Construction Material Management
Introduction, material procurement process in construction organization, materials management functions, inventory management
The term ‘materials’ is used in a general sense and refers to the whole range of goods and services that are purchased or otherwise procured from sources outside the organization and are used or processed in order to provide finished products for sale. One can notice a fundamental difference in materials management in a factory-like situation and a construction project-situation. In a factory situation, products are standardized, the manufacturing location and process are permanent, and, as such, long-term planning is possible. Further, increase in input costs of materials can be passed on to the customer through increase in sales price of the end products. However, as has been repeatedly pointed out in the text, each construction project is unique in content and nature of execution. Project locations are transient and temporary, and the cost is predetermined at the start of the project, which calls for utmost care in material procurement in order to ensure that cost provisions are not overrun. Materials account for a large fraction of overall construction project cost.
A typical construction project requires a variety of materials. Materials in a project are broadly classified under capital equipments, construction machineries, and consumables. Some companies classify their materials under two broad categories—capital items and revenue items. Plant and machinery, vehicles, office equipment, land and buildings are placed under capital items, while non-capitalized items, heavy tools and tackles, small tools, consumables, electrical items, construction materials, special/one-time items, and spares are designated under revenue items.
The importance of materials management can be gauged from the fact that in any typical building project the share of material costs is about 55 per cent; labour costs, about 25 per cent; and POL (petrol, oil and lubricants), overheads, tax components and profits, about 5 per cent each. Thus, materials management occupies an important place in construction management and in recent times has received considerable attention. This is due to the following major factors:
- First, a worldwide recession has had the impact of reducing sales volumes and revenues, and this has forced management to reconsider how best to lower the levels of inventory in order to maintain margins (by reducing interest and obsolescence costs).
- Secondly, the changes in manufacturing philosophy, specifically the growth in just-in-time (JIT) applications, have reduced the need for inventory as an insurance buffer within the overall logistics activity.
- Thirdly, many companies have realized that a greater return on investment (ROI) can be obtained by developing the core business, and that investment in working capital items, such as inventory and debtors, returns far less in comparison.
- Fourthly, developments on the information technology (IT) front have provided a potential tool to reduce the inventory.
Materials management is integrated functioning of the different sections of a company dealing with the supply of materials and other related activities, so as to obtain maximum coordination and optimum expenditure on materials. The scope of materials management is vast as it begins with ‘award of contract’ and ends with material resting at its point of use. Typically, the objectives of materials management are to:
- minimize material cost;
- procure and provide material of desired quality when required;
- reduce investment tied in inventories for use in other productive purposes and to develop high inventory turnover ratios;
- purchase, receive, transport and store material efficiently and to reduce the related costs;
- cut down costs through simplification, standardization, value analysis, import substitution, etc.;
- modify paper-work procedure in order to minimize delays in procuring material; and
- train personnel in the field of materials management in order to increase operational efficiency.
In summary, materials management aims to provide the right item of the right quality, in the right quantity, at the right price, at the right place, and at the right time for ensuring uninterrupted execution of works.
Empirical evidence strongly suggests that materials management activities are either not being practiced or being practiced ineffectively in the construction industry. ‘Not being able to get material’ and ‘not being able to get the right tool’ are commonly heard complaints on the site. In fact, research indicates that as much as one-third of the worker’s time is spent waiting for the right materials or tool to perform a construction task. ‘Unavailability of materials and tools’ may act as a major demotivator to workers’ performance on a typical construction site. The result is reduced productivity and delay in project. It is the responsibility of the construction manager to make sure that the right material and the right tool are available to the worker.
Muehlhausen (1987) points out some of the reasons for poor materials management practices adopted by construction contractors:
- Senior management of construction firms do not recognize the impact that materials management has on the cost-effectiveness of their project operations.
- Personnel performing related materials management activities have not been properly selected and trained.
- Computerized systems related to materials management activities have not been properly selected, designed, or used to provide needed information for management and control.
The problem of low worker productivity and unreasonable construction project cost due to unavailable materials at the time and place of need will continue until construction managers have learnt how to manage the flow of materials to and through the construction site.
It can be appreciated that one of the areas of great concern today is the effective utilization of our planet’s limited resources. This has led to a renewed understanding of the need for new and efficient construction materials, and the re-use and recycling of materials from existing facilities.
Reconstruction and replacement of an ageing infrastructure will place increased emphasis on the development of new and/or improved materials for use in pavements, bridges, water and electrical distribution facilities, buildings and other structures. Management skills and analytical tools are needed to effectively utilize the multitude of resources required for the completion of a construction project.
In this chapter, various issues related to materials management have been highlighted. These include material procurement process in construction organization, different functions of materials management, management of inventory, inventory-related costs, functions of inventory, classification of inventory systems, selective inventory control, and inventory models. It is envisaged that by following these principles, one may be able to manage the materials function effectively within the construction industry.
11.2 MATERIAL PROCUREMENT PROCESS IN CONSTRUCTION ORGANIZATION
In the context of a large construction organization, having countrywide domestic as well as overseas operations, the set-up for performing materials management function can be quite big. For an organization that has regional offices throughout the country and a head office in a major metropolitan of the country, the materials management department is normally headed by a person of vice president cadre and he or she is supported by a general manager. The general manager is overall in charge of central materials department and regional materials department. The responsibilities of central materials department are:
- to procure high-value materials centrally for different regions;
- to arrange for their transport to respective regions;
- to exercise inventory control;
- to enter into rate contract for frequently used construction materials such as cement, steel and plywood at organization level;
- to develop computerized procedures;
- to procure capital equipments and to arrange for their maintenance;
- to supply raw materials to company’s manufacturing units, if any, and to cater to material needs of overseas projects;
- to import construction materials depending on the requirement of projects;
- to gather management information system (MIS) reports and their analyses;
- to standardize and codify the construction materials; and
- to dispose of the waste and scrap materials.
The regional materials department arranges for different construction materials for different projects falling in their jurisdiction. The department arranges for the transport of materials to different projects, manages inventory at regional level, enters into rate contract for the projects falling in the region, assists projects to develop computerized materials management procedures, and arranges for the maintenance of the capital equipment being utilized in the region.
A number of people are involved in the materials procurement process. For example, in a large construction organization, the project manager is by and large responsible for materials management. The planning engineer and the materials engineer are responsible for preparing the materials schedule, sending the requisition for the materials, monitoring and control of materials consumption at projects, comparing the tender provision and actual cost of materials, and so on. For selection of sources, especially for procurement of materials of natural origin such as aggregate and stones, the quality control engineer is responsible. The quality engineer is responsible for sampling and testing of materials received at project sites as also for checking their conformance with the specification. The stores in-charge is responsible for follow-up with the vendors, receiving and issuing the right materials, and so on.
After the contract is awarded to a construction organization, the planning engineer in association with the materials engineer prepare a materials schedule, and lists out the important materials and the departments responsible for their procurement. In a large organization having countrywide and overseas operations, materials are purchased at head-office level, regional- or branch-office level and project-site levels. The materials engineer in consultation with the planning engineer fills up the requisition for desired materials giving all the details such as quantity required, schedule of procurement, specification of materials, drawings, list of approved manufacturers/suppliers, and so on. The requisition in most of the cases needs approval from higher authorities at the project site or regional office, and is forwarded to the procurement or materials department, which may be located at regional office, head office, or project site itself, as the case may be.
At the regional- or head-office level, it is ascertained whether the requested material pertains to (a) rate contract items, (b) standard price-list items, or (c) other items. In case of rate contract items, purchase order is released as per the existing rate contract, and for standard price-list items the purchase order is placed with agreed discount. For other items, suitable vendors are identified, enquiries are sent with all the details received from project sites, and price offers are received from suppliers. The price offers are compared and evaluated; a structured negotiation takes place with a few suppliers; and the purchase order is issued to the most eligible supplier. The materials supplied by the supplier is dispatched to the project sites, which inspect, receive and dispatch the material receipt note to the concerned office from where the materials have been procured. Payment is released to the vendor after the materials receipt note has been received from the project sites.
11.3 MATERIALS MANAGEMENT FUNCTIONS
The functions involved in materials management are described below.
11.3.1 Materials Planning
The site-planning engineer is responsible for this function. Normally, purchase of any material is initiated by requisitioning for it. In order to have proper control on material purchase, it is a good idea to have some specific engineer approving the material requisition. The site-planning engineer makes a purchase requisition in consultation with the construction manager, following which the material is procured by administrative people (mainly stores people). Materials schedule should be the basis for raising material requisitions. Materials planning involves identifying materials; estimating quantities; defining specifications; forecasting requirements; and locating right sources for procurement.
Before procurement, the site-planning engineer along with the materials engineer survey the local market and identify the items that are to be procured locally and those that are to be procured from the head office under centralized procurement system.
Local procurement should be kept to the minimum and, as far as possible, limited to non-engineered items and consumables. The advantages and disadvantages of centralized and local purchasing are given in Table 11.1.
Table 11.1 Advantages of centralized and local purchasing (George Stukhart 1995)
For items that are required from head office (centralized purchasing), an authorized purchase request is sent to head materials manager, who will coordinate with the site materials engineer and organize for the items. Head materials manager and site materials engineer ensure that procurement is as per the terms and conditions of the contract. Early and late procurement of materials can be the two approaches to material procurement. The advantages and disadvantages of these approaches are given in Table 11.2 and Table 11.3.
11.3.3 Custody (Receiving, Warehousing and Issuing)
The main documents used are—inward register, material receipt note (MRN), delivery challan (DC), indent, dispatch covering note, outward register, loan register, repair register, and plant and machinery movement register. The functions of warehousing cover receipt, inspection, storage, issue/dispatch, materials accounting, valuation and insurance.
Table 11.2 Advantages and disadvantages of early procurement
Table 11.3 Advantages and disadvantages of late procurement
11.3.4 Materials Accounting
The main purpose of materials accounting is monitoring inflow and consumption of raw materials. Material accounting involves materials stock accounting; materials issues and returns accounting; monthly stocktaking of selected materials; and materials wastage analysis.
Material wastage analyses aims at finding the causes of wastages and rectifying them. Wastage during procurement can result from various factors—buying materials of wrong specifications; buying more than the actual requirements; unnecessary buying of items to cater for unrealistic and unforeseen eventualities; untimely buying of short-life materials; improper and unnecessary handling of materials; and wastage while transportation. Some other reasons of wastage of materials are breakages and damages during handling; lack of pre-work preparation and coordination; inferior quality of materials; improper accounting and poor storekeeping; negligent and careless attitude of the supervisor; unforeseen circumstances like accidents, fire, etc.; high rate of deterioration due to long storage at the place of work; over-issues from the central stores and failures to return unused surplus materials; and thefts and pilferage.
Construction materials used at project sites undergo considerable movement right from their point of origin to storage point, to the actual point of consumption. In some construction companies, materials are first received in central stores, from where they are dispatched to the project stores located at project sites and then finally to the workplace. The construction materials could be in the form of raw materials such as aggregate, sand and plywood, or they may be in semi-finished form such as mixed mortar, mixed concrete and dressed stones. In general, raw materials procurement is within the scope of materials management team, while the procurement of semi-finished material comes under the purview of construction team. Proper care should be taken while planning for transportation of raw and semi-finished materials so as to avoid any adverse effect on the characteristics or performance of materials.
11.3.6 Inventory Monitoring and Control
Inventory may be defined as ‘usable but idle resource’. If resource is some physical and tangible object such as materials, then it is generally termed as stock. Thus, stock and inventory are synonymous terms, though inventory has wider implications. It is very important to have a check on the inventory level. Scientific inventory management is an extremely important problem area in the materials management function. Materials account for more than half the total cost of any business, and organizations maintain a huge amount of stocks, though much of this could be reduced by following scientific principles. Inventory management is highly amenable to control. Across industries, there is a substantial potential for cost reduction through inventory control. Inventory being a symptom of poor performance, one can reduce inventories through proper design of procurement policies by reduction in the uncertainty of lead times by variety reduction and in many other ways.
The financial implications of inventory as an element of the company’s assets must be understood properly. The following reasons could be used to justify inventory:
- Improves customer service
- Permits purchase and transportation economies, the argument here being based on the notion that both product procurement and transportation costs will be reduced if lot sizes are large
- Hedges against price changes: One can observe the tendency to hoard commodities in anticipation of price rise just before the budget (in the months of January/February in the Indian context)
- Protects against demand and lead-time uncertainties: When there are uncertainties in the customer demand patterns and the suppliers’ replenishment lead times, it is preferable to invest in ‘safety stock’ so that services are maintained at acceptable levels to customers
- Hedges against contingencies: While there are now fewer labour disputes in most economies, fires, floods and other exogenous variables can create problems. It is argued that these will be minimized if stockholding is increased
There are a number of inventory control mechanisms such as ABC analysis (based on value of consumption), FSN analysis (based on movement from store), and VED analysis (based on necessity). Considering the importance of inventory monitoring and control, we discuss these in detail later in the text.
11.3.7 Materials Codification
Codification is an important function in materials management, especially for construction companies where thousands of different items are used all along the project duration. There are different systems of codification followed by construction organizations—namely, numeric, alphanumeric, and colour codification. As the term suggests, in numeric codification numbers are used, while in alphanumeric system both letters and numbers are used. Colour codification uses different colour schemes to codify different items. An example of numeric codification could be—3 4 06 5 12 100 (see Figure 11.1), where the first digit represents the class of material (for example, 0 may mean capital items; 1, heavy tools and tackles; 2, small tools; 3, consumables; 4, electrical items; 5, construction materials; 6, special/one-time items; 7, spares; 8, reserved for future use; and 9, miscellaneous). The second digit may represent a major group of materials; the third set of digits may represent a minor group; and so on.
Figure 11.1 Illustration of material codification
An example of alphanumeric codification used normally for equipment and spare parts could be 9 C B 6 2 0007. Here, the first digit could represent class (for example, spares); the second space, equipment category (for example, concreting equipment); the third space, equipment name (for example, batching machine); the fourth space, the make of equipment (for example, Schwing Stettor); the fifth space, the equipment model (for example, 56 m3); and the sixth space, the serial-number coding for parts.
A proper system of material codification serves the following purposes:
- proper identification of items by all departments concerned
- avoiding use of long description of items
- avoiding duplicate stocks under different descriptions
- material accounting and control
- ensuring receipt and issue documents are posted in appropriate records
- helps in mechanization of records
Computers are being used increasingly in the application of construction materials management. They find wide application in almost all the functions of materials management, including:
- forecasting the prices of materials based on past data and analysing past trends
- planning of different materials—using the construction schedule, one can work out the materials schedule quite easily using computers. This aspect was also discussed in Chapter 7. The quantity of different materials required for a project can also be worked out using computers
- developing the specification of materials—one can refer to past specifications stored in the computer and make suitable adjustments depending on the requirement of the project
- purchasing of materials—it is now possible to float enquiries for different materials online as well as invite bids from different suppliers online
- preparing a comparative statement and finalizing the supplier
- inventory control—computers can play an important role in decision-making as far as economic order quantity is concerned. An inventory analysis using different methods illustrated elsewhere can be easily performed using computers
11.3.9 Source Development (Vendor Development)
Source development is a continuous activity. As a policy, for every major item, more than one source should be identified. The vendor’s performance should be evaluated regularly and only satisfactory vendors should be encouraged.
Managing vendors or suppliers is an important issue. It is not an easy task to manage a large number of vendors. Thus, it is better to have only a manageable number of vendors. It is also necessary to develop a long-term relationship with the vendors. It has become imperative and strategically important to manage vendors by considering them as partners in the business. Initiatives such as vendor-managed inventory (VMI) can play an important role in containing and managing the costs. To trace new sources of supply and to develop cordial relations with them in order to ensure continuous, reliable and quality material supply at reasonable rates, has become an important item in the agenda of professional materials managers.
Every year, old and used items that are not economical to use have to be disposed off in a planned way. For this, the quantity and quality of materials to be disposed off should be assessed. The reusable items from the scrap can be retained for further use. The remaining scrap is disposed off either by selling it to some scrap dealer or through the process of floating enquiry, collecting quotation, and awarding to the highest bidder. Normally, while disposing off scraps, payment is collected in advance from the scrap buyer.
11.4 INVENTORY MANAGEMENT
It can be recalled that inventory is usable but idle resource. The problem of inventory management is of maintaining an adequate supply of something to meet an expected demand pattern for a given financial investment. This could be raw materials, work in progress, finished products, or spares and other indirect materials. Inventory is one of the indicators of management effectiveness on the materials management front. Inventory turnover ratio (annual demand/average inventory) is an index of business performance. A soundly managed organization will have higher inventory turnover ratio, and vice versa. Inventory management deals with the determination of optimal policies and procedures for procurement of commodities. Since it is quite difficult to imagine a real work situation in which the required material will be made available at the point of use instantaneously, maintaining inventories becomes almost necessary. Thus, inventories could be described as ‘necessary evil’.
11.4.1 Inventory-Related Cost
Inventory related cost has following broad cost components.
- Cost of carrying inventories (holding cost)
- Cost of incurring shortages (stock-out cost)
- Cost of replenishing inventories (ordering cost)
The three types of costs are the most commonly incorporated costs in inventory analysis, though there may be other cost parameters relevant in such an analysis including inflation and price discounts. These are explained in the following sections.
Cost of Carrying Inventories (Holding Cost)
This is expressed as Rs/item held in stock/unit time. This is the opportunity cost of blocking material in the non-productive form as inventories. Some of the cost elements that comprise carrying cost are cost of blocking capital (interest rate); cost of insurances; storage cost; and cost due to obsolescence, pilferage, deterioration, etc. It is generally expressed as a fraction of value of the goods stocked per year. For example, if the fraction of carrying charge is 20 per cent per year and a material worth Rs. 1,000 is kept in inventory for one year, the unit carrying cost will be Rs. 200/year. It is obvious that for items that are perishable in nature, the attributed carrying cost will be higher.
Cost of Incurring Shortages (Shortage Cost)
It is the opportunity cost of not having an item in stock when one is demanded. It may be due to lost sales or backlogging. In the case of backlogging (or back ordering), the order is not lost but is backlogged, to be cleared as soon as the item is available on the stock. In lost sales, the order is lost. Both cases are characterised by demand, penalty cost, emergency replenishment, loss of goodwill, etc. This is generally expressed as Rs/order.
Cost of Replenishing Inventories (Ordering or Set-up Cost)
This is the amount of money and efforts expended in procurement or acquisition of stock. It is generally called ordering cost. This cost is usually assumed to be independent of the quantity ordered, because the fixed-cost component is generally more significant than the variable component. Thus, it is expressed as Rs/order.
11.4.2 Functions of Inventory
As mentioned earlier, inventory is a necessary evil. It is necessary because it aims at absorbing the uncertainties of demand and supply by ‘decoupling’ the demand and supply sub-systems. Thus, an organization may be carrying inventory for the following reasons:
- Demand and lead-time uncertainties necessitate building of safety stock (buffer stock) so as to enable various sub-systems to operate somewhat in a decoupled manner. It is obvious that the larger the uncertainty of demand and supply, the larger will have to be the amount of buffer stock to be carried for a prescribed service level.
- Time lag in deliveries also necessitates building of inventories. If the replenishment lead times are positive, then stocks are needed for system operation.
- Cycle stocks may be maintained to get the economics of scale so that total system cost due to ordering, carrying inventory and backlogging is minimized. Technological requirements of batch processing also build up cycle stocks.
- Stocks may build up as pipeline inventory or work-in-progress inventory due to finiteness of production and transportation rates. This includes materials actually being worked on or moving between work centres, or materials in transit to distribution centres and customers.
- When the demand is seasonal, it may become economical to build inventory during periods of low demand to ease the strain of peak period demand.
- Inventory may also be built up for other reasons such as quantity discounts being offered by suppliers, discount sales, anticipated increase in material price, and possibility of future non-availability.
Different functional managers of an organization may view inventory from different points, leadings to conflicting objectives. This calls for an integrated systems approach to planning of inventories so that conflicting objectives can be scrutinized to enable the system to operate at minimum total inventory-related costs—both explicit costs such as purchase price as well as implicit costs such as carrying, shortage, transportation and inspection costs.
11.4.3 Inventory Policies
In this section we discuss (a) Lot size reorder point policy, (b) Fixed order interval scheduling policy, (c) Optional replenishment policy, (d) Two-bin system. In practice, there may be other policies that may be special cases of the policies mentioned or may be a combination of these policies. Some of the factors affecting the choice of an inventory policy are—the nature of the problem; the usage value of an item; and situational parameters. It is desirable to first select an operating policy before determining optimal values of its parameters.
Figure 11.2 Typical stock balance under Lot Size Reorder Point Policy
Lot size reorder point policy
The inventory status is continuously reviewed and as soon as the inventory level falls to a prescribed value called ‘reorder point’, a fresh replenishment order of fixed quantity known as EOQ is placed. This is one of the very classical types of inventory policies. The decision variables for the design of policy are Lot size and reorder point.
Figure 11.2 shows the typical stock balance under this type of inventory policy. The solid line in this figure represents the actual inventory held with a finite lead time, while the broken line shows the ideal situation if no lead time existed.
Fixed order interval scheduling policy
The time between the consecutive replenishment orders is constant. A maximum stock level (S) is prescribed and the inventory status is reviewed periodically with a fixed interval (T). At each review an order of size O is placed, which takes the stock on hand plus an order equal to the maximum stock level. The order quantity could vary from period to period. In this policy, when the level of stock on hand is high at review, a smaller-size replenishment order is placed.
The decision variables for the design of policy are S, the maximum stock level, and T, the review period
Figure 11.3 Typical stock balance under Fixed Order Interval Scheduling Policy
Figure 11.3 shows the typical stock balances under the fixed reorder cycle policy.
Optional replenishment policy
This policy is also known as (s, S) policy. The status of stock is periodically reviewed and maximum stock level (S) and minimum stock level (s) are prescribed. At the time of review, if the stock on hand is less than or equal to s, an order of size Q is placed so that stock on hand plus the order equals the maximum stock level S. If stock on hand at review is higher than s, no order is placed and the situation is reviewed at the next review period.
The decision variables for the design of policy are S, s and T.
Figure 11.4 shows the typical stock balance under this policy.
Figure 11.4 Typical stock balance under (s, S) policy
This system is simple to operate and easy to understand. There are two bins kept full of items. Item from the first bin are used first. The moment the first bin is exhausted, an order is placed for items and the second bin acts as buffer or safety cushion. Figure 11.5 shows all the stages of this system in a schematic manner which is self explanatory.
11.4.4 Selective Inventory Control
A list of items used in any typical construction can be found in Appendix 10. The appendix lists out the materials related to a typical construction project, in addition to commonly used small tools and equipments. These tools are used by craftsmen and skilled labour such as mason, carpenter, steel fitter, painter, welder, plumber and electrician. In addition, the appendix lists out general stores materials and administration and safety materials.
As is evident, there is a large variety of items stocked by a project site and applying scientific inventory control for all these items is neither feasible nor desirable. Since applying inventory control across all items may render the cost of inventory control more than its benefits, it may prove to be counter-productive.
Inventory control has to be exercised selectively. Depending upon the value criticality and usage
frequency of an item, we may have to decide on an appropriate type of inventory policy. Selective inventory control, thus, plays a crucial role so that we can apply our limited control efforts more judiciously to the more significant group of items. In selective control, items are grouped in a few discrete categories depending upon value, criticality and usage frequency. Table 11.4 shows some of the ways to make such groupings. This type of grouping may well form the starting point for scientific inventory management in an organization.
Figure 11.5 Schematic representation of different stages in Two bin system
Table 11.4 Some commonly adopted inventory-control policies
This is based on Pareto’s Law, which says that in any large group there are ‘significant few’ and ‘insignificant many’. For example, only 20 per cent of the items may be accounting for 80 per cent of the total material cost procured by a construction organization. Here, the 20 per cent constitute the ‘significant few’ that require utmost attention.
To prepare an ABC-type curve, we may follow a simple procedure:
- Different materials required for the project are identified and their estimated quantities worked out. The quantity estimate could be on the basis of either annual consumption or the project’s total requirement.
- The unit rates of materials are estimated.
- The usage values for each of the materials are obtained by multiplying the estimated quantities and their unit rates. These values are converted into percentage of total annual usage cost or total project cost, as the case may be.
- The percentage usage cost for each of the materials is arranged in the descending order of their ranking, starting with the first rank, i.e., highest to lowest usage value. The cumulative percentage usage value is also calculated.
- A curve as shown in Figure 11.6 is plotted, and points on the curve at which there are perceptible sudden changes of slopes are identified. In the absence of such sharp points, cut-off points corresponding to the top 10 per cent and the next 20 per cent or so are marked as a general indicator of A, B and C type of materials.
- According to an empirical approach, ‘A’ class items account for about 70 per cent of the usage value, ‘B’ class items for about 20 per cent of the usage value, and ‘C’ class items for about 10 per cent of the usage value. In terms of numbers, ‘A’ class items constitute about 10 per cent of total items, ‘B’ class items about 20 per cent of total items, and ‘C’ class items about 70 per cent of total items. These percentages are indicative only and can vary depending on a number of factors.
Figure 11.6 Illustration of ABC analysis
Upon classification of materials into A, B and C types, suitable inventory policies can be decided. Corresponding to each type of materials, the implications on inventory policy are mentioned below:
Item type ‘A’ The salient features are:
- accurate forecast of quantities needed
- involvement of senior level for purchasing
- ordering is on requirement basis
- enquiries for procurement need to be sent to a large number of suppliers
- strict degree of control is required, preferably monitoring on a weekly basis
- low safety stock is needed
Item type ‘B’ The salient features are:
- approximate forecast of quantities needed
- requires involvement of middle level for purchasing
- ordering is on EOQ basis
- enquiries for procurement need to be sent to three to five reliable suppliers
- moderate degree of control required, preferably monitoring on a monthly basis
- moderate safety stock needed
Item type ‘C’ The salient features are:
- no need of forecasting; even rough quantity estimate is sufficient
- junior-level staff is authorized to order purchase
- bulk ordering is preferred
- quotations from even two to three reliable suppliers are sufficient
- a relatively relaxed degree of control is sufficient, and monitoring can be done on a quarterly basis
- adequate safety stock can be maintained
This analysis attempts to classify items into three categories depending on the consequences of material stock-out when demanded. As stated earlier, the cost of shortage may vary according to the seriousness of such a situation.
Thus, the items are classified into V (vital), E (essential) and D (desirable) categories. Vital items are the most critical having extremely high opportunity cost of shortage and must be available in stock when demanded. Essential items are quite critical with substantial cost associated with shortage and should be available in stock by and large. Desirable group of items do not have very serious consequences if not available when demanded, but these can be stocked items.
Obviously, the percentage risk of shortage with the vital group of items has to be kept quite small, thus calling for a high level of service. With ‘essential’ category we can take a relatively higher risk of shortage, and for ‘desirable’ category, even higher. Since even a C-class item may be vital or an A-class item may be desirable, we should carry out a two-way classification of items grouping them in nine distinct groups as A-V, A-E, A-D, B-V, B-E, B-D, C-V, C-E and C-D. We can then determine the aimed service level for each of these nine categories and plan for inventories accordingly.
Vital group comprises those items for the want of which the production will come to a stop—for example, power in the factory. Essential group features those items for whose non-availability the stock-out cost is very high. Desirable group contains items whose non-availability causes no immediate loss of production; the stock cost involved is very less and their absence may only cause minor disruption in the production for a short time.
The steps used for classifying materials as vital, essential and desirable are given below:
Factors such as stock-out case, lead time, nature of items, and sources of supply are identified and considered for VED analysis.
Assign points or weightages to the factors according to the importance they have to the company, as shown above.
Divide each factor into three degrees and allocate points to each degree.
Prepare categorization plan to provide basis for classification of items—for example, items scoring between 100 and 160 can be classified under desirable items; items between 161 and 230 can be classified under essential items; and items between 231 and 300 can be classified under vital items.
Specify the degree and allocate weightages to all the factors.
Evaluate and find the final score for every item, and specify the type of item.
Not all items are required with the same frequency. Some materials are required quite regularly, some are required very occasionally, and yet some others may have become obsolete and might not have been demanded for years together. FSN analysis groups them as fast-moving, slow-moving and non-moving (dead stock), respectively. Inventory policies and models for the three categories have to be different. Most inventory models in literature are valid for the fast-moving items exhibiting a regular movement (consumption) pattern. Many spare parts come under the slow-moving category, which have to be managed on a different basis. For non-moving dead stock, we have to determine optimal stock disposal rules rather than inventory provisioning rules. Categorization of materials into these three types on value and critical usage enables us to adopt the right type of inventory policy to suit a particular situation.
‘F’ items are those items that are fast-moving—i.e., in a given period of time, say, a month or a year, they have been issued a number of times. However, ‘fast-moving’ does not necessarily mean that these items are consumed in large quantities.
‘S’ items are those items that are slow-moving—in the sense that in the given period of time they have been issued in a very limited number.
‘N’ or non-moving items are those that are not at all issued for a considerable period of time.
Thus, the stores department, which is concerned with the moving of items, would prefer to classify items in the categories F-S-N, so that they can manage, operate and plan stores activity accordingly. For example, for efficient operations it would be necessary that fast-moving items are stored as near as possible to the point of issue, for these to be issued with minimum of handling. Also, such items must be stored at the floor level, avoiding higher heights. Thus, if the items are slow-moving or issued once in a while in a given period of time, they can be stored in the interior of the stores and even at greater heights because handling of these
items becomes rare. Further, it is necessary for the stores in-charge to know about non-moving items for various reasons mentioned below:
- Non-moving items mean unnecessary blockage of money which affect the rate of returns of the company.
- Non-moving items also occupy valuable space in the stores without any usefulness and, therefore, it becomes necessary to identify these items and find reasons for their non-moving status. If justified, recommendation may be made to top management for their speedy disposal so that company operations are performed efficiently.
To some extent, inventory control can be exercised on the basis of FSN analysis. For example, fast-moving items can be controlled more severely, particularly when their value is also high. Similarly, slow-moving items may not be controlled and reviewed very frequently since their consumption may not be frequent and their value may not be high.
11.4.5 Inventory Models
There are a number of computer-based analytical inventory models available (such as economic order quantity [EOQ] model), most of which are able to generate economic purchase orders, shipping orders, delivery notes and invoices. Most models claim to improve management control by reducing inventory-holding costs without loss of customer service. The basic philosophy behind these models is to use a trade-off analysis by comparing the cost of inventory holding versus the cost of ordering. We are discussing one of the most popular inventory models in the following section.
Economic Order Quantity (EOQ) Model
The EOQ model provides answers on how much to order. Figure 11.7 shows the behaviour of EOQ model. The reorder point R and the quantity to be ordered, Q, are shown in the figure, as is the lead time L. The ordered quantity derived from this model is known as economic order quantity, EOQ.
Figure 11.7 Inventory behaviour under EOQ model
It is usually less expensive to purchase (and transport) or produce a bunch of material at once than to order it in small quantities. If orders for large quantities are specified, there will be fewer orders placed. For purchasing, this means that quantity discounts and transportation efficiencies may be realized. The other side of the coin, however, is that larger lot sizes result in more inventory, and inventory is expensive to hold. EOQ model attempts to specify a balance between these opposing costs. This aspect is shown graphically in Figure 11.8, where it is clear that there is a decrease in cost associated with increase in order quantity, while there is increase in cost with increase of inventory.
The total cost is given by the sum of inventory-carrying cost and ordering cost.
The following notations are used to develop the EOQ model:
D = Demand rate; unit/year
A = Ordering cost; Rs/order
C = Unit cost; Rs/unit of item
I = Inventory-carrying charges per year
H = Annual cost of carrying inventory/unit item
Q = Order quantity; number of units per lot
It is assumed that demand is at a uniform rate. Thus, the average inventory required would be throughout the year.
The total number of orders placed would be per year.
Using the notations mentioned above, we can write the expression of TC as:
For optimum Q, one needs to find the particular value of Q which will minimize total cost. This can be done by differentiation, and one gets:
Some of the observations that are clear from the above expressions are:
- The more the demand per year, the larger the order quantity.
- The higher the order cost, the larger the order quantity.
- The more expensive the item, the smaller the order quantity.
- The higher the carrying cost, the smaller is the order quantity.
The derivation of EOQ is based on a number of assumptions such as:
- Demand is deterministic and continuous at a constant rate.
- The process continues infinitely.
- No constraints are imposed on quantities ordered, storage capacity, budget, etc.
- Replenishment is instantaneous (the entire order quantity is received all at one time as soon as the order is released).
- All costs are time-invariant.
- There are no shortages of items.
- The quantity discounts are not available.
- There is negligible or deterministic lead time.
The above assumptions mean that there is no uncertainty and one is able to predict the demand and the constancy of cost parameters such as item cost, carrying rate, or ordering cost. In real life, however, all these assumptions may not hold good.
In case the lead time is varying, one has to keep safety stock or buffer stock. Normally, the service level that is expected will decide the safety stock. If one keeps a very small quantity as safety stock, there is a danger that stock-out may occur. On the other hand, large safety or buffer stock may result in large inventory-carrying cost. Thus, safety stock will be decided based on the service level desired. The following relations are important and should be noted.
- Reorder Point = Demand or usage per period × Lead time (11.8)
- Average Inventory Carried = + Safety Stock (11.9)
- Transit Inventory = Days in transit × Inventory carried per day (11.10)
- The higher the lead time, the more will be the safety stock, and vice versa. In general, the safety stock varies with the square root of lead time (assuming all other factors as constant). For example, if the lead time for an item is reduced by a factor of 4, then the safety stock will be reduced by a factor of 2 (i.e., ().
Effect of Uncertainty in Demand
Generally, demand is never uniform all throughout the year. In case, the demand has a mean Dm and standard deviation σd, the reorder point is expressed as given below:
Where, Z is standard normal variate for a given service level. In order to find the value of Z, one can use normal distribution table provided in Appendix 5 of the text. For ready reference, values of Z for some commonly used service levels are given in the Table 11.5. The service level is the probability of having material in stock when demand of this material occurs in a construction project.
Table 11.5 Values of Z for different service levels
A shop dealing in construction goods has seven different items in its inventory. The average number of units of each of these items held in the store along with their unit costs is given in Table Q11.1.1. The shopkeeper has decided to employ ABC inventory system. Classify the items in A, B and C categories.
Table Q11.1.1 Data for Example 11.1
|Average cost per unit in inventory (in Rs.)|
From Table S11.1.1, it is clear that total number of units stored in the shop is 200,000 and the cost is equal to Rs 32.025 lakh. The total cost of inventory is worked out by summing up the cost of storing the given numbers of all the seven items. The percentage share of each item and cost are calculated as shown in Table S11.1.1. From these two values, cumulative percentage values are worked out.
Table S11.1.1 Computation details for Example 11.1
Figure S11.1.1 Cumulative percentage of cost and cumulative percentage of numbers for Example 11.1
A graph as in Figure S11.1.1 is drawn between cumulative percentage of cost and cumulative percentage of numbers. From the graph, it is clear that about 70 per cent cost is consumed in 10 per cent of the inventory items. These are for items 1 and 2. Thus, items 1 and 2 are Class ‘A’ items. Similarly, items 3 and 4 have a cost share of about 20 per cent (89.9 per cent – 69.2 per cent) and an inventory share of 20 per cent. Thus, items 3 and 4 are Class ‘B’ items. Finally, we can see that items 5, 6 and 7 belong to Class ‘C’ as their cost share is about 10 per cent (100 per cent – 89.9 per cent) and inventory share is 70 per cent.
A construction company stores various items (see Table Q11.2.1) in the central stores. The average annual consumption and cost per unit of items stored are given. Classify the items using ABC analysis.
Table Q11.2.1 Data for Example 11.2
|Name of the item||Average annual consumption (No.)||Average cost
per unit (Rs.)
Table S11.2.1 Computation details for average annual cost of consumption (Example 11.2)
The computations of average annual cost consumption of different items have been performed in Table S11.2.1. The ranking based on the average annual cost of consumption has also been performed.
Now, we prepare Table S11.2.2 in the descending order of average annual cost of consumption. The average annual cost in percentage of total annual cost is computed. The cumulative value of this percentage is also computed.
A graph as in Figure S11.2.1 is drawn. From the graph, it is clear that about 70 per cent cost is consumed by items c, f & a. Thus, items c, f & a are Class ‘A’ items. Similarly, items g, b & h have a cost share of about 20 per cent. Thus, items g, b & h are Class ‘B’ items. Finally, we can see that items d, k, j, i, e & l belong to Class ‘C’ as their cost share is about 10 per cent.
Table S11.2.2 Computation details for A,B,C classification (Example 11.2)
Figure S11.2.1 Illustration of A, B, C Classification for example 11.2
A construction material trading company receives a total of 200 t as annual demand for steel reinforcement. The annual cost of carrying per-unit t of reinforcement is Rs. 2,000, and the cost to place an order is Rs. 25,000. What is the economic order quantity?
The economic order quantity is computed using the expression
Thus, economic order quantity 5 70.7 t per order.
A construction company purchases 10,000 bags of cement annually. Each bag of cement costs Rs. 200 and the cost incurred in procuring each lot is Rs. 100. The cost of carrying is 25 per cent. What is the most economic order quantity? What is the average inventory level?
Given, Unit item cost (C) = Rs. 200
Ordering cost = Rs. 100 per order
Annual usage = 10,000 units
Carrying rate = 25%
To find, EOQ
Hence, the order quantity will be 200 units and on an average, 200/2 = 100 units in inventory will be carried.
For Example 11.4, if the lead time of procuring cement is two weeks, determine the reorder point.
The lead time given is two weeks. So, the weekly usage is 10,000 units/52 weeks = 192 units. The reorder point will be = 192 units × 2 weeks = 384 units. That is, place an order for cement whenever the stock reaches the level of 384 units. The order quantity will be 200 units.
1. Chitkara, K.K., 2006, Construction Project Management: Planning, Scheduling and Controlling, 10th reprint, New Delhi: Tata McGraw-Hill.
2. Gopalkrishnan, P. and Sundaresan, P., 1996, Materials Management: An Integrated Approach, New Delhi: Prentice-Hall of India.
3. Mohanty, R.P. and Deshmukh, S.G., 2001, Essentials of supply chain management, New Delhi: Phoenix Publishers.
4. Muehlhausen, F.B., 1987, ‘Materials management model for construction management curriculum development’, ASC Proceedings of the 23rd Annual Conference, Purdue University, West Lafayette, Indiana, USA.
5. Naddor, E., 1986, Inventory Systems, New York: Wiley.
6. Stukhart, G., 1995, Construction Material Managementuc, Marcel Dekker.
- State whether True or False:
- Construction materials account for a large fraction of overall construction project cost.
- Materials are classified broadly into capital items and revenue items.
- Functions involved in material management are—materials planning, procurement, custody (receiving, warehousing and issuing), materials accounting, transportation, inventory monitoring and control, and materials codification.
- Costs related to inventory are holding cost, stock-out cost and ordering cost.
- Commonly used inventory-control policies are ABC analysis, VED analysis and FSN analysis.
- EOQ inventory model aims to provide an answer to how much to order—i.e., it fixes the trade-off between ordering cost and carrying cost.
- Discuss the importance of inventory management in material management.
- What are the different functions of material management?
- What are the advantages and disadvantages of centralized and local purchasing?
- What are the advantages and disadvantages of early and late procurement?
- What are the benefits of proper classification of materials?
- Discuss the role of vendor management in material management.
- What are the inventory-related costs? What are the functions of inventories?
- How do we classify different inventory systems?
- Discuss different inventory-control policies.
- Differentiate between ABC analysis, VED analysis and FSN analysis.
- Why are inventory models needed? Discuss EOQ model.
- Collect consumption data for 100 different items for an organization and classify these into an ABC framework. List these items in a two-way classification, ABC and VED, and identify the number of items belonging to each of these nine distinct groups.