Purchasing and Inventory

Management

Objectives
The Objective of this course is to
gain the knowledge of possibilities of
efficient

optimization

management
Purchasing

of

and

operation

and

in

Inventory

Management and also the ability to

apply them in the enterprise reality
to improve the overall efficiency of
the firm
Unit I: Purchase policy Rate and
Running Contract Subcontracting
Systems

Contract

Stockless

purchase Buying Seasonal items

Forward

Buying

Hedging

Purchasing Activities Indent Status

to

of

Purchase

Order

Transportation Incoming Inspection

Bill settlement Documentation.
Unit II: Meaning of Right Price
Price

Analysis

Determination

of

Right Price Influencing Factors on

Pricing Classification of Pricing
Price Forecasting Right Place
Purchase

Budgets

Budgetary

Control Need Identification Problem

Definition of lead time Elements
Cost Reduction and Lead Time.
Unit III: Relevance of Good Supplier
Advantage of Good Relations
Prerequisites

Evaluation

of

suppliers The Buyers Role Role

of the Vendor Relevance of Good
Suppliers

Need

for

Vendor

Evaluation Goals of Vendor Rating

Advantages of Vendor Rating
Parameters of Vendor Rating.
Unit

IV:

Role

of

Material

Management Classes of Material

Materials and Profitability Profit
Center Concept Material Objective

Centralized

Decentralizing
Powers

Purchasing

Delegation

of

Definition

of

Material

Planning Bill of Material Material

Requirement Planning Importance
of Material Research Definition
Advantage of Materials Information
System.

Unit V: Codification Classification

Methodology Requirements of
Codes

Coding

Designing

Structure

and

Advantages

international Codification Cost and

Consequences
Economic

Right

Ordering

Quantity
Quantity

Derivation of EOQ.

Reference:
1.

Gopalakrishnan P Purchasing
and

Materials

Tata McGraw Hill

Management

TABLE OF CONTENTS

Unit Number

Title

Unit 1

Purchasing

Unit 2

Price Analysis

Unit 3

Vendor Rating And Evaluation

Unit 4

Materials Planning

Unit 5

Codification

UNIT I
PURCHASING
STRUCTURE
1.1 Introduction
1.2 Purchase policy
1.3 Rate and Running Contract
1.4 Subcontracting
1.5 Systems Contract
1.6 Stockless purchase
1.7 Buying Seasonal items
1.8 Forward Buying
1.9 Hedging
1.10 Purchasing Activities
1.11 Indent Status
1.12 A to Z of Purchase Order

1.13 Transportation
1.14 Incoming Inspection
1.15 Bill settlement
1.16 Documentation
1.17 Summary
1.18

Answers

to

Check

Your

Progress
1.19 Exercises & Questions
1.20 Further Readings

UNIT OBJECTIVES
After learning this unit you would be
able

To understand the elements of

purchase policy

To

learn

in

detail

about

the

Federation

of

purchasing activities

1.1 INTRODUCTION
The

International

Purchasing

and

Materials

Management accept the definition of

materials management given below.
According
management

to
is

it,
a

total

materials
concept

having its definite organization to

plan

and

control

all

types

of

materials, its supply, and its flow

from raw stage to finished stage so
as to deliver the product to customer
as per his requirements in time. This
involves
purchasing,

materials
receiving,

planning,
storing,

inventory

control,

scheduling,

production, physical distribution and

marketing.

It

also

controls

the

materials handling and its traffic. The

materials manager has to manage all
these functions with proper authority
and

responsibility

in

the

material

management department.
All the organizations need an efficient
and

economic

purchasing

and

procurement of its various supplies

of materials from the suppliers. The
materials
has

to

management
perform

purchasing

and

this

department
function

procurement

of
of

materials very efficiently. Since 50%

to 60% of sales turnover is spent
on the purchase of various materials,

the amount of profit earned on this

sale

very

economically
purchased

much
the
and

organization.

depends

how

materials

are

utilized
The

in

the

profitability

depends on the efficiency by which

this particular function of purchasing
and procuring the requisite materials
at appropriate time will be done and
its availability is assured.

The

function

of

purchasing

can be stated as follows:

1.

The

requisition

of

material

is

necessary by proper authority to

initiate its purchase.

2.

To select proper supplier for the

materials

requisitioned,

before

placing an order.
3.

To negotiate about the price of

the material from the supplier
and it will be purchased at the
cheapest price.

4.

The quality of material must be

assured

and

should

not

be

compromised with the cost of the

material.
5.

The

material

should

be

purchased of right quantity and

right quality at proper time at
the cheapest cost.
6.

To set the proper purchase policy

and procedure.

1.2 PURCHASE POLICY

There

are

several

systems

of

purchasing available to the buyer.

Admittedly the system to be adopted
depends

on

supply,

price,

requirement,
material,
powers
past

factors

like

urgency

vendor,

type

organization
of

delegation,

precedents,

demand,
of
of

culture,
procedure,

decision

making,

value, level in the hierarchy, imports,

indigenous,

capital,

consumables,

spares, seasonal commodities.

We are familiar with the well known
system

of

bartering,

which

is

practiced even today in some parts

of the world. The simplest purchasing

system is buying off the counter, on

a

cash

transaction.

At

the

other

extreme is the constitution of a high

power steering committee that buys
on the basis of global tenders. Each
system has its own advantages and
disadvantages and organizations will
have to choose a system suited to
meet their requirements. It is noted
that the objective of the purchase
policy is to buy the required material
in the right quantity from the right
source at the right time and price, to
obtain the maximum value for each
rupee of expenditure.
Large organizations usually have a
written purchase policy to be adhered
to by all. The purchasing activities

are always subject to audit and hence

the systems should be so designed
that they do not give rise to any
strictures. The purchase executive
has to dispose of excess materials,
scrap, etc., in addition to his buying
activities. The amounts involved in
these items will be rather high, if
these are metallic in nature, which
requires the disposal system to be
properly designed. Therefore, if the
purchase executive has to effectively
use the resources at his disposal, his
system should be well established
and flexible enough to cope with the
ever changing environment.

1.3 RATE AND RUNNING

CONTRACT

The principle of rate and running

contract is for a centralized agency,
like the DGS&D enter into a contract
with vendors on the rates applicable
for items for a specific period of time.
In rate contracts, only the rate is
fixed. In running contracts quantity
variation allowances, usually of plus/
minus 25 per cent is also possible.
The

centralized

agency

gets

information,

from

its

various

constituents

about

their

needs,

consolidated these needs and enters

into contract with probable suppliers
(usually

by

Because

of

the
the

tender

system).

consolidation,

the

quantities required are high and the

rates entered are competitive. When
there is more than one contract for
the same article, orders should be
normally placed against the contract
with lowest rates, orders may be
placed against other contracts also,
by justifying two reasons in writing.
As and when the need arises, the
indentors

or

direct

demanding

officers with the requisite authority

buy

the

item

directly

approved

suppliers,

rigmarole

of

from

the

without

the

selecting

suitable

source. They need not fear audit

objections

as

well.

corporations

with

several

Large
units

situated in different locations can

adopt this system. It is common for

the suppliers, to advertise their rate
contract with Directorate General of
Supplies and Disposals, in order to
boost their sales.

1.4 SUBCONTRACTING
One of the most commonly used
systems of procuring manufactured
components and subassemblies is to
subcontract the manufacture of a few
items to properly chosen sources.
The decision to subcontract is based
on

factors

utilization,
better

such
cost

of

opportunities

as

capacity

manufacture,
of

existing

facilitates, availability of technology,

etc.

The

major

advantage

of

subcontracting

is

that,

the

subcontractor us a specialist in the

line and has lower overheads with
small establishments. Hence he is
able to provide the services at a
cheaper

rate

manufacturing

than
cost

of

the

actual

the

buying

organization.
In this process, the choice of the
subcontractor is the most critical step
to reap the best results. The most
important factor to be considered in
subcontracting

is,

whether

the

supplier is able to keep the delivery

schedules and maintain the quality
requirements.

Since

the

organizations

production

line

depends on the regularity of supplies,

effective intelligence is needed to

follow-up the subcontracted items. It
may also be advantageous to carry
out

make/buy

analysis,

before

subcontracting to the vendors.

1.5 SYSTEM CONTRACT

In systems contracting, the seller
effectively

becomes

the

material

planner for the buyer. It is a longterm contract between the buyer and
the

seller

and

provides

automatic

replenishment

consuming

departments

for

the

of

the

stocks

by

the seller. The consumer gets his

requisition/supplies directly from the
approved

vendor.

The

ordering

procedure is simplified, thus leading

to a reduction of paper work. The

system is designed to assist both the
buyer

and

consumed

the
low

seller.
value

Regular

items

are

system contracted.
The

major

objectives

of

systems

contract are:
a.

Simplify

the

ordering

procedures,
b.

Improve

the

stocking

of

repetitively used materials,

c.

Reduce administrative expenses,

d.

Maintain adequately

e.

Improve the profitability of both

buyer and seller and

f.

Increase
relations.

the

buyer-seller

It

is

usually

adopted

in

office

equipment and air-conditioners since

a long time.
The buyer has to be careful in the
choice of the contractor, because the
agreement

is

usually

for

duration.

This

continuance

contract

will

depend

compliance
contractual

of

the

maintaining

the

of

upon

seller

obligations

long
the
the

to

the

and

his

quality

requirements. On the receipt of the

requisition,
vendor

duly

delivers

authorized
the

goods

the
and

collects the payment in this system,

on the basis of the goods and collects

the payment in this system, on the
basis

of

receipts.

contracted
The

vendor

rates

and

must

hold

sufficient stocks, so that he can serve

the consumers' requirement and has
access

to

past

consumption

and

ordering data of the company. The

buyer can concentrate on costlier
items and items of shortage, leaving
other

items

to

the

contractors.

The

Company

United

in

systems

Carborundum
States

has

developed this new approach and

claims a substantial savings by a
simple

contract

delivery
procedure.

cycle

involving
and

price,

invoicing

1.6 STOCKLESS PURCHASE

Generally buyers of standard off-theshelf

items,

required

in

large

quantities, for which seller has other

markets as well can consider zero
stock buying. The vendor has a clear
idea of the requirements of the buyer
and holds the stock in convenient
locationwarehouses

adjoining

the

factoryand the buyer can draw from

the

warehouse

according

to

his

needs.
Aviation fuel pumps at airport, petrol
pumps

in

warehouse

near

manufacturing
examples

transport

of

units,
stockless

and

tyre

automobile
are

typical

purchasing.

The

seller

has

the

financial

responsibility of holding the stock

and in view of the service; he may
charge

more,

which

can

be

duly

negotiated. The increased price is

compensated by decreased carrying
cost for the buyer.
If this system is to succeed, then
the buyer and seller must have very
sound relations and source selection
has to be done cautiously. The main
advantage of this system is that, the
seller is a specialist in storage and
distribution of the product and this
knowledge is made use of by the
buyer from a single depot. The buyer
significantly

gains

from

reduced

investments in working capital and

reduction
processing

of

paper
orders.

work

for

Fear

of

obsolescence is removed with leadtime becoming negligible. The seller

is assured of his marked and his
salesman's

time

can

be

spent

in

developing new clients. The seller

also

does

not

have

problems

of

obsolescence as the requirements are

well known. If he is a manufacturer,
he

can

optimally

schedule

his

production run and if he is a trader

he can buy when prices are low. The
only drawback is, the supplier can
become a monopolistic source, with
larger volumes of business.

1.7 BUYING SEASONAL ITEMS

Seasonality could be natural or manmade. Natural seasonality is most
common

in

Man-made
because

the

organization

agricultural

industry.

seasonality

arises,

operations
are

reflected

of

an

in

the

accounts books. The purchasing and

sales will be at its peak, as the
financial year nears its end, because
the annual sales targets have to be
met

and

exhausted.

purchase
The

raw

budgets
material

availability in the agricultural sector

of food grains, linseed oil, groundnut
oil, edible oil, are seasonal, even
though the demand may be uniform;

on

the

other

fertilizers,

hand,

paints,

demand

for

construction

material, cough syrups are seasonal,

whereas the supply of these items is
uniform. In both the cases, the buyer
has to assure continuous supply to
the company and to make purchases
at

reasonable

price,

with

the

constraints of storage capacity and

working capital availability.
If

the

buyer

purchase

at

regular

intervals to meet the requirements of

factory, he will sometimes pay a high
or low price, but in the long range,
the overall cost will be equal to the
market price. Such a conservative
policy is inevitable, if the factory has
no facility for storing in excess of

F9EI=F9A9BHG 5B8 H<9 6IM9F 7<CCG9G

BCH HC 6IM :CFK5F8 .<9 6IM9F <5G HC
65@5B79 H<9 DFC656=@=HM C: H<9 DF=79
:5@@=B; =B H<9 B95F :IHIF9 5;5=BGH H<9
7CGH C: 6IM=B; BCK 5B8 GHCF=B; :CF
@5H9F

IG9

8MB5A=7

#H

=G

=B

H<=G

DFC;F5AA=B;

7CBH9LH
H97<B=EI9

<9@DG HC =89BH=:M H<9 CDH=A5@ 7CGH C:

6IM=B; 5B8 H<9 F958=B; 58J=G98 HC
F9:9F

HC

5BM

6CC?

C:

CD9F5H=CBG

F9G95F7<
:CF
H<=G
DIFDCG9

1.8 FORWARD BUYING

CFK5F8

6IM=B;

=G

BCH<=B;

6IH

7CAA=HH=B; 5B CF;5B=N5H=CB =BHC H<9

:IHIF9 .<9 6IM9F 7CAA=HG HC 6IM 5H
5 :IHIF9 85H9 5 7CBHF57H98 EI5BH=HM
5H 7CBHF57H98 DF=79 K<5H9J9F A5M 69

the ruling market price then. He is

trying to cover beyond the current
requirement. The trader makes such
moves with a speculative interest,
with an idea that the prices will rise
in future and hence he will be able
to make profits. The reasons of the
industrial buyers are different. He
seeks

to

protect

his

organization

from any future shortages or due

increases in price. He is interested
in having an uninterrupted supply of
materials to the user.
The

factors

that

have

to

considered for forward buying are:

a.

The availability of item,

b.

Financial constraints,

be

c.

Economic order quantity,

d.

Minimum quantity for obtaining

discounts;

e.

shelf-life of the item

f.

Cash availability, etc.

In periods of scarcity or shortage

items, the buyer will be forced to
purchase
subject

whatever
to

the

is

available,

working

capital

constraints. Forward buying practices

are met within commodity markets,
agricultural

products,

and

prime

metals. The industrial buyer has to

protect
supplies
buying.

himself
by

from

resorting

interrupted
to

forward

The forward market operates as a

mechanism

for

coordinating

the

company's current plans and future

expectations. It enables producers
and traders to review the existing
stock and revise the commitments.
It

makes

for

an

integrated

price

structure throughout the country and

introduces
Large

the

stability

purchases

and

of

prices.

sales

are

possible in advance of production. It

enables buyers and sellers to insure
themselves

against

uncertainties

arising from frequent changes in the

supply

and

demand.

In

Indian

conditions, trading in forward market

is controlled by the government. A
forward

markets

commission

established by the government acts

as an advisory body for implementing
the

provisions

Contracts

Act.

of

the

Forward

Notifications

are

issued from time to time to regulate

the trade and the commodities that
can be traded. Forward trade can
usually

be

carried

only

through

recognized associations.

1.9 HEDGING
Hedging is different from forward
buying. The buyer tries to protect
himself in the future by entering into
two transactions a purchase and
a sale in two markets, whose prices
move up and down together. Thus
the profit or loss sustained in the

buying transaction is compensated by

the

loss

or

profit

in

the

selling

transaction. This implies that the two

markets behave similarly, and one
can reach the ideal solutions of zero
loss by a perfect hedge. Such ideal
conditions do not exist in practice,
and

there

will

be

marginal

adjustments of profit or loss. It is

very difficult for two even identical
markets to exist.
Hence the usual practice is to trade
in the spot market, as well as in the
future market. As future price follow
spot prices, we can expect to protect
ourselves by hedging. Thus, hedging
is

basically

tool

for

protecting

against future losses due to vagaries

of prices in the commodities market.

There

are

also

different

kinds

of

risks, like destruction, business risk,

dishonesty, personal risk etc., To
operate

successfully

in

future

market, a strong forecasting base is

required,

if

the

buyer

wants

to

reduce the risk.

Besides the pure risk, avoidance risk,
avoidance hedging, there are four
categories of hedging. The carrying
charge hedging involves holding and
hedging commodity stocks to earn
the

carrying

charge.

In

this,

merchant acquires stocks and hedges

them when the current ready price is
lower than the current future price,
by an amount equal to the carrying

cost. Operational hedging facilitates

operations involved in merchandising
business,

where

merchants

match

the forward sales with actual stocks

and forward purchases do not need
long term hedges. Selective hedging
is motivated by price expectations.
Stocks

are

hedged

when

decline

is

expected,

but

are

left

rises

are

unhedged,

when

price

price

anticipated. Anticipatory hedging is

ordinarily

guided

expectations,

but

by

price

the

hedging

contract is not matched by either a

stock

of

goods

commitments.
influence

The

the

businessmen

or

to

merchandising
factors

which

decision

of

most

hedge

are

price

expectations, relation between ready

and future prices and degree of risk
aversion

of

the

businessman.

Hedging is counter speculative, as it

helps

the

speculative

hedger
risk

to

avoid

inherent

the

in

the

normal economic activity.

1.10 PURCHASING ACTIVITIES

Gone

are

the

days

of

the

user

commanding the buyer to get an item

that

he

needs

without

bothering

about procedures and formats. Since

purchasing departments account for
over 60 per cent of the turnover,
procedures,

systems

have

formulated

been

and

number of organizations.

in

manuals
a

large

The activities of purchasing include:

a.

The

identification

of

requirements,
b.

Selection of proper sources of

supply,

c.

Deciding on quantity and quality,

d.

Finalizing delivery schedule and

price,

e.

Placing a purchase order,

f.

The suppliers,

g.

Transporting the goods,

h.

Receive them in stores and

i.

accept

them

for

consumption

after getting the items inspected.

The time taken tom complete these
activities

of

the

purchasing

cycle

comprises

the

lead-time,

which

stated otherwise would read as the

time

that

lapses

identification

of

between
need

and

the
its

fulfillment.
Purchasing plays a crucial role in the
material cycle, because it is in charge
of the input stage up to consumption
in manufacturing. The efficiency of
the purchase cycle is reflected by the
Japanese slogan We live by sales,
but make our profits by purchasethe

process

of

purchasing

cannot

start ticking, unless the purchase

knows what is to be bought. He
should

know

the

quality

specifications, quantity required and

timing

of

requirement

much

in

advance. Based on this information,

the purchasing division will locate the
suppliers, place orders and procure
the materials.

1.11 INDENT STATUS

The purchase division is informed of
the indents, or purchase requisitions.
The indent should indicate the item,
specifications,
time

when

code,

required.

quantity,
The

and

normal

practice is to get indents checked by

stores personnel, in order to verify
whether these are available in stock.
This will present unnecessary buying.
Regularly stocked items are usually
bought by the stores personnel. The
bill

of

materials

is

used

in

engineering industry, as a starting

point of the indents.

To

have

control

on

indenting,

powers are delegated to personnel

in

the

consuming

division.

Only

authorized personnel are eligible to

requisition the purchase of materials
as per the delegated powers given
in the purchase manual. Sometimes,
particularly in case of spare parts,
more than one department like
user, finance, design, maintenance
is

involved

in

clearing

the

requisition. In such cases, the indent

may be in the form of travelling
purchase requisition made of thick
paper

to

be

handled

by

different

departments, indicating the remarks

and approvals.

Once the indents have been received,

the purchasing division must verify it
and cross-check with the budgetary
allocation. Depending upon the item,
the purchase policy and purchase
system

like

tendering,

help

to

identify the sources. In this context,

the purchase policy spells out make/
buy, ancillary development, vendor
development,
assistance,

provide
financial

technical

concurrence,

cost reduction, techniques, etc., in

the manual. Even telephonic orders
should

be

confirmed

purchase orders.

by

written

1.12 A TO Z OF PURCHASE
ORDER

After getting a complete description

of

the

item

in

the

indent,

and

identifying the sources, the buyer

classifies

the

consumables,
non-repetitive,

indents
spares,

as

capital,

repetitive,

standard,

non-

standard, budgeted, special etc., The

availability of the item is ascertained
from

the

sources

and

bids

are

requested in order to determine the

price. If necessary, negotiations are
conducted to arrive at the right price.
Since the purchase order is a legal
document, that commits that buyer
to the seller, a careful drafting of the

order is a must. The purchase order

should be made without any clerical/
typing mistake. A list of clauses is
included as the governing conditions
of supply in a purchase order. As
the order is the primary document
based on which supplies are made,
inspected, accepted and paid for, it
should be unambiguous and clear
about specifications, quantity, rates,
delivery schedules and contractual
terms. Copies of the purchase order
are

sent

inspection

to

receiving

section,

payment

section.

and

Some organizations stencil the order

copies

and

everywhere.

send
This

will

the

copies

necessarily

increase the paper costs. It may be

desirable to do away with the indent/

purchase order and other paper work
for items with annual consumption up
to a certain amount.
The purchase order should contain:
a.

The order number,

b.

Date,

c.

Serial number,

d.

Full name and address of the

supplier,

e.

Consignees' name and address,

f.

Terms and conditions printed on

the reverse of purchase order,

g.

Description
aspects,

h.

Quantity,

of

goods

in

all

i.

supplier's quotation reference,

j.

Price terms,

k.

Billing,

l.
m.

Mode of payment,
Delivery date and schedule,

n.

Packing instructions,

o.

Transport instructions,

p.

Freight payment terms,

q.

Inspection procedures,

r.

Insurance,

s.

Warranty,

t.

Cancellation provisions,

u.

Authorized signatures,

v.

Acknowledgment,

w.

Removal of rejections,

x.

Penalty,

y.

Bonus,

z.

Other

special

terms

and

conditions.

1.13 TRANSPORTATION
The materials have to be transported
to the buyer's premises from the
sellers

premises.

Formalities

like

sales tax have to be completed by

means of filling necessary forms. One
cannot

escape

verification,

the

whether

routine
these

of

forms

have been properly filled, or else the

goods can remain impounded at one
of the numerous check posts. In
certain cases, the buyer has often to
take additional care of the insurance
and freight formalities. Here many

forms

will

have

to

be

filled

and

formalities such as assessing and

rate fixing will have to be carried out.
The buyer has to coordinate with rail,
road, ship, customs and clearance
agencies,

to

minimize

the

transportation bottlenecks and obtain

the items in the shortest time at the
lowest rates. For urgently wanted
costly materials, some organizations
send a messenger to accompany the
goods, in order to ensure, that they
reach

in

adequate

time.

The

transportation selection must also be

coordinated

with

other

activities,

such as finished goods dispatching in

order to achieve overall economies.

1.14 INCOMING INSPECTION

On receipt of the materials in stores,
the

receipt

section

checks

the

quantity with that mentioned in the

invoice. Sometimes the inspection for
quality is carried out at the supplier's
premises,

at

production.

different

The

buyer

stages
has

to

of
be

satisfied about the quality of the

materials

through

quality

an

independent

control

department,

which

inspection
checks

conformance.

The

procedures

methods

and

the

inspection
are

also

mentioned in the contract. Lack of

inspection
equipments,

staff,

lack

of

testing
improper

communication

to

the

criteria

for

inspection, number to be analyzed

for

quality,

intolerances

and
from

concession
the

original

standards, are the usual causes of

delay at inspection stage.
Acceptance of items that have passed
the quality tests usually cause no
problem. The necessary entries will
have to be made on the acceptance
and items are taken to stock for
consumption. The inspection note,
wherein the inspection has indicated
the

acceptance

of

the

materials,

becomes the basis for the payment

of these items. However, the paper
work is more complicated for rejected
materials. The purchase section and

payment section should be informed

about the rejection, for necessary
follow-up

with

vendors.

Prompt

removal of rejection by the supplier

is always a problem as he feels that
rejected items will be consumed by
the buyer in due course of time. The
buyer should take adequate steps to
prevent the stock outs and increased
number

of

orders

resulting

from

rejection.

1.15 BILL SETLLEMENT

The role of the purchase executive
does not end with the acceptance of
quality goods. He has to maintain
good relations with the suppliers,
because

the

transactions

will

be

repeated. Therefore, he has to see

that the payment is made for the
goods supplied within the due date.
The payment is usually made by the
accounts department on the basis of
purchase order, sellers invoice, the
goods

inspection

received
accepted,

note.

note

The

quantity

and

rate,

good

quantity

supplied,

etc.,

have to be tallied by the accounts

department.

The

problem

usually

arises when the full quantity has not

been supplied, or where more than
one item is invoiced together and
where the necessary documents have
not reached the accounts section.
The system of payment varies with
the type of market from cash and

carry system to pay advance now,

take the material later are operated
in real shortages. But everybody is
operating

under

conditions
duration
availed

and
of

by

60
the

tight

hence
days
buyer.

money

credit
is

for

normally

The

buyer

should insure that the contractual

obligations of payment must be met.
The

supplier

strained.

If

will
he

be
is

very

much

small-scale

manufacturer and the buyer is his

largest single customer. Therefore,
the purchase executive must take all
the

necessary

steps

within

his

authority, to expedite payments and

see that the contractual obligations
are kept by his organizations. If the

payment is very much delayed, the

suppliers

have

increases

the

tendency

prices

in

to

future

contracts.

1.16 DOCUMENTATION
The job is not finished until paper
work is done, is the motto behind
the purchase cycle. We see copies
of a lot of documents in the form
of requisitions, indents, requests for
quotation, comparative statements,
draft

purchase

follow-up

forms,

orders,

contracts,

inspection

notes,

goods receipt note, reject notes, bin

card, kardex, ledger, reconciliation,
vouchers, issue note, receipt note,
vendor records, vendor ratings, etc.

In organization and method study

should

be

effective

conducted

documentation

to

make

and

clear

flow of information to the relevant

executives.
Effective documentation is a critical
factor in the purchasing function, as
they are essential to ensure adequate
accountability

and

misunderstanding.

to
Much

prevent
of

the

material and equipment issued from

stores goes astray, because of lack
of

documents.

occurred,

Losses

because

of

have

also

consignment

notes, way bills, and manifests are

incomplete, in that consigned articles
have not been properly listed. Office
automation,

Xeroxing,

facsimile

machines,

computerization,

addressograph, adequate number of

terminals, introduction of personal
computers, etc., will help streamline
the administration
organization

and

should

be

also

in buying. The
method

oriented

study
towards

cutting the costs in paper, filling,

telephone charges, etc., which aim at
smooth work flow. An efficient filing
system

is

the

managerial

starting

efficiency

point
in

for
any

organization and reduces purchase

office
item

space
files

commonly

expenses.

and

vendor

accepted.

Individual
files

are

Physical

facilities like adequate, lighting, well

designed

office

equipment,

filing

cabinets and modern gadgets will

contribute to the buyers' efficiency.
The

activities

of

purchase

cycle

appear to consist of 14 jobs and it

is up to the buyer to introduce latest
scientific

concepts

documentation

like

control,

cycle

counting, just in time and travelling

requisition, to need the challenges in
the job.

1.17 SUMMARY
The

most

materials

important
management

activity
is

of
the

purchase policy of an enterprise. The

ordering

systems

running

contract,

systems

such

as

rate/

subcontracting,

contract,

stockless

purchase,
forward

seasonal
buying,

commodities,
hedging,

are

discussed in this unit. The process

of purchase cycle and the involved
activities

are

also

discussed.

The

status of indents, characteristics of

a

purchase

order,

procedure

for

chasing, inspection, bill settlement

and the purchase documentation are
analyzed.

Check your progress:

1.

Define Materials Management

2.

What

are

the

functions

of

the

objectives

of

Purchasing?
3.

What

are

systems contract?
4.

What

are

purchasing?

the

activities

of

1.18 ANSWERS TO CHECK YOUR

PROGRESS

1.

Materials management is a total

concept

having

its

definite

organization to plan and control

all types of materials, its supply,
and its flow from raw stage to
finished stage so as to deliver
the product to customer as per
his requirements in time.
2.

The

function

of

purchasing

includes the selection of proper

supplier

for

the

materials

requisitioned, to negotiate about

the price of the material from the

supplier, to assure the quality of

material purchased, to purchase
the material of right quantity and
right quality at proper time at
the cheapest cost, and to set the
proper

purchase

policy

and

procedure.
3.

The

objectives

contract

are

of

to

systems

simplify

the

ordering procedures, to improve

the stocking of repetitively used
materials,

to

reduce

administrative

expenses,

to

improve the profitability of both

buyer and seller and increase the
buyer-seller relations.
4.

The

activities

include:

of

purchasing

a.

the

identification

of

requirements,
b.

selection of proper sources

of supply,

c.

deciding

on

quantity

and

quality, &
d.

finalizing delivery schedule

and price,

e.

placing a purchase order,

f.

the suppliers,

g.

transporting the goods,

h.

receive them in stores and

i.

accept them for consumption

after

getting

inspected.

the

items

1.19 EXERCISES & QUESTIONS

1.

Explain

the

functions

of

objectives

of

purchasing.
2.

What

are

the

systems contract?
3.

What is stockless purchase?

4.

Differentiate forward buying and

hedging.

5.

What

are

the

contents

of

typical purchase order?

6.

Explain

the

importance

of

documentation in purchasing.

1.20 FURTHER READINGS

1.

Gopalakrishnan

Purchasing

and Materials Management Tata

McGraw Hill

2.

Tony

Arnold,

Stephen

Chapman, R V Ramakrishnan Introduction

to

Materials

Management

Pearson

Education

UNIT II
PRICE ANALYSIS
STRUCTURE
2.1 Introduction
2.3 Meaning of Right Price
2.4 Price Analysis
2.5 Determination of Right Price
2.6

Influencing

Factors

Pricing
2.7 Classification of Pricing
2.8 Price Forecasting
2.9 Right Place
2.10 Purchase Budgets
2.11 Budgetary Control

on

2.12

Need

Identification

Problems
2.13

Definition

of

lead

time

Elements
2.14 Cost Reduction and Lead
Time.
2.15 Summary
2.16

Answers

to

Check

Your

Progress
2.17 Exercises & Questions
2.18 Further Readings

UNIT OBJECTIVES
After learning this unit you would be
able

To understand the price analysis

and determination of right price

To

learn

in

detail

about

the

purchase budgets and lead time

elements

2.1 INTRODUCTION
The materials executive is concerned
mostly with the right price of the
product, determination of which is
very

difficult.

There

is

hardly

anything in the world that someone

cannot make a little cheaper and the
man who considers price alone is the
lawful
Ruskin.

prey,
One

according
can

also

to

John

see

this

quotation used in the advertisement

of some products. Thus the lowest

price need not necessarily be the

best price, but the lowest responsible
price is the right price. Even the
orthodox

conservative

government

agencies,

departments,

public

sector undertakings want the lowest

responsible price. At the same time,
we should not be blinded by the idea
that the higher repay, the better will
be the quality. Price theory from
mathematician and economist point
of

view

has

been

made

rather

complex. The price depends in actual

practice, essentially on demand and
supply factors. Price is an opinion,
and cost is the fact according to the
fundamentals

of

finance,

because

price is what you pay, whereas the

buyer

is

ignorant

of

the

cost

comprising of materials cost, labour

charges, depreciation and overheads.

2.2 MEANING OF RIGHT PRICE

The

difference

between

price

and

cost is the profit, which can be very

high

when

the

supplier

wants

to

exploit an urgent situation. Even the

incurred cost of an item could be
reduced at the manufacturers, by the
well

known

techniques,

like

cost

reduction

standardization,

variety reduction, value engineering,

codification, waste control, quality
control,
control,

indent

control,

consumption

lead-time
control,

budgetary control, inventory control,

etc.,

leading

profitability.

to

increase

Hence

for

in

the

effective

functioning, the buyer should know

the cost of the item to determine
the right price. For this he should
be equipped with knowledge of price
analysis , cost analysis, break-even
point at manufacturing economy-lot
size of production etc., Right price
doesn't not mean the lowest price or
average price, but lowest responsible
price consistent with other factors.
It is indeed very difficult to estimate
this and the aim of any purchasing
executive should be to determine the
right

price

quality,

that

quantity,

adheres
trade

to

the

credits,

regularity of supply, reliability and

after sales service.

Obviously the

basis for deciding on the right price

will depend upon on the type of
material,

market

availability,

supply,

conditions,
demand

socio-politico-economic

and

aspects.

Since the basic aim of purchasing is

to pay reasonably low prices for the
best

values

considering

obtainable

after

negotiations

and

corporate

commitments,

determination of right price becomes

important.

2.3 PRICE ANALYSIS

One way of determining the right
price is the mechanism of cost plus
pricing. The sale price of a product

has to contribute to the direct costs

of manufacturing the product, bear
certain

amount

of

overhead

expenditure, and yield a reasonable

profit
made,

as

in

return
the

on

form

investment
of

capital

employed by the organization. The

direct cost of manufacture includes
the cost of material, man power, fuel,
power

utilities

manufacture

used
of

in

the

product.

Technically, direct cost is the cost

which has been incurred because the
item was manufactured and would
not have been incurred if it had not
been manufactured. To estimate the
direct cost, we must have an idea of
the material content and man-hours

required, for example in the case of

transformer it will be in terms of
copper,
insulation,

oil,
etc.,

electrical

steel,

Overheads

are

incurred in the form of expenditure

on salaries to employees other than
direct labour, rents and statutory
rate

of

incurred

depreciation.

The

under

cannot

these

costs
be

charged off to a single product; and

are apportioned on the basis of time
taken to manufacture. To enter in
the market the firm may not charge
the overheads and may even sell at
direct costs. Periodic revenues must
be made on the pricing structure for
effecting improvements.

No

commercial

philanthropic

organization

institution;

its

is

basic

purpose is to obtain a return on its

investments which is reflected in the
pricing by the profit term. Usually a
new firm may agree to forgo profit;
to capture the market and profit is
expressed as percent of the capital
employed.

These

components

constitute the quoted basic price. The

basic price by itself is not the right
price to be paid, the right price is the
total amount spent by the buyer on
procuring the item for consumption.
Normally the vendors try to increase
the

price

by

10

percent

of

the

previous year's price and attribute

this to general inflationary spiral in

developing countries like India. The

buyer has to study this effect on a
specific item, in considering the right
price. For similar group of materials,
detailed cost structural analysis must
be made for different vendors, in
order to identify various alternatives
such as change of vendor, use of
alternative material, etc.

2.4 DETERMINATION OF RIGHT

PRICE

Right price, which brings the best

ultimate value is usually determined
with other factors, such as quality,
quantity,
availability,

delivery,
demand,

standard/non-standard,

shelf-life,
supply,
repetitive/

non-repetitive,
seasonal,

seasonal/non-

etc.

Prices

by

previous

ascertained

may

be

purchase,

catalogues, list price, market price,

by telephone, by enquiry, by tender,
through negotiations, estimates of
cost

plus,

for

the

casting

price

trends, etc. The process of obtaining

quotations involves a certain amount
of work and this should be justified
by the order.
It is usual to place repeat orders
within a period of about one year at
the previous rate for items of low
value, or when there is no price
increase.
final

Catalogue

and

usually

price

are

not

should

be

negotiated, while for urgently needed

items, telephonic price quotations are
obtained.

The enquiry is a simpler version of

tender and is used for small value
items. Price determination by tender
is commonly adopted in the public
sector

establishments

and

government departments. The tender

is

the

process

of

ascertaining

availability and price in sealed covers

which

are

opened

committee

in

by
the

the

tender
buying

organization. The system induces the

buyer to quote the lowest price and
safeguard the interest of the buyer
and seller. If there is only one firm,
the tender is called single tender. In
the

limit

tender

system,

requirements are sent to a limited

number of suppliers whose capability
might

have

been

assessed

by

prequalification. In the open tender,

or advertised tender, the details of
requirements are advertised in the
newspaper in the country. In the case
of

international

purchase,

global

tenders are resorted to, when the

requirements are advertised in the
local and international newspapers.
In

all

the

cases,

the

tender

committee compares the quotations

and

prices

are

considering
insurance,
terms,

compared

freight
tax,

packing

charges,

discounts,
charges,

after

credit

handling

cost wherever necessary, negotiation

is

resorted

to

by

the

vendor

committee to determine the right

price,

for

the

same

commercial

quality items. Care has to been taken

in case of discounts, as the inventory
carrying charges will be large in case
of bulk buying, when reduction in
price and reduction in ordering cost
must

be

greater

than

inventory

holding cost, bulk discount must be

availed off.

2.5 INFLUENCING FACTORS ON

PRICING

In the above price analysis, it is

implied that the quality, quantity and
time schedules are adhered to by the
vendor. Obviously, if the vendor is

not able to keep the requirements,

then though his price may be lower,
the actual cost to the organization
will be more. For example, if the
quality is not maintained, it will lead
to rejections occupying the scarce
stores space. The losses incurred due
to increased rejections will have to
be added to the cost of materials.
Similarly, if the quality and time
requirements are not met by the
vendor, it can be lead to idling of
the buyers manufacturing facilities.
The opportunity cost of this loss in
production must then be added to
the cost of material; alternatively if
this results in a rush order, the extra
charges must be added to the cost.

Thus the right price will have to be

compared,

considering

all

such

factors into accounts ---i.e. up to the

final production of the material in the
production process.
Sometimes

the

supplier

arbitrarily

increases the price due to increase in

material cost and/or labour cost, or
even when he is not able to recover
material advances. Certain suppliers
or fabricators specify a formula for
price increases. Where there is no
such understanding and where the
price

is

covered

by

escalation

clauses, it would be ideal if the buyer

stipulates that such ad hoc increases
should

be

notification
authorities.

supported
from

by

public

appropriate

The

socio-economic

and

political

forces and nature factors including

drought/floods, earthquakes as well
as

increased

defence

spending,

subsidies for farm inputs and rural

sector,

etc.

have

forced

the

government to adopt certain fiscal/

taxation

policies.

These

include

overdrafts and borrowings in the case

of

central

government

budgetary

deficits in most of the years; have a

tendency to push the price upwards
for

all

commodities.

Besides

the

revenue deficit, the country has also

been

facing

decreasing

trade
foreign

deficit

and

exchange

reserves. These conditions are ideal

for steep inflationary conditions and
even

land

witnessed

us
in

in

debt

trap,

as

the

Latin

American

economy. The government tries to

reduce the problem by fiscal policy
measures,

such

as

administered

prices, levy price, transfer price, dual

price,

retention

price,

price

preferences for small industries etc.

These factors will include price of
commodities

in

inflation

inbuilt

economy like ours.

2.6 CLASSIFICATION OF PRICING

The purchasing requirements can be
classified into

a.

commodity

or

raw

material,

which are in their prime form,

b.

standard

manufactured

items

like nuts, bolts, stationary,

c.

specially manufactured products

like machine tools, generators
and

the

price

determination

varies with each class of items.

Apart

from

organized

consumer

resistance, which may be effective

in case of perishables, the prices of
commodities or raw materials cannot
be modified by the purchaser, except
for a bulk trade discount. The price of
these items, such as tobacco, cotton,
agricultural

commodities,

metals,

and ores are usually determined by

the cost of inputs that go into their

production, the level of production,
macro supply and demand condition.
A single purchaser is too small to
have

any

bearing

on

price

determination of such commodities,

even though he can try to estimate
the

price

by

applying

scientific

forecasting techniques. While they

have largely to accept the market
prices they can protect their interest
by

adopting

techniques

such

as

future buying and hedging.

The second class of items is the
standard
cloth,

manufacture
stationary,

items
etc.

like
The

manufacturers have produced these

items based on the perception of the

market requirements and have priced

them according to what it had cost
them

and

what

the

market

can

absorb. Usually these items are sold

at the manufactured list price and
buyer can bring down the rates if
we buy larger quantities directly from
the manufacturer.
The third class of items are specially
manufactured

items,

which

are

custom built and usually have a long

production cycle, as it has to be
individually designed. Based on the
designed

specifications,

requirements and the capabilities of

the vendor contracts are awarded in
the negotiations are also long drawn
out, before ordering. Payments are

normally

done

during

the

manufacturing cycle and testing is

done in the presence of the purchase.
Such

items

clauses.

carry

The

price

variation

purchaser

has

to

prepare himself very well with cost

aspects, before negotiating the price
for these items. Cost benefit analysis
of vertical integration, or to company
manufacturing

key

raw

materials

must also be considered.

2.7 PRICE FORECASTING

Forecasting

is

the

basic

and

inescapable job of the buyer; he

should have some idea of the future
quantity

requirements

and

future

price of the item for better planning

and budgeting. A mere collection of

data cannot become an end in itself,
but forms the input. The systematic,
marshalling of facts and judgment is
essential for sound decision making
in

the

field

of

forecasting.

Admittedly, longer the time horizon,

the hazier will be the picture of
forecasts. Usually, five year forecasts
are prepared and broken into annual
and quarterly figures. Reviews are
carried

out

periodically

and

corrections are carried out whenever

necessary. A very large number of
factors influence the calculation of
forecasts, and material intelligence
provides the basic infrastructure and
information. The accuracy of price

forecasts depends on the reliability of

raw data and the methods are used
for high value items. Every method
depends upon collection, compilation,
analysis,

interpretation,

charting,

implementation and review.

Usually in price forecasts, errors up
to +/- 10 per cent are tolerated, even
though it is advantageous to reduce
the error of estimates. Admittedly,
a

very

including
influence

large

number

demand
the

of

and
forecast.

factors,
supply,
The

judgement or thumb rule technique

is based on the fact that prices will
increase on an average by 10 per
cent in a developing inflation-inbuilt
economy like India. The price trend

of the items for earlier years is also

considered and a price forecasting on
the basis of ten per cent annual price
increase is made, accordingly to this
technique.

The

simplest

method

amongst the scientific technique is

the simple average of the prices of
the preceding months (or years) and
the average price is taken as the
price forecast for the future. The
moving

average

is

the

next

sophistication, usually three or four

consecutive monthly average prices
are taken, in order to smoothen the
short-term
figure

fluctuations

obtained

is

and

considered

the
the

price forecast. In this process, we

can use weights as proportion of

quantities

to

total

purchased

and

take the average, and this process is

called the weighted average method.
Exponential
allows

for

smoothing
various

method

weights

(d)

ranging from 0 to 1 for the different

months depending upon the weight
desired. A higher value will give a
heavier

weight

or

comparatively

recent data and a lower value will

give

lower

weight,

thereby

spreading the weight over a longer

period. The weightages

given are

independent of the nature of changes

in prices. In this method, the price
forecast for the next month is based
on the price forecast made for the
earlier months and the actual price of

the earlier months. It is given by the

relation, new forecast = old forecast
+ d (Current demand old forecast).
Computer programmes are available
for

most

of

the

scientific

price

forecasting methods.

2.8 RIGHT PLACE

Geographical location of the supply
affects the cost of transportation and
lead-time, which certainly occupies a
prominent place while evaluating a
supplier.

vendor

located

at

relatively far-off place compared to

a local stockiest or short distance
supplier, is much more difficult to
tackle and follow-up even in this age
of advanced communicating world.

Accidents, strikes, floods, transport

inadequacy,

supplier's

own

negligence are a few problems, which

may cause delivery delays and stock
outs, if suppliers are located in faroff places. This will invariably result
in

increase

inventory
and

transport

carrying

cost,

communication

charges,
lead-time

bottlenecks,

which have to be translated into the

right price while comparing different
quotations.

Wherever

possible,

multiple suppliers may be considered

to reduce the tension created in such
cases. For small lot size, the local
distributor,

commission

agent,

stockist, wholesaler or retailer may

come to the rescue with increased

prices, but this factor has to be

considered in the determination of
the right price. The vendor located in
far flung places must be considered,
only if they are competitive in all
aspects.

The

geographical

factors

and suitable price rating will help or

allocate

the

market

share

of

the

items for such suppliers.

2.9 PURCHASE BUDGETS

Once the right price and the quantity
are determined, the next step is to
initiate

the

process

of

purchase

budget. A budget is a coordinated

financial forecast of the income and
expenditure of an organization and
the purpose of the budget are to plan

and control the activities of various

departments, in order to achieve the
corporate goal. Purchase budget is
a plan showing how much of the
various resources will be spent on
buying.

It

is

well

known

that

purchase department accounts for a

bulk of cash outflows. For a purchase
budget, the sales forecast

is the

starting point, and aspects such as

the

product

mix,

the

seasonal

fluctuations in manufacture, packing

sizes, schedules of production and
bill of material are obtained. We will
have to work backwards from the
sales

targets,

break

them

into

assemblies, sub assemblies and so

on, after allowing for rejections at

all stages. Besides giving the timing

of purchases and estimated cost of
raw materials, this will give us the
material requirements that will have
to

be

procured

from

outside

the

organization.
The purchase executive must then
formulate his purchase plan, taking
into account the procurement leadtime. From this he must compute the
funds

required

and

monthly

cash

outflows. The quantity, specifications

and

the

time

schedule

of

the

requirements are available from the

materials plan. The purchase division
will have to give the price data and
a

multiplication

and

summation

exercise will give the funds needed

for the procurement action. Needless

to say, forecasting the price is a
tough task and the last purchase
price can be the starting point for
estimations. The computer can be
useful for the multiplication of price
by the quantity and will have access
to latest price by holding the supplier
data file. The purchase budget covers
capital items, tools, raw materials,
production

material,

miscellaneous
possible

to

spares

and

It

also

items.
have

it

is

class-wise,

department-wise and work centrewise, brought in for compiling the

budget. Periodic reviews and regular
feedback

enable

the

purchase

executive to identify the variances

and take an appropriate remedial

measure in consultation with the user
department,
genuine

on

price

factors

increase,

such

as

increased

quantity of consumption, higher-inprocess rejections, etc.

2.10 BUDGETARY CONTROL

Management

uses

the

purchase

budget for the purpose of educating

the performance and exercising the
function of control, which envisages
an improvement of performance by
knowing

how

exactly

we

have

performed in the past. The objective

of

any

purchasing

division

is

to

expend only the right price for the

purchased quantities. In other words,

we have to optimize the utilization of

the available resources by procuring
as

much

as

possible.

The

responsibility for budget preparation,

operation,

supervision,

must

be

formally defined for this purpose.

In

any

organization,

operations

are

unless

monitored

the
and

controlled, they can cause havoc.

This is more important in the case
of purchasing, as it is main expender
of the organization's finance, and
budgetary

control

comes

in

very

handy in such situations. Based on

budgets, costing exercises and the
price

forecasts,

we

can

estimate

fairly accurately, the upper limits of

expenditure under broad categories

of materials, such as raw materials,

consumables

and

spares.

We

can

have separate limits for each of the A

category items and group limits for C
categories. So long as the purchasing
division is keeping the consumables
supplied and functioning within the
budgetary constraints, the operations
are well under control. No sooner us
there a clamour for materials, or the
budget is exceeded, then remedial
action is called for, as to whether the
price has increases or consumption is
more. Price reduction, or performing
within the budget, while at the same
time

meeting

the

consumer's

requirements goes to the credit of

the

purchasing

and

operating

divisions.

Naturally,

this

should

preclude situations where there is a

general
adopting

price

decrease.

conservative

Similarly,
budgeting

strategies to be on the safe side,

should be discouraged. One obvious
advantage of budgetary control is
that we can do away with the system
of

sanctioning

by

the

competent

authority. This will reduce the leadtime

required

for

converting

an

indent into a purchase order and will

increase the discretionary powers of
the

purchasing

executive,

thereby

improving the overall efficiency of

the operating system.

2.11 NEED IDENTIFICATION

PROBLEMS

Man is forced to procure most of his

requirements of goods and services,
since he can specialize only in a few
trades.

Similarly,

organizations

specialize in their own field and find

it economical to procure their other
requirements. Before effecting the
purchase, one should have a clear
understanding and idea of what is to
be purchased, in other words need
identification at the right time is the
first step.
The needs of the ultimate consumer
can be easily identified, as he will
require

regular

supply

of

food

grains, clothing, cosmetics, fuel, etc.,

at the opportune time. To this need
will

be

added

the

occasional

requirements of consumer durables,

like furniture, oven, etc., which are
available off the shelf. Hence, the
consumer has no need identification
problems,

under

circumstances.
complicated

normal

This
in

process

case

of

is
the

middlemen, who depend to a large

extent

on

customer

behavior

and

forecasting the demand pattern as

well as the timing of the sales. Need
identification
problem

is
in

organizations

indeed
the

and

major

industrial
the

problem

increases with the complexities of the

firm. Research establishments and

heavy engineering industry catering
to customer orders run into greater
differences of determining the right
time

of

extent,

procurement.
material

To

planning

some
reduces

these difficulties.

2.12 DEFINITION OF LEAD TIME

ELEMENTS

There is a finite time lag between the

identification of the need for an item,
till it is approved for use after placing
an order, manufacturing, transport,
shipping, and inspection. The total
duration that elapses between the
recognition of the need for an item
and its fulfillment is known as the

lead-time for that item, which plays

an important part in identifying the
right time. Lead-time is the time that
elapses

between

ordering

goods,

receiving them and placing them into

use at the point of order. Though
the trivial cases of zero lead-time when a production man collects his
daily consumable requirement from
the store and negligible time taken
for a bazaar purchase items do exist,
we will concentrate on items that
require lead-time in months or years.
This delay factor includes the time of
assessing the needs, as well as the
time taken to prepare and place an
order and for the material to reach
the stores.

There is a direct relationship between

the lead-time and inventories. Longer
the lead-time, the more will be the
working

capital

commitment.

Evidently, during lead time there will

be no delivery of materials and the
consumption departments will have
to be served from the inventories
held in the stores. Both lead-time
and consumption rate can increase
without notice and the stock will have
to be geared for this contingency.
The stock will have to take care of
normal consumption during abnormal
lead-time or extensions in the leadtime. In addition, the stocks have to
cater to increase in the consumption
during the normal lead time. It will

be

noticed

that

as

the

lead-time

increases, the inventories will have

to increase correspondingly, resulting
in increase working capital. Hence,
the buyer should take steps from
profit centre point of view to reduce
the total lead-time. For this purpose,
he has to identify the time element
in

the

total

lead-time.

Materials

shipments as a factor of delay in

procurements

create

important

problems for developing economy.

BASIC LEAD-TIME ELEMENTS

The

basic

elements

of

purchasing

activity involving time elements from

the

need

satisfied

identified
in

many

to

the

need

organizations

include the following aspects:

a.

The

need

recognized

for
by

department
requirements

an

item

the
and

are

is
user

their

determined;

this may come from stores or

bill of material schedule, or past
consumption data or forecasts.
b.

The

detailed

specifications

of

items are spelt out and entered

on

the

indent;

specifications

have to be drawn for new items.

c.

This is approved by putting the

signature of relevant authority.

d.

This indent is transferred to the

purchase department, which will
activate into a purchase action
plan.

e.

Rate,

terms

of

conditions,

availability, sources, authority,

procedures, etc., are identified.
f.

Sometimes a new source may

have to be developed as per the
approved procedure, quotations
are called for on simple tender,
limited

tender,

advertised

tender, global tender basis.

g.

Obviously, the time element will

increase
items

from

to

including

local

global
the

purchase

tender

for

time

for

advertising, etc.
h.

Tabulation

and

comparison

of

quotations

by

the

or

buyer

tender committee for identifying

the vendor.

i.

Rates,

terms,

purchase

are

conditions
negotiated

of
and

finalized.
j.

Requisite number of copies of

purchase
spelling

order
out

is

the

prepared,
terms

and

conditions of purchase.
k.

The

supplier's

acceptance

of

purchase order is obtained.

l.
m.

Manufacturing the items.

Follow-up

of

the

supplier

or

chasing the vendor with regard

to the manufacture of the item
and

expected

delivery schedule.

adherence

to

n.

Stage-wise

inspection

at

vendors' premises is carried out,

if necessary.
o.

Identify the method of transport.

p.

The

materials

are

transported

either by ship, train, or lorry with

relevant documentation.
q.

The material is received in the

stores

and

the

relevant

documentation raised.
r.

The invoice quantity is tallied

with the actual quantity received
and discrepancy note prepared.

s.

The

material

quality

is

inspected

characteristics

for

against

the desired specifications.

t.

The accepted material is taken

into the bins in the stores with
documentation.

u.

Suitable action is taken on the

rejected material, by sending to
the vendor.

v.

Adjustments
the

for

requisition

invoice/vendor's

bill

in
as

carried out, if replacements are

not possible.
w.

A cheque is issued to the supplier

as payment for supplies received
and

x.

The

documents

properly.

are

filed

2.13 COST REDUCTION AND

LEAD TIME
The

duration

for

activities

as

mentioned above from (a) to (j) is

called

the

lead-time
powers

internal
and

of

organization,
within

the

administration

depends

upon

the

delegation

in

the

but

the

control

duration

of

the

is

user

organization; (k) (l) (m) (n) are in

the

manufacturing

components;

(o)

and

lead-time
(p)

are

the

transport or shipping lead-time; (q)

(r) (s) and (t) are the components
due

to

delays

inspection
is

lead-time.

encountered

in

The
the

inspection lead-time must be reduced

within

the

organization

with inspection staff.

by

liaising

In

determination

of

adequate caution

must

that

and

the buyer

lead-time,
be

taken,

requisitioner

do not add volumes to increase the

lead-time, as it

will

working

commitment.

capital

enhance

the
The

availability of the item is the most

important
decision

parameter in
making.

available

off

have

the

to

purchased

The item may be

shelf, or
be

may

specially

manufactured. The time element in

the

later

nature

of

case
the

depends
supplier,

upon

the

location

details as well as the complexity of

the product. It may even extend to
two or three years, depending upon
several factors. The purchaser can
at best follow-up the manufacturing
and expedites the supply but it will
cost more.

Added

to

this

is

the

transportation time taken by road/

rail/marine

carriers,

which

is

substantial in the case of imported

items through shipping. The above
time elements are under the control
of

agencies

organizations.

external
As

to

the

against

the

uncontrollable external portion of the

lead-time, we have the internal leadtime, which implies the time needed
for the conversion of the indent to
a

purchase

administration
upon

the

order.

This

lead-time
systems,

internal
depends

procedure,

initiative, manuals, precedence etc.,

and may go up to one year for an
open tender item, or in the case of

imported
approval

item,
of

necessitating

several

the

governmental

agencies. When the item is received

in the central warehouse, until and
unless it is inspected for quality it
cannot be claimed as approved for
use. There is always a time element
or delay involved in inspection, due
to problems in the facilities/personal/
communication, etc., thus the total
lead-time

consist

of

internal

administration lead-time of triggering

off a purchase order, manufacturing
lead-time,
and

transportation

inspection

lead-time.

lead-time
We

are

interested in the total lead-time and

the efforts should be made to control
the internal administration lead-time
by a critical look into procedures, as

the stock level and order quantities

are likely to be high, if the lead-time
is large. Admittedly, the above four
components will also fluctuate and
efforts should be made to control the
maximum lead-time.

2.14 SUMMARY
In this unit, determining the right
price of the material is discussed.
The influencing factors on price are
analyzed
classifying
analysis.

in

great

the

detail,

items

Price

for

by
price

forecasting

for

developing the purchase budget and

budgetary
also

control

studied.

buying

is

mechanism

are

right

for

The
critical

materials management.

time

parameter

in

This

involves

the

total

lead-time,

starting from the need identification

to the satisfaction of the demand.
For this purpose the basic
time

element

The
on

effects

of

are

identifying

analyzed.

lead-time reduction

inventories,

efficiency

lead-

are

product cost,

and

discussed

after

the

methods

to

reduce the lead-time.

Check your progress:

1.

What

are

the

influencing

factors on activities of pricing?

2.

What are the methods of price

forecasting?

3.

What are the basic lead time

elements in purchasing?

2.15 ANSWERS TO CHECK YOUR

PROGRESS

1.

Right

price

is

influenced

by

several factors including quality,

quantity and overheads in the
production process. Sometimes
the supplier arbitrarily increases
the

price

due

to

increase

in

material cost and/or labour cost,

or even when he is not able to
recover material advances.
2.

Simple
weighted

moving
moving

averages,
averages,

exponential smoothening method

are

some

forecasting.

methods

of

price

3.

The basic lead time elements are

the

detailed

specifications

of

items are spelt out and entered

on

the

indent;

specifications

have to be drawn for new items,

the indent is transferred to the
purchase department, which will
activate into a purchase action
plan, rate, terms of conditions,
availability,

sources,

authority,

procedures, etc., are identified,

tabulation

and

quotations

by

comparison

of

the

or

buyer

tender committee for identifying

the

vendor,

conditions
negotiated

of

rates,

terms,

purchase
and

are

finalized,

manufacturing the items, follow-

up of the supplier or chasing the

vendor

with

manufacture

regard
of

the

to

the

item

and

expected adherence to delivery

schedule,

stage-wise

inspection

at vendors' premises is carried

out, if necessary, transport time,
materials

receipt,

checking

invoice with purchase order and

payment.

2.16 EXERCISES & QUESTIONS

1.

Explain

the

functions

of

purchasing.
2.

Describe the influencing factors

on pricing.

3.

Explain

the

classification

pricing in purchasing.

of

4.

What are the methods of price

forecasting?

5.

Explain

purchase

budgets

and

budgetary control.
6.

Explain in detail the basic lead

time elements in purchasing.

2.17 FURTHER READINGS

1.

Gopalakrishnan P Purchasing
and Materials Management Tata
McGraw Hill

2.

Gopalakrishnan P & Sundaresan

M Management An Integrated
ApproachPrentice Hall of India

3.

Tony

Arnold,

Stephen

Chapman, R V Ramakrishnan Introduction

to

Materials

Management

Pearson

Education

UNIT III
VENDOR RATING AND
EVALUATION
STRUCTURE
3.1 Introduction
3.2 Relevance of Good Supplier
3.3

Advantages

of

Good

Relations
3.4 Prerequisites
3.5 Evaluation of suppliers
3.6 The Buyers Role
3.7 Role of the Vendor
3.8 Need for Vendor Evaluation
3.9 Goals of Vendor Rating
3.10
Rating

Advantages

of

Vendor

3.11

Parameters

of

Vendor

Rating.
3.12 Summary
3.13

Answers

to

Check

Your

Progress
3.14 Exercises & Questions
3.15 Further Readings

UNIT OBJECTIVES
After learning this unit you would be
able

To understand the importance of

role suppliers and buyers

To

learn

in

detail

about

vendor evaluation and rating

the

3.1 INTRODUCTION
The major long term objective of
purchasing is to aim at having at
least

two

sources

for

all

critical

items. The success of a purchase

executive depends a great deal on
how well he has chosen his suppliers.
They are his strength and they can
become his weakness by failing at
critical moments. They can make or
mar

his

career

as

the

purchase

executive acts as the buffer between

the vendor and the organization. A
good supplier who is able to maintain
quality, quantity and time schedules
is

an

invaluable

organization.

asset

to

the

3.2 RELEVANCE OF GOOD

SUPPLIER

The vendors are considered as the

best

intangible

assets

of

any

organization. Hence both new and

established vendors are coming for
a

critical

review

capacities,

of

financial

their

plant

conditions,

performance, particularly in today's

recessionary situation. The material
executive has to follow a selective
policy

and

suppliers

to

choose
have

only
at

least

those
two

suppliers for each item.

The material executive has to cater
not

only

to

the

immediate

requirements, but also to the future

requirements

of

his

organization.

Hence he cannot rest content with

selecting or developing a source for
an

immediate

need.

He

has

to

cultivate the source, so that he may

be able to use it effectively for future
needs. He must have a clear idea
of rating the vendors and improve
the relations with vendors. However,
he cannot afford to cultivate all the
sources he comes across. He has to
follow a selective policy to pick and
choose those that are suitable to his
needs. Rating the suppliers helps to
choose the best vendor and also
improves the buyer-seller relations,
on an objective basis. It is also
inconceivable for any organization to

exist

in

business

without

the

vendors; as a matter of fact, the

corporate

strategy

of

many

organizations is to have at least two

sources, for any items. Sometimes,
the suppliers also serve as the public
relations

officers

of

the

buying

company, if the relations between

them are good.

Figure 3.1: Supplier Screening Process

3.3 ADVANTAGES OF GOOD

RELATIONS
A

reliable

vendor

is

the

greatest

asset of any organization and hence

the

need

for

correct

and

cordial

buyer-seller relations. The smooth

running of the entire business is
based on healthy buy-seller relation,
and in this process, the purchase
department

has

responsibility,

to

working

crucial

establish

conditions

cordial

with

the

suppliers. His dealings can enhance

or

mar

the

reputation

of

the

company. The seller also knows that

his profit and progress depend upon
the ability of the vendors to provide
the material when needed most. Both

the buyer and the seller are bound

by a mutual objective and maintain
a close, cooperative, communicative
channel and cordial relations in order
to satisfy the conditions of their very
survival. Purchasing may not be in
the forefront of building the image of
the organization, but as an activity
that

touches

various

policies,

its

performance directly affects the total

picture and the corporate images of
the organization. It is not uncommon
to have resident experts located in
vendor's plants, as a means of liaison
and communication to improve the
relations when large contracts are
involved.

3.4 PREREQUISITES
In order to build the buyer-seller
relations, the following prerequisites
and

rules

of

the

game

must

be

observed; this list is only illustrative

and not exhaustive:
a.

Completeness
communication

and
on

clarity
both

of

sides

concerning the need, application

and usage of the item;
b.

Mutual confidence and interests

of both the parties, by avoiding
unreasonable

demands,

cancellations,

postponements,

delivery

alterations

and

changes in specifications;

the

c.

Exhibiting

genuine

mutual

interest

in

problems

of

procurement, supply, and market

situation,

cost

reduction,

packaging,

rejects,

transportation and forecasting;

d.

Cooperation in prompt shipment,

processing formalities, payment
of invoices and sharing relevant
information;

e.

Continuous

improvement

in

ordering methods and supplying

the services;
f.

Intimate

understanding

intelligent

evaluation

of

other's business interest;

and
each

g.

Aiming for sustained and ethical

relations, both in short-term as
well as long-term.

3.5 EVALUATION OF SUPPLIERS

An

important

factor

contributing

towards better buyer-seller relations

is proper objective evaluation of the
registered suppliers periodically. The
four stages involved in the process
of supplier evaluation are discussed
below:
a.

In the survey stage, all possible

sources are explored and the
capabilities are evaluated on the
basis of prima facie information
given by the vendor, or through

advertisements, catalogues and

other reports. This process leads
to the list of vendors, who have
to be investigated further before
registration.
b.

in the enquiry stage a detailed

analysis is made, after getting
maximum

possible

information

through a standard enquiry form

containing

large

number

of

questions.
c.

These

vendors

who

pass

the

critical enquiry stage are visited

to

assess

their

financial

capabilities, technical capacities,

labour
with

motivation,
the

satisfactory

credibility

customers.
vendors

are

The
then

registered and negotiations are

conducted on quality, quantity,
delivery,

price,

service,

and

other contractual obligations.

d.

the final stage is termed as the

experience

stage,

where

the

actual performance of the vendor

on

quality,

service

and

delivery,
other

price,

parameters

over a period of time is assessed,

in

order

to

carry

on

further

business with him.

3.6 THE BUYERS ROLE

The

buyer

expects

the

seller

to

honour the commitments, supply the

scheduled
adhere

to

quantities
the

in

time

agreed

and

quality

specifications. He also expects him

to be accommodative, if there are
any delays in payments. He expects a
good after-sales service and prompt
replacement

of

rejected

material.

Moreover, the price that is charged

should be commensurate with the
value

of

the

materials

that

are

supplied and the seller should treat

him on par with his other customers.
The relations between a buyer and
a seller cannot be confined to the
legalities. If either party proceeds on
such a premise, they will find the
futility of following such a collision
policy to their disadvantage. It would
be to the mutual benefit, if they
recognize the fact that they are in

a cooperative situation, rather than

in a conflicting situation. It would be
better for them to work on each
others strengths rather than at each
other's

weaknesses.

effectiveness

of

the

The

parties

will

improve mutual trust and a give-andtake approach can be built up. The
supplier expects the buyer to be fair
and honest in his dealings, and to
follow ethical practices. They expect
him to treat their representatives
promptly

and

with

respect,

and

discharge the bills as contracted. The

person who negotiates should have
the necessary authority to enter into
a

contract

on

behalf

of

his

organization. The organization should

stand by his commitments. The broad

features of the corporate purchasing
policy must be made known to the
vendor. This will save time and a
great deal of effort. A well brought
out

brochure

giving

the

requirements,

policies,

production

programming conditions of purchase,

and other relevant information will be
useful. It may also be a good public
relations

exercise

to

inform

the

unsuccessful bidders.

3.7 ROLE OF THE VENDOR

The vendor should not indulge in
back

door

selling

methods,

by

directly approaching the buyer after

bypassing the purchase department.

He

should

understand

that

his

negotiations will be done only with

the authorized buyer and not with
the actual users. He is surely entitled
to demonstrate the effectiveness of
his products to the actual consumers
of the buying organization. But, he
should not convert this opportunity
to bear any undue favouritism or
influence. Similarly, he should not try
to

influence

quality

the

control

working
staff,

of

who

the
pass

judgment of acceptance or rejection

of the material. He should not deal
with the finance department, without
the approval of the authorized buyer
for

expediting

the

settlement

of

outstanding bills. By so doing, not

only

does

he

antagonize

the

authorized buyer, but also demeans

himself in the eyes of the buying
organization in the long run. In his
turn,

the

buyer

understand
suppliers,

the
as

should

position

far

as

should

avoid

minute

cancellations.

should

rush

not

also

of

possible,

orders,

or

Similarly,

abruptly

the
he
last
he

severe

connections with the suppliers. If he

is going in for a new material, he
should give prior intimation, so that
the vendor can find other clients for
the material already manufactured.
This is particularly essential in the
case of small suppliers, who may not
be strong enough financially to face
such

business.

sudden

stoppage

of

the

3.8 NEED FOR VENDOR

EVALUATION

A true measurement of an effective

purchasing department is obtained
by the quality of reliable vendors
selected
services.
interest

for

supplying

The
lies

goods

and

purchaser's

primary

in

for

getting

his

company the best value of money

from his suppliers. This implies that
he should be in a position to assess
and rate their performance against
what

is

supplier
political

expected
in

the
and

from

an

prevailing

ideal
socio-

economical

environment. The absolute standard

is difficult to define with any degree
of

exactness,

but

mathematical

models are available to evaluate the

performance

of

the

suppliers

and

grade them. However, many firms do

not

apply

any

formal

technique;

usually the purchasers use their own

judgment in grading their suppliers
as

good,

satisfactory

unsatisfactory.

Their

or

as

subjective

assessment is not supported by any

recorded

evidence,

specifically

collected for the purpose.

In

judging

the

efficiency

of

supplier, some companies make use

of elaborate records. A file for each
supplier with all possible information

about his performance is built and

regularly

updated.

But

few

companies make use of a simple

check

list,

assess

as

the

suppliers.

indicated

performance
This

list

below
or

to

their

obviously

is

illustrative and not exhaustive. No

rating is involved in these questions,
but the information on answers built
over a period of time is helpful to
the company in the choice of a good
supplier:
1.

Has

the

vendor

specifications

and

accepted
inspection

procedure in their entirety?

2.

Does the vendor have adequate

quality
system?

control

inspection

3.

Is delivery and service reputed

to be satisfactory?

4.

Is quotation within 10 per cent

on either side of the estimated
average price?

5.

Does the vendor have the right

type and up-to-date equipment?

6.

Is his financial status sound?

7.

Can the vendor provide adequate

technical service?

8.

Does the vendor have a scientific

production planning system?

9.

Has

the

satisfactory

vendors'
labour

relations climate?

firm

industrial

10.

Which companies constitute the

major purchasers of the vendor's
products?

11.

What is his market reputation?

3.9 GOALS OF VENDOR RATING

Vendor
appraisal

rating
of

is

technique

performance

of

of
the

vendors periodically to make sure

that they deliver the right quality
materials at the right time in right
quantity and at the right price.
The goals of vendor rating are as
follows:
1.

to facilitate the procurement of

right materials at the right time,

2.

to identify the reliable supplier,

3.

to

minimize

the

cost

of

purchases,
4.

to prevent wastage arising due to

poor maintenance of quality by
the suppliers,

5.

to

ensure

continuity

in

production,
6.

to

meet

the

customer

requirements,
7.

to prevent stock-outs,

8.

to help the vendors realize their

shortcomings

only

to

improve

their performance,
9.

to achieve preservation of quality

of materials, and

10.

to promote and maintain cordial

relations with the vendors.

3.10 ADVANTAGES OF VENDOR

RATING
Vendor

rating

has

the

following

advantages.
1.

The

process

of

vendor

rating

helps the buyer to select the

responsible supplier.
2.

The production is not allowed to

be held up for want of materials.

3.

It is possible to meet the quality

requirements of the customers of
the buying firm effectively.

4.

It

is

easier

to

shortlist

the

suppliers, by cutting down the

time

required

for

needless

evaluation of all suppliers.

5.

Effective

inventory

control

is

facilitated as only A class items

need to undergo rigorous vendor
rating.
6.

There

is

no

element

of

subjectivity as the whims and

fancies

of

purchase

personnel

have no room in the selection of

the supplier.
7.

It

is

possible

to

bargain

for

better terms of purchases with

the suppliers.
8.

The vendors ability to update

their

technology

can

be

given

weight age while rating them,

thus

enabling

the

buyer

choose the right supplier.

to

9.

The capacity of each vendor's

plant can be assessed only to
ensure that the buyer can make
the purchase of desired quantity
of

items

as

and

when

need

arises.
10.

The

buyer

can

keep

himself

current as far as the supplies are

concerned, only to ensure that
there is no need to run pillar to
post during emergencies.
11.

Vendor

rating

unwarranted
the

disputes

supplier

fostering

prevents

and
cordial

between them.

the

between
buyer,
relations

The primary use of vendor rating is to

objectively compare the performance
of vendors and improve the relation
with

the

ratings

better

can

feedback

performers.

also

to

be

the

used

The
as

vendors

a
for

improving their product. To inculcate

a competitive spirit, the scores of
other vendors may be mentioned,
after

properly

identities.
been

disguising

Vendor

used

as

rating
an

their

has

also

important

mechanism to allocate the share of

business amongst a large number of
suppliers. Decisions to disqualify or
blacklist or discriminate the existing
suppliers can be arrived at on an
objective

basis,

through

vendor

rating. Some Indian Organizations

claim that scientific vendor rating
some schemes have eliminated much
of the bickering and frustrations",
that

existed

introducing

earlier,

the

before

vendor

rating

schemes. On the basis of vendor

rating

few

formulated,

organizations
authority

have

could

be

delegated at different echelons in

purchasing
rating

not

organizations

departments.
only
to

Vendor

enables

the

know

the

performance of their suppliers, but

also gives an idea to as to how much
they out-perform" their competitors
with regards to price, quality, leadtime,

split

shipment,

service,

technical

assistance,

emergency,

ad

hoc

meeting

requirements,

etc.
Implementation

of

the

scientific

vendor rating scheme has to be done

very

carefully.

organization's

From

side,

the
lot

of

computational effort of a confidential

nature is required, after choosing the
characteristics.

Identification

characteristics,

of

collection,

compilation, analysis with previous

feedback,

etc.,

costs

money

and

hence the periodicity of the rating

calculation should be so chosen as
to

optimize

the

returns.

Many

organizations usually follow a halfyearly rating for regular purchase

items.

Unless

informed
system,

the

and
the

suppliers

convinced

rating

could

of

are
the

become

dysfunctional. They must be taken

into confidence and the soundness
of the system should be explained
to them. However, while discussing
the performance of other suppliers,
the individual identities should be
disguised. This is a requirement not
only from ethical considerations, but
also

to

between

prevent
the

an

understanding

suppliers

and

thus

reduce the purchasing effectiveness

of the organization.

3.11 PARAMETERS OF VENDOR

RATING

The parameters included in vendor

rating are as follows:
1.

Delivery of materials on time,

2.

Maintenance of quality

3.

Price of the materials supplied,

4.

Delivery

of

right

quantity

of

materials,
5.

Providing

effective

service

capability

to

emergency

orders,

meet

dissemination

of

vital

information, readiness to try out

new designs etc.
All the buyers in general, are very
much concerned with timely delivery

of materials by the vendors. Any

delay in the arrival of materials would
drastically

disrupt

the

production

schedules of the buyer. The buyer

needs to compare the number of lots
delivered on time by a vendor with
the total number of lots delivered by
him to judge his efficiency regarding
maintenance of delivery schedules.
Similarly, all the vendors need to be
under scrutiny.
Quality is another parameter that is
used to identify the reliable vendor.
The

vendor

must

maintain

consistency in quality in all the lots

submitted to the buyer. The ratio of
number of lots accepted to the total
number of lots submitted needs to be

worked out to decide the right vendor

on the basis of quality. It is essential
to make a comparison of prices at
which

the

vendors

made

their

supplies in the past. The contract

price needs to be compared with the
average

market

price

for

all

the

vendors only to determine the one

who economizes the purchases.
Ability of a vendor in making the
supply of right quantity needs to be
determined. If the buyer has never
experienced

any

discrepancy

regarding the quantity of materials

supplied in the past by a vendor,
he would better select the latter to
ensure that the production is not held
up for want of materials. Vendor

rating should also be based on as to

how a vendor offers effective service
to

the

buyer.

information

Providing

about

the

advance
possible

increase in the prices of materials in

the near future, offering better terms
of credit, giving increased discount
on bulk purchases etc. may help a
vendor being rated high compared to
others.

The

buyer

may

give

appropriate weight to each criterion

to

make

vendor

rating

effective

facilitating the choice of the right

supplier.

3.12 SUMMARY
A reliable source is the greatest asset
of any organization and hence the

need

for

cordial

buyer-seller

relations. The role of the buyer in

this context and the prerequisites for
cordial

relations

are

analyzed

to

improve the relations between the

two parties.

Check your progress:

1.

What are the advantages of

good relations with suppliers?

2.

What is the need for supplier

evaluation?

3.

What are the parameters of

vendor rating?

3.13 ANSWERS TO CHECK YOUR

PROGRESS
1.

The smooth running of the entire

business

is

based

on

healthy

buy-seller relation, and in this

process,

the

department

has

responsibility,

purchase

to

crucial
establish

cordial working conditions with

the

suppliers.

knows

that

The
his

seller
profit

also
and

progress depend upon the ability

of the vendors to provide the
material

when

needed

most.

Both the buyer and the seller are

bound by a mutual objective and
maintain a close, cooperative,
communicative

channel

and

cordial

relations

in

order

to

satisfy the conditions of their

very survival.
2.

The purchaser's primary interest

lies in getting for his company
the best value of money from
his suppliers. This implies that he
should be in a position to assess
and

rate

their

performance

against what is expected from an

ideal supplier in the prevailing
socio-political

and

environment.
standard

is

economical

The

absolute

difficult

to

define

with any degree of exactness,

but

mathematical

available

to

models

evaluate

are
the

performance of the suppliers and

grade them.

3.

The technical factors include past

performance

in

quality,

warranty, inspection plans, toolroom facilities, laboratory testing

equipments,

skill

supervisors

of

mix

of

various

departments, support document

availability, testing equipments,
design facilities, knowledge of
cost

reduction

value

techniques

analysis,

like

quality

consciousness at all levels, plant

capacity,

plant

layout,

maintenance policies, facilities to

meet

energy

manufacturing

shortages,
experience,

inspection

methods,

rejections,

process

replacement

of

rejected items, etc. The financial

parameters

include

discounts,

credit

discounts,

product

volume

terms,
price,

cash
real

profit margin, return on total

assets, current ratio, quick ratio,
funds flow analysis, cash flow
analysis,

follow-up

procedures

for payment, guarantee of price

protection against inflation, etc.

3.14 EXERCISES & QUESTIONS

1.

Explain

the

advantages
relations.

prerequisites
of

and

buyer-supplier

2.

Describe

the

process

of

evaluation of suppliers stating

the role of buyers and vendors.
3.

What

is

the

need

for

vendor

evaluation?
4.

What

are

the

goals

and

advantages of vendor rating?

5.

If you are a purchase executive

of

manufacturing

company,

provide a simple check list to

evaluate your supplier.
6.

Explain in detail the parameters

of vendor rating.

3.15 FURTHER READINGS

1.

Gopalakrishnan

Purchasing

and Materials Management Tata

McGraw Hill

2.

Gopalakrishnan P & Sundaresan

M Materials Management An
Integrated

ApproachPrentice

Hall of India
3.

Tony

Arnold,

Stephen

Chapman, R V Ramakrishnan Introduction

to

Materials

Management

Pearson

Education

UNIT IV
MATERIALS PLANNING
STRUCTURE
4.1 Introduction
4.2 Role of Material Management
4.3 Classes of Materials
4.4 Materials and Profitability
4.5 Profit Center Concept
4.6 Material Objective
4.7 Centralized Purchasing
4.8 Decentralizing
4.9 Delegation of Powers
4.10

Definition

of

Planning
4.11 Bill of Materials

Material

4.12

Material

Requirement

Planning
4.13

Importance

of

Material

Research
4.14

Materials

Information

System
4.15 Summary
4.16

Answers

to

Check

Your

Progress
4.17 Exercises & Questions
4.18 Further Readings

UNIT OBJECTIVES
After learning this unit you would be
able

To understand the importance of

role of materials

management

and profit center concept.

To

learn

in

detail

about

the

Material Requirement Planning

To understand the advantages of

material information system.

4.1 INTRODUCTION
Materials Management is simply the
process by which an organization is
supplied with the goods and services
that it needs to achieve its objectives
of buying, storage and movement of
materials. Materials Management is
related

to

planning,

procuring,

storing and providing the appropriate

material

of

right

quality,

right

quantity at right place in right time

so as to co-ordinate and schedule the
production activity in an integrative
way for an industrial undertaking.
Most

industries

transport

them

buy
in

materials,

to

the

plant,

change the materials in to parts,

assemble
products,

parts
sell

in

and

to

finished

transport

the

product to the customer. All these

activities of purchase of materials,
flow of materials, manufacture them
in to the product, supply and sell
the product at the market requires
various types of materials to manage
and control their storage, flow and
supply at various places. It is only
possible

by

management.

efficient

materials

The materials requirements planning,

purchasing,

inventory

planning,

storage, inventory control, materials

supply, transportation and materials
handling

are

the

activities

of

materials management.

4.2 ROLE OF MATERIALS

MANAGEMENT
There

are

performance

several
in

any

centers

of

organization.

This list includes profit centre, cost

centre, activity centre, work centre,
centre
planning

for

conversion

centre,

etc.

of

jobs,

We

shall

examine how materials activity can

be considered as a profit centre. To
start with, we all know that the

development of human being can be

directly

correlated

development

of

to

the

the

materials

function. Man spent millions of years

hunting for his food. Then he learnt
to use the skin of the animals for
clothing.

Slowly

advantages

of

he

found

agriculture.

the
Some

became adept in the art of weaving,

others in pottery, and a few in metal
working. Man found that it would be
his advantage, if instead of learning
all the trades, he specialized in one
trade

and

products

in

purchased
return

for

the

other

what

he

produced, and thus the barter system

developed,

which

even

prevalent in tribal areas.

today

is

As the specialization increased, he

found it difficult to fix values for the
products to facilitate exchange. To
ease the transactions, the monetary
system

was

developed.

In

fact,

money itself has come to represent

only

what

it

can

buy.

Once

specialization in trade was developed

and currency system was introduced,
the

development

of

mankind

was

really rapid. Man could purchase his

requirement of goods and services
and gain satisfaction. This process
was extended to the organizations he
built. As there was a ready market
for specialized goods and services,

economic

development

became

viable, that resulted in a growth of

technology.

Thus,

purchasing

or

supply function is always an essential

part of mans activities and it forms
the very basis of the individual's
development, resulting in corporate
growth and the country's progress,
as effective utilization of materials
in

manufacturing

and

service

organization, is a key area of great

relevance in the context of today's
Indian professional manager.

4.3 CLASSES OF MATERIALS

Today, there are different groups of
purchasers,

amongst

whom

the

ultimate consumers, who purchase

for their personal consumption, are

the most important, because they
constitute the group which family
uses all the products of the economy.
In

fact,

the

dependent
survival.

whole

on

this

The

purchasers

economy
group

second

is

for

its

group

of

consists

of

the

middleman, who purchase not for

their own consumption, but to meet
others'

needs.

distributors,

These

wholesalers,

are

the

retailers

and agents who form the channels

of distribution of the manufactured
products from the producers to the
consumers.

Obviously,

their

purchasing will be dictated by the off

take from their premises. This class

of

purchasers

adds

value

to

the

products by making them available

to the consumers. The third group
of purchasers is the manufacturers,
who convert materials into products
required

by

the

consumers.

They

purchase raw materials, components,

consumables,
packing

machine

materials,

tools,

etc.,

fuel,

work

on

them and add value in the conversion

process.
Their

products

manufacturers'
consumed

by

enter
works,

the

other
or

ultimate

are
users.

Another class of purchasing is that

category belonging to governmental
agencies and institutions, who buy
for

public

utilities.

Quantity

and

value-wise
single

they

group

of

form

the

largest

purchasers.

Their

requirements range from the largest

single

group

of

purchasers.

Their

requirements range from tiny pins to

giant airplanes. Each group has its
own set of problems. It should be
evident

that

with

increased

purchasing efficiency, each group can

improve its satisfaction and thus lead
to the growth of the economy.

4.4 MATERIALS AND

PROFITABILITY

The common consumer can easily

understand

the

importance

of

purchasing efficiency, because of his

limited

resources.

His

monthly

purchase bill will include items of

food, clothing, fuel, cosmetics and
charges for services like transport,
electricity, recreational facilities, etc.
Barring the rich, the common man
has

to

endeavour

his

utmost

to

obtain all his requirements within his

budget. Therefore, if he is able to
reduce the prices without a reduction
in quality, he will be able to improve
his satisfaction. Similarly, he will be
able to increase his profitability and
turnover,

if

he

can

improve

his

purchasing efficiency. Many of the

isolated

problems

and

hard-to-

control costs of industries can be

traced
material

to

scattered

and

the

control

many

over

different

conflicting

ways

it

can

be

manipulated to achieve the goals of

the organizations. Purchasing brings
these forces together, so that best
results can be produced.
We have sufficient data to show that
in a majority of the industries and
manufacturing

operations,

input

including fuel and utilities constitute

over 60 per cent of the turnover of
the final product. Analysis of the cost
structure
accounts

from
of

the
large

published
number

of

industries indicates the pattern given

in Table 4.1. In addition to these
regularly

consumed

items,

manufactures have to procure capital

items like plant and machinery to

create the manufacturing facilities.

Thus a major portion of the fixed
capital is in plant and machinery and
substantial

part

of

the

working

capital is in raw materials, parts and

other supplies. All these items have
entered the organization through the
purchase

function,

which

thereby

effectively controls a major portion of

the organizations' finances.

Percentage
of
Materials

Industry Group

Cost

Fabrication,
Above 75

construction,
petroleum refining.

projects,
electrodes,

Wool, sugar, jute, cotton yarn,

65 - 75

commercial

vehicles,

earthmoving

equipment,

scooters, furniture.

Cotton

textiles,

building,
55 - 65

electricity

cables,

bread,

ship

dyestuffs,

generation

and

distribution, refrigeration, heavy

machinery.

Chemicals,
pharmaceuticals,
45 - 55

cement,
electronics,

paper, engineering, non-ferrous,

tyres, machine tools, explosive,
agriculture

Table 4.1: Industry wise Per Cent

Cost

4.5 PROFIT CENTER CONCEPT

It has been recognized that materials
department can contribute effectively

to corporate profits, as purchasing is

considered a spending function and
every rupee saved in buying goes to
the

profit

column

of

the

balance

sheet. From the above table, it is

noted

that

materials

function

accounts for a major portion of the

cash outflow in many organizations.
By asking judicious questions on this,
the

purchase

contribute

executive

substantially

can

to

the

savings. Materials executives by the

intrinsic nature of their job gain a
good knowledge of a wide range of
external industrial activities. Hence,
more

than

anybody

else

in

the

organization, they are able to bring

information

about

new

products,

materials

and

processes.

This

enables them to suggest alternatives,

which

can

reduce

dependence

on

costs

imports.

or
By

developing new sources of supply,

they help in the industrial growth of
the country. Therefore, purchasing is
not a simple clerical or post-box
spending function, but a dynamic
discipline
greatly

which
to

resulting

in

can

corporate
the

contribute
profitability,

growth

of

the

economy.
The role of the materials executives
is that of a catalytic agent, who can
quicken

the

pace

without

undue

of

development

hardship.

Materials

managers can effectively contribute

to import substitution and conserve

variable

foreign

exchange.

The

attention given by governments and

industry both at macro and micro
levels - to purchasing function has
be negligible, despite the importance
of supply function. It is noted that
in any commercial transaction, there
is always a buyer and a seller. The
buyer

requires

certain

goods

and

materials to satisfy his wants. He

seeks a seller who can and is willing
to

supply

him

what

he

needs.

Together, they negotiate a mutually

satisfactory price and the deal is
completed.

Thus,

purchasing

is

basic function not only in an industry,

but in the Indian economy.

Industrial purchasing is a refined and

highly

specialized

version

of

this

activity, as purchases responsibilities

has a direct effect on the corporate
financial and competitive nature of
the firm. The buyer in addition to
investing

the

prudently

must

demands

of

company's
also
the

money

satisfy

the

operating

departments. The ideal in this case

should be the traditional housewife,
who is the best material manager, as
she is able to satisfy the fluctuating
demand, without any shortages and
at

reasonable

cost.

The

most

meaningful label that can be pinned

on industrial purchasing function is
money management.

4.6 MATERIAL OBJECTIVE

This

successful

operation

of

any

business depends, to a larger extent,

on

the

availability

of

goods

and

services of the right quality in the

right quantity at the right time, from
the right source, at the right price.
These form the classical Five Rights
objective of the materials department
that broadly generalize and sum up
the

fundamental

elements

of

the

function. These basic requirements

will

be

suitably

amplified

and

modified by the needs and objectives

of the individual organizations.
To

achieve

these

objectives,

purchasing can be considered as a

Profit Centre. These objectives can

be translated in practical terms of
maintaining an uninterrupted flow of
materials. Any stock out and the
resulting loss of production can be
debited as a loss. The value-added
by

the

purchase

function

in

maintaining supplies can be credited

as a profit. Objectives can be set in
terms of price, quality, delivery and
service.
Any reduction in the price can be
credited as a Profit. The function
contribution towards cost reduction
and product improvement can also
be measured against the objectives.
Similarly, the purchase division can
contribute

to

the

avoidance

of

wastage and obsolescence. Because

of the very nature of its work, the
purchasing

section

will

have

interaction with the best of internal

and

external

groups.

necessitates

This

improvement

in

interpersonal relations, which is one

of

the

means

of

achieving

the

objectives.
The

above

discussion

of

the

environment at once indicates to us

that materials management is not a
routine

function

entrusted
purchasing

to

that

anybody.

has

to

can

be

Scientific

maintain

an

uninterrupted flow of materials and

at the same time reduce inventories,
obsolescence and varieties, without a

F98I7H=CB =B 7CBGIA9FGU G5H=G:57H=CB

#H

AIGH

<5J9

GD97=:=75H=CB

C:

5B

577IF5H9

H<9

A5H9F=5@G

F9EI=F98 5B8 7@95F IB89FGH5B8=B; C:

H<9

7CGHG

G

H<9

JC@IA9

C:

HF5BG57H=CBG ;FCKG H<9 89D5FHA9BH

K=@@ <5J9 HC IG9 7CADIH9FG .<9G9
57H=J=H=9G B979GG=H5H9 5 DF9A=IA CB
H<9 5B5@MH=75@ 5B8 897=G=CB A5?=B;
56=@=H=9G
C:
H<9
A5H9F=5@
9L97IH=J9

4.7 CENTRALISED PURCHASING

&9H IG BCK 9L5A=B9 H<9 DF9J5@9BH
A5H9F=5@G
89J9@CD=B;

GMGH9AG

GD97=5@=N=B;

9LD9FH=G9

56CIH

CF
H<9

=H9AG 5:H9F 6I@?=B; H<9 CF89FG =B H<9

<958EI5FH9FG

HC

5J5=@

EI5BH=HM

8=G7CIBHG CB DIF7<5G=B; 57H=J=H=9G

Usually, in multi-product, multi-unit

organizations,
purchasing

of

key

centralized
raw

materials,

which may be common has been

found

to

be

very

economic

proposition.

It

is

noted

that

largest

central

organizations
general

of

is

purchasing
the

supply

the

directorate

and

disposal,

catering to the needs of defence,

railway

and

communication

and

buying goods worth around Rs. 7000

crore per year.
Bharat

Heavy

Electricals

Ltd.

for

instance, can well afford to centralize

its

purchase

of

major

items

like

copper and electrical steel for its

various units. Other than the positive

advantage

of

centralized

specialization,

purchasing

can

reduce

the prices, because of acquisition of

the bulk quantities. However, a major
requirement for centralization is a
well established information system,
which

feeds

the

materials

requirement data taking into account

the consumption and stock figures.
With

the

help

of

the

information

system, it is possible to introduce

all cost reduction techniques in the
materials management field.
Centralization enables the need for
rationalization and economy in the
acquisition

and

use

of

resources

through standardization of policies,

controls

and

uniformity

of

procedures.

Needless

to

say,

the

stores have to be located nearest to

the user or consuming point.
100 per cent centralization can exist
only in wishful thinking. Moreover,
it is often said that centralization
automatically
time,

increases

causing

the

unnecessary

leaddelays

and lack of commitment on their

part. Hence, considering all aspects,
often it may not be worthwhile to
centralize the purchase of all items.
If centralization is to be implemented
effectively,

it

should

be

supplemented by a proper delegation

of powers to the executives at the
units.

We

can

use

the

selective

control technique of ABC analysis and

centralize the purchasing of class A

items

alone,

which

may

be

advantageous in the overall interest

of an organization.
Thus

the

problems

reported

in

centralized set-up can be summed up

as follow:
a.

Inordinate delay in procurement,

with advantage internal leas time
of converting an indent into an
order going up to 12 months
in

some

government

sectors

companies,
b.

Supply

of

material,

inferior

which

has

quality
to

be

consumed sometimes due to the

non

availability

material,

of

required

c.

Officers

of

consuming

the

individual

units,

spending

considerable amount of time in

following

up

with

central

purchase and suppliers for the

delivery of the item,
d.

Resorting

to

procurement

in

emergency
case

of

stock

outs, particularly for spare parts,

e.

The

design

and

operation

personnel spending a lot of time

with

suppliers

to

explain

the

technical details,
f.

Building up in process inventory,

due

to

non

availability

of

matching components of spares,

g.

Purchasers having neither ever

seen the item not having any
knowledge about their use; etc.

To overcome the above pitfalls, and

to make central purchase effective,
the user department must avoid:
a.

Incomplete specifications,

b.

Frequent last minute changes,

cancellations

and

postponements,
c.

Non availability of drawings,

d.

Making every indent as urgent

due to improper planning,

e.

Creating an artificial shortage by

removing
stores and

all

items

from

the

f.

Rejecting good quality materials

in case of surplus situation and
accepting bad quality materials
when urgently needed.

4.8 DECENTRALISING
The

decentralized

purchasing,

or

method

each

unit

of
or

department being made responsible

is another alternative model used in
some

companies.

Admittedly,

decentralized purchasing eliminates

the disadvantages encountered in the
centralized system.
The advantages cited in favour of
decentralization are as follows:

a.

the materials manager at the

local spot, will have a better
commitment and knowledge of
the

needs

factory
transport

of

of

his

individual

local

suppliers

of

and

warehousing

facilities;
b.

the local decision making system

on the spot will shorten time of
communication;

c.

the local purchase officer, being

part of a local profit centre of the
unit, will have better liaison and
tighten control on performance
than the purchase officer sitting
miles away from the plant;

d.

Admittedly, he has to liaise with

the purchase officers of the same

group, so that he does not have

to pay more price for the same
item from the common suppliers,
e.

Decentralization
individual

helps

users

in

the
speedy

execution of a project due to

ease

of

proximity

to

supply

sources.
Generally

the

advantages

of

one

system result in the disadvantages of

the other and hence a combination
of both i.e. partial centralization
for high value items and leaving the
remaining

to

the

unit

level

is

desirable to be adopted for obtaining

better results for the company. As
pointed

earlier,

usually

the

high

consumption value items are handled

in headquarters.

4.9 DELEGATION OF POWERS

For

smooth

materials

functioning

activities,

of

delegation

the
of

powers is a prime necessity. One of

the

major

contributing

administrative

factors

lead-time

is

to
an

improper delegation of power. The

purchase order is a legal offer of a
company and unless the powers are
delegated appropriately, there can be
plenty of uncalled for liabilities on
the company. Thus the importance of
delegation of powers can never be
overemphasized.

We can use the selective control

technique as the basis for delegating
powers. All the important materials
should be handled right from the top.
The importance may be due to high
consumption value or criticality, or
price or scarcity of items. People
lower down the ladder of hierarchy
should

be

delegated

the

responsibility for the less important

items. This gives them a sense of
belonging and a chance to learn and
work independently, so that when the
occasion

demands,

they

charge

at

higher

the

can

take
level.

Insufficient delegation of powers in

government undertakings, where the
competent financial authority is still

supreme, buying every item after

financial

concurrence

calling

for

tenders ever for small orders, and

obtaining

financial

sanction

for

regular budgeted items, is reasons

for

major

irritants

causes
and

or

delays

and

hence

must

be

minimized.

4.10 DEFINITION OF MATERIAL

PLANNING

Materials planning is the scientific

way of determining the requirements
of raw materials, components, spares
and

other

items

that

grow

into

meeting the production needs within

economic investment policies. As the
definition

needs

planning

within

economic investments, we need a

system which evolves methodology
to plan the purchase requirements in
a scientific fashion. It is related to
the user departments activities and
hence to the investment policy of the
individual organization.

TO

INFLUENCING

FACTORS
Materials planning process will be
influenced

by

large

number

of

factors such as:

a.

state

of

health

of

economy,
b.

price trends and validity,

c.

credit policies,

national

d.

direct and indirect taxes,

e.

foreign exchange regulations,

f.

import policy,

g.

international market conditions,

h.

business cycles,

i.

corporate objectives,

j.

technology availability,

k.

demand for the item,

l.
m.

supply of the item,

transportation losses,

n.

total lead-time,

o.

rejection rate,

p.

working capital,

q.

storage capacity,

r.

plant utilization,

s.

seasonal factors,

t.

communication systems,

u.

delegation of power,

v.

information available,

w.

location of plant and location of

suppliers,

x.

cost

criticality

reliability

and

availability of items,
y.

information

on

substitute

products, and
z.

techniques

used

to

determine

forecasts.
It may be noticed that the above
factors

could

be

classified

as

controllable, uncontrollable, external,

internal, quantifiable, intangible, etc.
Sometimes

the

regulations

affect

government
the

planning

process;

like

the

government

stipulating urea should be packed

100 per cent in jute bags and not
polythene

bags.

uncontrollable

This

and

becomes

representations

by the industry are needed but, since

the

whole

organization

moves

on

purchase planning, it is desirable to

consider

the

above

factors

while

formulating plans.
Macro-factors

such

as

revenue

budgetary deficits of about several

lakhs of crore rupees and negative
balance of payment adversely affect
the price. In this context, control
which

is

always

associated

with

planning as an essential aspect of

management arises from the inherent

imperfection of things and people,

both within a particular plant and
outside, in the form of suppliers and
purchase executives. Usually people
add

ten

per

cent

of

the

current

consumption and treat it as the next

years planned estimates, but let us
discuss some more methods.

4.11 BILL OF MATERIALS

Bill

of

materials

(BOM)

is

the

document generated at the design

stage, which details the structure of
the product. It provides details such
as

the

item

stock

number,

description, type, quantity required,

material and the type of relationship
between the group of components.

BOM is the basic document used by

all departments to accomplish their
activities

involved

product.

to

Material

finish

the

requirement

planning (MRP), procurement action

for bought-out components, releases
of orders for manufacturing, issue of
bought-out

items

manufacturing
product,
cost,

items,

detailed

etc.,

are

for

assembly,
pricing

break-up
based

on

of
bill

a
the
of

materials. For example if a chair is

assembled, the bill of material will be
four legs, two arms, back rest, glue
and a box of nails. By multiplying the
quantities given above the required
chairs, we get the BOM.

The

BOM

must

not

only

list

all

components of a given product, but

must be so structured as to reflect
the way the product is actually made
in

steps,

from

raw

material

to

component, part to subassembly and

then to assembly and finished items.
Explosion

of

BOM

refers

to

the

splitting of the requirements for the

product to be manufactured into its
basic components.
Sometimes, this is also known as
parts schedule in some engineering
organizations. Instead of maintaining
the bill of material for individual end
products, under the MRP approach,
the bill of material is restated in
terms

of

the

building

blocks

or

modules,

from

which

the

final

product is put together. In MRP, as

the components are planned based
on production schedule of products
and their bill of materials, the items
are

better

matched.

Specific

demands for these items have been

calculated rather than forecast in the
MRP and the existing surplus is taken
to find the net demand. The inputs
for the computer are the product
master

schedule,

orders

from

external sources, forecast of items

subject
product

to

independent

structure

file

demand,
and

the

inventory file. The outputs from the

computer are:

a.

order release notices

b.

rescheduling notices,

c.

cancellation of orders,

d.

item status analysis, backup data

and

e.

planned

order

schedule

for

future.

4.12 MATERIAL REQUIREMENT

PLANNING
Material

requirement

planning

consists of a set of logically related

procedures,
records

decision

discovered

to

rules

and

translate

master production schedule into time

phased net requirements and the
planned

coverage

requirements

for

each

of

such

component

inventory item needed to implement

the schedule. It is both an inventory

control and scheduling technique. It
consist of series of steps which start
by

determining

what

finished

products are needed to meet the

demand by time periods, and are
completed with a schedule of the
finished product components needed
at

each

assembly

level

for

each

product. Specific plants through a

computer can be used as in MRP,
the demand is known for all practical
purposes.

Figure 4.1: Inputs and Outputs of Material

Requirement Planning

It is particularly useful:
a.

When

the

final

product

is

complex and made up of several

levels of assemblies,
b.

The

finished

expensive,

product

is

c.

The lead time for input materials

are relatively longer,

d.

The

production

cycle

time

is

long,
e.

The consolidation of requirement

for several products is desirable,
so that economic lot size are
applicable, and

f.

Existence of a bill of materials

listing the identification of the
numbers

through

the

code

numbers.
MRP

is

requirement

oriented

system, whose objective is to deliver

material

to

the

production

department to meet their product

requirements. With the absence of

buffer stock in the MRP system, the

purchasing personnel are always on
their

toes

to

meet

the

frequent

demand of production schedule. The

ideal period for material requirement
planning is three months, which is
reviewed for corrections from time to
time.

4.13 IMPORTANCE OF MATERIAL

RESEARCH
Materials
intelligence,
management
right

research,

purchase

market

research,

information

information

purchasing,

system,

materials

system,
creative

intelligence,

etc., are often used in the context of

the scientific materials management,

but a major handicap in purchasing is

the lack of coordination of activities
and materials research is the most
neglected

aspect

in

many

organizations. The four decades of

industrialization in the country has
made

the

buyer

shoulder

heavy

responsibilities. Just as an astronaut

cannot guide his spacecraft using a
compass or slide rule, so also modern
buyers

cannot

potential

achieve

and

their

improve

true
their

profession without the best blend of

scientific

and

judgmental

skills

obtained by purchase intelligence.

Purchase
visualizing

research
the

helps

in

underlying

possibilities, within the economy, and

hence comes out with a future vision,

forecasts

future

problems

suggests

suitable

solutions

and
in

scientific manner. Proper purchase

intelligence tries to answer questions
which

are

expected

to

arise

in

practice in future. Improvement in

purchasing activity and adaptability
to new techniques can be effective
only through purchase research, in
view

of

nature
activities.

the

increasingly

of

industrial
The

complex
purchase
industrial

technological revolution is giving way

to industrial information.

4.14 MATERIAL INFORMATION

SYSTEM

Research is defined as a purposive

analysis that tries to establish a basis
for

prediction

and

control

in

the

behavior it studies. It is an important

business

activity

based

on

the

concept information is power' and

should

be

considered

development
materials

activity,

department.

as
in

It

a
the

can

be

defined as a systematic formal and

continuous

analysis

of

all

factors

affecting the purchasing and material

function.

Give

the

manager

the

information he needs and the will

improve. The system should aim from
fragmentation to integration.

Materials intelligence is a systematic

approach

of

furnishing

accurate

information to the right person in the

purchase hierarchy, with a view to
assist him in optimizing the available
resources towards the profit centre
goal. The information requirements
for

planning,

budgeting

and

controlling in all aspects of materials

function should be included in MIS.
The purchase research provides the
buyer with the information he needs
in order to take decisions, as well as
plan and control the activities within
the area of his responsibility. The
strategic information is usually long
term,

having

uncertainty

and

high
poorly

risk

and

structured

and relies on external environment

which is qualitative in nature.

The

managerial

contains

level

internal

information

information

medium

term

duration

medium

risk.

The

with

operational

level information details are

term

and

repetitive

of

short

in nature, in

that any risk involved is concerned

with

internal

materials

environment.

information

may

Thus
be

defined as an organized network of

information;

flow

aimed

at
by

supporting

materials

activities

furnishing

relevant,

reliable

and

timely information.

A TO Z CONSTRAINTS ON MIS
In

developing

information

the

system,

there

materials
can

several constraints as follows:

be

a.

organization,

b.

support of top management,

c.

reaction to change,

d.

secret nature of information,

e.

data security, and fragmentation

of MISD,

f.

lack of motivation, and interest,

g.

costs/benefits not quantifiable,

h.

lack of resources/manpower,

i.

old

and

inadequate

data

of

published sources,
j.

vendors noncooperation,

k.

utility not felt by the user,

l.

inability to understand/use the

information,

m.

information not integrated but

conflicting,

n.

difficult

to

quantify

all

information,
o.

difficult to forecast price quantity

accurately,

p.

attitude

of

government/

monopoly suppliers,
q.

irregular frequency,

r.

non-uniform formats,

s.

not need based,

t.

routine reporting,

u.

historical and post mortem in

nature,

v.

MIS is not nerve centre,

w.

control cycle not defined

x.

absence

of

flexibility,

consistence,

clarity,

pervasiveness, feedback, etc.,

y.

improper

collection,

storage,

generation, processing data and

z.

aversion to scientific methods.

Steps should be taken to avoid these

constraints.

ADVANTAGE OF MIS
The buyer in many organizations is
semi-illiterate and materials research
helps to broaden his outlook towards
scientific purchase management to
attain his true potential. Purchasing
intelligence

is

systematic

investigation
alternate

to

locate

sources

of

better

supply,

to

improve the quality, reduce the price,

standardize specifications and find
substitutes for items in short supply.
It enables him to consider in advance
the

implications

of

the

following

internal and external aspects:

a.

company's

long

range

requirement of material,
b.

likely sources of supply during

the next decade,

c.

supplier capability, reliability and

back-support

d.

shortages in a particular sector

and substitutes for others,

e.

procurement

and

planning

provisioning,
f.

control of obsolete and surplus

stocks,

g.

technological

changes

and

breakthroughs expected in the

market,
h.
i.

likely price trends,

expected

changes

in

the

government policy on imports,

taxes,

finance

and

monetary

policies,
j.

contract negotiations relating to

insurance,

handling,

insurance

and transportation,
k.

general behavior of national and

world economy,

l.

market surveys of supply sources

and price trends,

m.

pments,

forecasts,

competition

and
n.

socio-political trends,

o.

price preferences for small-scale

sector, etc.

4.15 SUMMARY
The organization to suit the materials
management

objectives

are

discussed at length. The problems

arising
external
versus

out

of

internal

environment,
decentralized

interface,
centralized

organization,

delegation of powers are discussed at

great length in this unit. In this unit,

the profit centre concept of materials

management, by its contribution to
the

profitability,

investment

return

and

on

corporate

performance is discussed. We live

by sales and make our profit from
materials, Uncontrolled inventory is
industry's cancer are the slogans to
the

profit

centre

concept.

The

definition of materials planning, the

need

and

benefits

of

materials

planning, and the factors influencing

the process of material planning are
discussed

in

this

chapter.

The

process of materials planning in the

form of bill of materials, materials
requirements planning is discussed at
length in this unit.

Check your progress:

1.

What is profit center concept?

2.

Difference between centralized

and decentralized purchasing?

3.

What is MRP?

4.16 ANSWERS TO CHECK YOUR

PROGRESS
1.

Materials
contribute

department
effectively

can
to

corporate profits, as purchasing

is considered a spending function
and every rupee saved in buying
goes to the profit column of the
balance sheet. It is noted that
materials function accounts for a
major portion of the cash outflow
in

many

organizations.

The

purchase

executive

can

contribute substantially to the

savings.
2.

Centralization enables the need

for rationalization and economy
in the acquisition and use of
resources

through

standardization
controls

of

and

procedures.

policies,

uniformity

The

of

decentralized

method of purchasing, or each

unit or department being made
responsible for purchasing raw
materials.
3.

Material

requirement

planning

consists

of

logically

related

procedures,

set

of

decision

rules and records discovered to

translate

master

production

schedule into time phased net

requirements and the planned
coverage of such requirements
for

each

component

inventory

item needed to implement the

schedule.

4.17 EXERCISES & QUESTIONS

1.

Explain

the

role

of

materials

management in a contemporary
organization
2.

What is profit center concept?

Explain its significance.

3.

Describe the difference between

centralized

purchasing

and

decentralized purchasing stating

its

advantages

disadvantages.

and

4.

What

does

bill

of

materials

mean?
5.

List out all the factors influencing

materials planning.

6.

Describe

in

detail

materials

requirement planning stating its

inputs and expected outputs.
7.

Explain

in

detail

materials

information systems stating its

advantages and constraints.

4.18 FURTHER READINGS

1.

Gopalakrishnan

Purchasing

and Materials Management Tata

McGraw Hill

2.

Gopalakrishnan P & Sundaresan

M Materials Management An
Integrated

ApproachPrentice

Hall of India
3.

Tony

Arnold,

Stephen

Chapman, R V Ramakrishnan Introduction

to

Materials

Management

Pearson

Education

UNIT V
CODIFICATION
STRUCTURE
5.1 Introduction
5.2 Classification
5.3 Methodology
5.4 Requirements of Codes
5.5

Coding

Structure

and

Designing Advantages
5.6 International Codification
5.7 Cost and Consequences
5.8 Right Quantity
5.9 Economic Ordering Quantity
5.10 Derivation of EOQ
5.11 Summary

5.12

Answers

to

Check

Your

Progress
5.13 Exercises & Questions
5.14 Further Readings

UNIT OBJECTIVES
After learning this unit you would be
able

To understand the importance of

codification

in

materials

management.

To

learn

in

detail

about

the

coding structure and design

To understand the concept of

economic order quantity.

5.1 INTRODUCTION TO
CODIFICATION

In order to contribute effectively to

the

profit

centre

concept,

the

materials executive is constantly on

the

lookout

techniques

as

for
he

cost
is

reduction

the

largest

spender of the resources. He should

appreciate the fact that costs do not
occur but are incurred and this is the
philosophy behind all cost reduction
programmes.

While

techniques

cost

on

plenty

of

reduction

are

available for the purchase executive,

the

starting

point

for

any

cost

reduction programme is to identify

the individual, material or problem
uniquely.

The

periodic

table

of

elements in an ordered systematic

representation

bears

ample

testimony as to how this is done.

To facilitate need identification, a
unique nomenclature of the material
is essential. Each item should have
a single name and each name should
correspond to a single item.

5.2 CLASSIFICATION
Linked

with

the

specifications
are

the

and

system

standardization

classification,

cataloguing

of

coding

processes.

and

These

processes are administrative devices

that facilitate the identification and
retrieval
purchased

of

the
in

numerous
an

items

organization;

classification enables like items to be

grouped together as a part of process
to identification marks to different
items to simplify and facilitate their
in

the

form

vocabulary,

of

comprehensive

information

on

all

classified and coded items, it serves

as a ready reference and operating
guide

to

both

user

departments,

supply agencies and other agencies.

For

effective

classification

it

is

necessary to have a unique uniform

name or descriptive phase and a
unique stock code number, where
two or more items happen to fall
within

the

same

name

category,

differentiation is achieved by a fine

definition

to

conclude

colour,

dimension and shape. The code is a

shortened form of identifying an item
and provides the channel through
which information on stock items can
be conveniently and quickly stored,
processed and retrieved. Coding is
a complex and cumbersome process.
Hence it is advisable that skilled
people

and

consultants

should

develop the codes.

5.3 METHODOLOGY
Codification

is

the

process

of

presenting each item by a number or

alphabet, the digits of which indicate
the group, the sub-group, the type
and

the

dimension

Sometimes

the

bin

of

the

location

item.
and

suppliers' name are also included in

the

codification

organizations
public

and

developed

in

process.
the

private
their

Many

government,
sectors,

own

have

system

of

codification. The number of digits

varies

from

seven

to

thirteen

depending upon the number of items,

use

of

check

digit,

number

of

manufacturing sister organizations,

inclusion of vendor, etc.
As the number of digits increase, the
amount of information that can be
built into the code also increases;
but correspondingly the chances of
committing an error while recalling a
code also increases and the cost of
computer space also goes up.

Check digits for EDP

Once the number of places has been
agreed upon, the next step is to split
them into groups, each group of
digits

signify

classification
type

of

grouping

based

product

on

and

or

materials,
availability.

Usually groups with more than four

digits

are

not

encountered

in

practice. The first two digits normally

represent the major groups, such as
raw materials, spare parts, packing
material,

tools,

lubricants,

stationery, etc. The next two places

indicate
ferrous,

the

sub-groups

non-ferrous,

such

etc.,

as
and

dimensional characteristics of length,

width and diameter.

The last group is for minor variations

such as type of steel, carbon content,
special values, etc. The bin location
and

suppliers

identification

are

included in some special cases. In

addition,

organizations

using

computers will have to introduce a

check digit in the last place. This is
done in order to check whether a
code

number

has

been

correctly

entered or not. It should be noted

that this takes care of mixing up of
data of one material with that of
another.
PART NUMBER AND CODES

There should be a logical basis for

classification into each group. Each

code should represent one item and

each item by a single code. It should
be simple and understood by all. It
should

be

compact,

concise

and

consistent. While building a code,

care

should

be

taken

to

provide

flexibility, so that future additions

and expansion can be accommodated
in the code. For instance BHEL, had
only 8 digit codes when it started,
but

later

on

when

inter-plant

common codes were thought of, it

had to re-do the coding and presently
a 12 digits common code has been
developed. As far as possible uniform
dimensions,

say

metric

system,

should be adopted. There should be

no redundant digit and each digit

must

represent

some

significant

characteristic. In a numerical code,

there

can

different

be

ten-zero

groups

in

by

each

nineplace,

whereas in an alphabetical system,

each place can represent 26 A to Z
items.

Hence

is

should

be

meaningful and oriented towards the

needs

of

an

organization.

The

codification process should extend to

spare parts as well. Unfortunately,
the suppliers' part numbers are still
used by most of the organizations.
Rationalized codification is essential
in

the

case

of

spares

for

easy

identification, because the range and

number of spares is very large. Many
expensive spares, such as bearings

manufactured by different suppliers,

has considerable interchangeability.
Hence a common code should serve
the purpose from a functional point
of view instead of using the part
numbers

given

Wherever

by

necessary

the
the

suppliers.
vendor's

name could be included in the code

structure and the part number given
by the supplier must be avoided.
Short-cut

methods

like

adopting

temporary codes have landed many

organizations to great difficulties of
duplicating the same item, flabby
inventories
obsolescence.

and

increased

5.4 REQUIREMENT OF CODES

The following requirements should be
kept

in

view

while

deciding

the

coding structure, in any organization

interested in cost reduction:
a.

Allocation

of

material

codes

should be governed by logical,

simple and easy rules;
b.

The material code assigned to an

item must be unique, with no
likelihood of its being duplicated
for another item;

c.

Similar items should be grouped

together

and

it

should

be

possible to retrieve a group of

items as a whole;

d.

the

material

facilitate

code

should

identification

of

inventory

group,

i.e.

materials,

packing

materials,

laboratory

raw

chemicals,

engineering spares, etc.;

e.

If necessary, the code should

also

identify

machineries

and

equipments/
their

related

spares;
f.

The retrieval of the code for an

item

should

be

simple

and

straightforward;
g.

The

code

should

enough

to

items

introduced,

be

flexible

accommodate

new

following

expansion and diversifications.

5.5 CODING STRUCTURE AND

DESIGNING

The coding structure for materials

should be designed after taking into
account the estimated population of
items, their end-uses, their type, etc.
In addition, the specific requirements
mentioned
considered,

above
while

should

also

designing

be
the

structure.
Two types of coding structures are
discussed below:
A nine-digit coding structure is shown
below:

Figure 5.1: A Nine Digit Coding Structure

Kodak System
The

Kodak

and

Brisch

systems,

described below give an indication as

to

the

procedure

codification.

These

for

tackling

systems

are

fundamental in nature. The Kodak

system has been developed in the
USA, while the Brisch system in the
UK.

The

Kodak

developed

system
by

has

Eastman

been
Kodak

Company of New York, which consists

of 10 digits of numerical code. The
logic of major grouping is based on
sources of supply. All materials are
divided into 100 basic classifications,
contributed

only

by

procurement

considerations. For instance, a bolt

is listed as hardware item, if this is
listed in hardware catalogues and
available with hardware suppliers. If
this bolt, however, is available only
as part of a machine, it will be
available under maintenance. Each
class is divided into 100 sub-classes.

For example, if class 20 represents

cutting tools, then 200 represents
drills, reamers, counter bars, etc.

Brisch System
The Brisch system, named after a
prominent consulting British engineer
in the UK, consists of seven digits
and is applied in three phases. The
items

are

preliminary
assemblies,
components,

grouped

into

categories,

suitable
such

as

sub-assemblies,
off-the-shelf

items.

After these preliminary categories,

items

are

grouped

within

the

respective clans, in order to bring

similar items together. The Brisch
system, though it consists only of

seven digits, is quite comprehensive,

as

the

basis

is

on

logical

major

groupings. If two digits are used for

this, then we can have 00 to 99
major category, the splitting is done
on the basis of materials, or use,
in

standardization

and

variety

reduction.
ADVANTAGES OF CODIFICATION

As

result

codification,
reduced
enables

the

of

many
number

systematic

rationalized
firms
of

have

items.

grouping

It
of

similar items and avoids confusion

caused by long description of the
items.

Since

names

is

standardization
achieved

of

through

codification, it serves as the starting

point

of

simplification

standardization

of

the

and

number

of

items, leading to accurate records.

Codification enables easy recognition
of an item in stores, thereby reducing
clerical efforts to the minimum. If
terms are coded according to the
sources, it is possible to bulk the
items while ordering.
To

maximize

advantages,

it

the
is

aforesaid

necessary

to

develop the codes with all concerned,

namely,

personnel

from

design,

production, engineering, inspection,

maintenance and materials.

Thus codification enables:

a.

Easy recognition of items,

b.

Avoiding

long

cumbersome

names,
c.

Systematic logical grouping of

similar items,

d.

Elimination of duplicate items,

e.

Reduction in number of items,

f.

Facilitate

bulk

ordering

on

staggered delivery basis,

g.

Cutting down the lead time,

h.

Minimizing the working capital

locked up,

i.

Help

in

simplification

and

standardization,
j.

Facilitate computerization,

k.

Facilitate

transfer

of

stocks

among sister organizations.

5.7 INTERNATIONAL
CODIFICATION
In

the

case

organizations,

of
it

multi-plant
would

be

advantageous to have the same code

in all the units for facilitating interplant

transfers.

This

may

be

extended to different organizations

belonging
groups.

to
In

the
this

same

industry

context,

it

is

necessary that industry associations

should

start

developing

common

codes. This concept of codification at

the industry level should be extended
to the national levels, where all the
industries using the same material
will identify each item by a common
code.

The

advantages

in

national

codification,

particularly

in

cost

reduction and lower inventory levels,

need not be over-emphasized in a
scarcity ridden economy like India.
A lead in developing the national
codification can be given by national
associations,

like

associations,
associations,

industry
manufacturing

small

associations,

industries
professional

associations,

Indian

institutions,

customs,

directorate
development,

general
chief

standards

of

excise,
technical

controller

of

imports, etc. Admittedly, this process

will take a long time, but the efforts
are worth the result and pave the
way

for

international

codification,

which will pave the way for a smooth,

meaningful

and

rewarding

work

environment.

5.8 COST AND CONSEQUENCES

According

to

the

food

processing

ministry of the Government of India,

about 45 per cent of food items like
fruits and vegetables and about 15
per cent of food grains are wasted
annually

in

the

country,

due

to

inadequate storage facilitates. It may

be remarked that the buffer stock of
inventory of food grains goes up to
30,000,000 tonnes valued over Rs.
60,000 million. The same is true in
the

industrial

scenario,

obsolete/surplus/non-moving

as

the
items

have been estimated to be about

10,000

crores,

for

which

the

inventory holding charges including

cost of capital and storage is about
30 per cent. No company in the
universe

has

access

working

capital

to

and

unlimited

hence

the

quantity procured becomes a critical

parameter

in

the

materials

management area.
Inventory is often defined as an idle
resource

of

any

kind,

having

an

economic value in the sense, that raw

material can be converted into semifinished goods and with additional
value, becomes finished goods. In all
these cases, the company's working
capital is tied up and hence the

finance manager is wary of servicing

the idle working capital at 30 per cent
per annum. On the contrary, if the
item is not kept in the stores, there
will be a stock out, if the demand
arises.

Thus

larger

quantum

of

inventories does not necessarily lead

to higher volume of output, while
lack

of

inventories

will

hamper

production.
It is noted that inventories also cost
money to acquire as well as hold
them.

The

including
development,

cost

of

acquisition

communication,
etc.,

varies

considerably and is about Rs. 600 per

order. This depends upon quantum
purchased, imports, advertisement,

follow-up, travel, communication and

other

elements.

The

cost

of

acquisition is increased, as smaller

quantities are procured each time,
but the decrease in inventories also
decreases

the

inventory

carrying

charges. Thus the materials manager

has to balance the two opposing
costs, in order to strike the optimum
level

of

minimize

inventories,
the

total

which
cost

in

will
an

organization.

5.9 RIGHT QUANTITY

Thus

the

inventory

basic

objective

management

of

any

is

to

determine the right quantity to be

procured, in order to release the

capital for more productive use. The

materials department is accused both
of

stock

outs

investments

as

in

well

as

large

inventories.

The

solution lies in exercising a selective

inventory control and application of
inventory
The

management

optimum

sufficient

to

quantity
achieve

principles.
should

be

maximum

production, but it should not be so

excessive with the locking of working
capital, as to restrict the ability of an
organization to earn a high rate of
return.
The

determination

quantity

assumes

of

the

right

tremendous

importance, satisfying the conflicting

views of

a.

not too much,

b.

not too little,

c.

at minimum total cost, and for

d.

increased profitability.

An efficient materials management

system includes, the means to ensure
that the stocks are maintained at
optimum levels and in quantities that
prevent

interruption

in

flow

of

needed resources. The aim is to avoid

the negative effects of both excessive
and insufficient stocks, which can be
disrupted

financially

operationally.

Effective

and
inventory

management is necessary to ensure

adequate supplies at optimum cost,
as

inventories

act

as

cushion

between supply and demand. In this

context, it is essential to study all
categories of inventory in detail, i.e.
raw

material,

production

components, work in progress and

finished goods for the reasons of the
existence and size of the inventory.
Broad norm for various categories of
inventories is, about two months for
raw material, about two weeks for
work in progress, about eight weeks
for finished goods have been given as
guidelines with flexibility for different
industries by the Tandon Committee
and

Chore

Committee.

The

top

management usually sets monetary

limits for investment in inventories
and the materials department has to

allocate this investment to various

items for the smooth operation of the
company.

We

will

confine

our

discussions only to stores inventory.

5.10 ECONOMIC ORDER

QUANTITY

The economic ordering quantity helps

the purchase executive to arrive at
a

solution

satisfying

discussed

the

four

above

conflicting

parameters. Let us now consider an

item

with

an

annual

usage

(forecasted consumption or previous

consumption as thousand units) with
price per unit being Re. One: It is
assumed

that

available

in

the
any

item

is

freely

quantity

when

required.

The

total

carrying

cost

including the cost of capital, and

storage charges is estimated at 30
per cent which depends on the cost
of capital and is true order, which is
true for most of the large companies.
The acquisition cost is Rs.600 per
order,

the

annual

consumption

is

1000 units, priced at one rupee per

item. We will arrive at the optimum
order quantity by means of trial and
error or we can order any quantity
and then measure the costs as in
Table 5.1. The ordering cost per year
is

obtained

by

multiplying

the

number by orders with unit ordering

cost

Inventory

Orders
Order

number

Quantity

per
year

Cost
per
year

Total
Average
quantity

Value

Carrying

cost

cost
(Rs.)

200

3000

100

100

30

3030

500

1200

250

250

75

1275

1000

600

500

500

150

750

2000

0.5

300

1000

1000

300

600

5000

0.2

120

2500

2500

750

870

Table 5.1: Cost Table

Thus, we see in this case, given the
annual
carrying
charges,

consumption,
cost
the

unit

and
optimum

price,

acquisition
or

right

quantity that minimizes the total of

ordering cost and carrying charges
is arrived as two thousand. At this
right quantity, we note that carrying
and ordering charges are equal. This
is called economic order quantity. In
manufacturing parlance, it is known
as economic lot of size, with set-up
cost replacing the ordering cost. This
set-up is the cost incurred due to
job changes, resetting, setting jigs,
fixtures, cleaning, etc. The inventory
charges will continue to be the same
as

manufacturing

department

produces the goods which will be

stocked for some duration.

5.11 DERIVATION OF EOQ

Let C o be the ordering charges per
order of Rs. 600 in the previous
example, C c be the carrying charges
per year at 30 per cent per year.
M

be

the

annual

demand/past

consumption/forecast, R be the price

per

unit.

The

annual

value

of

consumption is Rs. MR. Let q be the

quantity

to

be

ordered

which

is

unknown and is to be determined,

since M is the total quantity to be
used in a year, (M/q), is the number
of orders with total ordering cost as
(M/q) C o .
The opening inventory is zero and
replenished

by

q,

with

average

inventory being (q/2) and the value

of average inventory is (q/2) R.
The inventory carrying charges in
this context is (q/2) R C c .
The total cost is T c = (M/q) C o +(q/
2) R C c
and in this the only unknown is q.
The total has to be differentiated with
regard to the unknown q in order to
get the optimum.
M/q

Co + (1/2) RCc = 0:

M/q

Co (1/2) RCc

q = (2MCo)/(RCc);

optimum Q is EOQ =

2MCo
RCc

This can also be obtained by plotting

the relevant cost against the order
quantity as shown in figure 5.2

Figure 5.2: EOQ Graph

Thus economic order quantity is the

quantity to be ordered / purchased
so that the total inventory cost is

minimum.

It

is

evident

from

the

above graph that any quantity higher

or lower than the economic order
quantity will have high inventory cost
than the EOQ.

5.12 SUMMARY
The importance of identification of
materials

through

the

process

of

codification is the theme of this unit.

The

concepts

evolution

of

discussed

include

codification,

material

classification,

methodology

classification,

differences

of

of
part

number and codes, requirements of

codes,

coding

structure

design,

Kodak system, Brisch system and

advantages

of

codification.

The

scientific

inventory

control

starts

with the concept of economic order

quantity.

Check your progress:

1.

What are the requirements of

coding structure?

2.

What are the advantages of

codification?

3.

What

is

economic

order

quantity?

5.13 ANSWERS TO CHECK YOUR

PROGRESS
1.

The

requirements

of

coding

structure are
a.

allocation of material codes

should

be

logical,

simple

rules;

governed
and

by
easy

b.

the material code assigned

to an item must be unique,
with

no

likelihood

of

its

being duplicated for another

item;
c.

similar

items

grouped
should

should

together
be

and

possible

be
it
to

retrieve a group of items as

a whole;
d.

the

material

code

should

facilitate

identification

inventory

group,

i.e.

of
raw

materials, packing materials,

laboratory

chemicals,

engineering spares, etc.;

e.

if necessary, the code should

also

identify

machineries

equipments/
and

their

related spares;
f.

the retrieval of the code for

an item should be simple and
straightforward;

g.

the code should be flexible

enough to accommodate new
items introduced, following
expansion

and

diversifications.
2.

The advantages of codification

are
a.

Easy recognition of items,

b.

Avoiding long cumbersome

names,

c.

Systematic logical grouping

of similar items,

d.

Elimination

of

duplicate

items,
e.

Reduction

in

number

of

items,
f.

Facilitate bulk ordering on a

staggered delivery basis, &

g.

Cutting down the lead time,

h.

Minimizing

the

working

capital locked up,

i.

Help

in

simplification

and

standardization,
j.

Facilitate computerization,

k.

Facilitate transfer of stocks

among sister organizations.

3.

Economic order quantity (EOQ)

is the quantity to be ordered /
purchased

so

that

the

total

inventory cost is minimum. It is

evident that any quantity higher
or lower than the economic order
quantity will have high inventory
cost than the EOQ.

5.14 EXERCISES & QUESTIONS

1.

Explain

the

role

of

materials

management in a contemporary
organization
2.

What

are

the

general

requirements

of

coding

structure?
3.

Explain

the

methodology

of

materials codification
4.

What

are

codification?

the

advantages

of

5.

Explain Kodak and Brisch system

of codification.

6.

Explain in detail economic order

quantity.

With

the

help

of

graph derive the expression for

economic order quantity.

5.15 FURTHER READINGS

1.

Gopalakrishnan

Purchasing

and Materials Management Tata

McGraw Hill
2.

Gopalakrishnan P & Sundaresan

M Materials Management An
Integrated

ApproachPrentice

Hall of India
3.

Tony

Arnold,

Stephen

Chapman, R V Ramakrishnan Introduction

to

Materials

Management

Pearson

Education

Lessons Compiled by Prof. M Balaji

M.E., M.B.A.,
Assistant

Professor

Operations

Management Area,
Thiagarajar school of Management
(Autonomous),
Pambanswamy Nagar,
Thirupparankundram,
Madurai 625 005.
Lessons Reviewed by Dr. R. Ponraj
M.B.A., M.Phil., Ph.D.,
Associate Professor,
Department

of

Business

Administration,
N M S S V N College (Autonomous),
Nagamalai, Madurai 625 019.