Production and Operations Management

Module 5: Materials management

Scope of materials management1. Amount of materials is high compared to other inputs . and it is increasing year to year.

Proper materials management is key to the survival and growth of the company.2. Cost of materials could be as high as 70-75% of the cost of the product in engineering

industries. In other industries it could be between 40- 60 % . Hence reduction in the cost of materials plays an important role in the profitability of a company

3. Materials form a important part of current assets of the organization. Its proper utilization is vital for ROI ( return on Investment)

4. Added value of a product = Value of produced goods- value of materials purchased. It is imperative that not only that purchase cost of materials are to be low but also expenses incurred in purchasing, storing, handling should be as low as possible.

5. Quality of end product depends on quality of input materials. Hence it is important that right quality of products are to be procured at right time. Giving detailed description of requirements to supplier in the Purchase order ensures the same.

6. Materials management is one of the Key centers of accountability for performance. It includes purchasing, handling of materials, maintaining appropriate inventory levels and ensuring storage conditions.

7. Minimizing the use of scarce resources and finding alternatives8. Ensuring safety during handling and storage of hazardous materials and compiling with

regulatory requirements9. Efficiency of business depends on ensuring right quality of materials in right quantity ant

the right time. Otherwise it hampers the production to a great extent. Cost of production shoots up.

Primary Objective of materials management 1. Low prices- to be lowest - includes transportation: enhances profit 2. High inventory Turnover- value of inventories to be low in relation to sales. Reduces

storage costs3. Low cost acquisition and possession- reduced handling and storage costs. 4. Continuity of supply- alternative sources, , captive suppliers, flexible suppliers5. Low payroll costs- Low operating costs of material management personnel6. Favorable supplier relations- supplier development

Secondary objectives of Materials management1. New materials and products- working closely with Design and research departments for

development of new materials and products2. Economic make-buy- Coordinating and assisting other departments in Make-Buy

decisions3. Standardization- coordinating with Design departments in reducing no. of items. 4. Product improvement- Contribution towards product improvement by giving appropriate

inputs and assisting Design department.

5. Interdepartmental Harmony- Success of materials management department depends on the success of other departments . hence relations are to be harmonious

6. Forecasts- Forecasts in terms of prices, availability and general market conditions are to be regularly monitored towards taking important business decisions.

Functions of Materials Management1. Purchasing2. Vendor selection and rating3. Material storage and handling4. Inventory management

Purchasing:Objectives of Purchasing;

1. To pay reasonably low prices for best value of products2. To keep inventories low3. To develop satisfactory sources of supply4. To secure good vendor performance 5. To locate new materials or products as required6. To develop good purchasing policies and procedures7. To implement programs like value analysis , cost analysis and make-or-buy decisions8. To keep overheads of the department Low.9. To have a high degree of coordination with other departments

Main Functions of Purchasing department1. Selection of vendors2. Obtaining quotations/prices3. Awarding purchase orders4. Follow-up for delivery5. Handling complaints , if any6. Supplier development/ vendor relations7. Payment of invoices

Other functions of purchase department ( in coordination with other departments)1. Establishing specifications2. Scheduling orders3. Inspection 4. Accounting5. Market research6. Inventory policy7. Sale of scrap 8. Customs clearances ( during import of materials)9. Transportation10. Make-or-buy decisions

Steps in Purchasing 1. Receipt of Purchase requests ( qty, delivery, item description)2. Development Purchase specifications 3. Obtaining quotations from sources4. Selection of source 5. Release of purchase order and acceptance by supplier ( technical and commercial terms)6. Follow up for receipt7. Checking invoice and approval for payment

Vendor / supplier selection is based on the following considerations

1. Availability of Infrastructure ( equipment, building, inspection facilities etc)2. Availability of human resources ( managerial, workers, Inspectors)3. Technical capability4. Meeting delivery requirements5. Reasonable prices6. Flexibility to take up variations in demand7. Willing to work and grow with the company

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

Single source or Multiple sourcesSingle source:

1. Quantities may be very small for multiple sources2. Supplier may be exclusive ( eg patent) 3. Supplier is outstanding in quality and delivery and no need to consider others4. Ordering and scheduling is very easy and less costly

Multiple sources:1. Suppliers will be competitive2. Delivery disruptions cannot be sustained (because of Breakdowns , strike, floods etc)3. Quantities too huge for one supplier4. Scheduling flexibility

Vendor rating

Vendor rating is carried out periodically (once in 6 months / 12 months ) to gauge the performance of the approved supplier and to intimate him regarding improvement if needed. Suppliers may be classified as( example)A-good > 80% B-satisfactory > 60 and < 80%C-unsatisfactory < 60%

If the performance is not satisfactory , supplier may be given a chance to improve. If the supplier still falls under not satisfactory category, the supplier may be considered for removal from approved suppliers list

Some of the criteria for Vendor rating ( weightages may be given for the criteria )1. Quality of products received2. Delivery performance3. Price of product4. Flexibility in meeting demand fluctuations5. Assistance in Product development6. Cost reduction suggestions7. Implementation of Inventory plans / JIT system8. Credit terms9. Management competence10. Financial position

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

Supplier data Supplier A Supplier BQuantity supplied 108 90Quantity accepted 102 90Price Rs 1 Rs 1.2Delivery promised 3 weeks 4 weeksActual delivery 2.7 weeks 5 weeksResponse to suggestions 90% 85%Solution:

# description Supplier A Supplier B1 Percentage accepted ( quality

ratio)102/108 x 100 =94.4% 90/90 x 100 = 100%

2 Quality rating 94.4 x 50 /100 =47.2% 100 x 50/100 = 50 %3 Delivery against promise 3/2.7 x 100=111.11% 4/5 x 100=80%4 Delivery rating 111.11 x

25/100=27.77%80 x 25/100 =20%

5 Price ratio ( in percentage )= lowest price/supplier price X 100

1/1 x 100 =100% 1/1.2 x 100=83.33%

6 Price rating 100 x 15/100= 15% 83.33 x 15/100 =12.50%

7 Response to suggestions rating 90 x 10/100= 9% 85 x 10/100= 8.5%8 Total 98.97% 91%

Supplier A is better.

Stores management

Functions of stores management1. To receive materials and account for them2. To provide adequate and proper storage various materials3. To ensure proper identification4. To preserve product from deterioration 5. To receive indents from consuming departments , issue and maintain accounts6. To minimize obsolescence by stock rotation ( FIFO method) especially shelf life items7. To highlight stock accumulation, discrepancies and abnormal consumption8. Ensure good house keeping9. To ensure efficient material handling10. To verify stock periodically

Stores layout is critical to good stores management. It should have:1. Adequate storage areas2. Good lighting3. Good material handling equipments4. Safety provisions 5. Areas marked for receipt of material, inspection areas and area for rejected goods6. Easy access to all storage areas7. Storage areas are clearly identified for quick location and fast service8. Good usage of floor space and heights9. Secure areas for costly items to prevent theft, pilferage.

Stock verification is conducted to verify the physical stock against book stock. If the discrepancies are less , it indicates good stores management.Types of stock verification: Periodic verification- stock is verified once in 6 months or 12 months. Receipts and issues

are closed and all materials are checked physically. Continuous verification- materials are divided into 52 groups and physical stock is checked

weekly. This will distribute the stock verification burden over the complete year.

Proper classification and codification of various items helps in management of stores in an efficient way. It reduces duplication and enables reduction in sizes and verities.

Some broad classifications are – raw materials, parts, spares, tools, packing materials, hardware

Inventory ManagementInventory is the materials stocked in order to meet an unexpected demand or distribution in the future. The materials may include Raw materials, Materials in –process, Finished goods, spares, Tools and others.

Level of inventories depend on :

1. Nature of product 2. Nature of customer demand3. Lead times for manufacturing4. Lead times for procurement5. Consumption pattern6. Shelf life of product

Purpose of holding Inventories :1. Meeting delivery requirements2. Better utilization of manpower and equipment3. flexibility in scheduling

Carrying Inventories costs money. It increases production cost.

Inventory costs are : Ordering costs - preparation of purchase order, processing payments, Receiving and

inspection Carrying costs- deterioration, pilferage, taxes, insurance, storage, Interest Capital costs-space, buildings, equipments Storage space costs- rent, power, maintenance Service costs- salaries of employees, bonus, security, Record keeping, Overtime Looses- pilferage, damages, expired products

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

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

purchasing and transport

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

Factors influencing Inventory management and control:1. Type of product – if the unit cost is high , closer control is needed. Short supply may

have to be stocked more. custom built products may have to be stocked more. Standard products may be stocked less.

2. Type of Manufacture - stock out situation should not be allowed to occur. Batch production and intermittent manufacture allows greater flexibility in inventory control.

3. Volume of production – inventory may not increase with volume of production. If products have many components then inventory required may be high.

4. Others- objective of the company, supplier capabilities, information systems, capabilities of personnel

Benefits of Inventory management and control:1. Ensures adequate supply of materials and minimizes stock out situations2. Reduces costly interruptions in production3. Keeps down investment in inventories and inventory costs4. Bring in purchasing economies by monitoring consumption5. Better utilization of stocks of common materials for various departments6. Better accountability7. enables identification of obsolete items and their disposition8. enables reliable and consistent financial statements

Steps in inventory management and control:

1. Determination of optimum inventory levels- too much inventory blocks capital. Less inventory may result in production interruptions. Consumption trends and sales trends offer inputs for fixing the inventory levels. Inventory levels have to be reviewed periodically and adjusted as necessary.

2. Determine degree of control – normally based on value of item. ABC analysis is made and a class items are controlled closely for variations in consumption , stock, record keeping and review. ( A- high value, low , C- low value, high quantities)

3. Plan and design inventory system- a. Fixed Quantity system

Time

Inventory

EO Q Re order

level

Safety stock

Maximum level

Lead time

b Fixed period system

4. Organise structure to manage inventory- responsibility for inventory control, monitoring, keeping records, handling exceptions, raising requests etc ( normally production planning and control)

Inventory control techniques ABC classification- based on identification of “vital few” from ”trivial many”. And

controlling the vital few whose rupee value is high. Steps in classification is as follows;o List each item carried in inventoryo Determine annual volume and Rupee value of each itemo Calculate product of annual volume and rupee valueo Compute percentage of each item in terms of total inventory in rupeeso Select top 10% of all items which has the highest rupee percentages and

catagorise as ‘A ‘ itemso Select next 20% of all items which has the highest rupee percentages and

catagorise as ‘B‘ itemso Select next 70% of all items which has the highest rupee percentages and

catagorise as ‘C ‘ items

VED analysis ( effect on production)– V-vital, E- essential, D- desirable SDE analysis ( based on availability)- S=scarce, D-Difficult, E-easy FSN analysis ( based on consumption)- F-fast moving, S-slow moving, N- non moving Economic order quantity- EOQ is based on

TC=DC +D/Q x S + Q/ 2 x HTC = Total costD=Annual demandC= purchase cost per unitQ =quantity to be ordered ( EOQ)

Replenishment level

Fixed periods

Inventory

S= cost of placing orderH= holding cost per unit

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

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

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

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

Material requirement Planning ( MRP)For large firms with many different products and products with many components it is accurate and fast to use a soft ware for material planning purposes. MRP is such a software . Inputs to MRP are : Production plan with products, Quantities and delivery requirements Existing stock levels of various components Bill of materials ( BOM) – a list of components that make up the product. They may be

brought out, made in house or subcontracted. Purchasing information – products , suppliers and agreed prices Processing information – Production sequence, equipments, production rates

Outputs from MRP are : Purchase orders on suppliers with Quantities and delivery dates Production schedule

Just in time ( JIT)The concept originated in japan and adopted by many companies in India.

As a concept , JIT means materials arrive on time and no inventories are held at any time. Either in raw materials, WIP or finished goods. Materials are pulled in to the system. JIT system ensures great efficiency in production To ensure a good JIT system the following are essential:

Reliable suppliers Good processes with least rejections Break downs of equipment to be very less Continuous flow of materials with no bottle necks Low set uptimes

Benefits of JIT are: Faster through put time Less or no storage place Visual control and enhanced quality Greatly reduced production cost Constant flow of Finished goods to customers

Enterprise Resource Planning ( ERP)Enterprise Resource planning is similar to MRP . It can do what MRP can do and much more. ERP is very useful for planning and controlling activities in a very large firm with very many products and operations are carried out in many locations including many countries.

MRP

Purchase orders

Customer orders / production Plan

Bill of MaterialsInventory

Production Schedules

Purchase information Processing

information

ERP system can handle many functions and comes in modules, each of these can be individually used or together . normally the modules are:

1. Sales and marketing2. Materials 3. Production 4. Financial5. Human resources

Inputs to ERP are : Production plan with products, Quantities and delivery requirements Existing stock levels of various components Bill of materials ( BOM) – a list of components that make up the product. They may be

brought out, made in house or subcontracted. Purchasing information – products , suppliers and agreed prices Processing information – Production sequence, equipments, production rates Sales information Human resource information Accounting information

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

Benefits of ERP are:Tangible benefits:

Reduction of lead time for manufacture Improvement in delivery performance Increased Inventory turn over

Intangible benefits: Better customer satisfaction Improved supplier performance Reduced Quality costs Improved resource utilization Speed and accuracy of information Better decision making capability

Information systems for Material management:

Effectiveness of Materials management function is greatly enhanced if supported by good information system. Some of the information computer system can provide are : Purchasing

o Automatic release of orders on approved partieso Status of receipt ( dates, Quantities, acceptance details)o Vendor ratingo Payments to vendorso Handling of complaints and corrective actionso Vendor Audit and action taken

Inventory controlo Number and value of items in inventoryo Trends of consumptiono Fast moving, slow moving, and non-moving itemso FIFO control ( First- in –first-out)o ABC analysiso Inventory trends ( weekly, monthly etc)

Measurementso Inventory carrying costso Inventory turnso Stock out or incidences of going below safety levelso Over stock situations

Value Analysis / Value EngineeringValue analysis refers to the managerial activity which deals with study of existing products and its components with the objective of reducing the cost and retaining its value or function. This is done by a team of people comprising of , normally, Design, purchase, Methods engineering.Value analysis is done on products which in market but loosing to competitors on price.The following are the steps followed;

Analysis of function of each component to check its contribution using less expensive material for same function Combining components to reduce cost Use of standard parts Taking ideas from suppliers

Problem1 : ABC analysis

# Unit price( Rs) Consumption Annual value %1 1.5 2000 3000 0.3352 7.5 400 3000 0.3353 20 3500 70, 000 7.826 A4 80 800 64,000 7.155 A

5 4 2000 8000 0.8946 65 500 32, 500 3.6337 15 750 11, 250 1.2578 22 800 17, 600 1.9679 0.5 2000 1000 0.11110 3 600 1800 0.20111 2.5 2000 5000 0.55912 17.5 1500 26250 2.93413 22 1000 22, 000 2.45914 45 2500 1, 12, 500 12.578 A15 350 600 2, 10, 000 23.479 A16 30 3500 1, 05, 000 11.739 A17 45 700 31, 500 3.52118 115 200 23, 000 2.57119 260 450 1, 17, 000 13.081 A20 15 2000 30, 000 3.354

8, 94, 400

Problem 2 : computation of EOQ No. of tires sold= 9600 Annual carrying cost is Rs 16 Ordering cost is Rs 75Compute EOQ, total cost

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

Problem 3 ; inventory carrying cost

Average inventory = 60 lakhs Salaries o stores personnel=Rs 2, 75, 000 Cost of security =Rs 80, 000 Taxes and insurance = 1% of inventory Interest rate =20% p.a. Handling of inventory= Rs 1, 50, 000 Lost / damage= Rs 20, 000Compute inventory carrying cost as a percentage of value of inventory

Total cost = 2, 75, 000 + 80, 000 + 60, 000 (1/ 100 x 60,00, 000) + 12, 00, 000 ( 20/100 X 60,00,000) + 1, 50, 000 + 20, 000 = 17, 85, 000.

Inventory carrying cost as a % of Inventory = 17, 85, 000 / 60,00,000 X 100 = 29.75%