Material Management

© 2006 Prentice Hall, Inc. 12 – 1

 O tli
Outline

• Introduction

• Purchasing

• Inventory control

© 2006 Prentice Hall, Inc. 12 – 2

 I t d ti
Introduction

 Materials management is the

planning, organizing and controlling
planning,
of the flow of material from its initial
purchase stage, through internal
operations, to the distribution of
finished goods.

© 2006 Prentice Hall, Inc. 12 – 3

 M j Concerns
Major C
 purchasing,
 transportation (incoming & outgoing),
outgoing)
 control through production - and -
inventory management (includes
receiving, storage, shipping,
materials handling and inventory
counting) and
 warehousing and distribution.
© 2006 Prentice Hall, Inc. 12 – 4
 Purchasing
P h i

• Purchasing implies the act of exchange

of goods and services for money,

• procurement is a generic term with a

wider connotation for the total
responsibility of acquiring goods and
services.
© 2006 Prentice Hall, Inc. 12 – 5
 Purchasing
P h i
• Purchased parts and materials
inventories have to be p
planned,,
procured and delivered when needed.
• The real problem is to determine the
inventory level which ensures a high
rate of return on invested capital as
well as satisfy the demands of
operating and users departments
departments..
© 2006 Prentice Hall, Inc. 12 – 6
 P
Purchasing
h i principles
i i l
• All business consist of the following
ingredients.
– Creation, the idea of product concept
– Capital, resource planning for investment in plant
– Personnel, recruitment of human resources
– Purchasing, buying of plant, machinery,
equipment,
i t material
t i l and
d services.
i
– Conversion, manufacturing process, and
– Distribution,
Distribution selling and marketing of goods

© 2006 Prentice Hall, Inc. 12 – 7

 Basic principles of
Purchasing
• Buying the right quality
• Buying the right quantity
• Buying at the right price
• Buying from the right source
– Survey,
y, enquiry,
q y, negotiation
g and
experience stage.
• Buying
y g at the right
g time and place
p

© 2006 Prentice Hall, Inc. 12 – 8

 Fundamental Objectives of
Purchasing
1. To maintain continuity of supply to
support production schedules,
2. To minimize investment in store and
y must be
materials inventory
insured, consistent with safety and
economy
3. To avoid duplication of purchases,
wastes,, obsolescence and costly
y
delay
© 2006 Prentice Hall, Inc. 12 – 9
 Fundamental Objectives of
Purchasing
4. Maintaining proper quality
standards based on suitability
criteria
5. Materials must be pprocured at
lowest possible cost, consistent
with quality and service
requirements, and
6. Must maintain companies
p
competitive position in the market
© 2006 Prentice Hall, Inc. 12 – 10
 Purchasing Procedure
1. Origination of Purchase Requisition (PR)
• Description of the materials
• Quantity
• Date
D t off requires
i
• Date of issue
• Estimated unit cost
• Operating account to be charged
• An authorized signature

2 Verification of Authority and Budget

2.
Expediting and follow-
follow-up;
3 Request for Quotation or Bids /Price
3.
Quotation/
© 2006 Prentice Hall, Inc. 12 – 11
 P
Purchasing
h i Procedure
P d
4. Evaluation of Bids & Selection of
Suppliers, In terms of
– price proposed by the suppliers.
– discount they offer.
– the shipping terms
– delivery date
– reliability of the supplier by analyzing past performance
– reciprocity (this refers to mutual interchange of favors,
privileges in good sense)
– quality of work & other services

© 2006 Prentice Hall, Inc. 12 – 12

 P
Purchasing
h i Procedure
P d
5. Issuing of Purchase Order
• Suppliers name and address.
• Quotation reference and date.
• Description of items.
• Quantity Ordered.
• Unit Price.
• Terms of Payment.
• Date of the order.
• Delivery date and
© 2006 Prentice Hall, Inc.
• Signature of the purchasing agent 12 – 13
 P
Purchasing
h i Procedure
P d
6. Follow
Follow--up and expediting the Order
g, Inspecting
7. Receiving, p g and Storing
g
8. Closing the Order
– Closing an order simply entails a
consolidation of all documents and
correspondence relevant to the order in filling
them in closed order file

© 2006 Prentice Hall, Inc. 12 – 14

 Important issues in
purchasing
A. Make or Buy decision
• When we are planning to produce a new
product or modifying the existing product.
• When the current performance of supplier is
unsatisfactory.
unsatisfactory
• Changing demand in the external
environment.
– The relevant costs of buying are;
purchase cost of the parts,
t
transportation
t ti costs
t andd receiving
i i and
d
inspection costs
© 2006 Prentice Hall, Inc. 12 – 15
 Important issues in
purchasing
– The cost of making includes; In general,
• Delivered raw material costs
• Direct labor costs
• Incremental managerial costs
• Inventory Carrying costs
• Costs of Capital and
• Opportunity Costs.

© 2006 Prentice Hall, Inc. 12 – 16

 Important issues in
purchasing
B. Organization of Purchasing
– The organization of purchasing is
usually identified as centralized or
decentralized purchasing.
i. Centralized Purchasing
• This occurs when the authority and
responsibility
ibilit to
t handle
h dl the
th material
t i l needs
d off
the organization is given to one department.

© 2006 Prentice Hall, Inc. 12 – 17

 Important issues in
purchasing
ii. Decentralized Purchasing
• This occurs when the various departments in the
organization are established to satisfy material needs. It
i usually
is ll usedd when
h branches
b h are located
l t d in
i different
diff t
parts of a country.
iii Combuterization Purchasing
iii.
• This occurs when both the centralized and
decentralized ppurchasingg are operated
p in an
organization. Items of high value and those that
require high technical analysis and knowledge of
p
experts are purchased
p under centralized
purchasing. But those items of low value and of
routine use are purchased under decentralization.
© 2006 Prentice Hall, Inc. 12 – 18
 How to Describe Quality

• Quality description performs three

main purposes.
p p
 It makes it possible to describe the
items listed on the Purchasingg
Order.
It makes the supplier know exactly y
what type of material, and
It serves as a basis of inspection.

© 2006 Prentice Hall, Inc. 12 – 19

 Methods of Quality
Description
– Market Grades
– Trade/Brand names
– Commercial Standards
– Physical/Chemical Specification
– Performance Specification
– Materials and Methods of Manufacturers
Specification
– Engineering Design and Prints
– Combination method

© 2006 Prentice Hall, Inc. 12 – 20

 Inventory

 One of the most expensive assets

of many companies representing as
muchh as 50% off ttotal
t l iinvested
t d
capital
 Materials managers must balance
inventory investment and customer
service
i

© 2006 Prentice Hall, Inc. 12 – 21

 Functions of Inventory
1 To
1. T decouple
d l or separate
t various
i
parts of the production process
2. To decouple the firm from
fluctuations in demand and
provide
id a stock
t k off goods
d that
th t will
ill
provide a selection for customers
3. To take advantage of quantity
discounts
4. To hedge against inflation
© 2006 Prentice Hall, Inc. 12 – 22
 Types of Inventory
 Raw material
 Purchased but not processed
 Work
Work--in
in--process
 Undergone some change but not completed
 A function of cycle
y time for a p
product
 Maintenance/repair/operating (MRO)
 Necessaryy to keep
p machinery
y and p
processes
productive
 Finished goods
 Completed product awaiting shipment
© 2006 Prentice Hall, Inc. 12 – 23
 Th Material
The M t i l Flow
Fl Cycle
C l

Cycle time

95% 5%

Input Wait for Wait to Move Wait in queue Setup Run Output
i
inspection
ti be
b moved d ti
time f operator
for t ti
time time
ti

Figure 12.1

© 2006 Prentice Hall, Inc. 12 – 24

 I
Inventory
t Management
M t

 How inventory items can be

classified
 How accurate inventory records
can be maintained

© 2006 Prentice Hall, Inc. 12 – 25

 ABC Analysis
 Divides inventory into three classes
based on annual birr volume
 Class
Cl A - high
hi h annuall birr
bi volume
l
 Class B - medium annual birr volume
 Class C - low annual birr volume
 Used to establish ppolicies that focus
on the few critical parts and not the
many trivial ones

© 2006 Prentice Hall, Inc. 12 – 26

 ABC Analysis

Percent of
Item Number of Annual Percent of
Stock Items Volume Annual Birr Annual Birr
Number Stocked (units) x Unit Cost = Volume Volume Class
ETB
#10286 20% 1,000 ETB 90,000 38.8% 72% A
90.00

#11526 500 154.00

154 00 77,000
77 000 33.2%
33 2% A

#12760 1,550 17.00 26,350 11.3% B

#10867 30% 350 42.86 15,001 6.4% 23% B

#10500 1,000 12.50 12,500 5.4% B

© 2006 Prentice Hall, Inc. 12 – 27

 ABC Analysis
Percent of
Item Number of Annual Percent of
Stock Items Volume Annual Birr Annual Birr
Number Stocked (units) x Unit Cost = Volume Volume Class
ETB
#12572 600 ETB 8,502 3.7% C
14.17

#14075 2,000 .60 1,200 .5% C

#01036 50% 100 8.50 850 .4% 5% C

#01307 1 200
1,200 .42
42 504 .2%
2% C

#10572 250 .60 150 .1% C

© 2006 Prentice Hall, Inc. 12 – 28

 nnual Birrr usage ABC Analysis
A Items
80 –
70 –
60 –
50 –
40 –
ent of an

30 –
20 – B Items
Perce

10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100

Percent of inventory items

© 2006 Prentice Hall, Inc. 12 – 29

 ABC Analysis
 Other criteria than annual birr
volume may be used
 Anticipated engineering changes
 Delivery
ypproblems
 Quality problems
 High unit cost

© 2006 Prentice Hall, Inc. 12 – 30

 ABC Analysis
 Policies employed may include
 More emphasis
p on supplier
pp
development for A items
 Tighter physical inventory control for
A items
 More care in forecasting A items

© 2006 Prentice Hall, Inc. 12 – 31

 Record Accuracy
 Accurate records are a critical
ingredient in production and inventory
systems
 Allows organization to focus on what
is needed
 Necessary to make precise decisions
about ordering, scheduling, and
shipping
 Incoming and outgoing record
keeping must be accurate
 Stockrooms should be secure
© 2006 Prentice Hall, Inc. 12 – 32
 Cycle Counting
 Items are counted and records updated
on a periodic
i di basis
b i
 Often used with ABC analysis to
d t
determine
i cyclel
 Has several advantages
 Eliminates shutdowns and interruptions
 Eliminates annual inventory adjustment
 Trained personnel audit inventory accuracy
 Allows causes of errors to be identified and
corrected
 Maintains accurate inventory records
© 2006 Prentice Hall, Inc. 12 – 33
 Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B
items every quarter (60 days), and C items every six months
(120 d
days))

Item Number of Items

Class Quantity Cycle Counting Policy Counted per Day
A 500 Each month 500/20 = 25/day
25/day
B 1 750
1,750 Each quarter 1 750/60 = 29/day
1,750/60 29/day
C 2,750 Every 6 months 2,750/120 = 23/day
23/day
77/day
77/ day

© 2006 Prentice Hall, Inc. 12 – 34

 Independent Versus
Dependent Demand
 Independent demand - the
demand for item is independent
of the demand for any other
item in inventory
y
 Dependent demand - the
demand for item is dependent
upon the demand for some
y
other item in the inventory

© 2006 Prentice Hall, Inc. 12 – 35

 Inventory Models for
Independent Demand
Need to determine when and how
much
h to
t order
d

 Basic
B i economic
i order
d quantity
tit
 Production order q
quantity
y
 Quantity discount model

© 2006 Prentice Hall, Inc. 12 – 36

 Basic EOQ Model
Important assumptions
1. Demand is known, constant, and
independent
2. Lead time is known and constant
3 Receipt
3. R i t off iinventory
t is
i instantaneous
i t t and
d
complete
4 Quantity discounts are not possible
4.
5. Only variable costs are setup and holding
6 Stockouts can be completely avoided
6.
© 2006 Prentice Hall, Inc. 12 – 37
 Inventory Usage Over Time

Usage rate Average

Order inventory
vel

quantity = Q on hand
entory lev

(
(maximum
i
Q
inventory
level) 2
Inve

Minimum
inventory

Time

© 2006 Prentice Hall, Inc. 12 – 38

 Minimizing Costs
Objective
j is to minimize total costs
Curve for total
cost of holding
andd setup
t

Minimum
total cost
ual cost

Holding cost
curve
Annu

Setup (or order)

cost curve
Optimal Order quantity
Table 11.5 order
© 2006 Prentice Hall, Inc.
quantity 12 – 39
 EOQ Model
1. Ordering and setup costs are expenses for
placing orders, expediting, inspection and
changing or setting up facilities for home
made production.
2. Carrying costs on invested capital cover
storage
t handling,
h dli insurance,
i taxes,
t
obsolescence, spoilage and data-processing
costs.
costs
3. Item/Purchase costs include the price paid, or
the labor, material and overhead charges
g
necessary to produce the item.
© 2006 Prentice Hall, Inc. 12 – 40
 EOQ Model

4. Stock out cost results from lost sales

and possibly lost customers as a result
of the variation in demand during lead
time and the forecast.
5. Capacity associated costs are associated
with the variation in out put level of an
organization.
Total Cost  Ordering cost  Carrying cost  Purchase cost
 Stockout cost  Capacity related costs
© 2006 Prentice Hall, Inc. 12 – 41
 EOQ
Q Model
Co order D units
O d i cost 
Ordering  
order Q units year
Cc Q units
it
Carrying cost  
unit  year 2

P Birr D units
Purchase cost  
unit year

D Q
TC  Co  Cc  PD
© 2006 Prentice Hall, Inc. Q 2 12 – 42
 EOQ
Q Model

Differentiating with respect to the order

quantity Q.
dTC D Cc
 Co 
dQ Q2 2
Setting this first derivative equal to zero
identifies the point where the TC is minimum.

D Cc 2Co D
0  Co  Q  EOQ 
Q 2 2 Cc
© 2006 Prentice Hall, Inc. 12 – 43
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
Co = $10 per order
Cc = $.50
$ per unit per year

2DCo
DC
Q* =
Cc
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50

© 2006 Prentice Hall, Inc. 12 – 44

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
Co = $10 per order
Cc=
Cc= $.50
$ per unit per year

Expected D
Demandd D
number of = N = =
orders Order quantity Q*
1,000
1 000
N= = 5 orders per year
200

© 2006 Prentice Hall, Inc. 12 – 45

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
Co = $10 per order N = 5 orders per year
Cc= $.50
$ per unit per year

Number of working
g
Expected days per year
time between = T =
orders N
250
T= = 50 days between orders
5

© 2006 Prentice Hall, Inc. 12 – 46

 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
Co=
Co = $10 per order N = 5 orders per year
Cc=
Cc= $.50
$ per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = Co + Cc
Q 2
1,000 200
TC = ($10) + ($.50)
200 2

TC = (5)($10) + (100)($.50) = $50 + $50 = $100

© 2006 Prentice Hall, Inc. 12 – 47
 Reorder Points
 EOQ answers the
th “how
“h much”
h” question
ti
 The reorder point (ROP) tells when to
order
Demand Lead time for a
ROP = per day
d new order in da
ne dayss
=dxL
D
d = Number of working
g days
y in a y
year

© 2006 Prentice Hall, Inc. 12 – 48

 Reorder Point Curve
Q*
ory level (units)

Slope = units/day = d
Invento

ROP
(units)

Time (days)
Figure 12.5 Lead time = L
© 2006 Prentice Hall, Inc. 12 – 49
 Reorder Point Example
Demand = 8,000
8 000 DVDs per year
250 working day year
Lead time for orders is 3 working days
D
d=
Number of working days in a year

= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units

© 2006 Prentice Hall, Inc. 12 – 50

 Q
Quantity
tit Discount
Di t Models
M d l
 Reduced prices are often available when
larger quantities are purchased
 Trade-
Trade-off is between reduced product cost
and increased holding cost

Total cost = Setup cost + Holding cost + Product cost

D QCc
TC = Co + + PD
Q 2

© 2006 Prentice Hall, Inc. 12 – 51

 Q
Quantity
tit Discount
Di t Models
M d l
A typical quantity discount schedule

Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount ETB 5.00
2 1,000 to 1,999 4 ETB 4.80

3 2 000 and over

2,000 5 ETB 4.75
4 75

© 2006 Prentice Hall, Inc. 12 – 52

 Q
Quantity
tit Discount
Di t Models
M d l
Steps in analyzing a quantity discount
1 Determine the EOQ on the basis of non
1.
discounted steps;
steps;
2. Co
Compare
pa e the
t e tota
total cost at this
t s EOQOQ po
pointt
with that of price break points at;
at; and
3. If the EOQ happens to fall in quantity
discount range, recalculate it using the
quantity discount price and recheck to see
if the revised EOQ or price break point (to
the right) has the lower total.
total.
© 2006 Prentice Hall, Inc. 12 – 53
 Q
Quantity
tit Discount
Di t Models
M d l

Total stocking cost

Birr)
Cost (B

Price
break

EOQ Q1 Q2 Q3 Lot size

© 2006 Prentice Hall, Inc. 12 – 54

 Q
Quantity
tit Discount
Di t Example
E l
A producer of photo equipment buys lenses
from a supplier at Birr 100 each. The producer
requires 125 lenses/year and ordering cost is
Birr 18/order. Carrying cost per unit year (based
on average inventory) estimated to be Birr 20 for
each. The supplier offers a 6 per cent discount
for a purchase of 50 lenses and an 8 per cent
discount for a purchase of 100 or more lenses at
one time. What is the most economical amount
of order at a time?
© 2006 Prentice Hall, Inc. 12 – 55
 Q
Quantity
tit Discount
Di t Example
E l
Calculate EOQ for every discount 2Co D
EOQ 
Cc
EOQ 
2Co D 2  18  125  15 lenses
Cc

20
D Q
TC  Co  Cc  PD
Q 2
 125   15 
TC   18     20    100  125   12,800 Birr
 15   2 

© 2006 Prentice Hall, Inc. 12 – 56

 Q
Quantity
tit Discount
Di t Example
E l
For a 50 unit order and Q  100
nit order,

2  18  125
EOQ   15 lenses
Cc
Q is
i taken
t k 50 because
b th price
the i discount
di t is
i
applicable for 50 Q 100

 125   50 
TC   18     20    100 - 6   125
 50   2 
 12,295 Birr
© 2006 Prentice Hall, Inc. 12 – 57
 Q
Quantity
tit Discount
Di t Example
E l
For a 100 unit
nit order,
order
 125   100 
TC   18     20    100 - 8 125
 100   2 

 12,522
, Birr

Hence the 50 - unit lot size results in the

l
lowest
t total
t t l generall cost.
t

© 2006 Prentice Hall, Inc. 12 – 58