Operations management: Revision 1. Overview : Systems concept of operations management i.

A business can be regarded as a system with a number of sub systems that operate in an integrated fashion within a given environment (internal and external). ii. System laws: 1) Every system is designed to achieve the output it is designed to achieve. 2)Good people in a bad system will produce a bad product. iii. Everything connected with everything else-whole a sum of functions iv. Functions interact with each other and there are flows and feedback subsystems. b. Systems thinking stresses linkages. c. The parts must be managed to manage the whole d. Draw picture of input-> process-> output cycle with detailed picture of process adjustments and monitoring. e. Evaluation of systems efficiency i. Efficiency of conversion evaluation: Output/Input ii. Wastivity iii. Setting and monitoring of standardscomparison of output to standards iv. Monitoring and adjustment of input/output cycle f. Servicing and manufacturing systems Service Manufacturing Input Human resources, Input land, material, labour facilities and procedures and capital, product design, process Output intangiblenon Inventoriable, tangible inventorizable Variable process Unvaried fixed process Labour intensive Material intensive Location of users Location of source of raw material, transport etc. 2. Objectives of the organization a. Performance objectives i. Efficiency ii. Effectiveness iii. Quality iv. Lead times v. Capacity vi. Flexibility b. Cost objectives 1

i. Explicit costs ii. Implicit costs 3. Operations management decisions a. Different perspectives i. Perspective I : Periodicity of decisions: Periodic decision and continual decisions ii. Perspective II: Planning and control perspective: 1. Planning and design of systems and 2. Operations and control of systems iii. Perspective III: Planning , Organizing and Controlling 1. Planning: System planning, Use of system plans 2. Organization: Organizing for conversion; structuring, staffing, job work and design and payment systems 3. Controlling: Monitoring, setting standards, comparing, quality, inventory, cost, maintenance iv. Perspective IV: 1. Long term strategic planning and a. Product selection and design b. Process selection and design c. Facilities location d. Facilities layout e. Capacity planning 2. Short term operations planning a. Production planning, scheduling and control (optimal schedules, sequence of operations etc) b. Work and job design (design of work methods, systems and procedures etc) c. Maintenance and replacement i. Preventive maintenance ii. Trouble shooting d. Inventory planning (Optimal inventory of raw materials, in process goods, or finished products) e. Quality assurance (quality testing, standards, actual, comparison etc) f. Cost reduction and control (cost avoidance and cost reduction) b. Monitoring and feedback: Systems vital to organization and is complementary to planning. Should consider cost benefit aspects of control. If cost is greater than benefits it can be counter productive. i. Types of control systems 2

1. Selective controls Paretos law (useful in large organizations) 2. Self controlCybernetic or steering control (difficult in large organizations) ii. Control process 1. Establishing standards for performance and outputs 2. comparing of actual vs standards 3. Identifying areas for improvement/adjustment 4. Initiating corrective action c. Update and review of decisions i. Important as an indicator of the organizations response to environmental changes. 4. Types of Production Systems a. Mass or Flow line production Systems: Straight line flow; sequential; Problems== Balancing assembly lines; Machine maintenance and raw material supply. b. Batch production systems: Small quantity production; products compete for machine time; general purpose machines in use; material flow is complex: Problems= optimal layout; Aggregate planning to absorb fluctuations; Machine job allocation; economic batch quantity and scheduling and sequencing. c. Job Shop: Customer defined products; each order minor project in itself; complex system. Problems= dispatching per priority rule; waiting line or network of queues. d. Unit manufacture: Large product; labour moves in sequence; each product separate project requiring detailed planning. 5. Materials Management a. Need to manage materials: materials costly and is 60-70% of cost of production. b. Good materials management can bring down costs by 1520% i. Eg: Inventory is usable idle resources and could be used as a measure of the effectiveness of materials management c. Need for integrated approach i. Reducing uncertainties in demand ii. Reducing procurement lead time iii. Reducing excessive inventory iv. Reducing variations in inventory through standardizations, codification and variety reduction programmes. d. Methods to manage materials

i. Value analysis or purchase analysis where required function is evaluated against minimum cost. ii. Material handling :By locating storage near source to minimize cost iii. Inventory control iv. Stores management: appropriate layout, storage and issuing procedures v. Waste management: minimize or eliminate waste down the value chain. 6. System life cycle a. Womb to tomb Analysis i. Helps understand various decisions and their interdependence better ii. Alerts to external environmental changes and their impact on decisions. b. Stages of Product development i. Product, process, layout, capacity selectionBirth stage ii. Production management and update of systems: Steady State stage iii. Product decline or termination stage c. 8 stages i. System start-----------------Process, product, facilities selection stage ii. Development stageProduct, process, facility design; selection and sequencing of product manufacture; technology to be used iii. Production System establishment stage------------Facility location, layout, quality, Capacity planning iv. Management stageHR, Job design structure, work measurement, payment systems v. System start up------------------------------manufacturing, achieving full capacity vi. System steady stateOperational decisions, cost reduction decisions, improving system performance day to day operations. vii. Revision: relook at systems, update etc viii. Death of the systemphasing out, salvage etc. 7. Scientific methods in Operations management a. Industrial engineering i. Operations research ii. System analysis iii. Behaviourial sciences b. Models i. Represents systems and emphasizes system behaviour 4

1. Mathematical models preferred : identify and capture controllable and uncontrollable factors of production 2. Models are a means to an end and not a means in themselves c. Role of computers d. Role of behavioural science: relationships

Management of Materials: Book 6 A] Purchasing systems and Procedure 1. The process of exchanging money for goods is known as purchasing. 2. Materials an important ingredient in manufacturing and constitute a large portion of the expense of creating a product. 3. Complexity of materials and their characteristics has made purchasing function a specialized area of organizational activity. 4. In some org it is regarded as a supportive function. In others it is treated as a functional area. B] Purchasing objectives: 1. Buying at the right | quality; quantity; time; price; source; place 2. objectives of the purchasing function: a) Make users aware of market availability of materials and the range of material availability of right quality etc b) To procure the material at the lowest cost consistent with requirements c) Minimum investment in associated purchasing service costs d) Maintain continuity of supply of materials to meet schedules of operations e) To integrate requirements of all departments for economy of scale f) To create goodwill for the organization through healthy buyer supplier relationship. C] Purchasing Functions How does it meet the objectives? What are the inputs? Restraints? Factors? 5

1. Inputs; a. Purchase requisitions b. Purchase specifications 2. Outputs a. Supply sources b. Timing c. Price d. Quantity e. Quality 3. Restraints a. Legalities b. Management policies c. Available sources d. Market conditions 4. Factors a. Item used continuously b. Large single orders c. Small value purchases d. Normal purchases D] Related activities 1. Vendor rating and development 2. Make or buy decisions 3. Value analysis 4. Surplus disposal 5. Control and Audit C] 1) Inputs Pre purchasing activitypreparation of inputsimportant in deciding the success of the purchasing system. Input requirements received in form of indent Success => quality of indent and analysis of the indents Purchase requisition: Primary authorization to the purchase department. Contains the list of items required to be purchased. May have standard formats 1. Standard purchase requisition 2. Travelling purchase requisition 3. Bill of materials 6

Standard purchase requisition: May be different in different organizations. Used for non recurring requirements. Format Requisition number Date of requisition Name of Department making the requisition Account head under which it is to be charged Description and quantity of items Purpose of requisition Date by which items are required Approximate price per unit and total cost Suggested suppliers names Signature of the requisitioner/approving authority for the requisition. Traveling purchase Requisition Recurring requirements of stores, materials and standard parts. Format: Usually a card with a single item containing information about the item. Name Brief description of item Brief or coded names of the user department Annual usage rate Reorder point, Reorder quantity Card can be used for many requisitions. When stock levels drop below reorder point the card can be sent to the purchasing department for placing orders. To reduce delay and paperwork. Sometimes a separate requisition form (usually in the above format) is sent if it is not convenient to send the card. Bill of Materials List of all items for a finished product Prepared at the time of engineering drawing of the product BOM is sent along with purchase schedule to purchasing department Computes the total requirement for each part for each period of production. Eliminates need for typing numerous requisitions. Purchase Specification

Detailed description and characteristics of an item to be purchased by requisitioning department with or without the help of the purchasing department. Detailed description: features of the item to facilitate purchase of exact item and verification of item. Description can be by: 1. Market grade (accepted standard) 2. Commercial standards (standardized items by established practices and governmental approval or agency approval) 3. Trade or brand names 4. Material specification (properties, features desirable) 5. Performance specifications 6. Samples 7. Blue prints 8. Combined specifications Restraints and factors Restraints= legal issues, management policies, resource availability and market conditions. Legal issues: Sale of goods act, The law of agency, law of contract and other extant acts Management policies: Centralized vs decentralized purchases. 1. Centralized purchasing ideal for multi-product, multi location activities. 2. Development of specialized purchasing skills 3. Consolidation of order quantities for cash discounts 4. Better control over inventory 5. Less overlapping and deduplication effort 6. Uniform quality and less variety of materials However, problems 1. Purchase process is slow 2. rigid, rule bound procedures 3. Costly for low value purchases 4. Unrelated items and less frequently demanded items may cause difficulties Resource limitations: Financeshared by all departments and purchase departments have to operate within their budget. This may lead to purchasing decisions that are not optimal-- quantity discounts may have to be forgone for overall financial planning. There may be limitations of manpower, storage space etc.

Market conditions: Supply and demand for materialduring shortage reliability of supply may be more important than quantity or pricethe purchasing strategies may have to be changed. Demand factors Items used continuously: predictable demandcontracts can be negotiated with suppliersprice may be fixed as per market rates may conserve time and effort of the department. Large single orders: special machinery, goods such as computers, vehicles. Considerable planning involvedtendered for. Small value purchases: Infrequently used itemsusually purchased by concerned departments from local stores Normal Purchases: follow complete cycle of purchasing. Purchasing Decisions Introduction Inputs of departmentsimpact of external environmentrestraints of internal environmentdemand patterns Some may be operational decisions or long term decisions. Supplier selection Sources: Industrial advertisements; supplier catalogues; salesmen; trade journals; yellow pages; trade directories; government agencies and trade associations; list of suppliers approved by government; individual communications and records of past purchases Criteria: relative proficiency of supplier vis a vis competition; suppliers management capability; financial stability, ability to deliver in time etc. Timing of purchases Not critical in a price stable market but critical in an unstable market Speculative buying: storing excess quantities(more than foreseeable requirements) in face of soaring prices with a view to make imputed profitpossible when firm has sufficient working capital it can afford to lock up temporarily. Forward buying: Purchasing economical quantities exceeding current requirements but not beyond actual foreseeable requirements when price is stable to obtain quantity discounts and items when they are available(maybe protect against shortages).

Hand to mouth buying: Buying to satisfy immediate requirements and highly uneconomical. Used in high value itemsnot normal operations. Techniques to mitigate risks. All above techniques have financial risks attached. Techniques to mitigate risks. Time budgeting purchases: Purchasing small quantities over short operating periods of equal length to achieve average price very close to the average market price. Hedging: Used in organized commodity markets. Purchasing required quantities in the spot market and contracting to sell in the future market to take advantage of price fluctuations and reduce risk. Price determination Price=purchase price + transport price+ handling cost+ inspection + insurance etc. Right price=lowest possible price for an organization. Price determination from price lists, competitive bidding and negotiation. Price lists by suppliers Competitive bidding at least from three biddersmost applicable to standardized productsused when size of order exceeds a pre-defined minimum to the organization. Negotiation is the approach resorted to when time is short and number of bidders is too small; value of purchase is high or willingness to compete is lacking. While determining priceshipping terms have to be clarified. Who will pay; when doe the buyer get the legal title to the goods; who will prosecute loss and damage claims against carriers. FOB or free on boardbuyers plant. The supplier pays all charges and the buyer takes title to goods on delivery. FOB Sellers plant: Buyer pays transportation and takes charge of goods the moment it leaves the sellers factory.

10

FOB Sellers PlantFreight allowed Supplier pays freight charges even though buyer takes title the moment the goods leave sellers plant. CIF Contractsprice includes cost of goods, freight and insurance FAS (Free alongside ship): Used for shipping by sea when supplier is responsible for getting the goods to the ship and buyer takes title and responsibilities thereafter. Other types of contracts Fixed price contracts Cost plus contracts (no limit on costs) Blanket order (six months to one year) Discounts: Following types Trade discount: used for protecting a distributor channel making it more profitable to buy from the distributor than from the manufacturer. Quantity discounts: For purchasing something worth more than a specified limit Seasonal discounts: For purchasing off season Cash discounts: For prompt and full payment Quality and quantity Right quality= balance between technical specifications and economic considerations. Process for determining right quality 1. Requisitioning provides specifications 2. Purchasing department provides various market grades, trade names and commercial standards with prices 3. Requisitioning department specified quality standards 4. Purchasing department makes arrangements for delivery of items 5. Both jointly inspect items in vendors plant to minimize operational delays from inferior quality. Establ of procedures essential for handling inferior qualityshould the shipment be returned or should the buyer rework the item to an acceptable quality and bill the supplier? Should the items be replaced etc.

11

Right quantity for different types of items Blanket order for large continuously required items. Small purchases on demand. Normal purchases==two quantities to be determined Reorder point and order quantity. Reorder point=safety stock + average demand during the lead time. Order quantity= \/2AD H A= fixed cost of ordering D=Average annual demand H=holding cost Safety stock is based on variation of demand and can be taken as 3 times the standard deviation. Example Pam runs a mail-order business for gym equipment. Annual demand for the TricoFlexers is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. Calculate economic order quantity (EOQ) Calculation:

Underlying Assumptions of Economic Order Quantity: 1. 2. 3. 4. The ordering cost is constant. The rate of demand is constant The lead time is fixed The purchase price of the item is constant i.e no discount is available 5. The replenishment is made instantaneously, the whole batch is delivered at once. Organization of the Purchase Department 12

Functional department under the General manager or a division under the materials manager. The type of organization depends on the volume of work and the value of purchases. Good organization demands assignment of responsibilities, specific authorities and smooth chain of command. Organization by function: Purpose specialization of skills (list the skills) advantage, people know what to do and how to do it. Flip side may get bored doing the same job again and again. Organization by Product: specialization for purchase of materials for the specific product Organization by location: Large and several plants. Ideal Organization by stage of manufacturing:

Procedures, forms records and reports Steps for purchase transaction: important to establish a single set of procedures universally applicable 1. Receipt of requisitionanalyis of requirement 2. Selection of possible sources of supply 3. Determining time, price, quality and quantity 4. placing the order 5. Following up and expediting 6. Checking the invoice and receiving the order 7. Processing discrepancies and rejection after inspection 8. Communicating with the accounts section for payment 9. Closing completed records 10. Maintenance of records and files Purchase forms Purchase requisition Request for quotation Purchase order Follow up Receiving and inspection 13

Some organizations may acknowledge quotation received, change of order, purchase contract sample test report etc Purchase records Purchase order log: numerical brief record of all purchase orders issued. Order number, date, suppliers name, description, total value etc. Open order file: status of outstanding orders. Purchase requisition, order and followup information. Close order file: All historical data of completed purchases Vendor records: contains names and addresses of suppliers for different types of materials, delivery and quality records. Commodity record: record of each major material or service that is purchased repeatedly. Suppliers, annual usage rate, orders placed, orders received and disbursement to departments. Contract file: contains the purchase records of items under a term contract. Especially if it is an open contract on which many orders can be placed. Purchase Reports Periodic summary reports on 1. Total value of purchase 2. Allocation of purchase value against major items 3. Allocation of purchase value against each requisitioning department 4. Budget for purchase for the next year 5. Proposals for revisions of budget in the current year. Other reports: 1. Vendor performance 2. Pattern of consumption of materials 3. Pattern of market prices Evaluation of Purchasing department

14

Important to evaluate procedures of the purchasing department for continuous improvement; aid to organization and easy coordination among departments. Evaluation criteria is also difficult but following may be used. 1. Cost purchase comparison=Annual cost of purchasing department/ total value of purchasing 2. Cost per order=Total cost of purchasing department/number of orders 3. Return on investment=net savings per rupee spent on purchasing 4. Quality criteria= number of rejects 5. Quantity criteria= downtime 6. Price criteria=comparison with other organizations or standards 7. Past performances, budget performances etc. Vendor Evaluation rating Not easy to identify good suppliers; records obtained from other sources or reputation or past performance help in evaluation. Usually a combination of price, quantity, quality, delivery time is used. Other factors: reliability; technical capabilities; convenience; availability; after sales service and sales assistance. When does evaluation take place? 1. Before the purchase (Vendor evaluation) 2. After the delivery (Vendor monitoring) Vendor evaluation, buyer lacks direct evidence and must obtain information in other ways. Vendor rating Product quality as admitted by vendor against actual product quality delivered traditionally used. Now there are vendor rating formulas available. Provide quantitative rating of vendor quality. But it is not a tool for making a decision on submitted lots. Creating a single numerical quality score is difficult because of multiple inputs with own units of measure. Lot quality=lots rejected/lots inspected Parts qualities=percent defective 15

Characteristics quality=rupees per sq m or percent active ingredient etc. Economic consequences of bad quality=rupees. National Association of Purchasing Agents New York: Three other rating methods 1. Categorical plan: Vendors meet each month and rate themselves as plus, minus or neutral 2. Weighted Point plan: scored on quality, price, service etc. factors are weighted and composite rating is calculated for each vendor. Steps are: Step One Quality rating = Rq= Q1 +Q2 X1 +Q3 X2/Q *100 Q=quantity supplied Q1=Quantity accepted Q2=Quantity accepted with concession Q3 Quantity accepted with rectification Q4=Quantity rejected X1 and X2 are weightages given to the factors--each less than 1 Step Two: Price rating Rp=PL x100/P Where PL= lowest price and P=price agreed by supplier Step 3: Delivery rating Rd=Promised delivery time /Actual delivery time of full consignment x100 (rating in excess of 100 equated to 100) Step 4: Quantity rating Quantity supplied within stipulated delivery time /Quantity promised x 100

16

Step 5: Service rating: A1+ A2 +A3+AN=100 Where A assumes various values from the table such as A1=cooperativeness and readiness to help in emergencies; A2=readiness to replace rejected material A3=Providing supporting documents in time A4=Readiness in replying A5=Acceptance of terms without complaints Step 6: Composite vendor performance rating VPR=f1RQ +F2 RP +F3 RD+F4Rqty +F5Rs Where f1+f2+ f3+ f4=1 3. Cost Ratio Plan Compares vendors on total rupee cost for a specific purchase. TC=Price quotation; quality costs; delivery costs; service costs. Final rating =net value costs in rupees. Net value cost=adjusted unit price *number of units Adjusted unit price= quality cost ratio (relative cost of quality) + Delivery cost ratio (timeliness; penalty imposed)+Service Cost ratio (technical, managerial etc skill) Vendor relations Need: to ensure that materials conform to production requirements and there is no need for corrective procedures: 1. Communication of design, specifications, standards etc. 2. communication of engineering changes 3. Developing methods for identifying deviations from standards promptly 4. Providing for use of vendor quality data in lieu of incoming inspection 17

5. Reviewing performance of vendor through vendor rating Should be done in the spirit of partnership. Supplier should feel that he must deliver quality that is acceptable to the buyer. He should work constructively with the buyer. Important Question Describe Value analysis. How does the purchasing department contribute to a value analysis program? Define Value Analysis: Purchasing objectives 1. Buying at the right | quality; quantity; time; price; source; place 2. objectives of the purchasing function: a) Make users aware of market availability of materials and the range of material availability of right quality etc b) To procure the material at the lowest cost consistent with requirements c) Minimum investment in associated purchasing service costs d) Maintain continuity of supply of materials to meet schedules of operations e) To integrate requirements of all departments for economy of scale f) To create goodwill for the organization through healthy buyer supplier relationship. Purchasing Decisions Inputs of departmentsimpact of external environmentrestraints of internal environmentdemand patterns Some may be operational decisions or long term decisions. Supplier selection Sources: Industrial advertisements; supplier catalogues; salesmen; trade journals; yellow pages; trade directories; government agencies and trade associations; list of suppliers approved by government; individual communications and records of past purchases Criteria: relative proficiency of supplier vis a vis competition; suppliers management capability; financial stability, ability to deliver in time etc.

18

Timing of purchases Not critical in a price stable market but critical in an unstable market Speculative buying: storing excess quantities (more than foreseeable requirements) in face of soaring prices with a view to make imputed profitpossible when firm has sufficient working capital it can afford to lock up temporarily. Forward buying: Purchasing economical quantities exceeding current requirements but not beyond actual foreseeable requirements when price is stable to obtain quantity discounts and items when they are available (maybe protect against shortages). Hand to mouth buying: Buying to satisfy immediate requirements and highly uneconomical. Used in high value itemsnot normal operations. Techniques to mitigate risks. All above techniques have financial risks attached. Techniques to mitigate risks. Time budgeting purchases: Purchasing small quantities over short operating periods of equal length to achieve average price very close to the average market price. Hedging: Used in organized commodity markets. Purchasing required quantities in the spot market and contracting to sell in the future market to take advantage of price fluctuations and reduce risk. Maintaining records Vendor evaluation and rating 2. Different forms used by purchase department. Discuss different criteria employed in evaluating the purchase system. Procedures, forms records and reports Steps for purchase transaction: important to establish a single set of procedures universally applicable 1. Receipt of requisitionanalyis of requirement 2. Selection of possible sources of supply 19

3. Determining time, price, quality and quantity 4. placing the order 5. Following up and expediting 6. Checking the invoice and receiving the order 7. Processing discrepancies and rejection after inspection 8. Communicating with the accounts section for payment 9. Closing completed records 10. Maintenance of records and files Purchase forms Purchase requisition Request for quotation Purchase order Follow up Receiving and inspection Some organizations may acknowledge quotation received, change of order, purchase contract sample test report etc Evaluation of Purchasing department Important to evaluate procedures of the purchasing department for continuous improvement; aid to organization and easy coordination among departments. Evaluation criteria is also difficult but following may be used. 1. Cost purchase comparison=Annual cost of purchasing department/ total value of purchasing 2. Cost per order=Total cost of purchasing department/number of orders 3. Return on investment=net savings per rupee spent on purchasing 4. Quality criteria= number of rejects 5. Quantity criteria= downtime 6. Price criteria=comparison with other organizations or standards 7. Past performances, budget performances etc.

20

Inventory management
Concept of Inventory Usable idle resourcesphysical and tangible resources are called stock. Stock and inventory are synonymous though inventory is broader in meaning. Inventory management is about maintaining an adequate supply of something to meet an expected demand pattern. Deals with optimal management of inventory. It can be one of the indicators of management effectiveness. This is an index of business performance. Well managed org=higher inventory ratio. Inventory turnover ratio = annual demand/average inventory. Inventory costs Cost of carrying inventory: holding cost expressed in Rs./item. Opportunity cost of blocking material non productively. This cost is comprised of blocking capital (interest rate), cost of insurances; storage cost; cost of obsolescence, pilferage, deterioration etc. Expressed as a fraction of carrying charge eg 20% per year. For perishable items the carrying cost will be higher. Cost of incurring shortages: opportunity costnot having an item in storage when one is demanded. Loss of sales or backlogging resultto be cleared on availability. There are tangible and intangible costs associated with this. Cost of replenishing inventory: money and effort expended in procurement or acquisition of stock. Also called ordering cost assumed to be independent of quantity ordered and therefore a fixed cost. Expressed as Rs./order These costs incorporated into inventory analysis. Importance of inventory management 1. Materials account for a large percentage of manufacturing costs 2. Potential for cost reduction and quality control

21

3. Measure of performance of the organization. Functions of Inventory Why an organization carries inventory? 1. Demand and lead time uncertainties 2. Time lag in deliveries 3. Cycle stocks for economies of scale (eg technological requirements in batch processing demands build up of cycle stocks) 4. Pipeline inventory or work in process inventory due to finiteness of production and transportation rates (goods being transported between process steps or distribution centers and customers). 5. Seasonal demand economical to build during low demand for cost advantage or ease strain during peak demand 6. Quantity discounts or anticipated increase in material price or possibility of non availability of material Calls for an integrated systems approach to inventory management and planning. Classification of inventory systems 1. Lot size Reorder point Policy: a. inventory status continuously reviewed and when inventory level falls to reorder point, new inventory is purchased. b. The fixed quantity purchased is called Economic Order Quantity. This order size is constant and economically determined. c. Classical inventory policy d. Lead time is defined as delay between placing the order and receiving the stock. e. Broken line in the figure indicates the ideal situation for inventory if no lead time existed. f. Lot size and reorder point are two variables in this policy design. 2. Fixed order interval Scheduling Policy a. The time between consecutive replenishment orders is constant. b. There is a minimum stock level prescribed and inventory is viewed at fixed intervals. c. At each review an order size Q is placed which takes into consideration stock on hand plus an order equal to the

22

maximum stock level. Order quantity will vary from period to period. d. Stock level and review periods are variables under this policy. 3. Optional Replenishment system a. Popularly known as (s, S) policy b. Status of stock periodically reviewed c. Maximum and minimum stock levels are prescribed. d. If stock< or = s then order size Q is placed so that stock on hand + s=maximum stock level. e. Variables are s, S and review period (T) 4. Other types of inventory systems a. Special types or combinations of above policies b. Special case where (S-1, S) policy where one for one order is used to replenish inventory. c. Static inventory systems in which single purchase decisions are made for inventory requirements of the entire duration of a project. Selective Inventory management Role of Selective inventory control Difficulty= large variety of inventory stocks. So not scientific to apply rigorous scientific principles. So intermediate approach of selective inventory control depending on value of inventory; criticality; usage frequency etc. Items are grouped in few discrete categories depending on value, criticality and usage. ABC Analysis 1. Based on Paretos law: in any large number there is a significant few. Eg. 20% material may account for 80% inventory costs. 2. Analyses percentage of number of inventory items against a percentage of average inventory investment (annual usage value) 3. Annual usage value=demand multiplied by unit price Preparing an ABC curve 1. Arrange items in descending order of annual usage value 2. Annual usage value = annual demand x unit price

23

3. Identify cut off points on the curve when there is a perceptible change of slope or alternately find cut off points at top 10% or 20% or so but do not interpret literally. (general indicator) 4. Classification of items a. Average Annual usage of X=Total material cost/total number of items A Class items >=6X C Class items<=10.5 X In between B class items Depending on the category we adopt different levels of seriousness in our inventory analysis. VED Analysis 1. 2. 3. 4. 5. 6. 7. VED=Vital, essential and desirable Categorized on basis of consequences of stock out of a material. Cost varies on basis of seriousness Most serious are Vital and have high opportunity costs Essential items are critical with substantial costs attached Desirable groups do not have very serious consequences. % of risk with vital items have to be minimum. More risk with Essential and highest risk with desirable.

FSN Analysis 1. Not all items are required with same frequency. A frequency of usage based analysis. Categories fast moving, slow moving and non moving. 2. Inventory models for the three categories are different. Most inventory models are valid for fast moving items. 3. Helps adopt the right type of inventory policy.

Exchange curve and Aggregate inventory planning page 33 1. Effective technique to look at inventories at an aggregate level of planning. 2. Plot between total number of orders (TO) per year and total investment in inventories (TI) per year

24

3. Rationale= optimal inventory is tradeoff between total inventory and total procurement effort.indicated by total number of replenishment orders placed per year. 4. If TI is prescribedinventory policy must minimize TO. 5. Optimal inventory must exchange TI and TO such that 6. (TI). (TO)=K= constant 7. Value of K is constant and given by K=1/2 [N D1V1]2 i=1 Where Di=Annual requirement of ith item Vi=unit price for the ith item 8. The plot is a regular hyperbola and is called the Exchange curve. Any point in the exchange curve is an optimal trade off between investment in inventories and total number of orders. Uses of Exchange curve: 1. Useful for aggregate inventory analysis a. Quickly determine rationality or otherwise of existing stock provisioning policies b. If Current point is above exchange curve, the policies are not rational. c. Rationalization would require reduction of inventory for the same ordering effort or reduction of orders for the same inventory. Determinants of Inventory Models Classical EOQ Model Finite Replenishment rates Planned backlogging Model with Quantity discounts Sensitivity Analysis Purpose : discuss elementary models with deterministic demand and lead time situationsmathematical analysis of inventory systems

25

Classical EQQ Model 1. Developed by Harris in 1915. 2. Further developed by Wilson 1928 3. Two important decisions about stocked items a. How much to order b. When to order 4. EOQ tells you how much to order and ROP tells you when to order 5. Some assumptions are made a. Demand is continuous and at a constant rate b. The process continues infinitely c. No constraints are imposed on quantities ordered; storage capacity; budget etc. d. No lead time e. All costs are time invariant f. No shortages are allowed g. Quantity discounts are not available. 6. Inventory status is constantly reviewed 7. EOQ aims at minimizing total system cost. 8. Formula= TC=A(D/Q)+ H.O/.2 Q*=EOQ=\/2AHD/H TC*=\/2AHD D=demand A=ordering rate C=unit cost r=inventory carrying cost H =Annual cost of carrying inventory/unit item=r.c TC=total annual cost of operating the system Rs./year (objective function) Q=Order Quantity, number of units per lot (decision variable) 9. Curve = convex. Gives global minimum total cost. 10. EOQ is obtained at point of intersection of ordering cost and carrying cost.. Insights 26

1. ordering cost is high-. Optimal policy-- High EOQ 2. If inventory carrying cost r or unit cost C is high leading to a high value of H or annual cost of carrying inventory/unit item go for smaller lot sizes. 3. r may vary from 0.15 to 0.30 depending on the nature of item 4. Ordering cost will be marginal ordering cost 5. H will be based on total purchased cost of the items.

27