Definition: Materials Management is that aspect of Industrial Management

which is responsible for planning , sourcing, purchasing, storing and moving

and controlling materials in an optimum manner so as to provide goods and
services to a customer at a minimum cost.

Scope of materials Management:

Materials Planning and control:

Materials Planning and Control is based on sales forecast and production

plan. It involves estimating the individual requirements of parts make/by
decisions, preparing materials, budget, forecasting the level of inventions,
scheduling the orders and monitoring the performance relation to production
and sales.

Purchasing

This includes selection on sources of supply, negotiation, purchase order

placing, follow-up, maintenance of smooth relations with suppliers, approval
of payments with suppliers, evaluating and rating supplies.

Storing
The store function involves receipt on issue of material, protecting and
reducing wastage of materials due to deterioration, damage, pilferage and
absolence, scrap, disposal, efficient materials handling, proper location and
storing, physical beautification of and reconciling them with book figures.

The Advantages of inventory control are:

1) Finding out the limits of inventories which are to be held.

2) Laying down inventory policies.

3) Setting out an inventory policy pattern and its regulation as per the
individual and collective requirement.

4) Follow- up procedures to examine the working of the inventory

policies.
Symptoms of Poor Inventory Management
1. An increase in the number of backorders, indicating too
many stock outs

2. Rising inventory investment

3. High customer turnover

4. An increasing number of cancelled orders

5. Insufficient storage space – too much inventory on hand

6. An increase in the volume and value of obsolete products

7. Low Inventory Turn Over Ratio [about 50 is a good ratio]

8. Working Capital problems

Definition : Inventory is an unused asset, which lies in stock without
participating in value adding process.

Introduction: Inventory control is a process whereby the investment in the

materials, components, spare parts etc which are carried in the stock is
regulated within the pre- determined limits set in accordance with the
inventory policy established by the management. The term inventory control
controls relates to a set of policies and procedures by which an organization
determines which materials it will hold in stock and the quantity of each that
it will carry. The efficiency of inventory control can be measured in several
ways, but the standard of measure of service level is the percentage of total
demand on the stores which is actually met from stock. This objective of
inventory controller can of course be achieved by piling up bigger and
bigger stocks of everything which would conceivably be required to improve
the service level. In this level there is a distinct possibility that he might
bring the company to the brink of bankruptcy. It is expensive to carry stocks.
It is also obvious that it is not possible to aim at very low stocks, as this
might jeopardize the quality of service rendered. Balancing service with the
cost of providing the service so as to achieve the best return on the money is
tied up in stock and the effort employed in handling and controlling stockes
is what scientific inventory control is all about.

Inventory control is a management process. It forms the basis for

materials control. Inventory control plans out the methods of purchasing and
storing all the materials required by an organization at the lowest possible
cost without affecting the production and distribution schedule.
The Advantages of inventory control are:

5) Finding out the limits of inventories which are to be held.

6) Laying down inventory policies.

7) Setting out an inventory policy pattern and its regulation as per the
individual and collective requirement.

8) Follow- up procedures to examine the working of the inventory

policies.

Symptoms of Poor Inventory Management

1. An increase in the number of backorders, indicating too
many stock outs

2. Rising inventory investment

3. High customer turnover

4. An increasing number of cancelled orders

5. Insufficient storage space – too much inventory on hand

6. An increase in the volume and value of obsolete products

7. Low Inventory Turn Over Ratio [about 50 is a good ratio]

8. Working Capital problems

 The following are the functions of inventory:

1. Inventories are necessary for producing goods.

2. Inventories activise the markets

3. Inventories provide a cushion to prevent stock- outs.

4. Inventories help in providing employment in an enterprise.

5. Inventories help in utilizing various types of labor.

6. An inventory policy designed scientifically helps in avoiding

unnecessary waste as well as blocking working capital.

7. Inventories helps as an insurance against errors in demand forecast.

8. A well- planned inventory policy helps in effective service to

customers at an affordable cost.
 Cost associated with Inventories-

Carrying Cost: Cost to carry out an item in inventory for a length of time ,
usually a year. It relates to physically having items in storage. Costs include
interest, insurance, taxes (in some states), depreciation, spoilage etc.

Ordering Costs: Ordering costs are the costs of ordering and receiving
inventory. They are the costs that vary with the actual placement of an order.
Besides shipping costs, they include determining how much is needed,
preparing invoices, inspecting goods upon arrival of quantity and quality and
moving the goods to temporary storage

Shortage Costs: Shortage costs results when demand exceeds the supply of
inventory on hand; often unrealized profit per unit .These costs can include
the opportunity cost of not making a sale, loss of customer goodwill ,late
charges, and similar costs. Shortage costs are sometimes difficult to
measure, and they may be subjectively estimated.
 INVENTORY TURNOVER RATIO

The inventory-turnover ratio can be defined as the gross sales revenue to

average revenue held during a year . This ratio is too low in India. While it is
roughly about 3:1 in India, it is about 12 to 18 in USA on the average. The
same is about 7 in west Germany and about 6 to 8 in the UK. An RBI study
on 700 Joint Stock Companies shows the following investment structure:
Raw Materials and Inventories…………………….Rs. 600 crores
Plant And Machineries………………………….Rs. 540 crores

The above figures show higher capital outlay in raw materials and
inventories than in plant and machinery . A constant attempt should be
made to reduce investment in inventories. If a modest 5% reduction is
possible, that would mean release of an extra amount of investable for other
productive purpose. The overall picture is more gloomy. It has been
variously estimated that in India about Rs.1500 crores is blocked in
immovable inventory of which Rs.2,500 crores is blocked in dead
inventories. One wonders whether a developing economy can afford to block
so much money in an idle resource.
 ECONOMIC ORDER QUANTITY

Under the fixed order quantity system of inventory management, an order

for supplies is placed when the existing stock reaches re – order point.

EOQ is the technique, which solves the problem of the inventory

management.
EOQ is the order size at which the total cost; comprising ordering cost plus
carrying cost, is the least.

Graphical representation of EOQ

Graphing the two costs, viz., holding costs and ordering costs show exactly,
where the total cost curve is at its lowest point. An examination of the two
curves reveals that the carrying cost curve is linear i.e., the more the
inventory held in any period, greater will be the cost of holding it. Ordering
cost curve, on the other hand, is different. Ordering in small quantities
means more acquisition and higher ordering costs. The ordering costs
decrease with increase in order sizes.

A point where the holding cost curve and the ordering cost curve meet,
represent the least total cost, which incidentally is the EOQ.

EOQ technique is highly useful as it answers the question of how much to

order and in doing so, establishes the frequency with which, orders are
placed. EOQ is applicable to both to single items and to any group of stock
items with similar holding and procurement costs. Its use causes the sum of
the two costs to be lower than under any other system of replenishment.
 Economic order quantity
Definition: The question of how much to order is frequently determined by
using an economic order quantity (EOQ) model. EOQ models identify the
optimal order quantity by minimizing the sum of certain annual costs that
vary with order size. Three order size models are described here:

1. The basic economic order quantity model.

2. The economic production quantity model.

3. The quantity discount model.

Economic order quantity

Assumptions of Wilson’s lot size formula or Classical EOQ model

Demand is at a constant rate and continuous

• Process is continuous

• No constraints are imposed on quantities ordered, storage capacity,

budget etc.

• Replenishment is instantaneous

• All costs are time invariant

• No shortages are allowed

• Quantity discounts are not considered

Salient features of EOQ model
 Replenishment Cycle – is the time between two replenishments
 Concept of average inventory – the amount of inventory that
remains in stock on an average during replenishment cycle
 Inventory related total costs
 Ordering Cost and Carrying Costs – their relationship, when are
they equal to each other?
 Follow the classroom discussion, refer to the graphics used
EOQ = √ 2AD/H……….when all the assumptions are valid
EOQ = √ 2AD/H(1-D/P)……….when instantaneous replenishment is not
assumed
Total Inventory related costs at EOQ = √2ADH……….when all the
assumptions are valid
Total Inventory related costs at EOQ = √ 2ADH(1-D/P)……….when
instantaneous replenishment is not assumed
 Sensitivity Analysis: from the classroom analysis you may have
noticed that when total costs are minimum, the Total Cost curve is
nearly horizontal, indicating that for small changes may be made to
the EOQ without upsetting the Total Cost. In short, inventory
related total costs are not sensitive to changes in ordering quantity
at EOQ level
Probabilistic Inventory Control Models – Impact of uncertainties of lead-
time and demand on Re Order Level [ROL]

Determination of ROL:
Condition 1. when standard deviations of demand and or lead-time are
expressed
R = Expected Demand during Lead-time + Buffer [Safety Stock]
R = D L + K σ dl
σ dl =√Square of the σ d X L + Square of the σ l X square of D
1. D L is the lead-time demand
2. K σ dl is the buffer or safety stock
3. R is the re order level
4. D is the average demand rate
5. L is the average lead time
6. K is a factor obtainable from the normal distribution tables for the
percentage of risk we are willing to take
7. σ dl is standard deviation of lead-time demand
8. σ d is standard deviation of demand
9. σ l is standard deviation of lead-time
Condition 2.
a. When the average lead-time, maximum lead-time and its
probability of being maximum are given
b. When average demand, maximum demand and its probability
of being maximum are given
Calculate the lead-time consumption based on average values and find out
the buffer based on probability calculations. Follow sums done in the class.
 I: Base Economic Order Quantity
Total Demand
Ordering Cost
Holding Cost/unit/year
Unit Price
Clear

EOQ
Average Periodic Ordering
Intervals
Total Number of Orders
Total Cost

II: EOQ with Shortages and Lead

Time
Estimated Lead Time in Days
Shortage Cost/unit/year
Clear

EOQ
Level for Reorder Point
Maximum Inventory Level
Total Cost
Longest Delay Time in Days
Selective Inventory control
ABC Analysis, VED Analysis, FSN Analysis, HML Analysis………make
your own notes on the above concepts.
Classifying Inventory: we already know that inventory adds cost to the
deliverables to the customer. Hence management of inventory becomes
primary concern of managements everywhere. These management decisions
with respect to inventory are expected to minimize the costs without
sacrificing customer satisfaction. As an example, if we stock high value
items to avoid stock out, the carrying costs would increase while stock out
would result into loss of high value sale. From logistics perspective we need
to strategize our stocking policy for maximizing benefit for the company.
To facilitate such management decisions, inventory classification becomes
essential. This need to classify inventory was first recognized in 1951 by H.
Ford Dicky in GE for the first time. He suggested that the inventory can be
ranked as per sales volume, lead time, stock out cost etc. we now refer to
this analysis as ABC which is used as a primary management tool for
prioritization. Analysis rooted firmly in 80-20 rule or Pareto’s rule.
As an example let us perform ABC Analysis on the following data obtained
from a company from sales volume perspective
Item Annual Annual Item Percentage Cum. Percentag Classif.
code sales sales codes in of sales sales e of items catagory
volume volume same volume
Rs/- Rs/- in order
desc.
order
01 200
02 150
03 200
04 200
05 6800
06 500
07 400
08 1200
09 200
010 150
total

Quadrant Technique
Results of ABC Analysis should be applied judiciously to a situation while
deciding priorities. ABC Analysis analyses the items in stock from the
perspective of cost or value alone. In running business other considerations
also play significant roles. One such consideration is risk of stock-out.
Standard items have a low risk of stock-out, as they are available with
several suppliers with low lead times. Specifically engineered items being
non-standard in nature run the risk of stock-out.
ABC INVENTORY CLASSIFICATION (SELECTIVE INVENTORY
CONTROL)
This is a popular inventory control technique, which is an adaptation of
Pareto's Law. In a study of the distribution of wealth and income in Italy,
Vilfredo Pareto, an Italian Economist, observed in 1897 that a very large
percentage of the total national income and wealth was concentrated in the
hands of a small percentage of the population. Believing that this reflected a
universal principle, he formulated the axiom that the significant items in a
given group normally constitute a small portion of the total items in the
group and that majority of the items in the total will, in the aggregate, be of
minor significance. Pareto expressed this empirical relationship
mathematically. But, the rough pattern is 80 per cent of the distribution is
accounted for by 20 per cent of the group membership.

The 80-20 pattern holds true in most inventory situations, where it can be
shown that approximately 20 per cent of the items account for 80 per cent of
total cost (unit cost times usage quantity). In the typical ABC-Classification,
these are designated as A-items, and the remaining 80 per cent of the items
become B's and C's, representing the 30 per cent that account for 15 per cent
of cost, and the bottom 50 per cent that account for 5 per cent of cost. The
idea behind ABC-Classification is to apply the bulk of the limited planning
and control resources to the A-items, "where the money is", while, the
expenses on the other classes that have demonstrably much less effect on the
overall inventory investment, is kept to a minimum. The ABC control
concept is implemented by controlling A-items "more tightly" than B and C
items, in descending order.

Today, the principle of graduated control stringency may be somewhat

difficult to comprehend, But, in pre-computer days the degree of control was
equated with the frequency of reviews of a given inventory item's record.
Controlling 'tightly' meant reviewing frequently. The frequency of review, in
turn, tended to determine the order quantity. A-items would be reviewed
frequently and ordered in small quantities, in order to keep inventory
investment low. A typical ABC-classification, which is an acronym for
"Always Better Control", is graphically represented below.
The rationale of ABC-classification is the impracticality of giving
an equally high degree of attention to the record of every inventory
item, due to limited information-processing capacity.With computer
available, this limitation has disappeared and the ABC concept tends to
become more or less irrelevant. Equal treatment
FIXED ORDER QUANTITY(Q SYSTEM)

The above approach also called Q model signifies that the order quantity can
be fixed at a level depending on demand, value and inventory related costs.
A stock level called Re Order Level [ROL] is fixed, which triggers ordering.
Re Order Level is the lead-time consumption or product of lead-time and
demand rate during lead-time. When we follow this approach order quantity
is fixed by calculating EOQ and ROL is fixed by calculating lead time
consumption. Inventory cycles can be conceptualized by looking at the
figure given below and drawn in the class.

Q D

RO
INV

SAFETY STOCK

Lead Lead Lead

Time Time Time

INVENTORY CYCLE INVENTORY CYCLE INVENTORY CYCLE

TIME TIME TIME

TIME

Constant monitoring is the main disadvantage of this model

• Salient Features of the above approach
• Widely used technique
Requires constant monitoring of stock levels

• Suitable for high value and critical items

Limited by the assumptions made – cost of in transit inventory, volume

transportation rates, use of private carriage, etc
Min-Max Approach – a modification to EOQ model
When we follow EOQ model, an order is released when ROL is reached.
Here the assumption is stock depletion is at a specific rate ‘D’ during
replenishment cycle. In reality when stock depletes in larger increments we
may suddenly find that we are suddenly way below ROL. Min-Max
Approach suggests that the actual order quantity should be the sum of EOQ
and the difference between ROL and actual stock on hand at the time ROL
occurs.

Reorder Point: The inventory level R in which an order is placed where R =

D.L, D = demand rate (demand rate period (day, week, etc), and L = lead
time.

Safety Stock: Remaining inventory between the times that an order is placed
and when new stock is received. If there are not enough inventories then a
shortage may occur.

Safety stock is a hedge against running out of inventory. It is an extra

inventory to take care on unexpected events. It is often called buffer stock.
The absence of inventory is called a shortage.

Fixed Order Interval Approach :‘P’ model

The time between two successive orders [order interval], T is fixed and the
maximum stock that can be stored, S is also fixed as pre-requisites for this
approach. The inventory level is not monitored as in ‘Q’ model continuously
but checked in intervals of T fixed as a policy decision. On the fixed day as
per ‘T’ the stock is checked and the difference between current stock level
and maximum sock ‘S’ is calculated. This difference is the order quantity,
which will be ordered immediately. The order quantity arrives after the lead-
time. Next inventory check will be only after the interval ‘T’.

Salient Features of the above approach

• Widely used technique

• Does not require constant monitoring of stock levels

• Suitable for lower value and non critical items

Q D
 I2
I1

INV

SAFETY STOCK

Lead Lead
Lead
Time Time
Time

T T

TIME

Fixed Order Interval Approach :‘P’ model, Optional Replenishment

As in the earlier case, ‘T’& ‘S’ are fixed. But we also fix an additional
parameter called ‘s’ called minimum stock. Inventory is reviewed as per
interval P, but order is placed only when current inventory level is less than
 s. If the current inventory level is more than ‘s’ order is not placed and
inventory will be reviewed only after T
Salient Features of the above approach
1. Widely used technique
2. Does not require constant monitoring of stock levels
3. Suitable for low value and non-critical items

Q D
I2
I1
INV s

SAFETY STOCK

Lead Lead Lead

Time Time Time

T T

TIME
 THE TWO-BIN SYSTEM

One of the earliest systems of stock control is the two-bin system , which is
a simple method of control exercised by tow simple rules .One is when the
ordre should be placed , and the other is what quantity should be covered.
The following diagram shows this simple method .The bins contain , say,
mild-steel bolts and nuts. The bolts and nuts are issued from the first bin and
when required , and as soon as the first bin is empty ,more bolts and nuts are
ordered . The replenishment arrives when the second bin is empty . While
delivery is awaited , the nuts and bolts from the second bin is issued.
When the delivery arrives, then both the bins are again filled in.
 Just-IN-TIME
In today's competitive world shorter product life cycles, customers rapid
demands and quickly changing business environment is putting lot of
pressures on manufacturers for quicker response and shorter cycle times.
Now the manufacturers put pressures on their suppliers. One way to ensure
quick turnaround is by holding inventory, but inventory costs can easily
become prohibitive. A wiser approach is to make your production agile, able
to adapt to changing customer demands. This can only be done by JUST IN
TIME (JIT) philosophy. JIT is both a philosophy and collection of
management methods and techniques used to eliminate waste (particularly
inventory).
Waste results from any activity that adds cost without adding value, such as
moving and storing. Just-in-time (JIT) is a management philosophy that
strives to eliminate sources of such manufacturing waste by producing the
right part in the right place at the right time.

Features
JIT (also known as lean production or stockless production) should
improve profits and return on investment by reducing inventory levels
(increasing the inventory turnover rate), reducing variability, improving
product quality, reducing production and delivery lead times, and reducing
other costs (such as those associated with machine setup and equipment
breakdown).
The basic elements of JIT manufacturing are people involvement, plants,
and system. People involvement deal with maintaining a good support and
agreement with the people involved in the production. This is not only to
reduce the time and effort of implementation of JIT, but also to minimize the
chance of creating implementation problems. The plant itself also has certain
requirements that are needed to implement the JIT, and those are plant
layout, demand pull production, Kanban, self-inspection, and continuous
improvement. The plant layout mainly focuses on maximizing working
flexibility. It requires the use of multi-function workers”. Demand pull
production is where you produce when the order is received. This allows for
better management of quantity and time more appropriately. Kanban is a
Japanese term for card or tag. This is where special inventory and process
information are written on the card. This helps in tying and linking the
process more efficiently. Self-inspection is where the workers on the line
inspect products as they move along, this helps in catching mistakes
immediately. Lastly continuous improvement which is the most important
concept of the JIT system. This simply asks the organization to improve its
productivity,service,operation,and customer service in an on-going basis.
In a JIT system, underutilized (excess) capacity is used instead of buffer
inventories to hedge against problems that may arise. The target of JIT is to
speed up customer response while minimizing inventories at the same time. Inventories
help to response quickly to changing customer demands, but inevitably cost money and
increase the needed working capital.
JIT requires precision, as the right parts must arrive "just-in-time" at the right position
(work station at the assembly line). It is used primarily for high-vPolume repetitive
flow manufacturing processes.