCH A CASE UNDOUBTEDLY WILL BE HIGH SINCE DIFFERENT TYPES OF WHEELS VIZ. WHEEL FOR TELCO, LEYLAND, SHAKTIMAN, NISSAN ETC. REQUIRE DIFFERENT SIZE OF DISCS, FLANGES AND LOCK RING.

105


b) SCHEDULE FINAL ASSEMBLY OF A PARTICULAR TYPE OF WHEEL SAY FOR TELCO. INDIVIDUAL PART LINES (DISC, RIM, FLANGE AND LOCK RING LINE) WILL SUPPLY PARTS FOR THE SCHEDULED ASSEMBLY. INVENTORY UNDER THIS METHOD IS THUS VERY SMALL.

c) A COMPANY MANUFACTURING CABLES OF VARIOUS TYPES MAY SCHEDULE CABLES OF PARTICULAR SIZE, PRODUCE ‘P’ BUNDLES PER DAY, SHIP ‘D’ BUNDLES PER DAY, BUILD UP INVENTORY WITH THE DIFFERENCE (P – D) AND SWITCH OVER TO OTHER SIZE WHEN DESIRED INVENTORY OF THE FIRST SIZE HAS BEEN MAINTAINED. IT IS LIKELY THAT THE COMPANY WILL GET ORDERS FOR THE FIRST SIZE WHEN THE SECOND SIZE IS BEING MANUFACTURED. THIS DEMAND WILL BE SATISFIED FROM THE INVENTORY ALREADY BUILD UP FOR THE PURPOSE.

d) A VENDOR MANUFACTURING STANDARD HARDWARE CAN ALSO REAP THE BENEFITS OF THIS MODEL

106


• ASSUMPTIONS UNDERLYING THE MODEL:

i. THE ITEM IS CONSUMED AT THE KNOWN DEMAND RATE WHICH IS CONSTANT.

ii. THE COST TO SETUP A MACHINE (OR A GROUP OF MACHINES) AND ORDER WRITING IS FIXED AND DOES NOT VARY WITH THE LOT SIZE.

iii. THE INVENTORY CARRYING CHARGES VARY DIRECTLY AND LINEARLY WITH THE SIZE OF THE INVENTORY AND ARE GENERALLY EXPRESSED AS A PERCENTAGE OF AVERAGE INVENTORY INVESTMENT.

iv. THE INVENTORY DOES NOT INCREASE BY THE QUANTITY ON THE WORK ORDER BUT RATHER GRADUALLY AT A RATE (P – D) WHERE ‘P’ IS THE PRODUCTION RATE AND ‘D’ IS THE DEMAND RATE. (I.E. NON – INSTANTANEOUS STOCK REPLENISHMENT)

v. THE ITEM CAN BE MANUFACTURED IN DESIRED QUANTITY FREE FROM RESTRICTIONS OF ANY KIND SUCH AS TOOL STAND UP TIME, RISK OF OBSOLESCENCE, SPACE RESTRICTIONS, ETC.

107

GRAPHICAL REPRESENTATION (SKETCH) OF THE MODEL

• REPLENISHMENT OF INVENTORY UNDER THIS SYSTEM, OCCURS OVER THE PERIOD ‘t’ WHILE THE USAGE OCCURS OVER THE ENTIRE CYCLE T.

• THIS GIVES TWO EFFECTS ;

1. IT INCREASES THE ECONOMIC LOT SIZE SINCE THE AVERAGE INVENTORY IS NO LONGER Q* / 2 BUT SOME WHAT LESS THAN THAT (Q*/2).

2. ANNUAL TOTAL COST FOR THE SAME ANNUAL REQUIREMENT IS LESS THAN ANNUAL TOTAL COST UNDER INSTANTANEOUS REPLENISHMENT METHOD.

tT

(p –

d)

t

Y

XTIMEX1 X2

STOCK LEVELS SHOWING NON - INSTANTANEOUS REPLENISHMENT

108


• MATHEMATICAL TREATMENT OF THE MODEL:

• THE SYMBOLS USED ;

• ANNUAL REQUIREMENT OF THE ITEMS (UNITS) = D

• MANUFACTURING COST PER UNIT = C

• SETUP COST PER PRODUCTION RUN = S

• DAILY PRODUCTION RATE (UNITS) = p

• DAILY DEMAND RATE (UNITS) = d

• DURATION OF PRODUCTION RUN (DAYS) = t

• INVENTORY CARRYING COST AS A PERCENTAGE

OF AVERAGE INVENTORY INVESTMENT = I

• QUANTITY PER PRODUCTION RUN = Q

• ECONOMIC MANUFACTURING QUANTITY = Q*

109


• PREPARATION OF THE MODEL :• INVENTORY UNDER THIS SYSTEM BUILDS UP AT THE RATE ( P – D ) AND IS MAXIMUM AT THE END OF PRODUCTION RUN.• MAXIMUM INVENTORY AT THE END OF PRODUCTION RUN = (p – d) t• AVERAGE INVENTORY (UNITS) = (p – d) t / 2• SINCE Q = QUANTITY PRODUCED DURING A PRODUCTION RUN• = p X t• THEREFORE t = Q / P, • SO AVERAGE INVENTORY = (p – d)/2 X Q/p = Q/2 { 1 – d /p }• ANNUAL INVENTORY CARRYING COST = Q/2 {1 – d/p}C.I• ANNUAL SET – UP COST = [ NO. OF PRODUCTION RUN ] X [ SET – UP COST PER PRODUCTION RUN ] = D / Q X S• ANNUAL TOTAL COST (ATC) = = ANNUAL SET UP COST + ANNUAL INVENTORY CARRYING COST = D . S / Q + Q / 2 [ 1 – d / p ] C . I

110


• 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 DECISION VARIABLE Q AND EQUATE THE FIRST DERITIVE TO ZERO .

• d (ATC) / dQ = - D. S / Q² + [ 1 – d / p ] . C. I / 2 = 0

• OR D. S / Q*² = [ 1 – d / p ] C . I / 2

• WHEN d(ATC)/ dQ = 0 THEN Q = Q*

• Q*² = 2 . D . S / [ 1 – d / p ] C . I

• Q* = 2 . D . S / [ 1 – d / p ] C . I

111

EOQ WITH PLANNED BACK LOGGING

• THE SECOND MAJOR ASSUMPTION OF WILSON FORMULA IS THAT NO SHORTAGE (OR NO BACK ORDERING) IS ALLOWED.

• IF THIS ASSUMPTION IS RELAXED (I.E. IF SHORTAGE OR BACK ORDERING IS PERMITTED), THE INVENTORY – BEHAVIOUR WILL BE AS PER FOLLOWING FIGURE -

EO

Q

UNITS BACKORDERED

ST

OC

K

EOQ WITH PLANNED BACKLOGGING

TIME

112


• STOCK OUTS ARE NOT ALWAYS UNDESIRABLE. • IF CUSTOMERS ARE WILLING TO ACCEPT A

BACK ORDER WHEN AN ITEM IS OUT OF STOCK, IT IS ECONOMICAL TO PERMIT STOCKOUT SINCE THE SALE IS NOT LOST.

• UNDER SUCH SITUATION, INVENTORY CAN BE REDUCED.

• IN FACT, THEORETICALLY, THERE IS NO NEED TO CARRY ANY INVENTORY (SINCE THERE IS NO STOCKOUT COST).

• HOWEVER, WE WILL ASSUME THAT EACH UNIT BACK ORDERED CARRIES SOME SHORTAGE COST SO THAT SOME INVENTORY IS DESIRED.

113


• GRAPHICAL REPRESENTATION OF THE MODEL;

STOCKLEVEL

Y

X

Q

t1t2

OUT OFSTOCK ZONE

IN STOCKZONE

GRAPHICAL REPRESENTATION OF AN INVENTORY MODEL WHEN STOCKOUTS (OR BACK ORDERS) ARE PERMITTED.

DEMAND IS MET FROM STOCK DURING PERIOD t1 AND SHORTAGE OCCURS DURING PERIOD t2.WHEN THE FRESH SUPPLY ‘Q’ IS RECEIVED AND BACK ORDERS OF ‘Y’ARE FILLED (I.E. BEING THE DEMAND WHICH COULD NOT BE MET BECAUSE OF STOCKOUT)

114


• ASSUMPTIONS UNDERLYING THE MODEL;1. THE RATE OF DEMAND IS CONSTANT AND THE SAME IS

KNOWN.2. THE LEAD TIME TO PLACE AN ORDER AND PROCESS THE

DELIVERY IS ZERO.3. STOCKOUTS ARE PERMITTED SINCE BACK ORDERS CAN BE

FILLED.4. 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.

5. THE SHORTAGE COST PER UNIT IN THE EVENT OF STOCKOUT IS KNOWN.

6. THE INVENTORY CARRYING CHARGES VARY DIRECTLY AND LINEARLY WITH THE SIZE OF INVENTORY AND ARE GENERALLY EXPRESSED AS A PERCENTAGE OF AVERAGE INVENTORY INVESTMENT.

7. THE ITEM CAN BE MANUFACTURED IN DESIRED QUANTITY FREE FROM RESTRICTIONS OF ANY KIND.

115


• SYMBOLS USED;

• LET D = ANNUAL REQUIREMENT OF THE ITEM (UNITS)

C = COST OR PRICE PER UNIT [ RS.]

Cs= SHORTAGE COST PER UNIT [RS.]

S = SET UP COST PER PRODUCTION RUN

I = INVENTORY CARRYING COST EXPRESSED AS A

PERCENTAGE OF AVERAGE INVENTORY INVESTMENT.

Q = QUANTITY MANUFACTURED PER PRODUCTION RUN.

Q* = EOQ VALUE

• FROM THE ABOVE GRAPH AND THE SYMBOLS THE FORMULA WORKED OUT FOR EOQ IS -

• Q = Q* = [2 . D S / C . I ] X [ C . I + Cs / Cs ]

116

EOQ MODEL WITH QUANTITY DISCOUNTS

117


• THIRD MAJOR ASSUMPTION OF WILSON’S FORMULA IS THAT PRICE PER UNIT IS FIXED IRRESPECTIVE OF ORDER SIZE (I.E. QUANTITY DISCOUNTS ARE NOT AVAILABLE).

• IT IS NOT SO TRUE IN NUMBER OF CASES.• FREQUENTLY, VENDORS OFFER QUANTITY DISCOUNTS ON

BULK PURCHASES TO ENCOURAGE USERS TO PLACE BULK ORDERS IN LARGE QUANTITIES.

• QUANTITY DISCOUNTSS ARE MANY A TIMES DECEPTIVE.• THE IMMEDIATE REACTION MAY BE AVAIL DISCOUNT AND

PLACE BULK ORDERS BUT IF TOTAL DISCOUNT COST INCLUDING MATERIAL COST IS ANALYSED THE DECISION MAY BE OTHERWISE.

• QUANTITY WHICH MAY BE SINGLE OR MULTIPLE GIVE RISE TO YET ANOTHER EOQ MODEL CALLED “EOQ WITH QUANTITY DISCOUNTS”.

118


• ECONOMIC ORDER QUANTITY FORMULA ESTABLISHED UNDER THE BASIC EOQ MODEL IS BASED ON THE ASSUMPTION THAT THE PRICE PER UNIT IS FIXED IRRESPECTIVE OF THE QUANTITY ORDERED.

• THAT IS WHY TOTAL COST FUNCTION THEN ASSUMED TO BE UNIFORMLY CONTINUOUS.

• HOWEVER, 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 STEOWISE CONTINUOUS.

• THIS IMPLIES THAT IN ORDER TO ESTABLISH OPTIMUM QUANTITY, WE MUST INVESTIGATE ALL LOCAL MINIMUMS

(GLOBAL MINIMA) SOME OF WHICH MAY OCCUR AT PRICE BREAK LEVEL WHILE OTHERS MAY OCCUR WITHIN A PRICE RANGE.

119


• IN LIEU OF STEPWISE CONTINUOUS NATURE OF THE TOTAL COST FUNCTION, WHILE MAKING COMPARISON ON THE BASIS OF ANNUAL TOTAL COST, WE MUST ALSO CONSIDER MATERIAL COST IN THE COST CALCULATION.

• THEREFORE THE GENERAL FORMULA FOR THE ANNUAL TOTAL COST BECOMES;

• ATC = D X C + D / Q X S + Q / 2 X C X I • THE STEPS IN THE COMPUTATIONAL PROCEDURE UNDER THIS

METHOD ARE AS FOLLOWS;

1. CALCULATE EOQ AT DIFFERENT PRICE LEVELS.

2. DECIDE THE QUANTITY TO BE PURCHASED AT EACH PRICE LEVEL. (THIS EQUALS EOQ OR PRICE BREAK QUANTITY. THE LATTER BEING NECESSARY IF EOQ AT A PARTICULAR PRICE LEVEL WORKS OUT TO BE LOWER THAN CORRESPONDING PRICE BREAK QUANTITY)

3. CALCULATE ANNUAL TOTAL COST AT THE QUANTITIES FIXED UNDER STEP (2)

4. SELECT AN OPTIMAL PURCHASE QUANTITY, THIS BEING ONE WHICH ENTAILS THE LOWEST ANNUAL TOTAL COST.

120

AN ILLUSTRATION ON THE EOQ MODEL WITH PRICE (DISCOUNTS)

• A MANUFACTURER ELECTRIC MOTORS REQIURES A SPECIAL ROLLER BEARINGS AT THE RATE OF 300 NOS. PER YEAR. EACH BEARING COSTS THE COMPANY RS. 360 / - . THE PROCUREMENT COST AND INVENTORY CARRYING COST HAVE BEEN CALCULATED AT RS. 30 AND 20 % RESPECTIVELY.

• IF SUPPLIER OFFERS A DISCOUNT OF RS. 36 / - PER BEARING ON AN ORDER OF 200 OR ABOVE, SHOULD HIGHER QUANTITY BE PURCHASED ?

• SOLUTION ; • FROM THE DATA GIVEN ABOVE ;• D = ANNUAL CONSUMPTION = 300 NOS.• S = PROCUREMENT COST PER ORDER = RS. 30 /-• C1 = BASIC PRICE PER UNIT = RS. 360 /- • C2 = DISCOUNTED PRICE PER UNIT = 324 /- • I = INVENTORY CARRYING COST = 0.20• THE ABOVE PRICES ARE VALID FOR QUANTITY - PRICE - RANGE OF QTY. • RS. 360 0< Q < 200• RS. 324 200 ≤ Q

121


• STEP 1 ; CALCULATE EOQ AT DIFFERENT PRICE LEVELS.• EOQ AT THESE TWO PRICES HAVE BEEN COMPUTED AND TABULATED

BELOW ;

PRICE EOQ QTY. TO BE PURCHASED AT THE INDICATED PRICE

RS. 360 = √ [2.D . S / C1 . I ]

= √ [ 2 . 300 . 30 / 360 . 0.20 ]

= 5050

RS. 324 = √ [ 2 . D S / C2 . I ]

= √ [ 2 . 300 . 30 / 324 . 0.20 ]

= 51

200

•STEP 2 ; DETERMINE THE QUANTITY TO BE PURCHASED AT EACH PRICE LEVEL. THIS EQUALS EOQ OR PRICE – BREAK QUANTITY, THE LATTER BEING NECESSARY IF EOQ AT PARTICULAR PRICE LEVEL WORK OUT TO BE LOWER THAN CORRESPONDING PRICE BREAK QUANTITY. THESE HAVE BEEN ENTERED IN COLUMN 3 OF ABOVE TABLE.

122


• STEP 3 ; CALCULATE ANNUAL TOTAL COST AT THE

QUANTITITES FIXED UNDER STEP 2.• TABLE BELOW SHOWS ANNUAL TOTAL COST CALCULATIONS

WHICH ARE SELF EXPLAINATORY.

S. NO. COST ELEMENTS

ORDER QUANTITY

50 200

1 ANNUAL COST OF MATERIALS

D X C300 X 360 = 108000 300 X 324 = 97200

2 ANNUAL PROCUREMENT COST

[ D / Q X S ] 300 X 30 / 50 = 180 300 X 30 / 200 = 45

3 ANNUAL INVENTORY CARRYING COST

[ 1/2 X Q X C X I ]

1 / 2 X 50 X 360 X 0.2

= 1800

1 / 2 X 200 X 324 X 0.20

= 6480

4 ANNUAL TOTAL COST

1 + 2 + 3RS. 109980 RS. 103725

STEP 4 . SELECT AN OPTIMAL PURCHASE QUANTITIES FROM THE ANNUAL TOTAL COST FIGURES CALCULATED ABOVE WE FIND 200 QUANTITY INCURRED LEAST TOTAL COST. SO - EOQ = 200

3 - inventory control

Documents