Management Consulting/Material Management

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Question
Case -2 (10 Marks)
Cause of John Mathai s Sorrow
( A case of inventory car in m.m.)
John Mathai was a very sad man on Sunday, 12 April 1998. He was the Chief Executive of Telecom Installations
Ltd, TIL, a wholly owned subsidiary of the major producers of telecom equipment in the country: Telecom
Manufacturing Company (TMC). Around 88 per cent of the production of TMC was produced for the
Government of India under special terms and prices, but the balance 12 per cent was routed through TIL, who
were really the All India Sales, Serving and Installation network of TMC.
John’s wife Sheela, herself a commercial executive with a multinational, found John staring at some sheets of
papers after they returned from church. These papers had been delivered by John’s office while they were away.
Fearing bad news, Sheela gently took the papers from John. It was a brief performance report of TIL for the justended
financial year. The sales had grown at the rate of 32 per cent. Usually a poor performer, the Kolkata region,
had done extremely well. The company had performed the task of providing telecom facilities to villages very
well. This was a politically sensitive area. The number of villages provided telecom facilities during 1997-98 had
grown by 16 per cent over the figure for the previous year. TIL also took annual maintenance contracts, AMCs
for telecom systems sold by TIL/TMC and the income from the servicing contracts had also grown by a healthy
21 per cent. Sheela felt that TIL had done well and asked John to thank the lord for such good results. She
requested John not to be too ambitious and ask for more and more. John took the report from Sheela and showed
her the last page, which she had missed. It gave details of the inventory of TIL and Sheela realized that the
inventory too had grown and that too at a hefty 27 per cent during the year. The growth had been in all the
regions. The breakup of inventory under various heads followed. Sheela could not follow the technical details but
understood the cause for John’s despair!
John wondered, ‘How can the inventory grow when there has been such a steep increase in sales, servicing and
installation activities? This performance should have actually cleaned the stores and reduced the inventory.’
Sheela understood the problem and prompted John to have a detailed study conducted to analyse the situation and
determine the causes of inventory increase. She hoped that this decision would help John to have peaceful Sunday
at home and not run to the office!
All the field offices were hoping to get a congratulatory message from their Chief for the good performance
achieved by TIL in sales, servicing and installation fields. Instead, everybody was surprised to get a crisp FAX on
the black Monday morning on the unlucky 13 April 1998, announcing the setting up of an Inquiry Team
consisting of Mr. Sreedharan, an auditor from the Bangalore office and Girish Sehajwala, Technical Executive
from Mumbai office. The team was to analyze the reasons for the increase of inventory and submit its report by
30 April 1998. All the employees were directed to extend full cooperation to the team. The message, that the
inventory control was essential, was received loud and clear by all the field offices. There were reports of
demoralization and frustrations due to these events, but John Mathai chose to ignore these.
Sreedharan and Girish worked sincerely, as was expected from this handpicked team. They came out with
following startling causes for the increase of inventory:
1. The increase had been more in monetary terms due to an increase in prices by 11 per cent.
2. The field offices were immensely encouraged by the increase in sales and had augmented their orders on
the manufacturing units during August-September 1997. Deliveries were expected around December
1997. This was done because there were reports of a likely loss of production due to shortage of imported
components. Deliveries did not take place when expected. The production picked up much later and the
factories of TMC dumped the ordered equipment in March 1998. There were protests from the field
offices that there would be little time to sell these systems in the current year, but the factories insisted on
completing the deliveries since they had to show these sales during that year’s production. These items
had thus added to the inventories without much chance of sales before 31 March 1998. Had the factories
adhered to the delivery schedules, there would have been much less increase in the inventories.
3. The installation materials had shown a significant increase in all the field offices. This increase had been
due to the improper disposal of installation materials after every installation. For example, 60 to 70 per
cent of stocks of all types of cables consisted of small pieces left from the cable drums after an
installation. These pieces were too small to be used in subsequent work and, therefore, just added to the
inventory. The entire 4.2 kilometres of D-8 cable in the Delhi office stores consisted of two one-kilometre
drums and 2.2 kilometres of cable in the form of 503 pieces of lengths varying between half a metre to 3
metres. The field managers had not shown these amounts as consumed since an increase in consumed
materials reduced the profitability of the installation tasks. The managers had also been apprehensive of
scrapping the brand new cable. The small and unusable quantities of installation materials had been
accumulating over the years. This year the accumulation had been higher since the installation work had
been more.
4. Current generation of electronic/telecommunication equipment consist of a number of circuit boards held
together and interconnected. Fault detection system may be built in the equipment to indicate which
circuit board has developed a fault. This helps in urgent repairs, because even an operator can easily
replace the faulty circuit board. Each field office of TIL, therefore, stocked circuit boards to sell to
customers located at some distance from the field office. The objective has been that in the event of a
failure, the customer could restore the system by changing the defective circuit board with the spare good
circuit board held by him. Simultaneously, the customer was to send for a TIL technician. The service
engineer of TIL could repair the faulty circuit board and carry out a complete check up of the equipment.
The service engineers have also been keeping some circuit boards with them, so that they can put back a
system to work when visiting customers having problems and not having spare circuit boards. Badly
damaged, circuit boards beyond the repair capabilities of the field offices have to be sent to the factory for
repairs. Customers have to be given circuit boards for the duration of their circuit boards getting repaired
at the factory. The team sent by John Mathai found that there was gross misutilization of these circuit
boards. Service engineers ‘loaned’ some circuit boards to the customers, there was a lack of clarity about
the circuit boards sent to the factory, etc. There was, in brief, no clear policy about these costly circuit
boards and a large number continued to be on the inventory of the field offices.
John Mathai read the report twice and concluded that he must do something about the inventories. He
would have to make a large number of policy decisions and involve the manufacturing factories of TMC
who repaired the cards and sent the finished products for sale. What detailed actions would you
recommend, and why? Comment about the reactions of John Mathai when he saw the annual performance
report. Should he not have expected some of these results during his day-to-day working?
Question:-
Q.1) Summarize & Analyse the case with reference to the principles of materials management?
Q.2) How o reduce the inventory of TIL without affecting its operations?

Answer
Question:-
Q.1) Summarize & Analyse the case with reference to the principles of materials management?

TI  MATERIAL / SUPPLY  SITUATION  IS  AS  FOLLOWS:

1. The increase had been more in monetary terms due to an increase in prices by 11 per cent.BUT  NOT  BUDGETED.
2. The field offices were immensely encouraged by the increase in sales and had augmented their orders on the manufacturing units during August-September 1997.
3.Deliveries were expected around December
1997. This was done because there were reports of a likely loss of production due to shortage of imported components. Deliveries did not take place when expected. The production picked up much later and the factories of TMC dumped the ordered equipment in March 1998. There were protests from the field offices that there would be little time to sell these systems in the current year, but the factories insisted on completing the deliveries since they had to show these sales during that year’s production. These items
had thus added to the inventories without much chance of sales before 31 March 1998.
4. The installation materials had shown a significant increase in all the field offices. This increase had been due to the improper disposal of installation materials after every installation. For example, 60 to 70 per cent of stocks of all types of cables consisted of small pieces left from the cable drums after an installation. These pieces were too small to be used in subsequent work and, therefore, just added to the
inventory.
5.The entire 4.2 kilometres of D-8 cable in the Delhi office stores consisted of two one-kilometre
drums and 2.2 kilometres of cable in the form of 503 pieces of lengths varying between half a metre to 3 metres. The field managers had not shown these amounts as consumed since an increase in consumed materials reduced the profitability of the installation tasks. The managers had also been apprehensive of scrapping the brand new cable. The small and unusable quantities of installation materials had been accumulating over the years. This year the accumulation had been higher since the installation work had been more.
6. Current generation of electronic/telecommunication equipment consist of a number of circuit boards held
together and interconnected. Fault detection system may be built in the equipment to indicate which circuit board has developed a fault. This helps in urgent repairs, because even an operator can easily
replace the faulty circuit board. Each field office of TIL, therefore, stocked circuit boards to sell to
customers located at some distance from the field office. The objective has been that in the event of a failure, the customer could restore the system by changing the defective circuit board with the spare good circuit board held by him. Simultaneously, the customer was to send for a TIL technician. The service engineer of TIL could repair the faulty circuit board and carry out a complete check up of the equipment.
The service engineers have also been keeping some circuit boards with them, so that they can put back a
system to work when visiting customers having problems and not having spare circuit boards. Badly
damaged, circuit boards beyond the repair capabilities of the field offices have to be sent to the factory for
repairs. Customers have to be given circuit boards for the duration of their circuit boards getting repaired
at the factory. The team sent by John Mathai found that there was gross misutilization of these circuit
boards. Service engineers ‘loaned’ some circuit boards to the customers, there was a lack of clarity about
the circuit boards sent to the factory, etc. There was, in brief, no clear policy about these costly circuit
boards and a large number continued to be on the inventory of the field offices.John Mathai read the report twice and concluded that he must do something about the inventories. He
would have to make a large number of policy decisions and involve the manufacturing factories of TMC
who repaired the cards and sent the finished products for sale. What detailed actions would you
recommend, and why? Comment about the reactions of John Mathai when he saw the annual performance
report. Should he not have expected some of these results during his day-to-day working?


ALL  THESE  FACTORS  ADDED  TO  THE MATERIAL MIS-MANAGEMENT.
ALL  THESE  WENT  AGAINST  THE  BASIC  PRINCIPLES  OF  MATERIAL   MANAGEMENT  ---LISTED  BELOW.  
PRINCIPLES  OF MATERIAL MANAGEMENT
         
To get
 1. The Right quality
 2. Right quantity of supplies
 3. At the Right time
 4. At the Right place
 5. For the Right cost
PURPOSE OF MATERIAL MANAGEMENT
•   To gain economy in purchasing
•   To satisfy the  demand during period of replenishment
•   To carry reserve stock to avoid stock out
•   To stabilize fluctuations in consumption
•   To provide  reasonable level of client services
Objective of material management

Primary
•   Right price
•   High turnover
•   Low procurement
•   & storage cost
•   Continuity of supply
•   Consistency in quality
•   Good supplier relations
•   Development of personnel
•   Good information system
Secondary
•   Forecasting
•   Inter-departmental harmony
•   Product improvement
•   Standardization
•   Make or buy decision
•   New materials & products
•   Favorable reciprocal relationships

Economy in material management
•   Containing the costs  
•   Instilling efficiency in all activities
Four basic needs of Material management
1.   To have adequate materials on hand when needed
2.   To pay the lowest possible prices, consistent with quality and value requirement for purchases materials
3.   To minimize the inventory investment
4.   To operate efficiently
Basic principles of material management   
1.   Effective management & supervision
It depends on managerial functions of
•   Planning
•   Organizing
•   Staffing
•   Directing
•   Controlling
•   Reporting
•   Budgeting
2.   Sound purchasing methods
3.Skillful & hard poised negotiations
4.Effective purchase system
5.Should be simple
6.Must not increase other costs
7.Simple inventory control programme
Elements of material management
1.   Demand estimation
2.   Identify the needed items
3.   Calculate from the trends in Consumption   during last 2 years.
4.   Review with resource constraints
Functional areas of material management
1. Purchasing
2. Central service supply
3. Central stores
4. The print shops
PROCUREMENT
Procurement cycle
•   Review selection
•   Determine needed quantities
•   Reconcile needs & funds
•   Choose procurement method
•   Select suppliers
•   Specify contract terms
•   Monitor order status
•   Receipt & inspection
Objectives of procurement system
•   Acquire needed supplies as inexpensively as possible
•   Obtain high quality supplies
•   Assure prompt & dependable delivery
•   Distribute the procurement workload to avoid period of idleness & overwork
•   Optimize inventory management through scientific   procurement procedures
•    First technical bid is opened & short listed
•   Then financial bid of selected companies are opened & lowest is selected  
•   Delayed tenders & late tenders are not accepted. But if, in case of delayed tenders, if the rate quoted is very less, then it can be accepted.
•   Quotations are opened in presence of indenting department, accounts & authorized persons of party
•   Validity of tenders – generally 90 days
Negotiated procurement
Buyer approaches selected potential Suppliers & bargain directly
Used in long time supply contracts
Direct procurement
Purchased from single supplier, at his quoted price
Prices may be high
Reserved for proprietary materials, or low priced, small quantity & emergency purchases
Points to remember while purchasing
•   Proper specification
•   Invite quotations from reputed firms
•   Comparison of offers based on basic price, freight & insurance, taxes and levies
•   Quantity & payment discounts
•   Payment terms
•   Delivery period, guarantee
•   Vendor reputation
(reliability, technical capabilities, Convenience, Availability, after-sales service, sales assistance)
•   Short listing for better negotiation terms
•   Seek order acknowledgement
Storage
•   Store must be of adequate space
•   Materials must be stored in an appropriate place
•    in a correct way
•   Group wise & alphabetical arrangement helps in
•   identification & retrieval
•   First-in, first-out principle to be followed
•   Monitor expiry date
•   Follow two bin or double shelf system, to avoid
•   Stock outs
•   Reserve bin should contain stock that will cover
•   lead time and a small safety stock
Issue & use
Can be centralized or decentralized
Inventory control
It means stocking adequate number and kind of stores, so that the materials are available whenever required and wherever required. Scientific inventory control results in optimal balance
Functions of inventory control
•   To provide maximum supply service, consistent with maximum efficiency & optimum investment.
•   To provide cushion between forecasted & actual demand for a material
Economic order of quantity
EOQ = Average Monthly Consumption X Lead Time [in months] + Buffer Stock – Stock on hand
•    Re-order level: stock level at which fresh order is placed.
•    Average consumption per day x lead time + buffer stock
•    Lead time: Duration time between placing an order & receipt of material
•    Ideal – 2 to 6 weeks.
•   ABC ANALYSIS
•   (ABC = Always Better Control)
•   This is based on cost criteria.
•   It helps to exercise selective control when confronted with large number of items it rationalizes the number of orders, number of items & reduce the inventory.
•   About 10 % of materials consume 70 % of resources
•   About 20 % of materials consume 20 % of resources
•   About 70 % of materials consume 10 % of resources
‘A’ ITEMS
Small in number, but consume large amount of resources
Must have:
•   Tight control
•   Rigid estimate of requirements
•   Strict & closer watch
•   Low safety stocks
•   Managed by top management
.
‘C’ ITEMS
Larger in number, but consume lesser amount of resources
Must have:
•   Ordinary control measures
•   Purchase based on usage estimates
•   High safety stocks
ABC analysis does not stress on items those are less costly but may be vital
•    Based on critical value & shortage cost of an item
–   It is a subjective analysis.
•   Items are classified into:
Vital:
•   Shortage cannot be tolerated.
Essential:
•   Shortage can be tolerated for a short period.
Desirable:
   Shortage will not adversely affect, but may be using more resources. These must be strictly Scrutinized
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Q.2) How To reduce the inventory of TIL without affecting its operations?

TIL  CAN REDUCE THE  INVENTORY  COST  BY  BETTER  MANAGEMENT  OF  INVENTORY / PROCUREMENT.


INVENTORY  MANAGEMENT /  ECONOMIC  ORDER  QUANTITY
Inventory is held to avoid the nuisance, the time and the cost etc. of constant replenishment. However, to replenish inventory only infrequently would necessitate the holding of very large inventories. It is therefore apparent that some balance or trade-off or compromise is needed in deciding how much inventory to hold, and therefore how much inventory to order. There are costs of holding inventory and there are costs of re-ordering inventory and these two costs need to be balanced. The purpose of the EOQ model is to minimise the total costs of inventory.
The important costs are the ordering cost, the cost of placing an order, and the cost of carrying or holding a unit of inventory in stock. All other costs such as, for example, the purchase cost of the inventory itself, are constant and therefore not relevant to the model.
---------------------------------------------------------------------------------------
TO  maintain   the  inventory, it  costs  money.
THE  COMPONENTS   OF   INVENTORY  COST  ARE

1.Annual Usage/Demand   = cost  of  units  used

2.Order Cost: Also known as purchase cost or set up cost, this is the sum of the fixed costs that are incurred each time an item is ordered. These costs are not associated with the quantity ordered but primarily with physical activities required to process the order.


3.Carrying cost (Inventory Holding Costs): Also called Holding cost, carrying cost is the cost associated with having inventory on hand. It is primarily made up of the costs associated with the inventory investment and storage cost.

4. BANK  Interest.
5.Insurance  COST .

6.Taxes -VARIOUS  TAXES  PAID

7.Storage Costs.

8.Other costs that can be included in carrying cost are risk factors associated with obsolescence, damage, and theft. Do not factor in these costs unless they are a direct result of the inventory levels and are significant enough to change the results of the EOQ equation.
========================================================
THE  INVENTORY  IS  MANAGED  USING  THE  
ECONOMIC  ORDER  QUANTITY  MODEL  [ EOQ]

Demand is known and is deterministic, ie. constant.
***The lead time, ie. the time between the placement of the order and the receipt of the order is known .
The receipt of inventory is instantaneous. In other words the inventory from an order arrives in one batch at one point in time.
Quantity discounts are not possible, in other words it does not make any difference how much we order, the price of the product will still be the same. (for the Basic EOQ-Model)
That the only costs pertinent to the inventory model are the cost of placing an order and the cost of holding or storing inventory over time
Important Note: When calculating the Economic Order Quantity, be aware of the assumptions mentioned above!

Since the  cost associated with stock we need to deal with that stock in an Effective, Efficient and Economic manner (the 3E's )

The costs that we need to consider so that we can decide the amount of stock to have can be divided into stock holding costs and stock ordering (and receiving) costs as below.

Holding costs - associated with keeping stock over time
•   storage costs
•   rent/depreciation
•   labour
•   overheads (e.g. heating, lighting, security)
•   money tied up (loss of interest, opportunity cost)
•   obsolescence costs (if left with stock at end of product life)
•   stock deterioration (lose money if product deteriorates whilst held)
•   theft/insurance

Ordering costs - associated with ordering and receiving an order
•   clerical/labour costs of processing orders
•   inspection and return of poor quality products
•   transport costs
•   handling costs

Basic model
In this basic model we have the situation where:
•   our company orders from an outside supplier;
•   that outside supplier delivers to us precisely the quantity we ask for; and
•   we pass that stock onto our customers (either external customers, or an internal customer within the same company (e.g. if ordering raw materials for use in the production process)).
Assume:
•   Stock used up at a constant rate (R units per year)
•   Fixed set-up cost co for each order - often called the order cost
•   SOME  lead time between placing an order and arrival of the order
•   Variable stock holding cost ch per unit per year
Then we need to decide Q, the amount to order each time, often called the batch (or lot) size.


FROM  THE  ANALYSIS   OF   THE   ABOVE  VARIABLES,
THAT  IS  FIXED / VARIABLE /  HOLDING  COSTS
WHERE
EOQ = sqrt ( 2 * A * P / (S*(1-A/R))

•   Q = order quantity
•   A = demand per time period (e.g. Annual Demand)
•   S = Carrying / Holding Cost of 1 unit of Stock for one period
•   P = Order Cost
========================================
IF   FOR    A  PARTICULAR  OPERATION, WE  NEED  A  PARTICULAR
RAW  MATERIAL--WHOSE  UNIT  VALUE  IS  HIGH /  IT  IS  USED
ON  A  SLOW  MOVING  ITEM,

WE  FIND MOST  OF  THE  FACTORS   LIKE, listed  below,
ARE DIFFICULT  TO REDUCE

-cost  of  unit items [ already  negotiated  to the best]
-labor  cost  is  fixed
-CARRYING  COST  IS FIXED
-HOLDING  COST  IS  FIXED
etc etc.

ALSO   THERE  ARE   CONSTRAINTS  LIKE
-item is  a  slow  moving  [ because  of  the  nature of  demand]
-unit  cost  is  high  for  the  raw  material

WE  ARE  LEFT  WITH  NO  CHOICE, BUT
TO  PULL  THE  LEAD  TIME   TOWARDS   ''ZERO''
REDUCE  THE  LEAD  TIME
TO  MAKE  SOME  REDUCTION  IN   THE  TOTAL  COST.
THIS  IS  THE  ONLY  WAY, WE  CAN REDUCE  THE  HOLDING / CARRYING COST.

THE  HIGHER  THE  UNIT COST, THE  HOLDING / CARRYING  COST  GOES UP
AND THE MORE  LEAD TIME  IS GIVEN, THE  HOLDING / CARRYING COST GOES UP.

HENCE, IT  BECOMES  A  MUST, TO  REDUCE  THE  LEAD TIME,WHICH MEANS
-reducing  the  holding / carrying  cost.

SO  THAT   WE  CAN  SAVE  ON
-interest  payment  to the  bank
-reduction in    holding cost.
WHICH  WILL HELP   TO  IMPROVE  THE  PROFIT  POSITION.
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