Purchasing and Supply Chain Managementby W.C. Benton

Chapter FourMaterials Management

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Learning Objectives1. To identify the activities of materials management.

2. To identify the four functions of inventory.

3. To understand the relationship between purchasing and materials management.

4. To determine how the materials management concept makes a contribution to profitability.

5. To understand why firms are moving toward materials management.

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Materials Management

• The purpose of materials management is to support the transformation of raw materials and component parts into shipped or finished goods

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Five Functions of Inventory• The five functions of inventory are

1. Pipeline inventories (raw materials/in process)2. Cycle inventories3. Buffer stock4. Seasonal5. Decoupling

• These five basic functions of inventory are fundamental to achieving smooth flow, reasonable equipment utilization and materials handling costs, and maintenance of good customer service.

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Suppliers

• The supplier is the source of raw materials and component part inventories. Customer service is a concept that applies to all suppliers whether they are external to the company or internal

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Production Planning

• When planning to acquire materials, whether raw materials, component parts, or finished goods, the capacity must be considered for both the buyer and seller.

• Each materials acquisition must be translated into a capacity requirement by the supplier.

• For example, suppose we have a scenario as shown on the next slide

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(Purchasing) (Purchasing)

Information flows - - -Physical flows

(Demand management)

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Capacity Planning• Say capacity is the potential to produce 50 assemblies an

hour. Although the short-term capacity may be higher, effective capacity is a range of substantial output under normal conditions, that is, a rate.

• A manufacturing plant is designed to produce 1,000 units of product a day. Is it possible for the plant to operate at a rate of 10, 50, or 120 units a day? There is a lower limit beyond which it is not economical to run.

• At some point, management will decide to shut down rather than produce indefinitely at a rate that does not generate revenues to cover fixed and variable costs.

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Capacity Planning• The upper level of production is limited by the

process technology and/or the disposition of the workforce.

• Can a plant manager exhort workers to produce, in the short run, at very high levels of production to satisfy a very important customer? Probably yes, but not very often.

• Pushing the plant (equipment, people, and suppliers) to produce at very high levels of output accelerates wear and tear on machines and people. Machine maintenance, quality, and morale suffer

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Capacity and Inventory

• In general, inventory is stored capacity.

• If capacity is insufficient to satisfy peak demand for a product with seasonal sales, finished goods inventory can be accumulated during periods of low demand.

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Throughput Time• The delay between receipt of raw materials and the

availability of the finished goods produced from them is throughput time (TPT). The concept applies also to single components of the supply chain; for example, we speak of the TPT for the plant or distribution center.

• For the whole system, TPT should be as short as possible. Consumers prefer to obtain goods or services in the shortest possible time. If TPTs are long, it is more likely that the customer’s requirements will change

• The longer an order for material stays in the plant, the larger the work-in-process inventory will be, the larger the storage area required, and the more likely the material will be damaged, lost, or stolen

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Order Cycle

• The order cycle is both a link and a set of activities. As a link, the order cycle facilitates the flow of information and materials

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Pipeline

The pipeline is the means by whichvarious resources flow

1. Information (orders, billings, inquiries)2. Material3. Money (credit)4. Title

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Integrated Materials System

• It is not necessary that all resource flows between components occur at the same time or in the same manner.

• This idea is called channel separation and is useful when designing supply-distribution systems. It really isn’t accurate to say that components are joined by a single link.

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Integrated Materials System• The order cycle has some important characteristics. First,

an order cycle has “length.” The distance between supplier and customer determines, in part, how long it takes to transmit data and transport materials

• A customer may elect to have an order moved by various transportation technologies (modes):

1. Air2. Rail3. Truck4. Water5. Pipeline

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Speed, Reliability, Inventory, and Cost Tradeoff

Customer orders also may be transmitted by alternative technologies:

1. Telephone2. Postal service3. Internet4. Fax5. EDI

The prices of these modes vary; although more rapid service usually implies a higher price, technologies such as the Internet have somewhat changed that paradigm.

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Speed, Reliability, Inventory, and Cost Tradeoff

• The more rapid, the higher the price. The trade-off considerations are similar to those for transportation.

• The shorter the order cycle, the quicker the customer is served and the less inventory the customer needs

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Order Cycle—Activities

• The order cycle is not only a link, but a set of activities. The principal activities and the locus of responsibility are

_______________________________ Responsibility Customer Customer Supplier Supplier Customer

ActivityOrder preparation

Order transmission Order processing Order transportation Order receipt

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• Each activity is in turn a bundle of tasks. For example, the receipt of materials by the customer involves

1. Physical receipt2. Unloading3. Inspection4. Storage location decision5. Move to storage6. Documentation

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Lead Time

• If we represent the order cycle as a set of activities, we can identify an important property of the order cycle—lead time.

• Some may argue that lead time begins when the order is transmitted.

• We'll go a step earlier include order preparation, which begins when the need for material is recognized.

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Customer Satisfaction

• The managers of integrated materials systems have two objectives:

• Customer satisfaction

• Minimum total materials costs

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Material Availability

• Two cases must be distinguished. If a firm makes products to order, customer service is measured by the degree to which products are completed and shipped as promised.

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Material Availability• Conceivably, an order may be rescheduled at the

request of the customer, in which case the revised date is used to determine whether the order was shipped on time, early, or late

• Many make-to-order (MTO) firms faithfully calculate the ratio of on-time to total shipments.

• When customer service is measured this way, we speak of a firm’s delivery performance

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Service Level

• High delivery performance may only indicate scheduling inflexibility on the part of the supplier.

• The second case is the firm that produces standard products in anticipation of demand for them—a make-to-stock (MTS) firm.

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Service Level• If all customer orders are processed without delay, the

level of service is 100 percent. Service level (SL) for an MTS firm is the ratio

SL = (Orders shipped/Orders received) × 100

Unfilled orders are processed in one of three ways:1. Backorder2. Substitution3. Cancellation

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• This element of customer service is a variation on the notion of availability. On-time shipment has to do with the delivery promises made, and the ratio of orders shipped as promised to total orders.

• If an order is shipped on time, it is presumed that the customer is well served. Realistically, customers are more concerned about when the materials are received.

• Customers place orders based on need dates. The more imminent the calendar date, the more urgently material is needed.

• To say an item is needed on the 10th of the month means that, if the item is not actually in hand on that date, dire consequences ensue.

• Sometimes the need date is called the “drop dead date.”

On-Time Shipment On-Time Receipt

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• Orders commonly call for numerous items, sometimes in matched sets.

• A manufacturer of office furniture receives orders for matched desks, chairs, tables, and file cabinets.

• An order probably contains the requirements to furnish one particular office. The customer expects to receive all items at the same time.

• The quality of material can deteriorate between the time it leaves the production floor and the time it arrives at the customer’s storeroom. Packaging, loading, transport, and unloading can all take a toll.

• Although damages can be claimed, materials received in poor condition are unsuitable for processing.

Complete Shipment Quality of Receipt

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• Flexibility is the extent to which a supplier can accommodate a customer’s requests. Perhaps the request is for special processing, packaging, or shipment.

• The name of the game, whatever the firm’s classification, is customer satisfaction.

• Note that the costs of these extras are borne by the customer. The question is not who pays, but the willingness and ability of suppliers to cost-effectively perform nonstandard tasks for the customer.

• Customers want assurances that their orders are on schedule, especially as the shipping date nears.

• This element of customer service is the timeliness and accuracy of the information a supplier provides a customer.

• Suppliers who can’t locate an order on the shop floor, or in the warehouse, or who answer all inquires with, “It just went out on the truck,” inspire little confidence.

Flexibility Responsiveness to Inquiry

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Customer Satisfaction—The Balance

• To summarize, customers want1. Short lead time2. Good quality3. High value4. Customized products5. Post-sale service

• The cost of satisfying a customer’s delivery time needs may not be entirely known, but we can argue that none of these elements of customer satisfaction are realized without cost.

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Customer Satisfaction—The Balance

• If poor quality is produced, goes undetected, and is shipped, the costs to both supplier and customer are substantial.

• There are direct and measurable costs associated with poor quality.

• Yet the more important and difficult-to-measure costs are those associated with the damage to a supplier’s reputation, the loss of a customer’s capacity, and the dissatisfaction if the customer in the field vows never again to buy the product.

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Customer Satisfaction

• We could describe the costs of providing the other elements of customer dissatisfaction similarly. The balance that management seeks is between

1. Cost of customer satisfaction—A2. Cost of dissatisfied customer—B

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Quality• We hear so much about quality that it may come as a surprise

that even experts don’t agree about how to achieve it. Fortune recently asked the gurus of industrial quality to define it and to assign responsibility for quality.

• To some, quality is a technical matter. It has to do with engineering—both the process technology and product design.

• To others, quality is a statistical measure that utilizes sampling to achieve process control and make certain that inferior quality material isn’t shipped from the plant.

• There is a third view—that quality depends upon motivation. This means making a slogan a rallying cry—“Zero Defects” or “Quality is Free.”

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Quality

• Quality is neither good nor bad until consumers cast their ballots in the marketplace.

• Even though the technology of quality is steeped in statistics and manufacturing engineering, materials managers first need to consider quality as part of the expectations of customers, whether intermediate or final.

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Quality

• Quality is a strategic decision. What should the quality of a product or material be?

• How do we compete with off-shore manufacturers who enjoy reputations for leadership in quality?

• What’s the quality level of domestic producers in our industry?

• Top management must decide the quality level of materials—high, low, or in between.

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Quality

• Quality, in large part, is what people perceive it to be.

• Once formed, perceptions about the quality of a supplier’s materials are slow to change.

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QualityTo qualitatively evaluate consumer products and

services, Consumers Union first identifies the relevant characteristics of a product. It then tests comparable products of various manufacturers and classifies products as

• Best buy• Acceptable• Not acceptable• “Best buy” implies a product with high value. Value,

in turn, is the ratio of quality and price.• Value = Quality/Price

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Lawn Mower Quality Example

• In a recent issue of Consumer Reports, low-price lawn mowers were evaluated.

• The quality-defining product characteristics were1. Evenness of cut2. Dispersal of clippings3. Freedom from clumping4. Handling

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The Owners View• The quality-defining characteristics of products are

those that are important to the end user of the product.

• Owners of lawn mowers are not primarily concerned with detailed mechanical or electrical specifications. They want a product that leaves a good-looking lawn and provides relatively trouble-free operation.

• Owners look first at the way a product serves the purpose for which it was acquired. The perceptions of quality held by the consumer and the producer are both important.

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Specifications• Design means setting the specifications for a material

or product.

• Specifications result in the functional and aesthetic characteristics of the product.

• The job of the materials manager is to ensure that products are made in the least-costly way so that the item qualifies as a best buy.

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The Quality Level• The process technology and experience of a supplier limits the

range of quality possible. We wouldn’t expect a general machine shop to produce high-quality integrated circuit chips.

• The design of a product must “be producible” given the process capability of the supplier. Within that range, top management sets the quality level—the degree to which the product functionally satisfies customers.

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Conformance to Specifications• This is the degree to which material conforms to

specifications.

• If conformance is high, the company can claim that product quality is high. Lawn mower specifications are complex. Hundreds of parts are produced and assembled.

• Each part has numerous dimensions and properties. Surfaces of mating parts are finished to extremely small tolerances to ensure proper assembly.

• Overall product specifications are fixed—engine size, weight, blade length, and so forth.

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Objective Quality

• Is it possible that objectively a product is high quality but subjectively low quality?

• Too often the answer is yes. High-quality products must both

1. Conform closely to specifications.2. Satisfy consumer expectations.

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Can Quality Be Too High?

• Can a product’s quality be too high? Again, the answer is yes, but in this case we mean that objective quality can be too high.

• Tolerances are closer than need be, finishes are smoother than necessary—“the bottoms of the drawers are painted.”

• Customers have little difficulty accepting the product, but it’s much better than it needs to be, and very few customers would be willing to buy so high a quality item. It does in fact cost more to produce a Rolex watch than to produce a Timex.

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Rolex Vs. Timex

• If accuracy, durability, and appearance are the quality-defining properties of wristwatches, the Rolex should meet the customer expectations better.

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• We should now be able to understand that conformance isn’t a sufficient test of quality. The design of the product must be satisfactory. We also can understand why two customers appraising the quality of the same item can have very different opinions about its quality. In Figure 4.3 below only one of four outcomes results in a high-quality product.

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Specifying Materials• Disagreements between supplier and customer

about quality often stem from misunderstandings about material specifications.

• Suppliers frequently interpret specifications in ways customers never intended. Qualified suppliers, given identical specifications, may come to quite different conclusions about what a customer wants.

• If one definition of quality is conformance to specs, the specifications must be unambiguous. The manner of specifying materials depends on the kinds of material ordered.

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Raw Materials

• These are semi-processed materials intended for further processing—raw stock, crude oil, bituminous coal, paperboard, paper, lumber, copper, wheat, cotton, for example.

• The materials listed are called commodities. Their specifications result from agreements on standards, as, for example, the U.S. Department of Agriculture’s specifications for meat and grains.

• By definition, commodities are homogeneous.

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Specification Examples• Even though specifications are known, judgment is still a

factor.

• For example, the beef buyer for a fast-food restaurant chain may specify “USDA prime beef.” The grade, priori, implies age, appearance, weight, and so on

• Recall the umpire calling balls and strikes. The strike zone is defined for each player. It can be measured. But once play begins, umpires rely on judgment to decide the location of a ball traveling 90 miles an hour as it passes in front of a batter.

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Specification Examples• Materials such as steel are specified by process (e.g.,

“hot rolled”), physical properties (hardness, strength), and dimension.

• Note that while specs are unambiguous, the quality of the material produced may fail to conform to the specifications.

• It’s the same problem we discussed earlier—poor execution of a good design.

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Purchased Parts

• Purchased parts include semi finished items that will be further processed and finished materials that will become components of finished end items.

• The usual way of specifying purchased parts in a made-to-order environment is with a graphic description, that is, engineering drawings.

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Purchased Parts• Many parts can be purchased off the shelf. They are like

commodities in the sense that they are standardized. In effect, they are made to stock according to specifications established by an industry, professional association, or independent testing organization.

• Many small mechanical parts, for example, fasteners, are

manufactured to standards established by the Society of Automotive Engineers, SAE. The specifications for parts such as fixtures and wire are concerned with the satisfaction of safety standards.

• The buyer is assured that the part is safe to use in a particular application and that its correct installation complies with standards, for example, building construction.

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Maintenance, Repair, and Operating (MRO) Supplies

• MRO materials are quite diverse; they are specified in various ways. The keys are quality and uniqueness.

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Maintenance

• These are items that we expect to periodically replace in a piece of equipment. Over time, machine parts are subject to wear and are replaced.

• The original equipment manufacturer expects to re supply these parts during the life of the equipment.

• Maintenance also means the application or renewal of

materials such as lubricants and coolants. Periodic maintenance (labor and materials) ensures longevity and satisfactory machine operation

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Repair• The distinction between maintenance and repair materials is not

always clear. In theory, if good maintenance is practiced, events requiring repair will occur infrequently.

• Repair suggests the unexpected, which means the need to patch up or replace equipment components that we don’t expect to fail. Usually the parts are not carried as inventory by the equipment manufacturer.

• The more common event is repair of equipment failure in

which the services of skilled craftsman are more important than specific materials.

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Operating Supplies• These supplies, also called “indirect materials,” become part of

the end item and are essential for its production, but their unit value or size is too small to plan or control usage unit by unit.

• A good example is rivets used in airframe construction. Rivets are “counted” by weighing them. Bins of rivets are located throughout the plant and available to anyone on a “help yourself” basis.

• Generally speaking, operating supplies are standard items and are specified by manufacturer or industry codes. Nonstandard items should be questioned by the purchasing manager.

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Tooling• There are two kinds of tooling with respect to their specifications.

• The first kind is standard tooling. Various holding devices, partitioners, material cutting, and forming tools are standard with respect to their size and capacity. As with standard materials, tools are specified by the manufacturer’s part or model number, or by an industry code.

• The second, nonstandard kinds of tooling require elaborate specification. Tooling in this class is one of a kind and highly engineered. It is a make-to-order item. Detailed drawings of the tooling are necessary.

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Tooling

• Whether the tooling is designed to position or hold material during processing, or to modify or extend the operation of processing equipment, the tooling must be built to specifications; otherwise, the quality of the material produced is unacceptable.