CONCEPT

Productivity is the quantitative relation between what we produce and what we use as a
resource to produce them, i.e., arithmetic ratio of amount produced (output) to the
amount of resources input. Productivity can be expressed as:
Productivity = Output !nput
Productivity refers to the efficiency of the production system. !t is the concept that "uides
the mana"ement of production system. !t is an indicator of how well the factors of
production (#and, $apital, labour and ener"y) are utilised.
%uropean Productivity &"ency (%P&) has defined productivity as,
Productivity is an attitude of mind. It is the mentality of progress, of the constant
improvements of that which eists. It is the certainty of !eing a!le to do !etter today
than yesterday and continuously. It is the constant adaptation of economic and
social life to changing conditions. It is the continual effort to apply new techni"ues
and methods. It is the faith in human progress.#
& ma'or problem with productivity is that it means many thin"s to many people.
%conomists determine it from (ross )ational Product (()P), *ana"ers view it as cost
cuttin" and speed up, en"ineers thin+ of .it in terms of more output per hour. ,ut
"enerally accepted meanin" is that it is the relationship between "oods and services
produced and the resources employed in their production.
Productivity as $iewed !y %ifferent People
%$O)O*!-.-
&$$O/).&).- ,%0&1!O/2&#
-$!%).!-.- %)(!)%%2-
2atio of output to input (partial productivity
*easure and .otal Productivity *easure)
3inancial 2atios, ,ud"etary 1ariances
#abour /tilisation (*an days)
$apacity /tilisation, Production per *an hour,
*anpower efficiency
%E&INITION' O& P(O%)CTI$IT*
4. Productivity is a function of providin" more and more of everythin" to more and
more people with less and less consumption of resources.
5. .he volume of output attained in a "iven period of time in relation to the sum of
the direct and indirect efforts expended in its production.
6. Productivity is the measure of how well the resources are brou"ht to"ether in an
or"anisation and utilised for accomplishin" a set of ob'ectives.
7. Productivity is concerned with establishin" con"ruency between or"anisational
"oals with societal aspirations throu"h input8output relationship.
9. Productivity is the multiplier effect of efficiency and effectiveness.
P(O%)CTION +N% P(O%)CTI$IT*
Production is defined as a process or procedure to transform a set of input into output
havin" the desired utility and quality. Production is a value addition process. Production
system is an or"anised process of conversion of raw materials into useful finished
products represented as in 3i". 5.4.
Production system.
.he concept of production and productivity are totally different production refers to
absolute output whereas productivity is a relative term where in the output is always
expressed in terms of inputs. !ncrease in production mayor may not be an indicator of
increase in productivity. !f the production is increased for the same output, then there is
an increase in productivity.
Productivity can !e increased.
4. :hen production is increased without increase in inputs.
5. .he same production with decrease in inputs.
6. .he rate of increase in output is more compared to rate of increase in input.

P(O%)CTI$IT* ,E+')(E'
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Partial Productivity ,easures -PP,.
<ependin" upon the individual input partial productivity measures are expressed as:
Partial Productivity = .otal Output !ndividual !nput
4. #abour Productivity = .otal Output #abour !nput
#abour input is measured in terms of man8hours.
5. $apital Productivity = .otal Output $apital !nput
6. *anual Productivity = .otal Output *anual !nput
7. %ner"y Productivity = .otal Output %ner"y !nput
One of the ma'or disadvanta"e of partial productivity measures is that there is an over
emphasis on one input factor to the extent that other inputs are underestimated or even
i"nored. .his cannot represent the overall productivity of the firm.
Total Productivity ,easure -TP,.
!t is based on all the inputs. .his model can be applied to any manufacturin" or"anisation
or service company.
.otal Productivity = .otal tan"ible output .otal tan"ible !nput
.otal tan"ible Output = 1alue of finished "oods produced > value of partial units
produced > dividends from securities > interest > other
income
.otal tan"ible Output = 1alue of (human > material > capital . ener"y > other
inputs) used
.he word tan"ible here refers to measurable.
.he output of the firm as well as the inputs must be expressed in a common measurement
unit. .he best way is to express them in rupee value. .o compare productivity, indices are
be ad'usted) the base year, and must be stated in terms of base year rupee value. .his is
referred to as deflatin" the input and output factors. <eflators are used to nullify the
effect of chan"in" price from one year to another.
<eflator = $urrent year price ,ase year price
&eatures of Total Productivity ,easures
4. (ives both firm level and detailed unit level index.
5. 0elps to find out the performance and productivity of the operational unit.
6. 0elps to plan, evaluate and control.
7. &n important information to strate"ic planners re"ardin" expansion or phasin" out
decisions.
Total &actor Productivity ,easure -T&P.
!t is the ratio of net output to the labour and capital (factor) input.
.otal 3actor Productivity = )et output #abour > capital !nputs
&+CTO(' IN&/)ENCIN0 P/+NT /OC+TION
1. Proimity to ,ar2ets3
%very company is expected to serve its customers by providin" "oods and services at the
time needed and at reasonable price or"anisations may choose to locate facilities close to
the mar+et or away from the mar+et dependin" upon the product. :hen the buyers for the
product are concentrated, it is advisable to locate the facilities close to the mar+et.
#ocatin" nearer to the mar+et is preferred if
(i) .he products are delicate and susceptible to spoila"e.
(ii) &fter sales services are promptly required very often.
(iii) .ransportation cost is hi"h and increase the cost si"nificantly.
(iv) -helf life of the product is low.
)earness to the mar+et ensures a consistent supply .of "oods to customers and reduces
the cost of transportation.
4. 'upply of raw material3
!t is essential for the or"anisation to "et raw material in ri"ht qualities and time in order to
have an uninterrupted production. .his factor becomes all the important if the materials
are perishable and cost of transportation is very hi"h.
(eneral "uidelines su""ested re"ardin" effects of raw materials on plant location is:
(a) :hen a sin"le raw material is used without loss of wei"ht, locate the plant at the
raw material source, at the mar+et or at any point in between.
(b) :hen wei"ht loosin" raw material is demanded, locate the plant at the raw
material source.
(c) :hen raw material is universally available, locate close to the mar+et area.
-o the "eneral "uideline is ?)earness to source of raw material is of special importance
when he material is bul+y in relation to its value and when the volume and wei"hts are
si"nificantly reduced durin" the processin".@ .he place of production is li+ely to be at the
place of consumption where the final product is more expensive to carry because it is
more bul+y, fra"ile and perishable.
!f the raw materials are processed from variety .of locations, the plant may be situated so
as to minimise total transportation costs.
)earness to raw material is important in case of industries such as su"ar, cement, 'ute and
cotton textiles.
5. Transport facilities3
-peedy transport facilities ensure timely supply of raw materials to the company and
finished "oods to the customers. .he transport facility is a prerequisite for the location of
the plant. .here are five basic modes of physical transportation, air, road, rail, water and
pipeline. (oods that are mainly intended for exports demand a location near to the port or
lar"e airport. .he choice of transport method and hence the location will depend on
relative costs, convenience, and suitability. .hus transportation cost to value added is one
of the criteria for plant location.
6. Infrastructure availa!ility3
.he basic infrastructure facilities li+e power, water and waste disposal, etc., become the
prominent factors in decidin" the location.
$ertain types of industries are power hun"ry e."., aluminium and steel and they should be
located close to the power station or location where uninterrupted power supply is
assured throu"hout the year. .he non8availability of power may become a survival
problem for such industries. Process industries li+e paper, chemical, cement, etc., require
continuous supply of water in lar"e amount and "ood quality, and mineral content of
water becomes an important factor.
:aste disposal facilities for process industries is an important factor which influences the
plant location.
7. /a!our and wages3
.he problem of securin" adequate number of labour and with s+ills specific is a factor to
be considered both at territorial as well as at community level durin" plant location.
!mportin" labour is usually costly and involve administrative problem. .he history of
labour relations in a prospective community is to be studied. Prospective community is to
be studied. Productivity of labour is also an important factor to be considered. Prevailin"
wa"e pattern, cost of livin" and industrial relation and bar"ainin" power of the unions
forms the important considerations.
8. /aw and taation3
.he policies of the state "overnments and local bodies concernin" labour laws, buildin"
codes, safety, etc., are the factors that demand attention.
!n order to have a balanced re"ional "rowth of industries, both central and state
"overnments in our country offer the pac+a"e of incentives to entrepreneurs in particular
locations.
.he incentive pac+a"e may be in the form of exemption from a sales tax and excise
duties for a specific period, soft loan from financial institutions, subsidy in electricity
char"es and investment subsidy. -ome of these incentives may tempt to locate the plant to
avail these facilities offered.
9. 'uita!ility of land and climate3
.he "eolo"y of the area needs to be considered to"ether with climatic conditions
(humidity, temperature). $limate "reatly influence human efficiency and behaviour.
-ome industries require specific climatic conditions e."., textile mill will require
humidity.
)ow, with the development in air8conditionin" facilities the climatic condition can be
controlled but at a hi"h cost. .
:. 'upporting industries and services3
)ow8a8days the manufacturin" or"anisation will not ma+e all the components and parts
by itself and it subcontracts the wor+ to vendors. -o, the source of supply of component
parts will be the one of the factors that influences the location.
.he various services li+e communications. ban+in" services professional consultancy
services and other civil amenities services will play a vital role in selection of a location.
;. Community and la!our attitudes3
$ommunity attitude towards their wor+ and towards the prospective industries can ma+e
or mar the industry. $ommunity attitudes towards supportin" union activities is an
important criteria.
3acility location in specific location is not desirable even thou"h all factors are favourin"
use of labour attitude towards mana"ement, which brin"s very often the stri+es and loc+8
outs.
1<. 'ocial infrastructure3
&vailability of community facilities li+e (4) 0ousin" facilities, (5) 2ecreational facilities,
(6) %ducational facilities, and (7) *edical facilities A are to be considered while selectin"
a location.
C+P+CIT* ,+N+0E,ENT
.he ob'ective of capacity mana"ement (i.e., plannin" and control of capacity) is to match
the level of operations to the level of demand.
$apacity plannin" is to be carried out +eepin" in mind future "rowth and expansion
plans, mar+et trends, sales forecastin", etc. !t is a simple tas+ to plan the capacity in case
of stable demand. ,ut in practice the demand will be seldom stable. .he fluctuation of
demand creates problems re"ardin" the procurement of resources to meet the customer
demand. $apacity decisions are strate"ic in nature. $apacity is the rate of productive
capability of a facility. $apacity is usually expressed as volume of output per period of
time.
Production mana"ers are more concerned about the capacity for the followin" reasons:
-ufficient capacity is required to meet the customers demand in time.
$apacity affects the cost efficiency of operations.
$apacity affects the schedulin" system.
$apacity creation requires an investment.
Capacity planning is the first step when an organisation decides to produce more or
new products.
,E+')(E,ENT O& C+P+CIT*
!t is easy and simple to measure the capacity of the unit manufacturin" homo"eneous
tan"ible products, which can be counted. .he capacity of such units can be expressed in
number of units of output per period. 3or example, the capacity of an automobile unit is
expressed as number of vehicles produced per month. .he capacity of steel plant is
expressed as millions of tons per annum. $apacity of textile mill is expressed as metres of
cloth per day.
!t is difficult to express capacities when the company manufactures multiple products and
some of the products requirin" common facilities and others specialised facilities. !n this
situation measurin" capacity is more complicated. !n such situations, the capacity is not
expressed as output per period of time but usually expressed as roan8hours, machine
hours or sometimes in terms of applicable resources.
Eamples
& 'ob shop can measure its capacity in machine hours andor man8hours.
3or hospitals it is expressed as bed days per month.
.he transport system is expressed in seat +ms per month.
,E+')(E' O& C+P+CIT*
1= %esign capacity3
<esi"ned capacity of a facility is the planned or en"ineered rate of output of "oods or
services under normal or full scale operatin" conditions.
3or example, the desi"ned capacity of the cement plant is 4BB .P<. (.onnes per day)
$apacity (desi"ned) of the su"ar factory is 49B tonnes of su"ar cane crushin" per day.
4. 'ystem capacity3
-ystem capacity is the maximum output of the specific product or product mix the system
of wor+ers and machines is capable of producin" as an inte"rated whole.
-ystem capacity is less than desi"n capacity or at the most equal it because of the
limitation of product mix, quality specification, brea+downs. .he actual is even less
because of many factors affectin" the output such as actual demand, downtime due to
machineequipment failure, unauthorised absenteeism.
.he system capacity is less than desi"n capacity because of lon" ran"e uncontrollable
factors.
.he actual output is still reduced because of short8term effects such as brea+down of
equipment, inefficiency of labour. .he system efficiency is expressed as ratio of actual
measured output to the system capacity.
-ystem efficiency (-%) = &ctual Output -ystem capacity
Capacity and output relationship.
2educed by lon" ran"e effects
Product mix, lon" ran"e mar+et conditions
.i"ht quality specifications
!mbalance in equipment or labour
2educed by short ran"e effects
&ctual demand, inefficiency of wor+ers
*achine inefficiencies, schedulin"
Plannin" and control
<%-!() $&P&$!.;
-;-.%* $&P&$!.;
&$./&# O/.P/.
5. /icensed capacity3
$apacity licensed by the various re"ulatory a"encies or "overnment authorities. .his is
the limitation on the output exercised by the "overnment.
6. Installed capacity3
.he capacity provided at the time of installation of the plant is called installed capacity.
7. (ated capacity3
$apacity based on the hi"hest production rate established by actual trials is referred to as
rated capacity.
E'TI,+TIN0 &)T)(E C+P+CIT* NEE%'
$apacity requirements can be evaluated from two perspectives8lon"8term capacity
strate"ies and short8term capacity strate"ies.
1. /ong=term capacity strategies3
#on"8term capacity requirements are more difficult to determine because the future
demand and technolo"y are uncertain. 3orecastin" for 3ive or .en years into the future is
more ris+y and difficult. %ven sometimes companyCs todayCs products may not be
existin" in the future. #on" ran"e capacity requirements are dependent on mar+etin"
plans, product development and life8cycle of the product. #on"8term capacity plannin" is
concerned with accommodatin" ma'or chan"es that affect overall level of the output in
lon"8term (more than one year). *ar+etin" environmental assessment and implementin"
the lon"8term capacity plans in a systematic manner are the ma'or responsibilities of
mana"ement.
,ultiple products3
$ompanyCs produce more than one product usin" the same facilities in order to
increase the profit. .he manufacturin" of multiple products will reduce the ris+ of
failure. 0avin" more than on product helps the capacity planners to do a better 'ob.
,ecause products are in different sta"es of their life8cycles, it is easy to schedule them
to "et maximum capacity utilisation.
Phasing in capacity3
!n hi"h technolo"y industries, and in industries where technolo"y developments are
very fast, the rate of obsolescence is hi"h. .he products should be brou"ht into the
mar+et quic+ly. .he time to construct the facilities will be lon" and there is no much
time as the products should be introduced into the mar+et quic+ly. 0ere the solution is
phase in capacity on modular basis. -ome commitment is made for buildin" funds
and men towards facilities over a period of 689 years. .his is an effective way of
capitalisin" on technolo"ical brea+throu"h.
Phasing out capacity3
.he outdated manufacturin" facilities cause excessive plant closures and down time.
.he impact of closures are not limited to only fixed costs of plant and machinery.
.hus, the phasin" out here is done with humanistic way without affectin" the
community. .he phasin" out options ma+es alternative arran"ements for men li+e
shiftin" them to other 'obs andor to other locations, compensatin" the employees,
etc.
4. 'hort=term capacity strategies3
*ana"ers often use forecasts of product demand to estimate the short8term wor+load the
facility must handle. *ana"ers loo+in" ahead up to 45 months, anticipate output
requirements for different products, and services. *ana"ers then compare requirements
with existin" capacity and then ta+e decisions as to when the capacity ad'ustments are
needed.
&+CTO(' IN&/)ENCIN0 E&&ECTI$E C+P+CIT*
.he effective capacity is influenced by A (4) 3orecasts of demand, (5) Plant and labour
efficiency, (6) -ubcontractin", (7) *ultiple shift operation, (9) *ana"ement policies.
1. &orecasts of demand3
<emand forecast is "oin" to influence the capacity plan in a si"nificant way. &s such, it is
very difficult to forecast the demand with accuracy as !t chan"es si"nificantly with the
product life8cycle sta"e, number of products. Products with lon" life8cycle usually exhibit
steady demand "rowth compared to one with shorter life8cycle. .hus the accuracy of
forecast influences the capacity plannin".
4. Plant and la!our efficiency3
!t is difficult to attain 4BB per cent efficiency of plant and equipment. .he efficiency is
less than 4BB per cent because of the enforced idle time due to machine brea+down,
delays due to schedulin" and other reasons. .he plant efficiency varies from equipment to
equipment and from or"anisation to or"anisation. #abour efficiency contributes to the
overall capacity utilisation. .he standard time set by industrial en"ineer is for a
representative or normal wor+er. ,ut the actual wor+ers differ in their speed and
efficiency. .he actual efficiency of the labour should be considered for calculatin"
efficiency. .hus plant and labour efficiency are very much essential to arrive at realistic
capacity plannin".
5. 'u!contracting3
-ubcontractin" refers to off loadin", some of the 'obs to outside vendors thus hirin" the
capacity to meet the requirements of the or"anisation. & careful analysis as to whether to
ma+e or to buy should be done. &n economic comparison between cost to ma+e the
component or buy the component is to made to ta+e the decision.
6. ,ultiple shift operation3
*ultiple shifts are "oin" to enhance the firms capacity utilisation. ,ut specially in the
third shift the re'ection rate is hi"her. -pecially for process industries where investment is
very hi"h it is recommended to have a multiple shifts.
7. ,anagement policy3
.he mana"ement policy with re"ards to subcontractin", multiplicity of shifts (decision
re"ardin" how may shifts to operate), which wor+ stations or departments to be run for
third shift, machine replacement policy, etc., are "oin" to affect the capacity plannin".
&+CTO(' &+$O)(IN0 O$E( C+P+CIT* +N% )N%E( C+P+CIT*
!t is very difficult to forecast demand as always there is an uncertainty associated with the
demand. .he forecasted demand will be either hi"her or lower than the actual demand. -o
always there is a ris+ involved in creatin" capacity based on pro'ected demand. .his "ives
rise to either over capacity or under capacity.
The over capacity is preferred when3
(a) 3ixed cost of the capacity is not very hi"h.
(b) -ubcontractin" is not possible because of secrecy of desi"n andor quality
requirement.
(c) .he time required to add capacity is lon".
(d) .he company cannot afford to miss the delivery, and cannot afford the loose the
customer.
(e) .here is a economic capacity siDe below which it is not economical to operate the
plant.
The under capacity is preferred when3
(a) .he time to build capacity is short.
(b) -horta"e of products does not affect the company (i.e., lost sales can be
compensated).
(c) .he technolo"y chan"es fast, i.e., the rate of obsolescence of plant and equipment
is hi"h.
(d) .he cost of creatin" the capacity is prohibitively hi"h.
'T(+TE0IE' TO ,EET NON=)NI&O(, %E,+N%
1. 'trategy3 &bsorb demand fluctuations by varyin" inventory level, bac+ orderin"
or -hiftin" demand.
,ethod Costs
Produce in earlier period and hold until
product is demanded.
$ost of holdin" inventory.
Offer to deliver the products later when
capacity is available
<elay in receipt of revenue lost sales
and customer dissatisfaction.
-pecial mar+etin" efforts to shift the
demand to slac+ period.
$ost of advertisin", discounts or
promotional pro"rammes.
4. 'trategy3 $han"e only the production rate in accordance with non8uniform
demand.
,ethod Costs
:or+ additional hours without
chan"in" the wor+force siDe.
Overtime premium wa"es.
!ncrease wor+force siDe for hi"h
production so that overtime is avoided.
%xcess wa"es durin" slac+ period.
-ubcontract wor+ to other firms. 2educe company overheads and
increase subcontractors profit.
2evise ma+e or buy decisions to
purchase items when capacity is fully
loaded.
:aste of company s+ills, toolin" and
equipment unutilised in slac+ periods.
5. 'trategy3 $han"e the siDe of the wor+force to vary production level in
accordance with demand.
,ethod Cost
0ire additional personnel as. <emand %mployment costs for advertisin"
increases recruitment, cost of additional shift, if
shift is added
#ayoff personnel as demand decreases. $ost of compensation to wor+ers for
layoff.
?*aterials 2equirement Plannin" (*2P) is a technique for determinin" the quantity and
timin" for the acquisition of dependent demand items needed to satisfy master production
schedule requirements.@
,(P O>?ECTI$E'
1. Inventory reduction3
*2P determines how many components are required, when they are required in order to
meet the master schedule. !t helps to procure the materialscomponents as and when
needed and thus avoid excessive build up of inventory.
4. (eduction in the manufacturing and delivery lead times3
*2P identifies materials and component quantities, timin"s when they are needed,
availabilities and procurements and actions required to meet delivery deadline. *2P
helps to avoid delays in production and priorities production activities by puttin" due
dates on customer 'ob orders.
5. (ealistic delivery commitments3
,y usin" *2P, production can "ive mar+etin" timely information about li+ely delivery
times to prospective customers.
6. Increased efficiency3
*2P provides a close coordination amon" various wor+ centres and hence helps to
achieve uninterrupted flow of materials throu"h the production line. .his increases the
efficiency of production system.
&)NCTION' 'E($E% >* ,(P
1. Order planning and control3
:hen to release orders and for what quantities of materialscomponents.
4. Priority planning and control3
0ow the expected date of availability is compared to the need date for each component.
6. Provision of a basis for plannin" capacity requirements and developin" a broad
business plans.
.he followin" questions are addressed in *2P processin":
4. :hat do we want to produce, and
when.
A Provided by *aster Production -chedule
5. :hat component are required to
ma+e it and how many.
A ,ill of *aterials (,O*)
6. 0ow many are already scheduled
to be available in each future
period.
A !nventory status file
7. 0ow many more we need to
obtain for each future period.
A <ifference in required and available
9. :hen to order these amounts so
that they will be available when
needed.
A Planned order release
,(P TE(,INO/O0*
1. %ependent demand3 .he demand for an item depends on another item. .he
demand dependency is the de"ree to which the demand for
one item is associated with demand for another item. .
4. ,(P3 & technique for determinin" the quantity and timin" of
dependent demand items.
5. /ot si@e3 .he quantity of items required for an order. .
6. Time phasing3 -chedulin" to produce or receive an appropriate amount
(#ot) of material so that it will be available in the time
periods when required.
7. Time !uc2et3 .he time period used for plannin" purposes in *2P.
8. 0ross re"uirements3 .he overall quantity of an item needed at the end of the
period to meet the planned output levels.
9. Net re"uirements3 .he net quantity of an item that must be acquired to meet
the scheduled output for the period. !t is calculated as,
(ross requirements minus scheduled receipts for the period
minus amounts available from the previous period.
:. (e"uirements eplosion3 .he brea+in" down of (explodin") parent items into
component parts that can be individually planned and
scheduled.
;. 'cheduled receipts3 .he quantity of an item that will be received from suppliers
as a result of orders that have been placed.
1<. Planned order receipts3 .he quantity of an item that is planned to be ordered so that
it will be received at the be"innin" of the period to meet net
requirements for the period. .he order has not yet been
placed. .
11. Planned order release3 .he quantity of an item that is planned to be ordered or it is
a plan (quantity and date) to initiate the purchase or
manufacture of materials so that they will be received on
schedule after the lead time offset.
14. /ead time offset3 .he supply time or number of time buc+ets between
releasin" an order and receivin" the materials.
,aster Production 'chedule -,P'.
*P- is a series of time phased quantities for each item that a company produces,
indicatin" how many are to be produced and when. *P- is initially developed from firm
customer orders or from forecasts of demand before *2P system be"ins to operate. .he
*2P system accepts whatever the master schedule demands and translates *P- end
items into specific component requirements. *ost systems then ma+e a simulated trial
run to determine whether the proposed master schedule can be satisfied.
Inventory 'tatus &ile
%very inventory item bein" planned must have an inventory status file which "ives
complete and up to date information on the on hand quantities, "ross requirements,
scheduled receipts and planned order releases for the item. !t also includes plannin"
information such as lot siDes, lead times, safety stoc+ levels and scrap allowances.
,asically, the 'ob of the inventory status tile is to +eep data, about the pro'ected use and
receipts of each item and to determine the amount of inventory that will be available in
each time buc+et. !f the pro'ected available inventory is not adequate to meet the
requirement in a period, the *2P pro"ramme will recommend that this item be ordered.
>ill of ,aterials ->O,.
.o schedule the production of an end product, the *2P system must plan for all the
materials, parts and subassemblies that "o into the end product. .he ,ill of *aterial file
in the computer provide this information. ,O* file identifies each component by unique
part number and helps processin" by a process which EexplodesC end item requirements
into component requirements.
.hus ,O* identifies how each end product is manufactured, specifyin" all
subcomponents items, their sequence of build up, their quantity in each finished unit and
the wor+ centres performin" the build up sequence. .his information is obtained from
product desi"n documents, wor+ flow analysis and other standard manufacturin"
information.
.he ,O* processor is a software pac+a"e that maintains and updates the ,O* listin" of
all components that "o into the product. !t also lin+s the ,O* file with the inventory
status file so that the requirements explosion correctly accounts for the current inventory
levels of all components.
IN$ENTO(* ,+N+0E,ENT
!n ma'ority of the or"aniDations, the cost of material forms a substantial part of the sellin"
price of the product. .he interval between the receivin" the purchased parts and
transformin" them in to final products varies from industries to industries dependin"
upon the cycle time of manufacture. *aterials are procured and held in the form of
inventories. !t is therefore necessary to hold inventories of various +inds to act as a buffer
between supply and demand for efficient operation of the system. .hus, an effective
control on inventory becomes a must for smooth and efficient runnin" of the production
cycle with least interruptions. .he stoc+in" of anythin" that is tan"ible in order to meet
the future demand is the sub'ect8matter of inventory theory.
,E+NIN0 O& IN$ENTO(*
!nventory "enerally refers to the materials in stoc+. !t is also called the idle resource of an
enterprise. !nventories represent those items, which are either stoc+ed for sale or they are
in the process of manufacturin" or they are in the form of materials, which are yet to be
utilised.
T*PE' O& IN$ENTO(IE'
& manufacturin" firm "enerally carries the followin" types of inventories:
1. (aw materials3
2aw materials are those basic unfabricated materials which have not under"one any
operation since they are received from the suppliers, e."., round bars, an"les, channels,
pipes, etc.
4. >ought out parts3
.hese parts refer to those finished parts, subassemblies which are purchased from outside
as per the companyFs specifications.
5. Aor2=in=process inventories -AIP.3
.hese refer to the items or materials in partially completed condition of manufacturin",
e."., semi8finished products at the various sta"es of manufacture. .
6. &inished goods inventories3
.hese refer to the completed products ready for dispatch.
7. ,aintenance, repair and operating stores3
)ormally these inventories refer to those items, which do not form the part of the final
product but are consumed in the production process, e."., machine spares, oil, "rease.
8. Tools inventory3
!ncludes both standard tools and special tools.
9. ,iscellaneous inventories3
*iscellaneous inventories A office stationeries and other consumable stores.
!nventories can also be classified as: (i) 3luctuation inventories, (ii) &nticipation
inventories, (iii) #ot siDe inventories, and (iv) .ransportation inventories.
&luctuation inventories have to be carried for the reason that sales and production times
for the product cannot be always predicted with accuracy. .here are variations in demand
and lead times required to manufacture items. .hus, there is a need for reserve stoc+ or
safety stoc+ to account for the fluctuations in demand and lead time.
+nticipation inventories are built up in advance for bi" sellin" season, promotion
pro"ramme or anticipation of li+ely chan"e in demand suddenly and in case of plant
shutdown period. !t is the inventory for the future need.
/ot si@e inventory refers to producin" and storin" at the rate hi"her than the current
consumption rate. .he production in lots is "oin" to help the advanta"e of price discounts
for quantities purchased in bul+ and fewer set8ups and, hence, the lower set8up cost.
The transportation inventories exist because materials must be moved from one place
to another. :hen transportation requires a lon" time, the items in transport represent the
inventory. .hus, transportation inventory is a result of extended or lon"er transportation
time.
(E+'ON' &O( BEEPIN0 IN$ENTO(IE'
1. To sta!ilise production3
.he demand for an item fluctuates because of the number of factors, e."., seasonality,
production schedule etc. .he inventories (raw materials and components) should be made
available to the production as per the demand failin" which results in stoc+ out and the
production stoppa"e ta+es place for want of materials. 0ence, the inventory is +ept to
ta+e care of this fluctuation so that the production is smooth.
4. To ta2e advantage of price discounts3
/sually the manufacturers offer discount for bul+ buyin" and to "ain this price advanta"e
the materials are bou"ht in bul+ even thou"h it is not required immediately. .hus,
inventory is maintained to "ain economy in purchasin".
5. To meet the demand during the replenishment period3
.he lead time for procurement of materials depends upon many factors li+e location of
the source, demand supply condition, etc. -o inventory is maintained to meet the demand
durin" the procurement (replenishment) period.
6. To prevent loss of orders -sales.3
!n this competitive scenario, one has to meet the delivery schedules at 4BB per cent
service level, means they cannot afford to miss the delivery schedule which may result in
loss of sales. .o avoid this the or"anisations have to maintain inventory.
7. To 2eep pace with changing mar2et conditions3
.he or"anisations have to anticipate the chan"in" mar+et sentiments and they have to
stoc+ materials in anticipation of non8availability of materials or sudden increase in
prices.
O>?ECTI$E' O& IN$ENTO(* CONT(O/
4. .o ensure adequate supply of products to customer and avoid shorta"es as far as
possible.
5. .o ma+e sure that the financial investment in inventories is minimum (i.e., to see
that the wor+in" capital is bloc+ed to .the minimum possible extent).
6. %fficient purchasin", storin", consumption and accountin" for materials is an
important ob'ective. .
7. .o maintain timely record of inventories of all the items and to maintain the stoc+
within the desired limits.
9. .o ensure timely action for replenishment.
G. .o provide a reserve stoc+ for variations in lead times of delivery of materials.
H. .o provide a scientific base for both short8term and lon"8term plannin" of
materials.
>ENE&IT' O& IN$ENTO(* CONT(O/
!t is an established fact that throu"h the practice of scientific inventory control, the stoc+s
can be reduced anywhere between 4B per cent to 7B per cent. .he benefits of inventory
control are:
4. !mprovement in customers relationship because of the timely delivery of "oods
and services.
5. -mooth and uninterrupted production and, hence, no stoc+ out.
6. %fficient utilisation of wor+in" capital.
7. 0elps in minimisin" loss due to deterioration, obsolescence dama"e and
prelifera"e.
9. %conomy in purchasin".
G. %liminates the possibility of duplicate orderin".
CO'T' +''OCI.+TE% AITC IN$ENTO(*
1. Purchase -or production. cost3
.he value of an item is its unit purchasin" (production) cost. .his cost becomes
si"nificant when availin" the price discounts. .his cost is expressed as 2s.unit.
4. Capital cost3
.he amount invested in an item, (capital cost) is an amount of capital not available for
other purchases. !f the money were invested somewhere else, a return on the investment
is expected. & char"e to inventory expenses is made to account for this unreceived return.
.he amount of the char"e reflects the percenta"e return expected from other investment.
5. Ordering cost3
!t is also +nown by the name procurement cost or replenishment cost or acquisition cost.
$ost of orderin" is the amount of money expended to "et an item into inventory. .his
ta+es into account all the costs incurred from callin" the quotations to the point which the
items are ta+en to stoc+.
.here are two types of costs83ixed costs and variable costs.
3ixed costs do not depend on the number of orders whereas variable costs chan"e with
respect to the number of orders placed. .he salaries and wa"es of permanent employees
involved in purchase function and control of inventory, purchasin", incomin" inspection,
accountin" for purchase orders constitute the ma'or part of the fixed costs. .he cost of
placin" an order varies from one or"anisation to another. .hey are "enerally classified
under the followin" heads:
-i. Purchasing3
.he clerical and administrative cost associated with the purchasin", the cost of
requisitionin" material, placin" the order, follow8up, receivin" and evaluatin" Iuotations.
-ii. Inspection3
.he cost of chec+in" material after they are received by the supplier for quantity and
quality and maintainin" records of the receipts.
-iii. +ccounting3
.he cost of chec+in" supply a"ainst each order, ma+in" payments and maintainin"
records of purchases.
-iv. Transportation costs.
6. Inventory carrying costs -holding costs.3
.hese are the costs associated with holdin" a "iven level of inventory on hand and this
cost vary in direct proportion to the amount of holdin" and period of holdin" the stoc+ in
stores. .he holdin" costs include.
(i) -tora"e costs (rent, heatin", li"htin", etc.).
(ii) 0andlin" costs: $osts associated with movin" the items such as cost of labour,
equipment for handlin".
(iii) <epreciation, taxes and insurance.
(iv) $osts on record +eepin".
(v) Product deterioration and obsolescence.
(vi) -poila"e, brea+a"e, pilfera"e and loss due to perishable nature.
7. 'hortage cost3
:hen there is a demand for the product and the item needed is not in stoc+, then we incur
a shorta"e cost or cost associated with stoc+ out. .he shorta"e costs include:
(i) ,ac+order costs.
(ii) #oss of future sales.
(iii) #oss of customer "oodwill.
(iv) %xtra cost associated with ur"ent, small quantity orderin" costs.
(v) #oss of profit contribution by lost sales revenue.
.he unsatisfied demand can be satisfied at a later sta"e (by means of bac+ orders) or
unfulfilled demand is lost completely (no bac+ orderin", the shorta"e costs become
proportional to only the shorta"e quantity).
IN$ENTO(* CONT(O/ D TE(,INO/O0*
4. %emand3 !t is the number of items (products) required per unit of time. .he
demand may be either deterministic or probabilistic in nature.
5. Order cycle3 .he time period between two successive orders is called order
cycle.
6. /ead time3 .he len"th of time between placin" an order and receipt of items is
called lead time.
7. 'afety stoc23 !t is also called buffer stoc+ or minimum stoc+. !t is the stoc+ or
inventory needed to account for delays in materials supply and to account for
sudden increase in demand due to rush orders.
9. Inventory turnover3 !f the company maintains inventories equal to 6 months
consumption. !t means that inventory turnover is 7 times a year, i.e., the entire
inventory is used up and replaced 7 times a year.
49. (e=order level -(O/.3 !t is the point at which the replenishment action is
initiated. :hen the stoc+ level reaches 2.O.#., the older is placed for the item.
4G. (e=order "uantity3 .his is the quantity of material (items) to be ordered at the
re8order ! level. )ormally this quantity equals the economic order quantity.
IN$ENTO(* CO'T (E/+TION'CIP'
.here are two ma'or costs associated with inventory. Procurement cost (orderin" cost)
and inventory carryin" cost. &nnual procurement cost varies with the number of orders.
.his implies that the procurement cost will be hi"h, if the item is procured frequently in
small lots. .he procurement cost is expressed as 2s.Order.
.he annual inventory carryin" cost (Product of avera"e inventory x $arryin" cost) is
directly proportional to the quantity in stoc+. .he inventory carryin" cost decreases, if the
quantity ordered per order is small. .he two costs are diametrically opposite to each
other. .he ri"ht quantity to be ordered is one that stri+es a balance between the two
opposin" costs. .his quantity is referred to as ?%conomic Order Iuantity@ (%OI).
IN$ENTO(* ,O%E/'
One of the basic problem of inventory mana"ement is to find out the order quantity so
that it is most economical from overall operational point of view. 0ere the problem lies in
minimisin" the two conflictin" costs, i.e., orderin" cost and inventory carryin" cost.
!nventory models helps to find out the order quantity, which minimises the total costs
(sum of orderin" costs and inventory carryin" costs). !nventory models are classified as
shown in 3i". 55.5.
Inventory ,odels.
,O%E/ = I. ECONO,IC O(%E( E)+NTIT* AITC IN'T+NT+NEO)'
'TOCB (EP/ENI'C,ENT ->+'IC IN$ENTO(* ,O%E/.
+ssumptions
4. <emand is deterministic, constant and it is +nown.
5. -toc+ replenishment is instantaneous (lead time is Dero)
6. Price of the materials is fixed (quantity discounts are not allowed)
7. Orderin" cost does not vary with order quantity.
#et < be the annual demand (units per year)
$o = Orderin" costs (2s.order)
$h = !nventory carryin" costs (2s.unitunit time)
$p = Price per unit
I = Order quantity
IJ = %conomic order quantity
!nventory *odels
<eterministic (*odels
assumin" certainty)
Probabilistic
&ied Ety.
'ystem
&ied Period
'ystem
&ied Ety.
'ystem
&ied Period
'ystem
) = )umber of orders placed per annum
.c = .otal cost per annum
,O%E/=II. ECONO,IC O(%E( E)+NTIT* ACEN 'TOCB
(EP/ENI'C,ENT I' NON=IN'T+NT+NEO)' -P(O%)CTION
,O%E/.
.his model is applicable when inventory continuously builds up over a period of time
after placin" an order or when the units are manufactured and used (or sold) at a constant
rate. ,ecause this model is specially suitable for the manufacturin" environment where
there is a simultaneous production and consumption, it is called Production ,odel#.
+ssumptions
4. .he item is sold or consumed at the constant demand rate which is +nown.
5. -et up cost is fixed and it does not chan"e with lot siDe.
6. .he increase in inventory is not instantaneous but it is "radual.
,O%E/=III3 + IN$ENTO(* ,O%E/ ACEN 'CO(T+0E' +(E PE(,ITTE%
!n many practical situations, shorta"es or stoc+ outs are not permitted. -o, it is must that
stoc+ out situations are to be avoided. .here are occasions where stoc+ out are
economically 'ustifiable.
.his situation is observed normally when cost per unit is very hi"h.
$s = -horta"e $ost (-toc+ out cost) per unit per period.
- = ,alance units after bac+ orders are satisfied. .
I A - = )umber of shorta"es per order.
t4 = .ime period durin" which inventory is positive.
t5 = .ime durin" which shorta"e exists.
. = .ime between the receipt of orders.
.he basic assumption is that there is no loss of sales due to stoc+ out or shorta"es.
.he economic order quantity is expressed as follows:
,O%E/=I$3 IN$ENTO(* ,O%E/ AITC P(ICE %I'CO)NT'
:hen items are bou"ht in lar"e quantities, the supplier often "ives discounts. 0owever, if
the material is purchased to ta+e advanta"e of discount, the avera"e inventory level and
so the inventory carryin" costs will increase.
,enefits for the purchaser from lar"e orders are, lower cost per unit, lower shippin" and
transportation cost, reduced handlin" cost and reduction in orderin" costs due to less
number of orders.
.hese benefits are to be compared with the increase in carryin" costs. &s the order siDe
increases, more space should be provided to stoc+ the items.
& decision is, therefore, to be ta+en whether the buyer should stic+ to economic order
quantity or increase the same to ta+e advanta"e that, at lar"e quantities, the production
costs per piece are lower (economics of scale) and, hence, part of the savin"s can be
passed on to the customer.
Price=discount ,odel
#et < be the annual consumption. (<emand)
$4 is the price per unit. (,asic price)
$D is the discounted price per unit.
$o is the orderin" cost.
I is inventory carryin" cost expressed as a percenta"e of avera"e inventory investment.
I, be the price brea+ quantity. (Iuantity at which the price chan"es)
OPE(+TION' 'T(+TE0*
Productivity improvement is an imperative in operation strate"y for all firms. !n order to
remain competitive, a firm must continually see+ ways of continually reducin" costs and
must see+ new ways of improvin" the operations. 3or firms operatin" in "lobal mar+ets,
productivity improvement needs to become a mana"erial reli"ion. Productivity
improvement "et implemented throu"h productionoperations strate"y.
%efinition of Operation 'trategy
Operation -trate"y is concerned with settin" broad policies and plans for usin" the
resources of the firm to support in a best possible way firms lon"8term competitive
strate"y.
-chroeder, &nderson and $leveland (4KLG) have defined operations strate"y as consistin"
of four components A mission, distinctive competence ob'ectives and policies. .hese four
components help define what "oals operations should accomplish and how it should
achieve these "oals.
.he resultin" strate"y should "uide decision8ma+in" in all phases of manufacturin".
.hus, Operations strate"y is a vision for the operations functions that sets an overall
directions or thrust for decision ma+in".
OPE(+TION' P(IO(ITIE'
&ccordin" to s+inner of 0arward ,usiness -chool and 0ill .erry of #ondon ,usiness
-chool a few basic operations priorities are determined. .he priorities include 8
1. Cost
%very industry has a price sensitive se"ment, which ma+es the buyin" decision on the
basis of low cost. .o successfully compete in this se"ment, a firm must be a low cost
producer. .he products strictly sold on the basis of cost are typically A low valued
commodity in nature, i.e., it is difficult to distin"uish products of one producer from
another. $ompetition is fierce in this se"ment and the low cost producer will determine
the price of the product.
4. Euality
Iuality refers to both the product quality and process quality. .he level of quality offered
in the products desi"n will vary with the mar+et se"ment to which the product is offered.
.he ob'ective of establishin" the proper level of product quality is to focus on the
requirements of the customer. -o, level of quality is a balanced with the cost, which is a
compromise.
Process quality is critical as it relates directly to the reliability of the product. .he "oal of
process quality is error free production of products. 2eliability and quality are built in to
the product durin" desi"n and subsequently durin" manufacturin" phase.
5. %elivery
.he speed of delivery i.e. the companyCs ability to deliver "oods and services more
quic+ly than its competitors is critical for some products and services i.e. specially for
repairs. &lso alon" with the delivery speed, delivery reliability i.e. the ability of the firm
to supply the product or service on or before the scheduled delivery due date is also
critical. <elivery reliability is an indicator of dependability of the vendor and is one of
the criteria for vendor evaluation or ratin".
6. Changes in %emand
.he ability of the company to respond to increase or decrease in demand is an important
factor in their ability to compete. .he ability to effectively deal with dynamic mar+et
demand over the lon" term is an essential element of operations strate"y.
7. &lei!ility
3lexibility here refers to the ability of a company to offer a wide variety of products to
meet the needs of the customers. .he prime element of this ability to offer different
products is the time required for a company to develop new products.
.he other product specific criteria includeM
.he de"ree of customiDation or the variety and ran"e of products.
*eetin" the product launch dates
.echnical liaison and support
T*PE' O& OPE(+TION' 'T(+TE0*
Operationsmanufacturin" strate"y should be a part of overall business strate"y and it
should be lin+ed to mar+etin" and financial strate"ies. ,asically, there are two
diametrically opposite business strate"ies that can be selected. 3irst, there is a product
imitator business strate"y, which is characteriDed by mature, price sensitive mar+et, with
a standardiDed product. .he operations mission would emphasiDe on cost as a dominant
ob'ective. Operations would strive to reduce costs throu"h superior process technolo"y,
low personnel costs, low inventory costs, and hi"h de"ree of vertical inte"ration, quality
assurance aimed at savin" cost. *ar+etin" and finance would also practice and support
the product imitator strate"y.
.he second strate"y is called product innovation and new product introduction strate"y.
.his strate"y would typically be used in an emer"in" and possibly in "rowin" mar+et
where the advanta"e is "ained by brin"in" out superior products within a short span.
Price is not the dominant factor for competition. !n this case, operations would emphasiDe
flexibility to introduce new products as a dominant ob'ective in its mission. Operations
policies include the product teams, flexible automation to be adapted to new products
wor+ force with flexible s+ills, outsourcin" some +ey services and parts to retain
flexibility. Napanese strate"y believed and is successful in usin" imitator strate"y.
.he company after decidin" the mission, ob'ectives and the tar"et mar+et se"ment in
which the company will compete, the company has to choose between the fundamental
strate"ic competitive options li+e
(i) <ifferentiation strate"y
(ii) Overall cost leadership strate"y
(iii) 3ocus strate"y
%ifferentiation 'trategy
<ifferentiation strate"y aims to create a new product or service, which is unique in that
industry. .he uniqueness may be achieved throu"h desi"n or brand ima"e, technolo"y,
and customer service or dealer networ+. <ifferentiation is a strate"y to win customers and
retainin" them for a lon"er period. .here are many differentiation strate"ies of which
flexibility is important one. .
.he flexibility may be in terms of
(i) Product A ran"e, desi"n or product mix
(ii) Product volumes
(iii) Iuic+ deliveries
(iv) *inimum lead time between the product concept and introduction
(v) Iuic+er response to chan"in" needs of the customer
3lexibility is bein" part of fast response to chan"in" needs of the customers and includes
the flexibility of both manufacturin" and service, and desi"n functions. .he
manufacturin" or operations part consist of flexibility in machines, process and man
power to process alternative product desi"ns (variety) in small batches with minimum
wasta"e of time and at optimal cost. &n operations system should offer mar+et
flexibilities throu"h flexibilities in machinery, processes technolo"y implementation,
men, systems and utiliDation of capacity and time. .he flexibility should improve the
capacity and capability to adapt to the chan"in" external and internal environment.
Cost /eadership 'trategy
.he overall cost leadership aims to produce and deliver the product or service with
specified quality, at a lower cost relative to the competitors. .he firm practicin" this
strate"y will be distin"uished as a lowest cost producer and seller. .he lowest cost should
be achieved throu"h cost reduction.
&ocus 'trategy
Or"anisations usin" focus strate"y aim to concentrate on a particular "roup of customers
(nicthe mar+et), "eo"raphical mar+et or product lines in order to serve a well defined but
narrow mar+et better than its competitors.