CLASS 6 NOTES: Managing Materials/Inventories, Procurement




Types of Inventories and Their Functions:


Raw Materials  Inventories -


·        Buffer (against unreliable delivery of raw materials)


·        Cost Reduction (allow for purchase at optimum market opportunity)


Work In Process Inventories -


·        Buffer (against unreliable delivery from within production process)


·        Decouple process segments (i.e. Stroh's)


·        Allow for individual operations to produce economic runs, optimize set-up times


Finished Goods Inventories -


·        Customer Service - assure readily available supply


·        Buffer - protect against uncertain customer demand


·        Smooth demand to production - allow production to continue in the face of erratic demand, or allow build-up when demand increase is anticipated


Non-time-phased inventory systems -


·        Do not attempt to replenish items (by timing reorders) based upon expected use


·        Purpose is to periodically replenish to a pre-determined stockage level


·        Retailing and Distribution activities lend themselves to this methodology


non-time-phased techniques:


Reorder point system - Replenish to a pre-determined stockage level when inventory reaches a certain pre-determined reorder point


Another approach - Anticipatory Replacement - Materials Requirements Planning (MRP):


Monitor use and make choices based upon anticipated need


Extensive information requirements -


·        Master production schedule drives the entire process

·        BOM for each product

·        Inventory status of each component (on-hand/due-in)

·        Lead times for all parts (purchased and fabricated)

·        Production cycle times and Materials needs at each production stage

·        Other information requirements?? (i.e. standard costs)


MRP has met with mixed success depending upon level of commitment to fully implement the processes necessary to make it work. Commitment in cost may also be significant.


Other concerns relative to decision to implement MRP relate to:


·        ability to accurately establish (and maintain) a master production schedule

·        capability to maintain large buffer stocks of finished goods inventory

·        stability of sales over time

·        stability of product mix and seasonal swings

·        stability of process over time


Costs Associated with Inventories -


·        Costs to obtain (purchase) items

·        Costs to track (manage) items

·        Costs to store (maintain) items

·        Costs to produce items (if components, sub-assemblies) - this includes production changeover costs, etc. and requires make or buy analysis (make or buy later decision)


Negative costs (cost avoidance) may also be considered, for instance:


§         Value attributed to volume discounts

§         Value of seizing a low market opportunity (good buy)

§         Better customer service levels due to reduced delivery times

§         Smoother production flows

§         Insulation from market downside, i.e. seasonality, disrupted supply


Types of Materials  Organizations



                              narrow focus on:        

·        buying

·        purchasing research

·        expediting

·        value analysis



                              purchasing plus what? 

·        Planning

·        Item Management 


                  Materials Management:

                              integrated approach to:

·        planning                                   

·        acquisition                                

·        flow                                              

·        inventory management   

·        distribution                                     

·        disposition


(of production materials, from the raw material to the finished state)


Materials Management concept advocates SINGLE POINT of management of all activities affecting materials cost such as:

·        inventory

·        traffic

·        receiving

·        warehousing

·        disposal

·        production control (sometimes)


Form of MM organizations varies with a firm's operating activities, as does the locus of Production Control.


·        If majority of materials, parts, components, SUB-assemblies are purchased, with little or no transformation during the production process, an argument can be made for co-locating production  control and MM when production is uniform.


·        If materials are both purchased and Manufactured in house, production department and MM should be separate.


In either case, the key point is that production planning and purchasing schedules must be well coordinated, integrated into overall corporate objectives.


MM organization as an Operating Division may be appropriate when:

§         outside purchases are large

§         production processes are varied, cyclic

§         market is dynamic


An MM department is best suited to deal with the corporate "big picture" of Planning and control, i.e.:

§         inventory

§         production planning, scheduling

§         Purchasing, i.e.:

·        buying

·        purchasing research

·        expediting

·        value analysis

§         Physical distribution, i.e.:

·        receiving

·        packaging

·        shipping

·        transportation

·        warehousing


Logistics Management concept combines MM with Physical distribution management, i.e.: disposition of Finished goods, including:     

§         sales order processing

§         transportation

§         inventory control

§         materials storage


Logistics Management views firm as a single operating system seeks to minimize total matl's cost




§         Organization of firm

§         Geographic dispersal

§         Product lines

§         Market proximity

§         What Works!


Some advantages of Centralized MM include:

§         specialization

§         ability to consolidate requirements

§         improved coordination/control


Some advantages of Decentralized MM include:

§         ease of local (internal) coordination among depts.

§         speed, responsiveness

§         plant autonomy


A strong MM organization results in HIGHER PROFITS (and lower materials costs) stemming from:

§         higher machine utilization

§         greater inventory turnover

§         increased productivity

§         fewer stock-outs

§         better, more fully integrated materials planning






Procurement is more than purchasing, a modern purchasing departments duties include:


§         Understanding, participating in development of materials requirements with Engineering, Manufacturing, Marketing, Finance Departments

§         Question specifications when excessive or difficult to obtain

§         Suggest substitute materials as may be identified by vendor representatives

§         Be involved in Value Analysis/Value Engineering

§         Vendor selection and evaluation Based upon vendor history, i.e.:

§         Quality (conformance to specifications)

§         Ability to deliver on time, as specified

§         Trustworthiness and ability to anticipate, identify, communicate and to correct problems when they occur

§         Initiative in product design and innovation (including cost effective design and use of materials)


Emphasis on MM is shifting from lowest price to lowest cost characteristics of:

§         Quality

§         Performance

§         Delivery


Long-term relationships with vendors are mutually beneficial

§         Vendor certification programs limit market access to proven performers

§         Dual or multiple sourcing is wise - one major source, one or more secondary sources keep everyone on their toes and instill competition


Formal vendor evaluation programs should be instituted that Verify continuing ability to meet requirements


Purchasing Department is formal point of contact with vendors and performs the following functions:


§         Select Type of contract instrument to use (cost, ffp)

§         Negotiates Price, Delivery, Quality

§         Makes contract decisions such as: length of contract (multi-year, annual, discrete)

§         Methods of order placement

§         Who places orders

§         Delivery frequency


Purchasing Department oversees (but does not necessarily perform) receipt, inspection and Testing, (and maybe storage) of purchased materials:


§         Verification of receipt of proper items and quantities

§         Verification of timely receipt

§         Reporting receipt into materials status reporting system

§         Packaging for convenient dispersal to factory floor (bulk   vs. smaller quantities)


Levels of Inspection may vary depending upon items being received and their criticality, value:

§         100 percent

§         Acceptance sampling by lot

§         No inspection due to simplicity of item or vendor  certification


purchasing department coordinates Disposition of rejected items - hold or return?




§         Who?  Purchasing or supply?

§         Access to storage areas?

§         Degree of automation of storage, retrieval systems?

§         Method of issue?

§         Inventory control (annual, cycle count of selected items)?


Make or Buy Decisions - Purchasing should be involved


§         Look at marginal return vs. cost

§         Consider any requirement to assure in-house capability to produce

§         Consider consistency of need for the item over time - is the capital expenditure worth it?

§         Evaluate the degree of specialization required to produce the item

§         Consider any potential compromise of proprietary information


Organizational Location Issues - Purchasing Organization within Corporation or Agency:


§     Centralize vs. Decentralize or a combination of both (centralize functions and/or policy control)

§      Placement at Corporate level - Equal or subordinate to other operating divisions?

§         Internal Organization-Functional alignment of duties performed 

Purchasing organized as a top level function:







Purchasing organzed as a sub-functional organization:



Internal Purchasing Organization:




Considerations for just in time inventory managers


Events such as the UPS strike, the September 11, 2001 Attack and resulting decrease in air traffic have challenged the JIT concept in so far as the risks presented due to supply-chain interruptions


Corporate managers, financial, production, marketing, and purchasing must look at inventory management from the perspective of “contribution to overall profit” and maintain proper balances between investments in inventory and sales volume, for example, inventories have become smaller, as related to sales, over a recent 25 year period:


·        1986 Inventory:Sales = 1.60

·        2001 Inventory:Sales = 1.16




·        Inflation

·        Interest Rates

·        Ability to Manage Inventories through Information Technology

·        Suppliers to you

·        You to customers

·        Lead Times

·        Responsive Transportation Options

·        Competition

·        Product Life-Cycles

·        Production and Delivery Lead-Times by Suppliers


Customer demand and required service levels are critical components to effective inventory management to preserve your competitive position


Sales and Product Trend Forecasting become even more critical in a JIT environment


Profit can be positively impacted by holding larger than normal inventories when favorable pricing becomes available (all other inventory costs considered)

Some Features of Effective Inventory Management Include:





Cross-functional involvement between finance, marketing, purchasing, production

Inventory levels

Key to desired service levels, not vice versa

Market timing

Take advantage of opportunity to use forward buying when advantageous to do so

Relationships with suppliers

See partnership and long-term, mutually beneficial relationships

Incentivize desired actions

Buyers should have incentives compatible with corporate needs/desired customer service-levels

Systems Management

Keep inventory systems current with cost and pricing structures


Constantly evaluate distribution systems striving to attain the highest levels of efficiency


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