Procurement and Materials

Management (PMM)
 Process capability and performance

Sample Measurements from Beer-Filling Line

Sample Sample Measurements (ounces) Sample Sample Measurements (ounces)
1 12.03 12.05 11.92 11.91 12.01 16 12.08 11.93 12.06 11.98 12.01
2 12.09 12.11 11.94 11.99 12.05 17 11.92 12.11 11.96 11.97 11.99
3 11.87 12.02 12.06 12.08 12.00 18 12.07 12.09 11.99 12.10 12.00
4 12.04 11.93 11.96 11.90 11.98 19 12.05 12.01 11.94 11.98 11.92
5 11.99 12.02 12.00 11.97 12.01 20 11.99 12.07 12.05 12.09 12.01
6 11.92 11.87 12.02 12.03 11.98 21 12.11 12.04 11.99 11.97 12.04
7 12.12 12.09 11.98 11.96 12.02 22 11.93 11.99 12.01 11.95 11.98
8 12.10 12.11 12.03 11.99 11.98 23 11.97 12.05 12.08 11.99 12.00
9 11.87 11.95 12.04 12.00 11.97 24 12.06 12.04 12.05 11.99 11.97
10 12.11 12.04 12.01 11.95 12.02 25 11.92 11.99 12.01 11.96 11.93
11 12.01 11.96 11.87 11.97 12.03
12 11.98 11.96 12.01 12.05 12.00
13 12.04 11.93 11.99 12.01 12.05 Q1. Draw the 𝐗 − 𝑹 chart to confirm that process is in
14 11.98 11.96 11.90 12.05 11.98 statistical control or not??
15 12.10 12.07 11.96 12.02 12.03
 Process capability and performance- case study

Change the 10th sample reading to as shown here.

10
12.11
0.58
Cp = Process Capability 0.58 12.04
12.10
0.56 11.95
Cpk = Process Capability Index 0.56
12.02

Pp = Process Performance 0.58 0.57

Ppk = Process Performance Index 0.56 0.55

Inference: Any variation within subgroup impacts more on the process performance !!
Process capability and performance- case study

Mean Chart for two supplier processes (Exhibit 8)

What inference can you draw from the figure ??

 Process capability and performance- case study

Mean Chart for two processes

Can you draw the X bar-R chart for these two processes ??
 Process capability and Sigma level

Effect of Capability Improvement

PPM
Cpk Sigma Level
defectives
2.00 6.0 3.4

1.67 5.0 233

1.33 4.0 6210

1.00 3.0 66800

0.67 2.0 308540

LSL Which case have lowest defects (PPM defectives) ??

USL
Which case sigma level is highest??
What inference can you draw from the figure ??
 Process capability and performance - example

Supplier A Supplier B Supplier C

Question. A procurement manager observe the delivery
95 90 78
performance (in percentage) of three suppliers as listed.
90 90 98
Which supplier will be chosen based on delivery
performance and why? 98 98 95
85 85 100
100 100 100
89 89 86
96 96 98
70 85 70
100 77 99
Thus, these indexes can be used to measure the
performance of suppliers !! 100 80 100
90 90 90
80 80 75

STDEV 9.2 7.3 10.9

Mean 91.1 88.3 90.8
(USL-Mean)/3sigma Ppk 0.32 0.53 0.28
 Quality standards

What are different quality standards used in organizations related to procurement ??

ISO 3834 is the basis for quality requirements for welding, covering
both the manufacturer's quality management system and the
The ISO 9000 standards are technical aspects of welding.
majorly focused on QMS
and provide organizations
with necessary guidelines.

AS9100 is another key

quality standard, particularly
The ISO 9001 is a commonly developed for organizations
recognized standard among the and businesses of the
standards of ISO 9000 family. It aerospace industry.
highlighting the need to comply
with customer focus, process
approach, improvement, and
relationship management.

ISO 13485 is specific to the medical device manufacturing and servicing The IATF 16949 quality standard is designed
industries, providing requirements for a quality management system particularly for the automotive sector, mainly focusing on
around production, design, and servicing of medical devices. An agreement with quality management systems and frameworks
ISO 13485 ensures that medical devices meet regulatory requirements and used in automotive production and relevant
enhances product safety. services.
Material classification and
management
 Materials Management

Materials management is a planned approach of determining !!

What to order?
How much to order?
When to order?
How much to stock? and cost associated to it?
 Material classification
What are different techniques for the materials classification ??
S - scarce items (long lead time)
D - difficult item (moderate lead time)
E- easily available (low lead time). SDE
Analysis
ABC
Analysis

FSNO Inventory
Analysis Management
VED
Fastmoving, slow moving Analysis
and non-moving inventory
HML
Analysis SOS
Analysis
H-High cost, M-Medium cost, L-Low cost
(This types of analysis helps in exercising the Seasonal-off seasonal Analysis
control of use, like proper authorization is
required for using high value items).
 ABC analysis

 Classification based on the cost and volume

 ABC analysis is an inventory application of
the Pareto principal
 Based on the logic of vital few useful many

Criteria Class
A B C

A = Always, B = Better, C = Control Number of items 15-20 % 20-30% 50-60%

Cost of items 70-80% 15-20% 5-10%
 A category required strict inventory control like daily monitoring Importance High Medium Low
 B category required moderate control like weekly monitory
Forecast Accurate Estimate Roughly
 C category required less control, fortnightly/monthly monitoring
Control Strict Moderate Loose
 ABC Analysis- example
Q. Partwise quantity required and its cost are given below. The manager wants to prioritize these materials using ABC
analysis.

Part Number or units Cost/unit

A 5 59,400
B 3 85,000
C 3 68,333
D 5 15,000
E 2 22,500 Criteria Class
F 4 8,750
A B C
G 2 11,000
H 6 3,333 Number of items 15-20 % 20-30% 50-60%
I 2 9,900 Cost of items 70-80% 15-20% 5-10%
J 2 7,793 Importance High Medium Low
K 3 2,333
Forecast Accurate Estimate Roughly
L 7 1,000
M 2 3,250 Control Strict Moderate Loose
N 1 5,000
O 6 833
P 5 1,000
Q 3 1,333
R 3 1,000
 ABC Analysis- example

% Cost
Customer Number or orders Cost/piece Total cost Classification Number of items
Contribution contribtuion
A 5 59400 2,97,000 28.78227709 A
B 3 85000 2,55,000 24.71205609 A 73.4 16.67%
C 3 68333.33333 2,05,000 19.8665549 A
D 5 15000 75,000 7.268251792 B
E 2 22500 45,000 4.360951075 B
F 4 8750 35,000 3.391850836 B 19.1 27.78% There may be slight
G 2 11000 22,000 2.132020526 B
fluctuations in percentage.
H 6 3333.333333 20,000 1.938200478 B
I 2 9900 19,800 1.918818473 C
J 2 7792.5 15,585 1.510342722 C However, objective is to try
K 3 2333.333333 7,000 0.678370167 C to separate the “vital few”
L 7 1000 7,000 0.678370167 C
from the “useful many”.
M 2 3250 6,500 0.629915155 C
7.5 55.56%
N 1 5000 5,000 0.484550119 C
O 6 833.3333333 5,000 0.484550119 C
P 5 1000 5,000 0.484550119 C
Q 3 1333.333333 4,000 0.387640096 C Criteria Class
R 3 1000 3,000 0.290730072 C A B C
Number of items 15-20 % 20-30% 50-60%
Cost of items 70-80% 15-20% 5-10%
Importance High Medium Low
Forecast Accurate Estimate Roughly
Control Strict Moderate Loose
 How much to order?

How to decide order quantity ??

Ordering Quantity

Production order quantity Quantity discount

Basic EOQ model
model model
 Quantity discount model

 Quantity discounts is very prevalent nowadays. A quantity discounts is simply a reduced price (P)
for an item when it is purchased in a large amount.

Thus three cost considered here:

 Material cost
 Ordering cost
 Holding cost (in terms of material cost)

Here, EOQ is calculated same as discussed

In the basic EOQ model.
Total cost

Options Quantity Price

Initial price 1-49 1400
Discount price 1 50-89 1100
Discount price 2 90+ 900
 Quantity discount model-example

Question. A toy electric company offer quantity discounts as shown below. Its yearly demand is 5200 units. Inventory
carrying cost is 28% of the purchased price and ordering cost is $200 per order. Calculate the optimal order quantity
that minimizes the cost. 𝐷 𝑄
𝑇𝐶 𝑄 = 𝐶 + (ℎ) + 𝑝𝐷
𝑄 2
Options Quantity Price ($)
Initial price 0-119 100 𝒄𝒐 = $200 per order
2𝐷𝐶
Discount price 1 120-1499 98 D= 5200 𝑄∗ =
h= 28% of price per year ℎ
Discount price 2 1500+ 96
Here, we need to calculate the EOQ in three price levels and then decide, which one is in the feasible range.

2 ∗ 5200 ∗ 200 Adjusted EOQ= 119

@𝑝 = 100, 𝑄∗ = = 273
100 ∗ 0.28

2 ∗ 5200 ∗ 200 EOQ= 275

@𝑝 = 98, 𝑄∗ = = 275
98 ∗ 0.28

2 ∗ 5200 ∗ 200
@𝑝 = 96, 𝑄∗ = = 278 Adjusted EOQ= 1500
96 ∗ 0.28
 Quantity discount model-example

2 ∗ 5200 ∗ 200 5200 119

@𝑝 = 100, 𝑄∗ = = 273 𝑇𝐶 𝑄 = 200 + 100 ∗ 0.28 + 100 ∗ 5200 = 530405
100 ∗ 0.28 119 2

2 ∗ 5200 ∗ 200 5200 275

@𝑝 = 98, 𝑄∗ = = 275 𝑇𝐶 𝑄 = 200 + 98 ∗ 0.28 + 98 ∗ 5200 = 517155
98 ∗ 0.28 275 2

2 ∗ 5200 ∗ 200 5200 1500

@𝑝 = 96, 𝑄∗ = = 278 𝑇𝐶 𝑄 = 200 + 96 ∗ 0.28 + 96 ∗ 5200 = 520053
96 ∗ 0.28 1500 2

Compare all three costs

Options Quantity Price ($) Adjusted EOQ Total cost

Initial price 0-119 100 119 530405
Discount price 1 120-1499 98 275 517155
Discount price 2 1500+ 96 1500 520053

Thus order quantity is 275 @98 $ to get the minimum total cost.
 Reduce Lot Size - Production order quantity model

This model is applicable when (i) inventory continuously flows or builds up over a period of time after an order has been
placed (ii) when units are produced and sold simultaneously.

p = daily production rate

u = daily demand rate / usage rate
Production run in days = t
Inventory level

Q (Total quantity produced) = pt

𝐌𝐚𝐱𝐢𝐦𝐮𝐦 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐥𝐞𝐯𝐞𝐥 = 𝐩𝐭 − 𝐮𝐭
-u

𝐌𝐚𝐱 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 + 𝐌𝐢𝐧 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲

𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐢𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐥𝐞𝐯𝐞𝐥 =
𝟐

Production run (t) Inventory Time

depletion
𝐖𝐡𝐚𝐭 𝐢𝐬 𝐭𝐡𝐞 𝐨𝐩𝐭𝐢𝐦𝐚𝐥 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲 𝐢𝐧 𝐭𝐡𝐢𝐬 𝐜𝐚𝐬𝐞 ? ?
Inventory cycle
 Production order quantity model

Invenotry holding cost = Avearge inventory level ∗ (holding cost per unit)

𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙 = 𝑝𝑡 − 𝑢𝑡

𝑄
𝑄 = 𝑝𝑡, ℎ𝑒𝑛𝑐𝑒, 𝑡 =
𝑝

𝑄 𝑄 𝑢 𝑢
𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙 = 𝑝 −𝑢 =𝑄− 𝑄 = 𝑄(1 − )
𝑝 𝑝 𝑝 𝑝
𝑄 𝑢
𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 = 1− ℎ
2 𝑝

𝑆𝑒𝑡𝑢𝑝 𝑐𝑜𝑠𝑡 = 𝐶 𝐷 𝑄 𝑢
𝑇𝐶 𝑄 = 𝐶 + 1− ℎ=0
𝑄 2 𝑝
2𝐷𝐶
𝑄∗ =
𝑢
1−𝑝 ℎ
 Production order quantity model-example

 A component manufacturer supplies products to OEM. Demand forecast for next year is
1,000 units with an average daily demand of 4 units. The production rate is 8 units per day.
The setup cost is $10 and holding cost is $0.5. Calculate the economic production quantity.

𝐶 =$10, ℎ=$0.5, 𝐷 = 1000, 𝑢 = 4 𝑢𝑛𝑖𝑡𝑠 𝑑𝑎𝑖𝑙𝑦, 𝑝 = 8 𝑢𝑛𝑖𝑡𝑠 𝑑𝑎𝑖𝑙𝑦

2𝐷𝐶
𝑄∗ = ∗ ∗
𝑢
1−𝑝 ℎ
∗ = 283 units
∗ .

In other way, if 𝑄 ∗ is given then we can easily calculate the setup cost and time??
 Determining Optimal Set-up time

Problem: A tier 1 supplier firm that produces fuel injection pump for OEMs, desires to move toward a reduced lot size.
Supplier find that a 2-hour production cycle would be acceptable and thus concluded that a setup that would
accommodate the 2-hour cycle time should be achieved. Following information given below.
Annual demand (D) = 400,000 units (considering 250 working day, u= 1600 per day). Hourly rate = $30/hour
Production rate of supplier = 4000 per day. Supplier is working 8 hours a day. Holding cost = $20 per unit per year.
Calculate the setup cost?

2𝐷𝐶 Here, 𝑄 ∗ = 400 (1600/8 =200*2 hours = 400 units)

𝑄∗ = p= 4000, u=1600, Cs=?, h=20, D=40000
𝑢
1−𝑝 ℎ

2 ∗ 400,000 ∗ 𝐶
400 = Cs= $2.4
1600
1 − 4000 ∗ 20

Set up time = ($2.4/$30) = 0.08 hours = 4.8 minutes

 Optimal set-up time – Problem

Problem: Given the following information about a product at Sudhir’s firm, what is the appropriate setup time?
Annual demand = 39,000 units
Daily demand = 150 units
Daily production = 1,000 units
Desired lot size = 150 units
Holding cost per unit per year = $10
Setup labor cost per hour = $40

Here, 𝑄 ∗ = 150
2𝐷𝐶 p= 1000, u=150, Cs=?, h=10, D=39,000
𝑄∗ =
𝑢
1−𝑝 ℎ
2 ∗ 39,000 ∗ 𝐶
150 =
150
1− ∗ 10
1000 Cs= $2.45

Set up time = ($2.45/$40) = 0.0612 hours = 3.675 minutes

Apart from set up, kanban is also used to maintain the lean system!!
 Kanban

Kanban: Kanban is a Japanese word for card. In their effort to reduce inventory, the Japanese use systems that “pull”
inventory through work centers. They often use a “card” to signal the need for another container of material—hence
the name kanban.
 The card is the authorization for the next container of material to be produced.
 An order for the container is then initiated by each kanban and “pulled” from the producing department or supplier.
 Determining Number of Kanban Containers

Setting the number of containers (Kanban) involves knowing:

(1) Demand during lead time to produce a container of parts and

(2) The amount of safety stock needed to account for variability or uncertainty in the system.

Number of kanban (containers) = (Demand during lead time + Safety stock) / Size of container

Demand per day * Lead time in days

 Determining Number of Kanban Containers

Problem. A Bakery produces short runs of cakes that are shipped to grocery stores. The owner wants to try to reduce
inventory by changing to a kanban system. He has developed the following data and asked you to finish the project.
Lead time = 2 days
Daily demand = 500 cakes
Safety stock = 1/2 day
Container size (determined on a production order size EOQ basis) = 250 cakes

Demand during lead time = Lead time x Daily demand = 2 days x 500 = 1000 units

Safety stock = Daily demand x ½ = 250 units

Number of kanban (containers) = (1000+ 250) / 250 = 5

Inference: Once the reorder signal is triggered, five containers should be released.
SINGLE PERIOD MODEL
OR
NEWSVENDOR MODEL
 Newsvendor Model

Why we required newsvendor model ?

• A newspaper vendor must decide how many copies of the day’s paper to
stock in the morning.
• The demand is uncertain
• Unsold copies (due to overstock) will have a little value at the end of the
sales period.
• Unmet demand (due to understocking) will result in lost sales.
• What is the optimum quantity of newspapers that will maximize the profit?
• The newsvendor model is a single-period decision model because only one
order is placed for a product.
• This model is applicable to all perishable products?
 Newsvendor Model

How Much to Order ?

 Every month, Mr. Hemant Patel, the owner of a local news stand, purchases a number of copies of a
popular monthly magazine from a given supplier. He pays a wholesale price of INR 30 for each copy and
sells it for INR 40. It costs the supplier INR 20 to print a copy. Copies not sold during the month are
marked down and sold for INR 10 each. How many copies of magazine should he purchase for the coming
month? The exact monthly demand for the magazine is not known in advance. However, Mr. Patel has
kept careful records of the past demand, which suggests that the demand during any month is equally
likely to be 6, 7, 8, 9 or 10 (Discrete Demand) with equal probabilities.
 Newsvendor Model

 Purchasing price 30
 Retail price 40
 Salvage price 10
 Supplier’s cost 20

 Should he buy 1 unit?

Yes, since unit 1 is sure to sell and fetch a profit of Rs. 10
 Should he buy 2 units?
Yes, since 2 units is sure to sell and fetch a profit of Rs. 20
 Should he buy 3 units?
Yes, since 3 units is sure to sell and fetch a profit of Rs. 30
 Should he buy 4 units?
Yes, since 4 units is sure to sell and fetch a profit of Rs. 40
 Should he buy 5 units?
Yes, since 5 units is sure to sell and fetch a profit of Rs. 50
 Should he buy 6 units?
Yes, since 6 units is sure to sell and fetch a profit of Rs. 60
 Newsvendor Model

 Purchasing price 30
 Retail price 40
 Salvage price 10

 Should he buy 7th unit ?

E(Profit from 7th unit) = 10*Probability (it sells)=10*0.8 =8
E(Loss from 7th unit) = 10*Probability (it does not sell)= (30-10)*0.2 =4
E (net profit from 7th unit) = 8-4 = 4 > 0. Hence, he should buy 7th unit.

 Should he buy 8th unit ?

E(Profit from 8th unit) = 10*Probability (it sells)=10*0.6 =6
E(Loss from 8th unit) = 10*Probability (it does not sell)= (30-10)*0.4 =8
E (net profit from 8th unit) = 6-8 = -2 < 0. Hence, he should noy buy 8th unit.

Thus, Q* = 7 units
Newsvendor Model
 Newsvendor Model

𝑝: Retailer’s per unit selling price

𝑤: Retailer’s per unit purchase price
𝑠: Salavage value per unit at the end of the period

𝐶 : Understocking cost = 𝑝−w

𝐶 : Overstocking cost= w−s

So, stop when expected profit from the incremental unit = Expected loss from it.

Marginal overstocking cost = Marginal understocking cost

𝐶 ∗ 𝑃 𝐷 ≥ 𝑄∗ = 𝐶 ∗ 𝑃 𝐷 < 𝑄∗

𝑊𝑒 𝑘𝑛𝑜𝑤 = 𝐹 𝑄 ∗ = 𝑃 𝐷 < 𝑄 ∗
𝐶 𝐶 𝑝−𝑤 𝑝−𝑤
𝐶 ∗ 1 − 𝐹 𝑄∗ = 𝐶 ∗ 𝐹 𝑄 ∗ 𝐹 𝑄 ∗ = 𝐹 𝑄∗ = = =
𝐶 +𝐶 𝐶 +𝐶 𝑝−𝑤+𝑤−𝑠 𝑝−𝑠

𝒄𝒖
Service Level =
𝒄𝒐 𝒄𝒖
 Newsvendor Model

 Purchasing price 30
 Retail price 40
 Salvage price 10

𝐶 : Understocking stock = 𝑝−w = 40-30=10

𝟏𝟎 𝟏
Service Level = 𝟐𝟎 = 𝟑 = 𝟎. 𝟑𝟑
𝐶 : Overstocking cost= w−s =30−10=20 𝟏𝟎

Thus, Q* = 7 units

This model is also used in service industries from hotels to airlines with slight modifications.
 Newsvendor Model

Question. The newsvendor has past demand data for 50 days given as

Demand 20 21 22 23 24
Frequency 10 12 15 8 5
The cost of one item is $3 and the price at which it can be sold is $5. Unused part have
salvage value of $1. Determine the optimal ordering level.
 Newsvendor Model
We can write down the probability distribution of demand as:

Demand 20 21 22 23 24
Prob. 0.2 0.24 0.3 0.16 0.1

=3-1 = 2 Cu 2
Co 2
= 5-3=2
SL 0.5

Demand Prob (f(Q)) Cumulative F(Q)

20 0.2 0.2
21 0.24 0.44
22 0.3 0.74
23 0.16 0.9
24 0.1 1.0

 Cumulative F(Q) column indicates the percentage of time demand meet the requirements.
 Here, we required minimum 0.5 SL. Q=21 gives only 0.44 SL, thus we choose Q=22 numbers.
Thank You