Notes Pom Module 5

Production and Operations Management Module 5: Materials management Scope of materials management 1. Amount of materials is high compared to other inputs . and it is increasing year to year. Proper materials management is key to the survival and growth of the company. 2. Cost of materials could be as high as 70-75% of the cost of the product in engineering industries. In other industries it could be between 40- 60 % . Hence reduction in the cost of materials plays an important role in the profitability of a company 3. Materials form a important part of current assets of the organization. Its proper utilization is vital for ROI ( return on Investment) 4. Added value of a product = Value of produced goods- value of materials purchased. It is imperative that not only that purchase cost of materials are to be low but also expenses incurred in purchasing, storing, handling should be as low as possible. 5. Quality of end product depends on quality of input materials. Hence it is important that right quality of products are to be procured at right time. Giving detailed description of requirements to supplier in the Purchase order ensures the same. 6. Materials management is one of the Key centers of accountability for performance. It includes purchasing, handling of materials, maintaining appropriate inventory levels and ensuring storage conditions. 7. Minimizing the use of scarce resources and finding alternatives 8. Ensuring safety during handling and storage of hazardous materials and compiling with regulatory requirements 9. Efficiency of business depends on ensuring right quality of materials in right quantity ant the right time. Otherwise it hampers the production to a great extent. Cost of production shoots up. Primary Objective of materials management 1. Low prices- to be lowest - includes transportation: enhances profit 2. High inventory Turnover- value of inventories to be low in relation to sales. Reduces storage costs 3. Low cost acquisition and possession- reduced handling and storage costs. 4. Continuity of supply- alternative sources, , captive suppliers, flexible suppliers 5. Low payroll costs- Low operating costs of material management personnel 6. Favorable supplier relations- supplier development Secondary objectives of Materials management 1. New materials and products- working closely with Design and research departments for development of new materials and products 2. Economic make-buy- Coordinating and assisting other departments in Make-Buy decisions 3. Standardization- coordinating with Design departments in reducing no. of items. 4. Product improvement- Contribution towards product improvement by giving appropriate inputs and assisting Design department.

5. Interdepartmental Harmony- Success of materials management department depends on the success of other departments . hence relations are to be harmonious 6. Forecasts- Forecasts in terms of prices, availability and general market conditions are to be regularly monitored towards taking important business decisions. Functions of Materials Management 1. Purchasing 2. Vendor selection and rating 3. Material storage and handling 4. Inventory management Purchasing: Objectives of Purchasing; 1. To pay reasonably low prices for best value of products 2. To keep inventories low 3. To develop satisfactory sources of supply 4. To secure good vendor performance 5. To locate new materials or products as required 6. To develop good purchasing policies and procedures 7. To implement programs like value analysis , cost analysis and make-or-buy decisions 8. To keep overheads of the department Low. 9. To have a high degree of coordination with other departments Main Functions of Purchasing department 1. Selection of vendors 2. Obtaining quotations/prices 3. Awarding purchase orders 4. Follow-up for delivery 5. Handling complaints , if any 6. Supplier development/ vendor relations 7. Payment of invoices Other functions of purchase department ( in coordination with other departments) 1. Establishing specifications 2. Scheduling orders 3. Inspection 4. Accounting 5. Market research 6. Inventory policy 7. Sale of scrap 8. Customs clearances ( during import of materials) 9. Transportation 10. Make-or-buy decisions

Steps in Purchasing 1. Receipt of Purchase requests ( qty, delivery, item description) 2. Development Purchase specifications 3. Obtaining quotations from sources 4. Selection of source 5. Release of purchase order and acceptance by supplier ( technical and commercial terms) 6. Follow up for receipt 7. Checking invoice and approval for payment Vendor / supplier selection is based on the following considerations 1. 2. 3. 4. 5. 6. 7.

Availability of Infrastructure ( equipment, building, inspection facilities etc) Availability of human resources ( managerial, workers, Inspectors) Technical capability Meeting delivery requirements Reasonable prices Flexibility to take up variations in demand Willing to work and grow with the company

Normally suppliers are selected on the basis of few trail orders . if the performance is satisfactory , they are included in approved supplier list and future purchase orders are placed on them. Single source or Multiple sources Single source: 1. Quantities may be very small for multiple sources 2. Supplier may be exclusive ( eg patent) 3. Supplier is outstanding in quality and delivery and no need to consider others 4. Ordering and scheduling is very easy and less costly Multiple sources: 1. Suppliers will be competitive 2. Delivery disruptions cannot be sustained (because of Breakdowns , strike, floods etc) 3. Quantities too huge for one supplier 4. Scheduling flexibility Vendor rating Vendor rating is carried out periodically (once in 6 months / 12 months ) to gauge the performance of the approved supplier and to intimate him regarding improvement if needed. Suppliers may be classified as( example) A-good > 80% B-satisfactory > 60 and < 80% C-unsatisfactory < 60%

If the performance is not satisfactory , supplier may be given a chance to improve. If the supplier still falls under not satisfactory category, the supplier may be considered for removal from approved suppliers list Some of the criteria for Vendor rating ( weightages may be given for the criteria ) 1. Quality of products received 2. Delivery performance 3. Price of product 4. Flexibility in meeting demand fluctuations 5. Assistance in Product development 6. Cost reduction suggestions 7. Implementation of Inventory plans / JIT system 8. Credit terms 9. Management competence 10. Financial position Problems Calculate vendor rating with the data below and indicate which supplier is better Weightages for Quality=50; delivery=25; price =15 : response to suggestions = 10 Supplier data Quantity supplied Quantity accepted Price Delivery promised Actual delivery Response to suggestions Solution: # 1 2 3 4 5

Supplier A 108 102 Rs 1 3 weeks 2.7 weeks 90%

description Percentage accepted ( quality ratio) Quality rating Delivery against promise Delivery rating

Supplier B 90 90 Rs 1.2 4 weeks 5 weeks 85%

Supplier A 102/108 x 100 =94.4%

Supplier B 90/90 x 100 = 100%

94.4 x 50 /100 =47.2% 3/2.7 x 100=111.11% 111.11 x 25/100=27.77% 1/1 x 100 =100%

100 x 50/100 = 50 % 4/5 x 100=80% 80 x 25/100 =20%

6

Price ratio ( in percentage )= lowest price/supplier price X 100 Price rating 100 x 15/100= 15%

7 8

Response to suggestions rating Total

Supplier A is better.

90 x 10/100= 9% 98.97%

1/1.2 x 100=83.33% 83.33 x 15/100 =12.50% 85 x 10/100= 8.5% 91%

Stores management Functions of stores management 1. To receive materials and account for them 2. To provide adequate and proper storage various materials 3. To ensure proper identification 4. To preserve product from deterioration 5. To receive indents from consuming departments , issue and maintain accounts 6. To minimize obsolescence by stock rotation ( FIFO method) especially shelf life items 7. To highlight stock accumulation, discrepancies and abnormal consumption 8. Ensure good house keeping 9. To ensure efficient material handling 10. To verify stock periodically Stores layout is critical to good stores management. It should have: 1. Adequate storage areas 2. Good lighting 3. Good material handling equipments 4. Safety provisions 5. Areas marked for receipt of material, inspection areas and area for rejected goods 6. Easy access to all storage areas 7. Storage areas are clearly identified for quick location and fast service 8. Good usage of floor space and heights 9. Secure areas for costly items to prevent theft, pilferage. Stock verification is conducted to verify the physical stock against book stock. If the discrepancies are less , it indicates good stores management. Types of stock verification: • Periodic verification- stock is verified once in 6 months or 12 months. Receipts and issues are closed and all materials are checked physically. • Continuous verification- materials are divided into 52 groups and physical stock is checked weekly. This will distribute the stock verification burden over the complete year. Proper classification and codification of various items helps in management of stores in an efficient way. It reduces duplication and enables reduction in sizes and verities. Some broad classifications are – raw materials, parts, spares, tools, packing materials, hardware

Inventory Management Inventory is the materials stocked in order to meet an unexpected demand or distribution in the future. The materials may include Raw materials, Materials in –process, Finished goods, spares, Tools and others. Level of inventories depend on : 1. 2. 3. 4. 5. 6.

Nature of product Nature of customer demand Lead times for manufacturing Lead times for procurement Consumption pattern Shelf life of product

Purpose of holding Inventories : 1. Meeting delivery requirements 2. Better utilization of manpower and equipment 3. flexibility in scheduling Carrying Inventories costs money. It increases production cost. Inventory costs are : • Ordering costs - preparation of purchase order, processing payments, Receiving and inspection • Carrying costs- deterioration, pilferage, taxes, insurance, storage, Interest • Capital costs-space, buildings, equipments • Storage space costs- rent, power, maintenance • Service costs- salaries of employees, bonus, security, Record keeping, Overtime • Looses- pilferage, damages, expired products Inventory carrying costs per year may be 20-30% of the value of Inventory. Because of high costs involved in inventories proper management and control assumes importance . Inventory management involves; • Development of policies, systems and procedures • Administration of policies, systems and procedures • Close interaction with other functions like customer service, production scheduling, purchasing and transport Inventory control pertains only to administration of policies, systems and procedures

Factors influencing Inventory management and control: 1. Type of product – if the unit cost is high , closer control is needed. Short supply may have to be stocked more. custom built products may have to be stocked more. Standard products may be stocked less. 2. Type of Manufacture - stock out situation should not be allowed to occur. Batch production and intermittent manufacture allows greater flexibility in inventory control. 3. Volume of production – inventory may not increase with volume of production. If products have many components then inventory required may be high. 4. Others- objective of the company, supplier capabilities, information systems, capabilities of personnel Benefits of Inventory management and control: 1. Ensures adequate supply of materials and minimizes stock out situations 2. Reduces costly interruptions in production 3. Keeps down investment in inventories and inventory costs 4. Bring in purchasing economies by monitoring consumption 5. Better utilization of stocks of common materials for various departments 6. Better accountability 7. enables identification of obsolete items and their disposition 8. enables reliable and consistent financial statements Steps in inventory management and control: 1. Determination of optimum inventory levels- too much inventory blocks capital. Less inventory may result in production interruptions. Consumption trends and sales trends offer inputs for fixing the inventory levels. Inventory levels have to be reviewed periodically and adjusted as necessary. 2. Determine degree of control – normally based on value of item. ABC analysis is made and a class items are controlled closely for variations in consumption , stock, record keeping and review. ( A- high value, low , C- low value, high quantities) 3. Plan and design inventory systema. Fixed Quantity system Maximum level I n E v OQ e Re order n level t o Safety r stock y Lead time

b Fixed period system

Time

Replenishment level

I n v e n t o r y Fixed periods

4. Organise structure to manage inventory- responsibility for inventory control, monitoring, keeping records, handling exceptions, raising requests etc ( normally production planning and control) Inventory control techniques • ABC classification- based on identification of “vital few” from ”trivial many”. And controlling the vital few whose rupee value is high. Steps in classification is as follows; o List each item carried in inventory o Determine annual volume and Rupee value of each item o Calculate product of annual volume and rupee value o Compute percentage of each item in terms of total inventory in rupees o Select top 10% of all items which has the highest rupee percentages and catagorise as ‘A ‘ items o Select next 20% of all items which has the highest rupee percentages and catagorise as ‘B‘ items o Select next 70% of all items which has the highest rupee percentages and catagorise as ‘C ‘ items • • • •

VED analysis ( effect on production)– V-vital, E- essential, D- desirable SDE analysis ( based on availability)- S=scarce, D-Difficult, E-easy FSN analysis ( based on consumption)- F-fast moving, S-slow moving, N- non moving Economic order quantity- EOQ is based on TC=DC +D/Q x S + Q/ 2 x H TC = Total cost D=Annual demand

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

: Q= Sq Rt ( 2DS/H )

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

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

•

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

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

Customer orders / production Plan

Purchase information

Processing information

Inventory

MRP

Purchase orders

•

Bill of Materials

Production Schedules

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

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

ERP system can handle many functions and comes in modules, each of these can be individually used or together . normally the modules are: 1. Sales and marketing 2. Materials 3. Production 4. Financial 5. Human resources Inputs to ERP are : • Production plan with products, Quantities and delivery requirements • Existing stock levels of various components • Bill of materials ( BOM) – a list of components that make up the product. They may be brought out, made in house or subcontracted. • Purchasing information – products , suppliers and agreed prices • Processing information – Production sequence, equipments, production rates • Sales information • Human resource information • Accounting information

Main vendors of ERP are SAP, Oracle, Microsoft. It may take 1-2 years to put all the inputs and get the ERP online. Once the ERP is on line., all transactions are input into ERP system on a daily basis and decisions are taken as per recommendations of the system . With ERP system, the speed of transactions , accuracy and availability of information to various persons for taking decisions are greatly improved. Productivity of personnel is greatly improved. Benefits of ERP are: Tangible benefits: • Reduction of lead time for manufacture • Improvement in delivery performance • Increased Inventory turn over Intangible benefits: • Better customer satisfaction • Improved supplier performance • Reduced Quality costs • Improved resource utilization • Speed and accuracy of information • Better decision making capability

Information systems for Material management: Effectiveness of Materials management function is greatly enhanced if supported by good information system. Some of the information computer system can provide are : • Purchasing o Automatic release of orders on approved parties o Status of receipt ( dates, Quantities, acceptance details) o Vendor rating o Payments to vendors o Handling of complaints and corrective actions o Vendor Audit and action taken • Inventory control o Number and value of items in inventory o Trends of consumption o Fast moving, slow moving, and non-moving items o FIFO control ( First- in –first-out) o ABC analysis o Inventory trends ( weekly, monthly etc) •

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

Value Analysis / Value Engineering Value analysis refers to the managerial activity which deals with study of existing products and its components with the objective of reducing the cost and retaining its value or function. This is done by a team of people comprising of , normally, Design, purchase, Methods engineering. Value analysis is done on products which in market but loosing to competitors on price. The following are the steps followed; • Analysis of function of each component to check its contribution • using less expensive material for same function • Combining components to reduce cost • Use of standard parts • Taking ideas from suppliers Problem1 : ABC analysis # 1

Unit price( Rs) 1.5

Consumption 2000

Annual value 3000

% 0.335

2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

7.5 20 80 4 65 15 22 0.5 3 2.5 17.5 22 45 350 30 45 115 260 15

400 3500 800 2000 500 750 800 2000 600 2000 1500 1000 2500 600 3500 700 200 450 2000

3000 70, 000 64,000 8000 32, 500 11, 250 17, 600 1000 1800 5000 26250 22, 000 1, 12, 500 2, 10, 000 1, 05, 000 31, 500 23, 000 1, 17, 000 30, 000 8, 94, 400

0.335 7.826 7.155 0.894 3.633 1.257 1.967 0.111 0.201 0.559 2.934 2.459 12.578 23.479 11.739 3.521 2.571 13.081 3.354

A A

A A A A

Problem 2 : computation of EOQ • No. of tires sold= 9600 • Annual carrying cost is Rs 16 • Ordering cost is Rs 75 Compute EOQ, total cost EOQ = SQRT (( 2 x D x S )/ H )= SQRT (( 2 x 9600 x 75 ) /16 )= 300 tires Problem 3 ; inventory carrying cost • Average inventory = 60 lakhs • Salaries o stores personnel=Rs 2, 75, 000 • Cost of security =Rs 80, 000 • Taxes and insurance = 1% of inventory • Interest rate =20% p.a. • Handling of inventory= Rs 1, 50, 000 • Lost / damage= Rs 20, 000 Compute inventory carrying cost as a percentage of value of inventory Total cost = 2, 75, 000 + 80, 000 + 60, 000 (1/ 100 x 60,00, 000) + 12, 00, 000 ( 20/100 X 60,00,000) + 1, 50, 000 + 20, 000 = 17, 85, 000.

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