CHAPTER THREE

Material Management
 Introduction

• Materials management is the planning, organizing and controlling

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

Major Concerns About Material Management:-

• purchasing,
• transportation (incoming & outgoing),
• control through production - and - inventory management
(includes receiving, storage, shipping, materials handling and
inventory counting) and
• warehousing and distribution.
 Four basic needs of Material management

1. To have adequate materials on hand when needed

2. To pay the lowest possible prices,
3. To minimize the inventory investment
4. To operate efficiently

Basic principles of material management

1. Effective management & supervision. ( Planning, Organizing, Staffing, Directing,

Controlling, Reporting, Budgeting)
2. Sound purchasing methods
3. Skillful & hard poised negotiations
4. Effective purchase system
5. Must not increase other costs
6. Simple inventory control programmed
 Storage
•Store must be of adequate space
•Materials must be stored in an appropriate place
•Group wise & alphabetical arrangement helps in identification & retrieval
•First-in, first-out principle to be followed
•Monitor expiry date

Purchasing
• Implies the act of exchange of goods and services for money,
• Purchased parts and materials inventories have to be planned, procured and
delivered when needed.
• The real problem is to determine the inventory level
 Basic principles of Purchasing

• Buying the right quality, right quantity and right price,

• Buying from the right source
• Buying at the right time and place

Fundamental Objectives of Purchasing

1. To maintain continuity of supply

2. To minimize investment in store and materials inventory
3. To avoid duplication of purchases, wastes and costly delay
4. Materials must be procured at lowest possible cost,
5. Must maintain companies competitive position in the market
• Inventory control
• Inventory defined as the stock of goods, commodities, other resource that are
stored at any given period for future production
• It means stocking adequate number and kind of stores, so that the materials
are available whenever required
• Scientific inventory control results in optimal balance

Inventory

 One of the most expensive assets of many companies representing as much

as 50% of total invested capital
 Materials managers must balance inventory investment and customer
service
 Functions of Inventory

1. To decouple or separate various parts of the production process

2. To help the firm from fluctuations in demand and provide a stock of
goods that will provide a selection for customers
3. To take advantage of quantity discounts
4. To protect against inflation
5. To provide maximum supply service, consistent with maximum
efficiency & optimum investment.
6. To provide cushion between forecasted & actual demand for a
material

© 2006 Prentice Hall, Inc. 12 – 7

 Types of Inventory

 Raw material
Purchased but not processed
 Work-in-process
Undergone some change but not completed
 Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive and functioning well
 Finished goods
Completed product awaiting for shipment

Inventory Management

• How inventory items can be classified

• How accurate inventory records can be maintained
• Where there are a large number of items in the inventory.

• It becomes essential to have an efficient control over all items of stores.

• However, comparatively, greater care should be given to items of higher values

• The movement of certain manufacturing firms may consist of a small number

of items representing a major portion of inventory value and a large number of

items may represent a minor portion of inventory value.

• In such cases, a selective approach for inventory control should be followed.

© 2006 Prentice Hall, Inc. 12 – 9

 ABC ANALYSIS :(ABC = Always Better Control)
This is based on cost criteria.
It helps to exercise selective control when confronted with
large number of items
It rationalizes the number of orders, number of items &
reduce the inventory.
Divides inventory into three classes based on annual birr
volume
 Class A - high annual birr volume
 Class B - medium annual birr volume
 Class C - low annual birr volume
Classifying inventory according to some measure
of importance(cost criteria) and allocating control
efforts accordingly.

A - very important
High A
B - mod. important Annual
$ value B
C - least important of items
C
Low
Low High
Percentage of Items
 ‘A’ ITEMS
Small in number, but consume large amount of resources
Must have: Tight control, Rigid estimate of requirements,
Strict & closer watch, Low safety stocks, and Managed by top
management

‘B’ ITEMS
Intermediate
Must have: Moderate control, Purchase based on rigid
requirements, Reasonably strict watch & control, Moderate
safety stocks, and Managed by middle level management

‘C’ ITEMS
Larger in number, but consume lesser amount of resources
Must have: Ordinary control measures, Purchase based on
usage estimates, High safety stocks,
 ANNUAL COST CUMMULATIVE
ITEM % ITEM COST %
ABC [Rs.] COST [Rs.]
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500
9 2750 191250
S
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
S HEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
 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 77,000 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

 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 .42 504 .2% C

#10572 250 .60 150 .1% C

Percent of annual Birr usage ABC Analysis

A Items
80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |

10 20 30 40 50 60 70 80 90 100
Percent of inventory items
 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
 Cycle Counting

 Items are counted and records updated on a periodic basis

 Eliminates shutdowns and interruptions of production
 Trained personnel audit inventory accuracy
 Allows causes of errors to be identified and corrected
 Maintains accurate inventory records
 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 days)
Determine the no. of count items per day?
Item Number of Items
Class Quantity Cycle Counting Policy Counted per Day
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day

C 2,750 Every 6 months 2,750/120 = 23/day

77/day
 Inventory Independent Demand

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

.
• Independent demand: – finished goods, items that are
ready to be sold. Independent demand is uncertain
– E.g. a computer
• Dependent demand: – components of finished products.
Dependent demand is certain.
– E.g. parts that make up the computer, cpu, hardware,
motherboard, etc.
 Inventory Models for Independent
Demand
Need to determine when and how much to order

1. Economic Order Quantity Models

 Basic Economic order quantity (EOQ) model

 The order size that minimizes total annual cost
 Economic production model
 Quantity discount model
 Basic EOQ Model

Important assumptions
1. Demand is known, constant, and
independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts can be completely avoided
 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 handling, insurance, taxes,
obsolescence, spoilage and data-processing
costs.
3. Item/Purchase costs:- include the price paid,
or the labor, material and overhead charges
necessary to produce the item.
 EOQ Model

4. Stock out cost:- Associated with not serving

the customers, includes Some production is lost
resulting in idle time for men and machines, or
that the work is delayed, or that of lose of sales
and/or loss of customer goodwill
 Inventory Order Cycle

Order quantity, Q
Demand Average
rate inventory
Inventory Level

Q
2

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

13-25
 EOQ Cost Model
Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity

CoD
Annual ordering cost =
Q
C cQ
Annual carrying cost =
2
CoD C cQ
Total cost = +
Q 2
 EOQ Cost Model
Deriving Qopt Proving equality of
costs at optimal point
CoD C cQ
TC = +
Q 2 CoD C cQ
=
TC CoDCc Q 2
=– +
Q Q 2
2 2CoD
Q = 2
C0D Cc Cc
0=– +
Q2 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc
 EOQ Cost Model
Annual
cost ($) Total Cost
Slope = 0

CcQ
Minimum Carrying Cost =
2
total cost

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt
 EOQ Example
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
311 working days per year
2CoD CoD CcQ
Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2

Qopt = 2,000 gallons TCmin = $750 + $750 = $1,500

Orders per year = D/Qopt Order cycle time = 311 days/(D/Qopt)

= 10,000/2,000 = 311/5
= 5 orders/year = 62.2 store days
 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells when to order

Demand Lead time for a

ROP = per day new order in
days

ROP= d x L
 Reorder Point Curve

Q*
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Lead time = L
 Reorder Point Example
 Demand = 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
d = 8,000/250 = 32 units
Therefore:-
ROP = d x L
ROP= 32 units per day x 3 days = 96 units
 2. Economic Production Quantity
(EPQ)
• Assumptions
– Only one product is involved
– Annual demand requirements are known
– Usage rate is constant
– Usage occurs continually, but production occurs periodically
– The production rate is constant
– Lead time does not vary
– There are no quantity discounts
 Production Quantity Model

Inventory
level

Maximum
Q(1-d/p) inventory
level

Average
Q inventory
(1-d/p)
2 level

0
Begin End Time
order order
Order
receipt receipt
receipt period
Production Quantity Model

p = production rate d = demand rate

Q
Maximum inventory level = Q - d
p
d
=Q1-
p 2CoD
Qopt = d
Q d Cc 1 - p
Average inventory level = 1-
2 p

C o D C cQ d
TC = + 1- p
Q 2
CoD
Annual ordering cost =
Q
CcQ 1- d
Annual carrying cost = p
2
 Production Quantity Model
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day

2CoD 2(150)(10,000)
Qopt = = = 2,256.8 gallons
32.2
Cc 1 - d 0.75 1 -
p 150

C o D C cQ d
TC = + 1- p = $1,329
Q 2

Q 2,256.8
Production run = = = 15.05 days per order
p 150
Production Quantity Model

Maximum inventory level = Q 1 - = 2,256.8 1 -

= 1,772 gallons
3.Quantity Discounts Model
 Price reduction offered to customers for placing
large orders
 Price per unit decreases as order quantity
increases
CoD CcQ
TC = + + PD
Q 2
Where:-
P = per unit price of the item
D = annual demand
 Quantity Discount Model
ORDER SIZE PRICE
0 - 99 $10 TC = ($10 )
100 – 199 8 (d1)
200+ 6 (d2) TC (d1 = $8 )

TC (d2 = $6 )
Inventory cost ($)

Carrying cost

Ordering cost

Q(d1 ) = 100 Qopt Q(d2 ) = 200

 Quantity Discount
QUANTITY PRICE
Co = $2,500
1 - 49 $1,400
Cc = $190 per TV
50 - 89 1,100
D = 200 TVs per year
90+ 900

2CoD 2(2500)(200)
Qopt = = = 72.5 TVs
Cc 190

For Q = 72.5
CoD CcQopt
TC = + + PD = $233,784
Qopt 2

For Q = 90
CoD C cQ
TC = + + PD = $194,105
Q 2