Chapter 4

Materials
Management

Introduction
Materials Management may be thought of as an
integrated functioning of the different sections of a
company dealing with the supply of materials and
other related activities so as to obtain maximum co
co-ordination and optimum expenditure on materials
etc..
etc

OBJECTIVES OF MATERIALS
MANAGEMENT
The main objectives of material
management are:
To minimize materials cost
cost..
To procure and provide materials of
desired quality when required ,at the
lowest possible overall cost of the
concern..
concern

4.1 Inventory control

Lecture Outline
Elements of Inventory Management
Inventory Control Systems
Economic Order Quantity Models
Quantity Discounts
Reorder Point
Order Quantity for a Periodic Inventory
System

What Is Inventory?
Stock of items kept to meet future
demand
Purpose of inventory management

how many units to order

when to order

Types of Inventory
Raw materials
Purchased parts and supplies
Work-in-process (partially completed)
products (WIP)
Items being transported
Spare parts, Tools, and equipment

Two Forms of Demand

Independent

Demand for items used by external

customers
Cars, appliances, computers, and
houses are examples of independent
demand inventory

Dependent

Demand for items used to produce

final products
Tires stored at a plant are an example
of a dependent demand item

Inventory and Quality

Management
Customers usually perceive quality
service as availability of goods they want
when they want them
Inventory must be sufficient to provide
high-quality customer service in TQM

Inventory Costs
Carrying cost
cost of holding an item in inventory

Ordering cost
cost of replenishing inventory

Shortage cost
temporary or permanent loss of sales
when demand cannot be met

Inventory Control Systems

An inventory system provides the organizational
structure and the operating policies for maintaining and
controlling goods to be stocked
Classified into single period and multi period systems
The classification is based on whether the decision is
just a one-time purchasing decision where the
purchase is designed to cover a fixed period of time and
the item will not be reordered, or the decision involves
an item that will be purchased periodically where
inventory should be kept in stock to be used on demand

Multiperiod Inventory
Systems
There are two general types of multiperiod inventory
systems::
systems
Fixed
Fixed
order quantity models(also called the economic
order quantity, EOQ, and Q-model) and
Fixed
Fixed
time period models(also referred to variously as
the periodicsystem
periodicsystem,, periodic reviewsystem
reviewsystem,, fixed order
intervalsystem,, and P-model)
intervalsystem
model)..

Multi Period Inventory Control

Systems
Continuous system (fixed(fixedorder--quantity)
order

constant amount ordered

when inventory declines to
predetermined level

Periodic system (fixed(fixed-time

time-period)

order placed for variable

amount after fixed passage of
time

Economic Order Quantity (EOQ)

,Fixed Order Quantity Models
EOQ

optimal order quantity that will

minimize total inventory costs

Basic EOQ model

Production quantity model

Assumptions of Basic
EOQ Model
Demand is known with certainty and
is constant over time
No shortages are allowed
Lead time (time from ordering to
receipt) for the receipt of orders is
constant
Order quantity is received all at once

Inventory Order Cycle

Order quantity, Q
Inventory Level

Demand
rate

Reorder point, R

Lead
time
Order Order
placed receipt

Lead
time
Order Order
placed receipt

Time

EOQ Cost Model

A - cost of placing order
C - annual perper-unit carrying cost

D - annual demand
Q - order quantity

Annual ordering cost =

AD
Q

Annual carrying cost =

CQ
2

Total cost =

AD
+
Q

CQ
2

EOQ Cost Model

Proving equality of
costs at optimal point

Deriving Qopt
AD
TC =
Q
AD
TC
=- 2
Q
Q

CQ
+
2
C
+
2

AD
C
0=- 2 +
Q
2
Qopt =

2AD
C

AD
Q
Q2

CQ
=
2
2AD
=
C

Qopt =

2AD
C

EOQ Cost Model (cont.)

Annual
cost ($)

Total Cost
Slope = 0
CQ
Carrying Cost =
2

Minimum
total cost

AD
Ordering Cost = Q
Optimal order
Qopt

Order Quantity, Q

EOQ Example
C = $0.75 per yard
Qopt =

2CoD
Cc

Qopt =

2(150)(10,000)
(0.75)

A = $150

Qopt = 2,000 yards

Orders per year = D/Qopt
= 10,000/2,000
= 5 orders/year

D = 10,000 yards

AD
CQ
TCmin =
+
Q
2
TCmin

(150)(10,000) (0.75)(2,000)
=
+
2,000
2

TCmin = $750 + $750 = $1,500

Order cycle time = 311 days/(D
days/(D/Qopt)
= 311/5
= 62.2 store days

Reorder Point
Level of inventory at which a new order
is placed
R = dL
where
d = demand rate per period
L = lead time

Reorder Point: Example

Demand = 10,000 yards/year
Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
yards/day
Lead time = L = 10 days
R = dL = (32.154)(10) = 321.54 yards

Production Quantity
Model
An inventory system in which an order is
received gradually, as inventory is
simultaneously being depleted
Non-instantaneous receipt model

assumption that Q is received all at once is relaxed

p - daily rate at which an order is received over

time, production rate
d - daily rate at which inventory is demanded

Production Quantity Model

(cont.)
Inventory
level

Q(1
(1--d/p
d/p))

Maximum
inventory
level

Q
(1--d/p
(1
d/p))
2

Average
inventory
level

0
Order
receipt period

Begin
End
order order
receipt receipt

Time

Production Quantity Model

(cont.)
p = production rate

d = demand rate

Maximum inventory level = Q - Q d

p
=Q1- d
p
Q
d
Average inventory level =
12
p
AD
CQ
d
TC = Q + 2 1 - p

2AD
Qopt =

d
C 1p

Production Quantity Model:

Example
C = $0.75 per yard
A = $150
d = 10,000/311 = 32.2 yards per day
2AD
Qopt =

C 1-

D = 10,000 yards
p = 150 yards per day

2(150)(10,000)
d
p

AD
CQ
d
TC = Q + 2 1 - p

32.2
0.75 1 150

= 2,256.8 yards

= $1,329

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

Production Quantity Model:

Example (cont.)

Number of production runs =

10,000
D
=
= 4.43 runs/year
2,256.8
Q

d
Maximum inventory level = Q 1 p

= 2,256.8 1 -

= 1,772 yards

32.2
150

3. Quantity Discounts Model

Price per unit decreases as order
quantity increases
AD
CQ
TC =
+
+ PD
Q
2
where
P = per unit price of the item
D = annual demand

Cont
The goal : is to reduce price (P) for an item when it is purchased in
larger quantities
Discount Number Discount Quantity Discount (%) Discount Price (P)
1
2
3

0 to 999
1,000 to 1,999
2,000 and over

no discount
4
5

$5.00
$4.80
$4.75

Total Cost = Setup cost(order cost) + Holding cost + Product cost

TC

= DS/Q + QH/2 + PD

Q : Quantity ordered
D : Annual demand in units
S : Ordering or setup cost per order per setup
P : Price per unit
H : Holding cost per unit per year

 The Steps to determine Optimum Quantity order :

1. Calculate value of optimum order for each discount Q* = 2DS/IP,
Holding cost (I) as percentage of unit price (P)
2. If order quantity is too low, adjust the order qty upward to the lowest
qty that will qualify for the discount
3. Compute Total cost for each
4. Select Q* with the lowest total cost
Example : The store stocks toy race cars. Recently, the store has
been given a quantity discount schedule for these cars. The normal
cost for the race car is $5.00. For orders between 1,000 and 1,999
units, the unit cost drops to $4.80; for orders 2,000 or more units, the
unit cost is only$4.75. Furthermore, ordering cost is $49.00 per order,
annual demand is 5,000 race cars and inventory carrying charge as a
percent of cost is 20%. What order quantity will minimize the total
inventory cost?
1. Q1* = 2DS/IP = 2(5,000)(49)/(20%)(5.00)
= 700 cars order

Q2* = 2DS/IP = 2(5,000)(49)/(20%)(4.80)

= 714 cars order

Q3* = 2DS/IP = 2(5,000)(49)/(20%)(4.75)

= 718 cars order

2.
Q1* =
Q2* =
Q3* =

700
1,000 adjusted
2,000 adjusted

3. Calculate Total Cost each discount

Discount

Number
TC
1
2
3

Annual Product Annual

Annual
Total
Ordering Cost Holding Cost Cost

+ Quantity
QH/2 +Cost
PD
Unit=
riceDS/Q
(P) Order
$5.00
$4.80
$4.75

700
1,000
2,000

$25,000.00
$24,000.00
$23,750.00

$350
$245
$122,5

Annual Product Cost = PD

Annual ordering cost = DS/Q
Annual Holding cost = QH/2 = QIP/2
4. Select Order Quantity at the lowest cost 1,000 units

$350
$480
$950

$25,700
$24,725
$24,823

Safety Stocks
Safety stock
buffer added to on hand inventory during lead
time

Stockout
an inventory shortage

Service level
probability that the inventory available during
lead time will meet demand

Inventory level

Reorder Point with

a Safety Stock

Q
Reorder
point, R

Safety Stock

0
LT

LT
Time

Reorder Point With

Variable Demand
R = dL + zd L
where

zd

d = average daily demand

L = lead time

d = the standard deviation of daily demand

z = number of standard deviations
corresponding to the service level
probability (service factor)
L = safety stock

Reorder Point for

a Service Level
Probability of
meeting demand during
lead time = service level

Probability of
a stockout
Safety stock
zd L

dL
Demand

Service factor values for CSL

Reorder Point for

Variable Demand
The carpet store wants a reorder point with a 95%
service level and a 5% stockout probability
d = 30 m per day
L = 10 days
d = 5 m per day
For a 95% service level, z = 1.64
1.64
R = dL + z d L

Safety stock = z d L

= 30(10) + (1.64
(1.64)(5)( 10)

= (1.64
(1.64)(5)( 10)

= 325.9
325.9 m

= 25
25.9 m

Periodic Inventory Systems

Inventory level (on hand) is counted at specific time
intervals
An order placed that brings inventory up to a specified
level
Less costly to track of inventory level
Requires a new order quantity each time an order is
placed

Periodic Review Order Quantity

Assumptions

Inventory position is reviewed at constant intervals.

Demand during review period plus lead time period
is normally distributed with mean and standard
deviation .
Service level is defined in terms of the probability of
no stockouts during a review period plus lead time
period and is reflected in z.
On--hand inventory at ordering time: H
On
Shortages are not backordered.
Lead time is less than the review period length.

Order Quantity for Variable Demand

For normally distributed variable daily demand:
Q d (t L) Z t L I
b
d b
where:
d average demand rate
t the fixed time between orders
b
L lead time
standard deviation of demand
d
Z t L safety stock
d b
I inventory in stock

Order Quantity for Variable Demand Example

Corner Drug Store with periodic inventory system.
Order size to maintain 95% service level:
d 6 bottles per day
d 1.2 bottles
tb 60 days
L 5 days
I 8 bottles
Z 1.65 for 95% service level

Q d (tb L) Z d tb L I
(6)(60 5) (1.65)(1.2) 60 5 8
398 bottles

Example: Ace Brush

Joe Walsh is a salesman for the Ace Brush
Company.. Every three weeks he contacts Dollar
Company
Department Store so that they may place an order to
replenish their stock
stock..
Weekly demand for Ace
brushes at Dollar approximately follows a normal
distribution with a mean of 60 brushes and a
standard deviation of 9 brushes
brushes..
Once Joe submits an order, the lead time until Dollar
receives the brushes is one week
week.. Dollar would like
at most a 2% chance of running out of stock during
any replenishment period
period.. If Dollar has 75 brushes in
stock when Joe contacts them, how many should
they order?

Example: Ace Brush

The review period plus the lead time totals 4 weeks
This is the amount of time that will elapse before the
next shipment of brushes will arrive
Weekly demand is normally distributed with:
Mean weekly demand,
= 60
Weekly standard deviation, = 9
Weekly variance, 2
= 81
Demand for 4 weeks is normally distributed with:
Mean demand over 4 weeks, = 4 x 60 = 240
Variance of demand over 4 weeks, 2 = 4 x 81= 324
Standard deviation over 4 weeks, = (324)1/2 = 18

Single--Period Order Quantity

Single
A single
single--period order quantity model
(sometimes called the newsboy problem)
deals with a situation in which only one order
is placed for the item and the demand is
probabilistic.
If the period's demand exceeds the order
quantity, the demand is not backordered and
revenue (profit) will be lost.
If demand is less than the order quantity, the
surplus stock is sold at the end of the period
(usually for less than the original purchase
price).

Single--Period Order Quantity

Single
Assumptions

Period demand follows a known probability

distribution:
normal: mean is , standard deviation is
uniform: minimum is a, maximum is b

Cost of overestimating demand: $c

$ co
Cost of underestimating demand: $c
$ cu
Shortages are not backordered.
Period--end stock is sold for salvage (not
Period
held in inventory).

Single--Period Order Quantity

Single
Formulas
Optimal probability of no shortage:
P(demand < Q *) = cu/(
/(c
c u +c o )
Optimal probability of shortage:
P(demand > Q *) = 1 - cu/(
/(ccu+co)

Optimal order quantity, based on demand

distribution:
normal:

Q * = + z

uniform:

Q * = a + P(demand < Q *)(

*)(b
b-a)

Example: McHardee Fashion

McHardee Fashion produces a jacket and
wishes to determine how many units to
manufacture. There is a fixed cost of $5,000
to produce the item and the incremental
profit per unit is $0.45. Any unsold items
can be sold at salvage at a $.55 loss. Sales
for this item are estimated to be normally
distributed. The most likely sales volume is
12,000 units and they believe there is a 5%
chance that sales will exceed 20,000. How
many units should be printed?

Solution
= 12,000
To find , note that z = 1.65 corresponds to a 5%
tail probability
Therefore, (20,000 - 12,000) = 1.65 or = 4848
Co=.55 and Cu=.45, (C
(Cu/(
/(C
Cu+Co))=.45/(.45+.55)=.45
Find Q * such that P(D
P(D < Q *) = .45.
The probability of 0.45 corresponds to z = -.12.
Thus, Q * = 12,000 - .12(4848) = 11,418 Jackets

Solution--Cont.
Solution
If any unsold copies can be sold at salvage at a
$.65 loss, how many units should be produced?
Co=.65, (C
(Cu/(
/(C
Cu+Co))=.45/(.45+.65) = .4091
Find Q * such that P(D
P(D < Q *) = .4091. z = -.23
gives this probability.
Thus, Q * = 12,000 - .23(4848) = 10,885 units
However, since this is less than the breakeven
volume of 11,111 jackets (= 5000/.45), no item
should be produced because if the company
produced only 10,885 units it will not recoup its
$5,000 fixed cost.

ABC Classification
The items on hand are classified into A, B, and C types
on the basis of the value in terms of capital or annual
dollar usage (i
(i..e., dollar value per unit multiplied by
annual usage rate
rate),
), and then allocates control efforts
accordingly..
accordingly
Thus, the items with high value and low volume are kept
in A-type
type,, items with low value and high volume are kept
in C-type
type,, and the items with moderate value and
moderate volumes belong to the B-type
type..
A ---- very important, B ---- moderately
important, and C-- least important

The actual number of categories varies from

organization to organization, depending on the extent
to which a firm wants to differentiate the control efforts.

Class A

5 15 % of units
70 80 % of value

Class B

30 % of units
15 % of value

Class C

50 60 % of units
5 10 % of value

ABC Classification: Example

PART
1
2
3
4
5
6
7
8
9
10

UNIT COST

ANNUAL USAGE

$ 60
350
30
80
30
20
10
320
510
20

90
40
130
60
100
180
170
50
60
120

ABC Classification:
Example (cont.)
PART

9
8
2
1
4
3
6
5
10
7

TOTAL
PART
VALUE

$30,600
1
16,000
2
14,000
3
5,400
4
4,800
5
3,900
3,600
6
3,000
7
2,400
8
1,700

9
$85,400
10

% OF TOTAL % OF TOTAL
UNIT
ANNUAL
USAGE
VALUECOSTQUANTITY
% CUMMULATIVE

35.9
$ 60
18.7
350
16.4
30
6.3
5.680
4.630
4.220
3.510
2.8
320
2.0

510
20

6.0
5.0
4.0
9.0
6.0
10.0
18.0
13.0
12.0
17.0

90
A40
130
B60
100
180
170
C
50
60
120

6.0
11.0
15.0
24.0
30.0
40.0
58.0
71.0
83.0
100.0
Example 10.1

ABC Classification:
Example (cont.)
PART

TOTAL
PART
VALUE

9 $30,600
1
8
16,000
2
2
14,000
3
1
5,400
4
4
4,800
5
3
3,900
6
3,600
6
CLASS
5
3,000
7
10
2,400
A8
7
1,700
B
9
C
$85,400

10

% OF TOTAL % OF TOTAL
UNIT
ANNUAL
USAGE
VALUECOSTQUANTITY
% CUMMULATIVE

35.9
6.0
$ 60
18.7
5.0
350
16.4
4.0
30
6.3
9.0
5.680
6.0
4.630
10.0
4.220% OF TOTAL
18.0
ITEMS
VALUE
3.510
13.0
12.0
9, 8, 22.8
71.0
320
17.0
1, 4, 32.0
16.5
510
6, 5, 10,
7
12.5

20

6.0
90
11.0
40
A
15.0
130
24.0
30.0
B60
100
40.0
% OF TOTAL
58.0
180
QUANTITY
71.0
170
C 15.083.0
50
100.0
25.0
60 60.0
120

Example 10.1

4.2 Purchasing
Purchasing is an important function of
materials management.
In any industry purchase means buying
of equipments, materials, tools, parts etc.
required for industry.

Objectives of Purchasing
The basic objective of the purchasing
function is to ensure continuity of supply
of raw materials, sub
sub--contracted items
and spare parts and to reduce the
ultimate cost of the finished goods
goods..

Parameters of Purchasing
The success of any manufacturing activity is
largely dependent on the procurement of raw
materials of right quality, in the right quantities,
from right source, at the right time and at right
price popularly known as ten Rs of the art of
efficient purchasing
purchasing..

Purchase parameters

RIGHT PRICE
RIGHT QUALITY
RIGHT TIME
RIGHT SOURCE
RIGHT QUANTITY
RIGHT ATTITUDE

RIGHT CONTRACT
RIGHT MATERIAL
RIGHT TRANSPORTATION
RIGHT PLACE OF
DELIVERY

Purchasing Procedure

RECOGNITION OF THE NEED

THE SELECTION OF THE SUPPLIER
PLACING THEORDER
FOLLOW--UP OF THEORDER
FOLLOW
RECEIVING AND INSPECTION OF THE MATERIALS
PAYMENT OF THEINVOICE
MAINTENANCE OF THE RECORDS
MAINTENANCE OF VENDORRELATIONS

Exercise
The XYZ Ltd
Ltd.. carries a wide assortment of items for its customers
customers..
One of its popular items has annual demand of 8000 units
units..
Ordering cost per order is found to be Rs
Rs.. 12
12..5. The carrying cost
of average inventory is 20
20%
% per year and the cost per unit is Rs
Rs..
1.00
00.. Determine the optimal economic quantity and make your
recommendations..
recommendations