INVENTORY MANAGEMENT AND MATERIAL HANDLING

Inventory

Inventory is a critical element in the supply chain. It can be broadly classified as

raw material and components, work in progress, finished goods and operational
support inventories. Inventories are maintained in meeting production
requirements, supporting operations, extending customer service and hedging
against future uncertainties. In supply chain system, inventory is viewed as a
liability, which reduces both the profits and the returns on investments.

Classification of Inventory

Inventory

Process Number Demand

stage & Value Type Other

Raw Material A Items

Independent Maintenance
WIP B Items
Dependent Operating
Finished C Items
Goods

Raw materials - Items purchased that have not entered the process. i.e.
components, subassemblies etc
WIP – RM that have entered the process and not yet complete
Finished goods – Finished products that are ready to be sold
Distribution Inventories – FG in distribution system

A category based on high value or volume (quantity); B category based on

moderate value or volume; C category based on low value or volume.

Independent demand - demand for item is independent of demand for any other
item
Dependent demand - demand for item is dependent upon the demand for some
other item
 Types of inventories and their characteristics

Any organization finds it risky to hold on to inventory for two basic reasons:
a. The expensive capital investment involved in holding the inventory
b. The fear of damage and obsolescence.
c.
Inventory blocks capital, i.e. investment in inventory cannot be used for creating
assets, producing other goods, or investing in any other productive venture or
project. Inventory carries the risk of theft pilferage, or obsolescence. However, the
nature of risk varies with respect to enterprises position in the distribution channel.

Manufacturer- as the manufacturer has to simultaneously keep the inventories of

the raw material, work in progress and finished goods; the depth of risk is highest
among the other member of the supply chain.
The inventory commitment of the manufacturer last for a longer period even
though hiss product line are narrow as compared to wholesaler or retailer.
Inventory commitment are closely related to investments made in anticipation of
the returns budgeted, lead time of raw materials and the components, complexity
and width of the distribution network, unit value of the product, and the nature of t
he demand.

Wholesaler- the wholesaler handles more product line than the manufacturer. The
different products may face cycling variations in the market at different point of
time and hence the risk factor is limited to nonperforming product line. For
seasonal products the wholesaler purchase the inventory in advance, in anticipation
of future sales, thus winding the risk element the inventory commitments of the
wholesaler are no longer in the duration as compared to those of the manufacturer.

Retailer- the retailer risks duration is much less than that of wholesaler and his
commitment to inventory is not deep. More over the risk is spread over a range of
product. The retailer basically buys and sells and does no stock material for long
duration. He faces the risk of marketing rather than
Inventory

Functions of inventory

Geographical specialization: One function of inventory is to allow

geographical specialization for individual operating unit. Because of the
requirement of factors of production such as power, materials, water and
labour, the economical location of a manufacturing is often at considerable
distance from the major markets. E.g.: Tyres, batteries, transmissions and
springs are significant components are traditionally located in the proximity
to material sources in order to minimize transportation. This strategy leads to
geographical specialization of production so that each automobile
 component can be produced economically. However geographical separation
requires internal inventory transfer to completely integrate components into
final assembly.
Thus geographical separation permits economic specialization between the
manufacturing and distribution units.

1. Decoupling: Decoupling process permits each product to be manufactured

and distributed in economic lot sizes that are greater than market demand.
E.g.: tyre-manufacturing unit. This unit, once the production operation
begins, will continue to produce a certain type of tyre till an economic lot
size is produces. There nay not be a market demand for the entire lot of
production. But the production of the lot was carried out keeping in mind the
future demand as well as the economies of production. Customers can be
sent large shipment with full- loaded capacity of trucks at minimum freight
cost. In a way decoupling tends to ‘buffer’ or ‘cushion’ the operations of an
enterprise from uncertainty. Therefore decoupling enables increase in
operating efficiency.

2. Balancing supply and demand: Balancing is concerned with the elapsed

time between the consumption and manufacturing. Balancing inventories
means the availability of supply is attempted to be matched with the demand
for the product. Eg: in west, oranges juice is consumed to a great extent
throughout the year. But oranges are seasonal fruit, so the seasonal
availability has to be matched with the year round demand for orange juice.
Balancing of inventories, therefore attempts to link the economies of
manufacturing with the variations of consumption. When the demand for
the product is concentrated in a very short selling season then the
manufacturer, wholesaler and the retailer are forced to plan about the
stocking of goods far in advance of the peak selling period.

3. Buffer uncertainties: The safety stock or buffer stock function concerns

short-range variation in either demand or replenishment. The safety stock
requirement results from uncertainty concerning future sales. Safety stocks
protects against two types of uncertainties:
a. Demand can be in excess of forecast, during the performance cycle.
b. Delay in length of performance cycle itself.
In the first type, customer may demand more than what he had actually
planned. It can also happen that the demand from the customer may also fall,
which can also upset inventory.
In the second type, there can be delay in order receipt from the customer, or
delay in processing of the order, or delay in transportation of required
material. This brings about an uncertainty in the length of the performance
cycle.
 Reasons for carrying inventory

Inventory is required for producing finished goods, extending service to the

customers and keeping the buyer’s manufacturing operation running. Hence,
inventory plays an important role in the supply chain of the organization.
Following are the reasons for carrying inventory:

1. Meeting production requirement: Raw materials, components and

parts are required for producing finished goods. The manufacturing
organization keeps stocks of these materials to meet the requirement
of production. Companies operating on ‘JIT’ principle also keep some
inventory in stock to meet contingencies.

2. Supporting operational requirement: To support production

operations, inventories are required for repairs, maintenance and
operational support. These inventories include spare parts of
production machinery, consumables, like lubricants and welding rods,
chemical etc.

3. Customer service considerations: Products like equipment,

machinery or appliances require replacement of spare parts for trouble
free and smooth operations. Suppliers maintain an inventory of these
parts to extend after sales services to their valued clients. This is
closely related to the level of customer service offered by the
company.

4. Hedging against future expectations: To take care of shortages of

material availability in the market or an anticipated increase in the
prices of the product, the customer buys in excess and keeps the
material in stock, in order to keep his operations running without
interruptions. This obviously increases the inventory level for a short
period. However the benefits derived from keeping excess inventory
outweighs its carrying cost.

The function of buffer stock inventory is to provide a specified degree of

protection against both the types of uncertainties.

Different costs of Inventory

• Ordering costs
This category of costs is associated with the acquisition or ordering of
inventory. Firms have to place orders with suppliers to replenish inventory
of raw materials. The expenses involved are referred to as ordering costs.
Apart from placing orders, the various production departments have to
acquire materials from the stores. Any expenditure involved here is also a
part of the ordering cost. Included in the ordering costs are costs involved in
a) preparing a purchase order of requisition form and
 b) Receiving, inspection, and recording the goods received to ensure both
quantity and quality.

The acquisition costs are inversely related to the size of inventory:

They decline with the level of inventory. Thus, such costs can be minimized by
minimized by placing fewer orders for a larger amount. But acquisition of a
larger quantity would increase the cost associated with the eminence of
inventory, which is, carrying costs.

• Inventory carrying costs

Inventory carrying cost is the cost incurred in maintaining inventory e.g.
interest on capital locked up, losses due to deterioration and obsolescence,
insurance premium, storage and preservation expenses,
shrinkage\evaporation etc.
a) Capital cost: also called the interest or opportunity cost, this cost focuses
on what costs a company incurs by having capital tied up its inventory.
The capital cost which is the largest component of inventory carrying
cost accounts for approximately 8 to40 per cent of the value of average
inventory held over a period of one year.
b) Storage space cost : This cost includes handling costs associated with
moving products into and out of inventory as well as costs such as rent,
heating and lighting etc., Storage space costs increase or decrease as
inventory levels rise or fall.
c) Inventory service cost: this includes insurance and taxes on inventory.
Taxes: tax paid on the inventory which depends on the location.
Inventory: the insurance premium paid to cover the storage risks.
d) Inventory risk cost: this cost reflects the very real possibility that
inventory rupee value may decline for reasons largely beyond corporate
control. For example, goods held in storage for some reasons may
become obsolete and other deteriorate in value.
Any calculation of inventory risk cost should include the costs
associated with obsolescence, pilferage, relocation within the
inventory system, theft and other risks to inventoried products

Conceptual questions

1. Pipeline inventory: it represents the stock that is either moving or

awaiting movement in transportation vehicles. This portion of the total
inventory is also known as pipe line inventory. It can also be defined as
the materials moving forward but not yet received moving at the
destination.

2. EOQ
 The economic order quantity is the replenishment ordered quantity that
minimizes the combined total cost of inventory maintenance (inventory
carrying ) and ordering.
There are two types of costs associated with inventory management.
1. Cost of ordering
2. Cost of carrying inventory.

3. Bill of materials
A bill of material is a list that specifies the parts used to build a product.
When a company produces a product, it keeps the track of the materials
and components used in its creation. This bill of materials must be
included with the product before shipping it to a buyer. Generally, it is
included inside the box in which the product is shipped.

4. Fill rate:
It is the extent to which the orders were filled during the stockout situation. It
is a measure of magnitude or impact of stockouts overtime. Before a stockout
affects service performance it is necessary to confront a customer requirement.

5. Lead time
Lead time is an important parameter that determines the effectiveness of
customer satisfaction process.Lead time is the time between order placement
and shiopment receipt from customer’s perspective.Lead time when viewed
from supplier’s perspective is the time between order receipt and order
shipment also called order cycle time.

6. Reorder level
Re order level represents the stock level when the stores must place
purchase requisition on the purchase department for replenishment of
stock through fresh purchase. Order level should be so adjusted that fresh
supply is obtained often enough and in some cases invariability before
the stock runs out. The reorder level would be established at a point such
that the stock in hand would be just sufficient demand during the lead
time.

7. safety stock
It is the quantity which provides for average consumption during any
increase in the rate of consumption during average lead time.It is used
only at the end of replenishment cycles when uncertainty has caused
higher than expected demand or longer than expected performance cycle
times.

8. Vendor managed inventory.

The customer no longer places orders but shares information with the
vendor.It is the responsibility of the supplier to maintain the customers
inventory within the specified stock bands.The benefit to the customer is
 thet inventory levels can be significantly reduced whilst the risk of stock
out diminishes.This system of demand management and replenishment is
known Vendor Managed Inventory although because such arrangements
are usually based upon closed co-peration between the customer and the
supplier the term Co managed inventory is probably more appropriate.
INVENTORY PLANNING METHODS

JIT
JIT is a concept based on the fact that the activity should not take place until there
is need for it. Hence the inventory item should not be brought into the system
until it is required for making the final product. It is characterised by maintaining
zero inventories of raw materials and assemblies at the assembly plant. For this,
the JIT system involves close coordination between the buyers and the suppliers
on a real time basis. This means frequent receipt of materials from suppliers. The
following are the prerequisites of a successful JIT system:

 Buyer-seller partnership
 Online communication and information sharing
 Commitment to zero defects from both sides
 Frequent and small lot size shipments

Just in time (JIT) is a management philosophy that strives to eliminate sources of

manufacturing wastes by producing the right part in the right place at the right
time. Waste results from any activity that adds cost without adding value, such as
the moving and storing of materials, 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).

JIT is a structural approach in a manufacturing organization focused on improving

timeliness, Quality, Productivity and Flexibility utilizing various methods of Work
Simplification and Waste Reduction.

There are seven types of wastes categorized by Taiichi Ohno, the great genius who
spearheaded the transformation of Toyota Corporation and a number of companies
in Japan. Taiichi Ohno’s contribution was the major factor that brought about the
transformation in Toyota. According to him, all Non Value Adding activities
indicate ‘WASTE’. His new definition broadened the scope of Waste, as it was
understood till then. This naturally helped in tackling all types of waste, head on
and improved productivity. The different types of waste are:
 Waste arising from Overproducing
 Waste arising from time on hand (waiting)
  Waste arising from transporting and unnecessary motion
 Waste arising from processing
 Waste arising from unnecessary stock on hand
 Waste arising from producing defective good
 Waste arising due to time spent in changeover of set-up .

JIT –II
This new concept, called Vendor Managed Inventory (VMI), was made popular by
the Bose Corporation. It is now widely used in the industry and is giving food
results. In VMI the supplier takes charge of inventory of the product and manages
the replenishment process based on the consumption pattern of the customer. They
use EDI or other inter-organizational software packaged or place supplier’
representatives at the customer’ place.

In India a leading commercial vehicle manufacturer allowed its tyre supplier to

open up a small inventory shop in its manufacturing premises to supply tyres for
the day’s production of commercial vehicles. The supplier keeps three days
inventory in the area allocated to him and has a representative to manage the shop
and hand over the tyres to the customer as per the assembly line requirement
during the day. Inventory replenishing is done once in two days by the direct
truck loads of tyres from the supplier’s manufacturing plant. This system is based
on advance production planning for the coming week. The customer pays the
supplier daily, by cheque, for the quantity of tyres drawn from his shop. The result
is a reduction of 15 days in the inventory liability (to an inventory level of 3days ),
of the vehicle manufacturer which is entirely managed by the vendor, who gets
played daily for his supplies. It is a win- win situation, which is beneficial to both
the buyer and the supplier.

For VMI to be successful, three things are essential, i.e. the right partner, right set
of products, and mutual trust. Right partners means those who proved themselves
on the basis of consistency in quality, low cost transactions, and reliability as far as
on time delivery is concerned. The VMI is appropriate for products that have high
volumes and values, which involve huge carrying costs for the inventory to be
maintained. The partnership is based on mutual trust, which implies willingness on
the part of the buyer to share benefits and capabilities and on the part of the
supplier reliability and consistency on agreed delivery schedules. The benefits of
VMI, for the buyer, are reduction in inventory related costs and risk of stock-outs
and for the vendor, speedy payment realization, reduction in transaction cost, and
as sured business. It is rightly said that VMI is the starting point for greater
collaboration among supply chain partners and by graduating from one-sided
replenishment responsibility to collaboration replenishment results in greater value
being derived for the supply chain.
 KAIZEN
KAIZEN means improvement. More over, KAIZEN means continuing
improvement in personal life, home life, social life and working life. When applied
to the work place KAIZEN means continuing improvement involving every one -
managers and workers alike.
KAIZEN is a Japanese word meaning gradual and orderly continuous
improvement. The KAIZEN Business strategy involves every one in an
organization working together to make improvements ‘without large capital
investment’.
With KAIZEN, an involved leadership guides people to continuously improve the
ability to meet expectations of high quality low cost and on time delivery.

Why Kaizen?
 To remain competitive we need to change for better and hence Kaizen.
 If we do not move forward we will move back ward.
 Nothing will give n\more satisfaction, motivation than seeing our ideas
implemented.
 To make our job easier.
 To improve our customer service and make our customer happier.
 To work smarter and not harder.
 To improve productivity and quality.
 To achieve organization growth.
 To become world class.

By innovation we refer to break-through activity initiated by top management,

buying new machines, new equipment, developing new market, directing R &
D, change of strategy etc.
Kaizen is to be done by every one right across the organization as every one is
contributing to the organization out put.

KANBAN
The JAPANESE refer to KANBAN as a simple parts- movement system that
depends on cards on cards and boxes/containers to take a part from one station
to another on a production live. Kanban is visual communication. Kanban
stands for Kan- card, Ban- signal. Te essence of the Kanban concept is that of a
supplier or the warehouses should only deliver components to the production
line as and when they are needed, So that there is no storage in the production
area.
Within this system, workstation located along production lines only produces or
deliver desired components. When they receive a card and an empty container
indicating that more parts will be needed in production.

The Kanban coordinates the inflow of parts and components to the assembly
line, minimising the replenishment processing. It is used in process logistics for
the movement parts and components on the shop floor of the manufacturing
plant. The system first evolved at Toyota in Japan to support the concept and
practice of JIT in assembly line.

MATERIAL REQUIREMENTS PLANNING (MRP)

Material Requirements Planning is a software based production planning and

inventory control system used to manage manufacturing processes.

Material Requirements Planning (MRP) is designed to assist manufacturers in

inventory and production management. Using MRP helps ensure that materials will
be available in sufficient quantity and at the proper time for production to occur,
without incurring excess costs by having the materials on hand too early. MRP
assists in generating and (as needed) revising production plans to meet expected
demands and replenishment plans to assure the timely availability of raw materials
and all levels of product components.

An MRP system is intended to simultaneously meet 3 objectives:

• Ensure materials and products are available for production and delivery to
customers.
• Maintain the lowest possible level of inventory.
• Plan manufacturing activities, delivery schedules and purchasing activities.

Advantages of MRP I systems

• Improved Business Results

• Improved Manufacturing Performance Results
• Better Manufacturing Control
• More Accurate and Timely information
• Lower Inventory
• Time-Phased Ordering Of Materials
• Less Material Obsolescence
• Higher Reliability
• More Responsiveness To Market Demand
• Reduced Production Costs

Disadvantages Of MRP Systems

 • Materials Acquisition Cost Increases. (Because Inventory levels are kept
to a minimum, materials must be purchased more frequently and in
smaller quantities)
• Higher transportation bills and higher unit costs are incurred because the
firm is less likely to qualify for large volumes discounts.
• The potential hazard of production slowdown or shutdown that may arise
because of factors such “as unforeseen delivery problems and materials
shortages”. As safely stocks are reduced, this level of protection is lost.
• The use of standardized software packages, which may be difficult to
accommodate within the unique operating situations of a given firm.

DISTRIBUTION REQUIREMENTS PLANNING (DRP)

Process for determining inventory requirements in a multiple plant/warehouse

environment. DRP may be used for both distribution and manufacturing. In
manufacturing, DRP will work directly with MRP. DRP may also be defined as
Distribution Resource Planning which also includes determining labor, equipment,
and warehouse space requirements

DRP needs the following information:

• the demand in a future time period.
• the scheduled receipts at the beginning of a time period.
• the safety stock requirement for a period.
• the on-hand inventory at the beginning of a period.

DRP places emphasis on scheduling rather than on ordering. Inventory items

are not replenished unless there are future requirements to be met. DRP
anticipates the future requirements by forward planning at all levels of a
distribution network. Periods of potential storage can be identified early enough
to develop alternative plans. It can predict problems before they actually occur
and provide visibility to the distribution network.

MAJOR MARKETING BENEFITS OF DRP ARE:

1. Improved service sales that increase on time deliveries and decrease

customer complains,
2. Improved ability to anticipate shortages so that marketing efforts are not
expanded on product with low stocks.
3. Enhanced ability to offer customers a coordinated inventory management
service.

MAJOR LOGISTICS BENEFITS OF DRP ARE:

1. Improved inventory visibility and coordination between logistics and

manufacturing,
 2. Enhanced budgeting capability, since DRP can effectively simulate
inventory and transportation requirements and multiple planning scenarios,
3. Decreased warehouse space requirements because of inventory reductions,
4. Decreased inventory reductions since DRP can accurately determine what
product is needed and when.

CONSTRAINT OF DRP:

As the DRP is guided by customer demand which is normally beyond the control of the
enterprise, demand forecasting is an important ingredient of any DRP system. Hence, an
accurate forecast is the heart of any DRP system to avoid excess or stock outs of any
inventory at any location. In the present days’ era of dynamic environment, there is every
possibility of forecast which limits the effectiveness of DRP.

DIFFERENCE BETWEEN MRP AND DRP

MRP DRP
1. It deals with dependant 1. It deals with finished goods
demand items for production inventory.
of finished goods.
2. It generally operates in a 2. It operates in an independent
demand situation which is environment of uncertain consumer
controlled by the enterprise. demands which is not controlled by
the enterprises.
3. Guided by production 3. Guided by control customer
schedules demand
4. It is a process from master 4. It is a process from the lowest
production schedule to the levels of distribution to the central
detailed scheduling of the distribution centre.
components.

5. Under control of the firm 5. Not under control of the firm.

6. control inventory until 6. Control and coordinates

manufacturing and assembly is inventory after manufacturing and
complete assembly of finished goods.
Perpetual Inventory or Q System
In this system, the order quantity is fixed and the frequency of ordering varies and
is determined by the fluctuations in demand. In such a system four quantities serve
as critical decision rules:
(1) Maximum inventory which are the most items ever to be stocked.
(2) Minimum inventory which is the safety reserve below which should not
fall
(3) The reorder point that the level of inventory at which a replenishment
order should be placed is calculated by the formula:
Reorder point = Average usage rate x Lead time
The order size :Usually the replenishment order quantity is invariably
the E.O.Q

ADVANTAGES
 Simple cheap to operate and reliable.
 Preferable for consumption value items.
 Appropriate for widely different types of inventory within the same
firm.
 Most suitable when inventory carrying cost is measurable and
significant.
 Automatic generation of replenishment order at the appropriate time by
the comparison of stock level against re-order level.
 Somewhat more responsive to fluctuations in demand.
 DISADVANTAGES
 Many times may reach reorder level at the same time, thus overloading the
reordering system.
 There are no records of stock level and usage rates data.
 It does not lend itself to ordering more items simultaneously from the same
source. The drawback could be set off by classifying as slow-moving . fast-
moving, etc., and to make it easier, to group such items of each category
according to supplier wherever possible.

Periodic review inventory system or p system

This system has a fixed ordering interval but the size of order quantity may vary
with the functions in demand.
This system is specified for any item by:
Review period and
Requisitioning objective or replenishment level (ROL)

ADVANTAGES
 The inventory being reviewed at periodic intervals, therefore there is no
flexibility in the order time. Thus the fluctuation in demand is taken care of
by the safety stock.

 All stock items are reviewed periodically so that there is more chance of
obsolete items being eliminated.

 It is preferable whenever inventory carrying cost is meaningless.

 Larger quantity discounts may be obtained when a range of stock items are
ordered at same time from a supplier.

 The ordering inventory costs are low. The suppliers also give better price
discounts since the sale is guaranteed. The service i.e., keeping to delivery
 schedule, is better since suppliers known to your requirements in advance
and can plan for it.

 Because orders will always be in the same sequence, there may be

production economics due to more efficient production planning and lower
set-up costs.

DISADVANTAGES

 This system requires more inventory on hand, for a given frequency or

shortage, as compares to the fixed order inventory system.
 Less responsive to changes in consumption. If the rate of usage changes
shortly after a review, a stock out may well occur before the next review.
 Unless demands are reasonably consistent, it is difficult to set appropriate
periods for review.
 It requires additional labor to review items of stock at items other than when
receipts and issues are being posted.

Q SYSTEM P SYSTEM
1) There is continuous surveillance Normally, the stock level is checked
of the stock level. The moment the at fixed regular interval and the order
stock in hand touches ROL, order is placed for a quantity to replenish
equal to EOQ, is placed. to the maximum pre determined
level.
2)The average inventory is less The average inventory level is
compared to P system expected to be more compared to Q
system.
2) The probability of stock out is The probability of stock out could be
low. It is more sensitive to the higher .It is not sensitive to
demand fluctuations and can respond unanticipated demand behaviors.
promptly to any unanticipated
demand behaviors.
3) The order quantity is fixed but the The review period is fixed but order
review period is variable. quantity is variable.
4)The safety stock is set at a level to The safety stock is required to cater
guard against demand fluctuations to the demand fluctuations during the
during the replenishment period lead replenishments lead time plus the
time review period therefore higher stock
levels are required.
5)The suppliers will not know The suppliers will know when the
exactly when the orders will be orders would be placed. Accordingly
placed. Therefore the supplier is the production planning is made. The
forced to hold more inventory. inventory is expected to be low.

SELECTIVE CONTROL TECHNIQUES:

ABC ANALYISIS/PARETOS LAW

A-B-C analysis is a basic technique of inventory control and s often said to be its
starting point.

If all the stores items in undertaking, representing the entire inventory are analyzed
in terms of the annual consumption of each rupees, it will be found that not more
than 10 percent (usually 5% of thereabout) of the items about for 80% of the total
annual consumption cost about 20% for about 50% PF the annual consumption
cost , while balance 70% of the items will cover only 5% of the annual
consumption cost. the small no. of high consumption value items are called a items
, t he medium consumption value items are B items, while the large no, of items
whose annual consumption value is very low is C items. it must be clearly
understood that A-B-C analysis does not depend on the unit cost of an item , but
only on its total annual consumption.

The A-B-C analysis helps the physical distribution manager to exercise selective
control and focus attention on a few items which are expensive and from the bilk
of investment. whole this increases his effectiveness in inventory control it also
reduces effort on his part.

The following are the important applications of ABC analysis,

Inventory Control: “A” class items deserve careful attention with more updates
and accurate records for the determination of order quantities and priority. ”B”
class items have to be moderately controlled good records and regular attention,
while “C” class items require little or no control.
Price Control: It is possible benefits of ABC analysis by concentrating on price
and the possibilities of price discounts on “A” class items which involve a major
investment.

Consumption Control: By focus in attention on “A” class items and by day to day
monitoring of the pattern of consumption, it may be possible to cut down or reduce
the usage of one or more of these items.

Limitation of ABC Analysis

Systematic standardization and codification, which call for a quieter good deal of
effort and time on the part of the management.

Focus is only on the consumption (money) value of goods. Almost ignores low
value items. it may sometimes be so important from the point of view of
production that a stock out of the items may hold up total production.

Cannot be a stagnant one time effort there is a need for continuous monitoring and
periodic review and reclassification of the item if the analysis is to be relevant of
all times.

EOQ
Economic Order Quantity (EOQ)

Meaning: The economic order quantity (EOQ) is the replenishment ordered

quantity that minimizes the combined total cost of inventory maintenance
(inventory carrying ) and ordering. Estimation of Economic Order Quantity.
There are two types of costs associated with inventory management.
 Cost of Ordering.
 Cost of Carrying Inventory

As the number of units per order increases, the number of order reduces, thus
reducing the ordering cost, but increases the carrying cost. Thus he total cost
reduces as the order size increases, but beyond a certain point it again increases as
the increase in carrying cost is more than the reduction in ordering costs. The
Economic Order Quantity (EOQ) is the quantity ordered for which the total cost is
the lowest.
 Total cost

Minimum
Total
Cost
Carrying cost

Ordering cost

EOQ Units/Order

Square Root Formulae for EOQ

Let A = Annual Consumption (units)
P = Cost of Ordering (Rupees/Order)
U = Cost/Unit (Rupees)
C = Inventory Carrying Cost (% of Inventory Cost)
Q = Quantity/Order

2xAx P
EOQ = Q =
UxC

Assumptions of EOQ Model:

Following assumptions are implied in the calculations.

1) Constant or uniform demand – Although the EOQ model assumes constant
demand, demand may vary from day to day. It also assumes that the usage rate can
be predicted exactly. If demand is not known in advance – the model must be
modified through the inclusion of safety stock

2) Constant unit price – The EOQ mo0pdel assumes that the purchase price per
unit of material will remain unaltered irrespective of the order quantity. It also
assume a constant cost throughout the year. It does not take into account the
quantity discounts offered.

3) Constant carrying costs – Unit carrying costs may vary substantially as the size
of the inventory rises, perhaps decreasing because of economies of scale of
storage. This is not taken into consideration in EOQ. Same is the case with
economy of transporting larger volumes. It is also assumed that this cost can be
determined precisely.
4) Constant ordering cost – EOQ assumes that ordering cost are comtastant and
can be determined precisely.
5) Instantaneous Delivery – it is assumed that etn dlivery of goods is instantaneous,
and frther that there is no goods in transit.
6) Independent Orders – if multiple orders result in cost saving by reducing paper
work and the transportation cost, the original EOQ model must be further
modified. Thus, the EOQ model does not take into aacount multiple products
orders.
7) Availability of Finance – it is also assumed that there is no constraint in the
availability of funds.

Limitation of the EOQ Formula:

1. Erratic Changes usage – the formula presumes the usages of materials are
both predictable and evenly distributed. When this is not the case, the
formula becomes useless.
2. Faulty Basic Information – Order cost varies from commodity to commodity
and the carrying cost can vary with company’s opportunity cost of capital.
 Thus the assumption that the ordering cost and the carrying cost remains
constant is faulty and hence EOQ calculations are not correct.
3. Costly Calculations - the calculation required to find out EOQ is extremely
time consuming. More elaborate formula are more expensive. In many cases,
the cost of estimating eth cost of ordering and carrying and calculating EOQ
exceeds the savings made by buying that quantity.
4. NO formula is a substitute for a common sense – sometimes the EROQ may
suggest that we order a particular commodity every week based on the
assumption that we need it at eth same rate for the next one year. However
we have to order iot in eth quantities according to our judgment. Some items
can be ordered every week; some can be ordered monthly, depends on how
feasible it is for eth firm . further the model does not work well in case of
seasonal items.
5. EOQ ordering must be used by Judgment – sometimes guidelines provide a
conflict in ordering where an order strategy conflicts with an operational
goal, order strategy should be changed to permit honoring the goal.
6. Quantity Discounts- in the EOQ analysis, it has been assumed that material
prices and transportation costs are constant factor for the range of order
quantities considered. In practice some situations occur in which the
delivered unit cost of material decreases significantly if a slightly larger
quantity than the originally computed EOQ is purchased. Quantity
discounts, freight rate schedules and price increases may create such
situations.
Determining ordering point
In the EOQ model, the least time for the procurement material is assumed to be
zero. Consequently the ordering point for replenishment of stock occurs when the
level of inventory drops down to zero. In view of instant replenishment of stock,
the level of inventory jumps to the original level from zero level.

However, in real life situations, one never encounters a zero lead-time. There is
always a time lag from the date of placing an order for materials and the date on
which the materials are received. As a result, the ordering level is always at the
level higher than zero. If the firm orders the goods when the inventory level
reaches the reorder point, the firm will never run out of goods. The decision on
how much stock to hold is generally referred to as “Order point problem” that is
how low should the inventory be depleted before it is reordered.

The two factors that determine the appropriate order point are the:
a) Procurement or delivery time stock (inventory needed during the lead time)
and;
b) The safety stock, which is the minimum level of inventory that is held as a
protection against shortages.

Reorder point = Normal consumption + safety stock during lead-

time.

In summary, the efficiency of the replenishment system affects how much delivery
time is needed.

Determination of level of safety stock involves a basic trade-off between the risk of
stock-out, resulting in possible customer dissatisfaction and lost sales, and the
increased costs associated with carrying additional inventory.

Reorder level = (Average daily usage rate) x (Lead time in

days)

Safety stock

When the wage rate and/or lead-time vary, then the reorder level should naturally
be at a level high enough to cater to the production needs during then procurement
period and also to provide some measure of safety for at least partially neutralizing
the degree of uncertainty.
How much should the magnitude of safe stock be?
It depends on the degree of uncertainty surrounding the usage rate and lead-time. It
is possible to a certain extent of to quantify the values that usage rate and lead-time
can take along with the corresponding ‘chances of occurrences’ known as
‘probabilities’. These probabilities can be ascertained based on the previous
experiences and the judgmental ability of executives. Based on the above values
and estimated stock out costs and carrying costs of inventory it is possible to work
out the total cost associated with different levels of safety stock. Higher the
quantity of safety stock, the lower will be the stock-out cost and the higher will be
the incidence of carrying costs. Thus the reorder level will call for a trade-off
between stock out costs and carrying cost. The reorder level will be such that the
total stock out cost and the carrying cost will be at its minimum.
EOQ EXTENSIONS:

While the EOQ formulation is relatively straightforward, there are some other
factors that must be considered in actual application. The most important and
persistent problems are those related to various adjustments necessary to take
advantage of social purpose situations and utilization characteristics.

1. Volume transportation rate: In the EOQ formulation, there was no

consideration for the impact of transportation cost on order quantity. The
transportation cost from the origin to the inventory depot is incurred by the seller.
However if the ownership is transferred at the origin, the impact of the
transportation rates on the total cost must be considered when determining the
order quantity. As a general rule, greater the quantity, lesser will be the volume
transportation rate because many sellers tend to give a discount when the goods are
bought in a larger size (both by the truck and rail). Thus all other things being
equal, an enterprise will want to buy goods in large quantities to maximize
transportation economies. Such quantity may be larger than the actual quantity
determined by EOQ. Increasing the size of the order has a two fold impact on
the inventory:
• It increases the inventory carrying cost
• It provides better transportation economies.
Finally, two factors regarding inventory cost under costs of origin purchase
are:
• The transit inventory is a part of the enterprise’s average inventory and
therefore subjected to an appropriate charge.
• The transportation cost should be added to the price of the goods purchased
to assess the value of the goods tied up in inventory. Thus the inventory
carrying cost should be assessed on the combined cost of the item and
transportation.

2. Quantity Discounts
Purchase quantity discounts represent an EOQ extension. If the discount at any
associated quantity is sufficient to offset the added cost of maintenance less the
reduced cost of ordering, then the quantity discount offers a viable alternative. It
should be noted that quantity discounts and volume transportation rates each effect
later purchase quantities. However, this does not mean that the lowest total cost
purchase will always be a large quantity.

V-E-D Classification
V-E-D stands for vital, essential and desirable. This type of classification is
applicable mostly in the case of spare parts.
Here the categorization is made in terms of the important or critically of the parts
to the operation of the plant. If it is very vital, it is given a V classification. If it is
not so important, it is given a D classification. How such a classification is done
will purely depend upon the machinery or equipment involved and one’s own
experience, ease of availability of the items, etc.
 The whole objective is to select items for special control and
thus expend time and effort in a prudent way.

F-S-N Classification
The threee letters stand for fast-moving, slowmoving and non-moving. This
classification comes in very handy when we desire to control obsolescence. N
items require very great attention. There may be several reasons why an item has
got into the N category. There may have been a change in technology or change in
the specification of a particular spare part of the item may no longer be in use.

SAP Analysis
Scarce, Available, and Plenty analysis allows to build into provision forecasts. The
ordered quantity is governed by the scarcity factor. The limitations in supply or
obsolescence of the item in the near future will be the guideline for procurement
policy decisions.

MATERIAL HANDLING

One extremely encouraging aspect of logistics is the productivity potential that can
be realized from capital investment in material-handling equipment. Material
handling cannot be avoided in the logistics but can be reduced to minimum levels.
Material handling is an integral part of manufacturing activity. It does not add
value to the product but adds to the cost. Material handling problems are largely
due to the problems of a bad layout. Many a problems of materials handling can
be avoided by improving the existing plant layout.

In warehouses, material handling operations are performed at the following

stages:-
 Unloading the incoming material from transport vehicles
 Moving the unloaded material to assigned storage places in warehouses
 Lifting the material from its storage place during order picking
 Moving the material for inspection and packing
 Loading packages/boxes/cartons on to transport vehicles

MATERIAL HANDLING GUIDELINES

Over the years a variety of guidelines have been suggested to assist management in
the design of material handling system. These are representatives:
(1) Equipment for handling and storage should be as standardized as possible.
(2) When in motion, the system should be designed to provide maximum
continuous product flow.
(3) Investment should be in handling rather than stationary equipment.
(4) Handling equipment should be utilized to the maximum extent possible.
 (5) In handling equipments selection, the ratio of deadweight to pay load
should be minimized.
(6) Whenever practical, gravity flow should be incorporated in system design.

Various material handling systems are in use, right from those that are fully
manual to the ones that are fully automatic. However, the selection of a particular
system depends on the factors such as:
 Volumes to be handled
 Speed in handling
 Productivity
 Product characteristics (weight, size, shape)
 Nature of the product (hazardous, perishable, crushable)

OBJECTIVES OF MATERIAL HANDLING

(1) Improve logistics management. Ensuring efficient materials handling
to reduce total logistics cost and effective customer service.
(2) Space capacity of production as well as warehouse should be
increased. Use fully the length, width as well as height of the room.
Use the material handling equipment in such a way that the top most
position is within the reach.
(3) Reduced the number of handling of the material. No material should
be handled in more than required time.
(4) Develop good working conditions. All the working conditions should
be safe and secured. Accidents should be avoided.
(5) Reduced manual handling of the material. As much as possible avoid
load sharing by person. Heavy work must be taken up by equipment
or automation.
(6) Cost reduction has to be achieved. Damage, wrong dispatch, waste
etc are the sources of expenses.

MATERIAL HANDLING EQUIPMENT AND SYSTEM

Classification of the material handling system is based on the degree of its
sophistication. The major criteria for selection of the right system are: units moved
per hour, and the distance it is moved. Higher volumes over large distances call for
more sophisticated systems, which attract higher investment. Sophisticated systems
enhance the speed of material handling, ensuring reliability and productivity.
Handling systems can be classified as follows:
 Manual
 Mechanized
 Automatic
Manual

This is the cheapest and the most common method of material movement used in
warehousing. The investment in equipment is low. The equipment used are racks,
hand trucks. The operations are done manually. So the problems related to labour
control exist. The limitations of this system are low volumes, slow speed and
distances. In warehouses where cartons do not weigh more than 20 kilograms and
volumes handled are not large, material loading, unloading, and movement are
done manually.

Mechanized

Mechanization needs higher level of investment. The prime consideration before

going for mechanized material handling systems is the layout. Investment in the
material handling system will be a sheer wastage if it is not compatible to the
warehouse layout plan. In mechanization the human element in material movement
is removed, bringing speed and reliability in material movement. Mechanization
enhances system productivity. Mechanized systems employs wide range f handling
equipments which are as follows:-

1) Forklift trucks.
Forklift trucks are the work horses of the warehouse, and are most
commonly used for the movement of the unit loads like containers. These
trucks are much used in the production shops and warehouses .They are
good in moving the material from a place to place. Over and above the tote
boxes on the forks can be elevated to desired level above the ground level.

2) Wheeled trolley
The simplest mechanized handling equipment is the trolley on wheels. Hand
held trolleys are efficient in handling small volumes over short distance. The
two wheeled hand trolley is simple and versatile. The four wheeled hand held
trolley is called a platform truck capable of moving light loads horizontally. For
higher volumes and longer distances, powered (operated on electric battery or
diesel engine) trolleys are widely used. This trolley is available in a wide range;
some have provisions to carry the operator and some require the operator to
walk along.

3) Towlines
These are used for continuous movement of material. These four wheel
trailer are in continuous motion and are either floor or overhead mounted.
During the order selection process, the material picked by the order selector
is placed in the trailer, with is then moved to the packing and further to the
dispatch sections. The towline consist of a number of trailers, which are
 moving across the warehouse, placing or picking material for storage or
shipping.

4) Conveyers
Conveyers are used in applications where a continuous flow of material over
a long distance is required. They excel at straight transportation because they
eliminate rehandling before and after each function. Conveyers are also used
in sorting and merging operations. One characteristic of conveyers, which
has made them popular, is that they can be easily equipped with automatic
control device. The most common usages are baggage handling at airports,
coal handling at thermal power stations, and iron ore handling at integrated
steel plants.
The most common types are:-
I. Wheel conveyor
II. Roller conveyor
III. Belt conveyor
IV. Chain conveyor

5) Carousels
These are commonly used in order picking system. The numbers of bins
housing the various items are housed on the oval truck. The bins move on
the track an bins containing particular items can be brought to the order
selector. The typical application of the carousels is for the selection of
service parts for packing operations. The items selected are put into the
carton, which moves to the packing and further to the dispatch sections.

6) Overhead cranes
Overheads cranes are used for movement of very heavy items over a short
distance. Items such as steel plates, bars, coils, tubes, or machinery
components can be efficiently handled with overheads cranes. These cranes
are used where large, heavy items or containers are to be moved in and of
the warehouse. They are used for lifting weights over five tones.

AUTOMATIC SYSTEM
 Automated material systems are custom built and attract heavy investments. The
human factor is minimized substantially and restricted to programming and
controls. The advantages are speed and accuracy, which enhance the productivity
of the system. The main disadvantage of the automated system is high investment.
Complexity in development, and absence of flexibility. The system is connected to
the computer for programming equipment options, material pick up route and
packing and loading instructions.

 Sorting device
Sorting devices are normally used along with power conveyors. The sorting
device will sort the material based on the sorting codes. The automatic
sorting device increases system productivity through speed, accuracy, and
elimination of manual labor.

Robotics
These are human like machines with micro processors to perform the
programmed activity or series of activities. Robotics can also be used in
extreme temperature environments like cold storage or deep freezers. The
capacity of robotics to perform activities without fatigue and with accuracy
makes it an attractive proposition alternative to manual method.

 Automatic guided vehicle system (AGVS)

The AGVS is a mechanized material handling equipment without an operator. The
system consists of four components i.e. vehicles for movement pick up and drop
off locations, guidance system, and a computer control system. The vehicle moves
on a fixed magnetic or optical path. The AGVS is used in warehouses for material
movement through fixed, assigned paths during pick-up and drop operations. In
advanced AGVS, which is in use in developed countries and is based on the latest
IT and video technology, the fixed path movement of the vehicle can be
eliminated.

SPECIAL HANDLING CONSIDERATIONS.

As expected, the primary objective of material movement is for goods to flow in an

orderly and efficient manner from manufacturer to point of sale. However material
handling systems must also be capable of handling reverse goods flows within the
logistical network.
For a variety of reasons, goods may be recalled by or returned to a manufacturer.
Normally such returns flows are not of sufficient quantity or regularity to justify
goods movement. Therefore, the only convenient method for processing reverse
flows of goods is manual handling. To the degree practical material handling
design should consider the cost and impact of reverse logistics.