CHARACTERISTICS OF SERVICE

A service is any activity or benefit that one party can offer to another that is essentially intangible and
does not result in the ownership of anything.
Services do not always emerge out of physical products. When somebody rents a hotel room, deposits
money in a bank, travels on an airplane, visits a physician, gets a haircut, gets a car repaired, watches
a professional sport, watches a movie, and gets advice from a lawyer, he/she buys a service.
When designing marketing programs, a company must consider the characteristics of services.

Four characteristics of service are;

INTANGIBILITY,
INSEPARABILITY,
VARIABILITY AND
PERISHABILITY.
Intangibility – Services Cannot Be Felt Before Buying.

Services are intangible in nature. It means that services can not be seen, tasted, felt, heard, or smelled
before they are bought.
For example, an airline passenger has only a ticket and the promise of a safe and comfortable journey.
As the buyers are interested in service quality, the service provider must add tangible dimensions. The
place, price, equipment, and communication material must indicate the service quality as claimed by
the service provider.
Consider a bank that wants to convey the idea that its service is quick and efficient. It must make this
positioning strategy tangible in every aspect of customer contact.
The bank’s physical setting must suggest quick and efficient service: Its exterior and interior should
have clear lines; internal traffic flow should be planned carefully; waiting for lines should seem short
at teller windows and ATMs, and background music should be light and upbeat. The bank’s staff
should be busy and properly dressed.
The equipment – computers, copy machines, desks – should look modern. The bank’s ads and other
communications should suggest efficiency, with clean and simple designs and carefully chosen words
and photos that communicate the bank’s positioning.
The bank should choose a name and symbol for its service that suggest speed and efficiency. It is
pricing for various services should be kept simple and clear.

Inseparability – Services Are Generated and Consumed Together.

Inseparability is a major characteristic of services. It means that services are generated and consumed
simultaneously and can not be separated from their providers, whether they are people or machines.
As the customer remains present as the service is produced, provider customer interaction is important
in services marketing. The result of services is affected by both the provider and the customer.

Variability – Service Quality Never Stay The Same.

Variability is another important characteristic of services, which means that their quality may vary
greatly, depending on who provides them and when, where, and how they are provided.
For example, the Sheraton hotel has a reputation for providing better service than others.
One employee may be cheerful and efficient within a particular Sheraton hotel, while another may be
unpleasant and slower. Even the quality of a single Sheraton employee’s service varies according to
his or her energy and the state of mind at the time of each customer dealing.
Service variability can be managed in several ways. Employees can be selected and trained carefully
to provide good service. Employee incentives can be introduced that emphasize service quality.
Customer satisfaction can be checked regularly through suggestion and complaint systems, customer
surveys, and comparison shopping.

Perishability – Services Cannot Be Stored.

Services are perishable, which means that services cannot be stored for later sale or use. A ticket for
the evening show of a movie cannot be used for watching the night show.
The perishability of services has important implications for service providers. In the case of steady
demand, perishability is not a problem.
But where demand fluctuates, service providers face adjustment problems.
For example, public transportation companies have to own much more equipment then they would as
demand is not ever throughout the day.
Service providers can several steps to make better demand-supply adjustments.
Different prices can be charged at different times on the demand side, which will shift some demand
from peak periods to off-peak periods. On the supply side, part-time employees can be hired to cater
to peak demand.
Comparison Chart

BASIS FOR
GOODS SERVICES
COMPARISON

Meaning Goods are the material items that can Services are amenities, facilities,
be seen, touched or felt and are ready benefits or help provided by
for sale to the customers. other people.

Nature Tangible Intangible

Transfer of Yes No
ownership

Evaluation Very simple and easy Complicated

Return Goods can be returned. Services cannot be returned back

once they are provided.

Separable Yes, goods can be separated from the No, services cannot be separated
seller. from the service provider.

Variability Identical Diversified

Storage Goods can be stored for use in future Services cannot be stored.
or multiple use.

Production and There is a time lag between production Production and Consumption of
Consumption and consumption of goods. services occurs simultaneously.
List of different types of service sectors in India.
The sectors are:-
1. Trade
2. Tourism, Including Hotels and Restaurants
3. Shipping
4. Port Services
5. Storage Services
6. Telecom and Related Services
7. Real Estate Services
8. IT Services
9. Accounting and Auditing Services
10. Research & Development Services (R&D)
11. Legal Services
12. Consultancy and
13. Construction.

And also glance over the below given article to get an idea about the importance
of service sectors in Indian economy and its role in economic development.

Factors affecting Designing Service Process

Designing a service process system involves a careful consideration of factors related to services.
Various issues such as location, facility design, and layout for effective work flow procedures and job
definitions for service providers, customer involvement, equipment selection, etc., should be decided
while designing service process. Apart from these, the following factors should be considered in the
process design and implementation.
The service itself,
Customer participation in the process,
Location of service delivery,
Level of customer contact,
Degree of Standardization,
Complexity of the service.

1. The Service itself

The importance of the actual process in service delivery is being recognized of late. By employing
some principles, the service and delivery process can be designed, implemented and monitored. The
service itself is dependent upon its process. Even intangible services such as legal representation,
equipment-based services (services through vending machines, ATM) etc., are dependent upon their
process. While designing a service, it is necessary for the service provider to carefully understand the
process on which the service is dependent.

2. Customer Participation in the Process

The presence of the customer is a must when some services are being performed. The consumer is a
part of the production process and there is a close interaction between the service provider and the
consumer.
For example, services in a self service restaurant, hair dressing saloon, beauty parlours, etc., necessitate
the participation of customers in the production process.
Sometimes, the customer instead of being a passive bystander acts as productive labour if needed.
Customer participation enhances the degree of customization.
For example, the education service rendered by a college would depend upon the quality of student
participation in the programmes offered by the college. Through customer participation, the service
provider identifies the impact the receiver of the benefit has on the service.
3. Location of Service Delivery
The issues related to accessibility and availability of services are crucial. Priority must be given in
decisions about location of premises and services distribution. Provision of service may take place at
the service provider’s premises or at the customer’s home.
For example, air conditioning and plumbing services should be provided at the customer’s home, while
dry cleaning of clothes is carried out at service provider’s outlet.
Public services such as telephone, banking, insurance etc., should be easily accessible to the customers.
Generally, the service provider should choose to provide a location convenient to the customers.

4. Level of Customer Contact

The physical presence of the customer in the system is called customer contact. The level of customer
contact can be calculated from the amount of time a customer spends in the system compared to the
total system.
The level of contact with customers largely depends upon the type of service received. From this point
of view, a service may be high-contact service or low-contact service. Where performance of a service
is fully based on equipment (automatic weighing machines, ATM, public telephone), the level of
contact between the customer and service provider is nil.
In case of professional and medical services, the level of contact is very high. The service system
should be planned according to high contact and low contact operations in order to achieve overall
service quality.

5. Degree of Standardization
The services may be standardized services or customized services. In case of standardized services,
services are delivered in a very standard format. A standardized service is generally, designed for high
volumes with a focused service.
For example, pre recorded messages provided by telephone companies.
The tasks involved in standardized services require a workforce with relatively low levels of technical
skill. Service providers deviate from the standard to meet the needs of different customers. This is
called divergence. Customized services involve high divergence where flexibility and judgement are
called for on the part of the service provider. He interacts with the customers in order to identify the
needs of latter.
The interaction between the service provider and customer may be in terms of resources facility such
as expertise, skill, attention, attitudes, personnel, space, cleanliness etc. In other words, interaction is
more between the customer and the employees of the service provider. Provision of customized
services requires high levels of technical skill. Generally, customized services are unprogrammed and
not well defined before they are provided.
For example, counseling of students, house decoration, tailoring etc.

6. Complexity of the service

Complexity refers to the amount of steps involved in delivering services to customers. So, the degree
of complexity can be measured on the basis of the number of activities which contribute towards the
service delivery. Some services are high in complexity as well as high in divergence.
For example, a doctor’s service is highly complex and highly divergent. Every case history of the
patient is so different, yet they always diagnose correctly. But catering services are high in complexity
and low in divergence.
 The
SERVQUAL
Model
 Introduction
• Service quality is an approach to manage business processes in
order to ensure full satisfaction of the customers & quality in
service provided. It works as an antecedent of customer
satisfaction.
• If expectations are greater than performance, then perceived
quality is less than satisfactory and hence customer dissatisfaction
occurs.
• SERVQUAL is a service quality framework, developed in the
eighties by Zeithaml, Parasuraman & Berry, aiming at measuring
the scale of Quality in the service sectors.
• SERVQUAL was originally measured on 10 aspects of service
quality: reliability, responsiveness, competence, access, courtesy,
communication, credibility, security, understanding the customer,
and tangibles, to measure the gap between customer
expectations and experience.
 SERVQUAL as a Measuring Tool
• In 1988 the 10 components were collapsed into five dimensions
(RATER). Reliability, tangibles and responsiveness remained
distinct, but the remaining seven components collapsed into two
aggregate dimensions, assurance and empathy.
• Parasuraman et al. developed a 22-scale instrument with which to
measure customers’ expectations and perceptions (E and P) of the
five RATER dimensions. Four or five numbered items are used to
measure each dimension.
• The instrument is administered twice in different forms, first to
measure expectations and second to measure perceptions.
Dimensions Scale
Reliability 4
Assurance 5
Tangibles 4
Empathy 5
Responsiveness 4
 The Key Service Dimensions
• The five SERVQUAL dimensions are: R-A-T-E-R:
1. RESPONSIVENESS - Willingness to help customers and
provide prompt service
2. ASSURANCE - Knowledge and courtesy of employees
and their ability to convey trust and confidence
3. TANGIBLES - Appearance of physical facilities,
equipment, personnel, and communication materials
4. EMPATHY - Caring, individualized attention the firm
provides its customers
5. RELIABILITY - Ability to perform the promised service
dependably and accurately
Conceptual Model of Service Quality

 GAP 1: Not knowing

what customers expect

 GAP 2: wrong service

quality standards

 GAP 3: The service

performance gap

 GAP 4: promises do not

match actual delivery

 GAP 5: The difference

between customer
perception and
expectation
 The SERVQUAL Gaps
Management Expected

Gap 1 Perceptions
of Customer
Expectations
Service

• Commonly known as the management perception gap

• Gap 1 results from a difference between what customers
expect and what management perceives these
expectations to be.
• It indicates a problem with the understanding of the
market. This can occur, as a result of insufficient research
or communication failures.
• E.g. : Management of ABC Dry cleaning Ltd perceives that
a particular segment simply expects low prices on its
service, when in fact, the expectation is a value-for-
money service.
 The SERVQUAL Gaps
Service Management

Gap 2 Quality
Specifications
Perceptions
of Customer
Expectations

• Commonly known as quality specification gap.

• Gap 2 results from a difference between management
perceptions of what customers expect and the
specifications that management draws up when detailing
the service quality delivery actions that are required.
• Service design and performance standards are pre-
requisites for bridging this gap.
• E.g. : Most hotels do not do housekeeping in a room on
the day the customer is checking out. But has
management realised that the customer who is doing a
late checking out wants a clean room during that day?
 The SERVQUAL Gaps
Gap 3 Service
Delivery
Service
Quality
Specifications
• Commonly known as the Service delivery gap.
• Gap 3 results from a mismatch between the service delivery
specifications required by management and the actual service that is
delivered by front line staff.
• It is the difference between customer-driven service design &
standards, and the service delivery of the provider.
• Managers need to audit the customer experience that their
organization currently delivers in order to make sure it lives up to the
expected level.
• E.g. : Usually, all restaurants need to attend to every request and
orders of the customers. But very often when customers place
orders, they either do not receive the orders at all or the waiter has
confused it with that of another customer.
 The SERVQUAL Gaps
Gap 4 Service
Delivery
External
Communications
to Customers
• Commonly known as market communication gap.
• This is the gap between the delivery of the customer experience
and what is communicated to customers, i.e. the discrepancy
between actual service and the promised one
• All too often organizations exaggerate what will be provided to
customers, or discuss the best case rather than the likely case,
raising customer expectations and harming customer
perceptions.
• E.g. A company commercialising slimming products boasts that
customers may lose up to 4-5 kgs/week. But they do not specify
that a strict diet and regular exercise must accompany the
treatment for it to have the desired effect.
 The SERVQUAL Gaps
Gap 5 Expected
Service
Perceived
Service
• Commonly known as the perceived service quality gap.
• Gap 5 may be identified as the overall difference between
the expected service and the perceived service
experienced. Gap 5 results from the combination of Gaps 1
to 4
• Customers' expectations have been shaped by word of
mouth, their personal needs and their own past service
experiences.
• Unless Gap 5 is kept under check, it may result in lost
customers, bad reputation, negative corporate image.
 Causes for the Gaps
GAP 1 - not knowing what customers expect
E.g. : XYZ Events Ltd organised a wedding with the usual
white and blue decorations, when the customer had
expected something new and original.
Causes:
• Lack of a marketing orientation to quality
• Poorly interpreted information about customer’s
expectations
• Research not focused on demand quality
• Too many layers between the front line personnel &
• top level management
 Causes for the Gaps
GAP 2 - The wrong service quality standards

E.g. : XYZ Events Ltd perceived that the customer wanted a

very nice reception with at least 2 waiters at each table, but
management eventually decided otherwise to reduce costs.

Causes:
• inadequate commitment to service quality
• lack of perception of feasibility
• inadequate task standardization
• the absence of goal setting
• Insufficient planning of procedures
 Causes for the Gaps
GAP 3 - The service performance gap
• E.g. : XYZ Events Ltd had promised the most exquisite
catering and wedding cake, but the food was not
appreciable and the bride didn’t like the cake at all.
Causes:
• Poor employee or technology fit - the wrong person or
wrong system for the job
• Deficiencies in human resource policies such as
ineffective recruitment, role ambiguity, role conflict
• Failure to match demand and supply
• Too much or too little control
• Lack of teamwork within the organisation
 Causes for the Gaps
GAP 4 - When promises do not match actual delivery
E.g. : XYZ Events Ltd promised to have a Mercedes limousine
for the entry of the groom, but eventually the latter was
given a simple Nissan Sunny.
Causes:
• inadequate horizontal communication
• Over-promising in external communication campaign
• Failure to manage customer expectations
• Failure to perform according to specifications given to
customers
 Causes for the Gaps
GAP 5 - The difference between customer perception of
service and the expectation they had
Usually the cause is the occurrence of the 4 other Gaps, which
results in a difference between customer perception and the
expectation they had. Ultimately the groom’s experience was
way too far from what he had expected, and thus results in
dissatisfaction.
Other causes can be:
• cultural background, family lifestyle, personality,
• demographics, advertising, experience with similar service
• information available online
 Solution for the Gaps
No Solutions as such, but rather, measures that can be taken to minimize the gaps
Gap Definitions Measures
1 Customers’ expectations Use of good Customer Relationship Management Techniques to profile & know
versus management customer’s expectations, tastes and needs
perceptions E.g: XYZ Events Ltd should conduct sample surveys to know what customers expect
nowadays
2 Management perceptions Managers need to make sure the organization is defining the level of service they
versus service specifications believe is needed.
E.g.: XYZ Events Ltd could have offered pre-set wedding packages at different prices
with different services set.
3 Service specifications versus Managers need to audit the customer experience that their organization currently
service delivery delivers in order to make sure it lives up to the expected level.
E,g.: XYZ Events Ltd needs to ask customers to give their post experience feedbacks

4 Service delivery versus Use of good Communication skills and avoid ambiguous or fraudulent terms to
external communication: confuse or mislead the customer.
E.g.: XYZ Events Ltd should clearly inform the customer about something that will
not be possible to implement
5 The discrepancy between Application of all the above measures to make sure the service delivered meets the
customer expectations and expectations of the customer
their perceptions of the
service delivered
 Criticisms to SERVQUAL
• It has been criticized that SERVQUAL's 5 dimensions (RATER)
are not universals, and that the model fails to draw on
established economic, statistical and psychological theory.
• There is little evidence that customers assess service quality
in terms of Perception / Expectation gaps.
• SERVQUAL focuses on the process of service delivery, not
the outcomes of the service encounter.
• There is a high degree of intercorrelation between the five
RATER dimensions, thus the scores obtained cannot be
exact.
 SERVQUAL; Good or Bad???
• SERVQUAL “remains the most complete attempt to
conceptualize and measure service quality” – Nyeck, et al.
(2002)
• The main benefit to the SERVQUAL measuring tool is the
ability of researchers to examine numerous service industries
such as healthcare, banking, financial services, and education
• Nyeck et al. (2002) reviewed 40 articles that made use of the
SERVQUAL measuring tool and discovered “that few
researchers concerned themselves with the validation of the
measuring tool”, which means it is well anchored as a trusted
model.
• Service Quality is widely regarded as a driver of corporate
marketing and financial performance
 Advantages of Disadvantages of
SERVQUAL SERVQUAL
• Enables assessing service quality  The uniform applicability of the
from the customer’s perspective method for all service sectors is
• We can track customer difficult.
expectations and perceptions
over time, together with the  The use of expectations in
discrepancies between them measuring service quality has
currently come under a lot
• Servqual enables comparison to of criticism.
competitors on common aspects
 Does not measure service
• We can assess the expectations outcome perceptions.
and perceptions of internal
customers – e.g. other
departments or services we deal
with.
 Methodology of SERVQUAL
• The method essentially involves conducting a sample survey of
customers so that their perceived service needs are understood.
• For measuring their perceptions of service quality for the
organization in question, customers are asked to answer
numerous questions within each dimension that determines:
• The relative importance of each attribute.
• A measurement of performance expectations that would relate to
an “excellent” company.
• A measurement of performance for the company in question.
• This provides an assessment of the gap between desired and
actual performance.
• This allows an organization to focus its resources where necessary
and to maximize service quality whilst costs are controlled
 Uses of SERVQUAL
• To assess a company's service quality along each of the 5 SERVQAL
dimensions. E.g. XYZ Events Ltd carries out the servqual survey to
know where it stands in the perception of customers.
• To track customer's expectations and perceptions over time. E.g.
XYZ Events Ltd wants to compare its score of last year against that
of the current year to know whether it has improved or has to
improve
• To compare a company's SERVQUAL scores against competitors.
E.g.: XYZ Events Ltd wants to compare its score against that of
1570 Events Ltd to see who is the best.
• To identify and examine customer segments that differ
significantly in their assessment of a company's service
performance.
• To assess internal service quality (interdepartmental comparison)
 Applications of SERVQUAL
• Service quality has become an important research topic
because of its apparent relationship to costs, profitability,
customer satisfaction, and customer retention
• SERVQUAL has been a keyword in 41 publications which
incorporate both theoretical discussions and applications of
SERVQUAL in a variety of industrial, commercial and not-for-
profit settings.
Some of the published studies include :
• Hotels ,travel and tourism
• Car servicing, business schools
• Accounting firms, architectural services
• Airline catering
• Mobile Telecommunications in Macedonia
 Conclusions
• SERVQUAL is considered very complex, subjective and
statistically unreliable. The simplified RATER model however is
a simple and useful model for qualitatively exploring and
assessing customers' service experiences
• It is an efficient model in helping an organization shape up
their efforts in bridging the gap between perceived and
expected service
• SERVQUAL is used to track customer's expectations and
perceptions over time to compare the company's SERVQUAL
scores against competitors.
• Although SERVQUAL's face and construct validity are in doubt,
it is widely used in modified forms (RATER) to measure
customer expectations and perceptions of service quality.
Product and Service Design
 Product/Service Design
Product/service design directly affects:
• Product/service quality
• Production/delivery cost
• Customer satisfaction
 Product/Service Design and
Development
• Sources of Product Innovation
• Developing New Products/Services
• Getting Them to Market Faster
• Improving Current Products/Services
• Designing for Ease of Production
• Designing for Quality
• Designing and Developing New Services
 Sources of Product/Service
Innovation
• Customers
• Managers
• Marketing
• Operations
• Engineering
• Research and Development (R&D)
– Basic research
– Applied research
 Steps in Developing New
Products
1. Technical and economic feasibility studies
2. Prototype design
3. Performance testing of prototype
4. Market sensing/evaluation and economic
evaluation of the prototype
5. Design of production model
6. Market/performance/process testing and
economic evaluation of production model
7. Continuous modification of production model
 Steps in Developing New
Products
1. Technical and Economic Feasibility
Studies
– Determine the advisability of establishing a
project for developing the product
– If initial feasibility studies are favorable,
engineers prepare an initial prototype design
 Steps in Developing New
Products
2. Prototype Design
– This design should exhibit the basic form, fit,
and function of the final product
– It will not necessarily be identical to the
production model
 Steps in Developing New
Products
3. Performance Testing of Prototype
– Performance testing and redesign of the
prototype continues until this design-test-
redesign process produces a satisfactorily
performing prototype
 Steps in Developing New
Products
4. Market Sensing/Evaluation and
Economic Evaluation of the Prototype
– Accomplished by demonstrations to potential
customers, market test, or market surveys
– If the response to the prototype is favorable,
economic evaluation of the prototype is
performed to estimate production volume,
costs, and profits
– If the economic evaluation is favorable, the
project enters the production design phase.
 Steps in Developing New
Products
5. Design of Production Model
– The initial design of the production model will
not be the final design; the model will evolve
 Steps in Developing New
Products
6. Market/Performance/Process Testing and
Economic Evaluation of Production Model
– The production model should exhibit:
• low cost
• reliable quality
• superior performance
• the ability to be produced in the desired quantities
on the intended equipment
 Steps in Developing New
Products
7. Continuous Modification of Production
Model
– Production designs are continuously modified
to:
• Adapt to changing market conditions
• Adapt to changing production technology
• Allow for manufacturing improvements
Managing Product Development
Projects
• About 5% of all new-product ideas survive to
production, and only about 10% of these are
successful.
• It is best to cancel unpromising new-
product/service development projects early!
• Employees often become emotionally caught up
in these projects and are overly optimistic
• An impartial management review board is
needed for periodic reviews of the progress of
these projects.
Getting New Products to Market
Faster
• Speed creates competitive advantages
• Speed saves money
• Tools to improve speed:
– Autonomous design and development teams
– Computer-aided design/computer-aided
manufacturing (CAD/CAM)
– Simultaneous (concurrent) engineering
 Tools to Improve Speed to
Market
• Autonomous Design and Development
Teams
– Teams are given decision-making
responsibility and more freedom to design
and introduce new products/services
– Time-to-market has been slashed dramatically
– Enormous sums of money have been saved
– Teams do not have to deal with the
bureaucratic red tape ordinarily required to
obtain approvals
 Tools to Improve Speed to
Market
• Computer-Aided Design/Computer-Aided Manufacturing
(CAD/CAM)
– Engineers, using CAD/CAM, can generate many
views of parts, rotate images, magnify views, and
check for interference between parts
– Part designs can be stored in a data base for use on
other products
– When it is time for manufacturing, the product design
is retrieved, translated into a language that production
machinery understands, and then the production
system can be automatically set up.
 Tools to Improve Speed to
Market
Product/
Service Ideas

Economic and Technical

Feasibility Studies

Product/Service Design Production Process Design

Produce and Market

New Product/Service
 Improving the Design
of Existing Products/Services
• Focus is improving performance, quality, and
cost
• Objective is maintaining or improving market
share of maturing products/services
• Little changes can be significant
• Small, steady (continuous) improvements can
add up to huge long-term improvements
• Value analysis is practiced, meaning design
features are examined in terms of their
cost/benefit (value).
 Designing for Ease of
Production
• Ease of Production (Manufacturability)
– Specifications - Precise information about the
characteristics of the product
– Tolerances - Minimum & maximum limits on a
dimension that allows the item to function as
designed
– Standardization - Reduce variety among a group
of products or parts
– Simplification - Reduce or eliminate the
complexity of a part or product
 Designing and Developing New
Services
Three general dimensions of service design are:
• Degree of Standardization of the Service
– Custom-fashioned for particular customers or basically
the same for all customers?
• Degree of Customer Contact in Delivering the Service
– High level of contact (dress boutique) or low level
(fast-food restaurant)?
• Mix of Physical Goods and Intangible Services
– Mix dominated by physical goods (tailor’s shop) or by
intangible services (university)?
Designing and Developing New
Services
• Differences Between New Service and
New Product Development
– Unless services are dominated by physical
goods, their development usually does not
require engineering, testing, and prototype
building.
– Because many service businesses involve
intangible services, market sensing tends to
be more by surveys rather than by market
tests and demonstrations.
1.1 INVENTORY MANAGEMENT
1.2 Introduction

A business can run smoothly its operating activities only when appropriate amount
of inventory is maintained. Inventory affects all operating activities like
manufacturing, warehousing, sales etc. The amount of opening inventory and
closing inventory should be sufficient enough so that the other business activities
are not adversely affected. Thus, inventory plays an important role in operations
management.

1.3 Meaning & Types of Inventory

Inventory is an asset that is owned by a business that has the express purpose of
being sold to a customer. Inventory refers to the stock pile of the product a firm is
offering for sale and the components that make up the product. In other words, the
inventory is used to represent the aggregate of those items of tangible assets which
are –

 Held for sale in ordinary course of the business.

 In process of production for such sale.
 To be currently consumed in the production of goods or services to be
available for sale.

The inventory may be classified into three categories:

 Raw material and supplies: It refers to the unfinished items which go in

the production process.
 Work in Progress: It refers to the semi-finished goods which are not 100%
complete but some work has been done on them.
 Finished goods: It refers to the goods on which 100% work has been done
and which are ready for sale.

1.4 Meaning of Inventory Management

Inventory management is the practice overseeing and controlling of the ordering,

storage and use of components that a company uses in the production of the items
it sells. A component of supply chain management, inventory management
supervises the flow of goods from manufacturers to warehouses and from these

KMBI 602 SCM – Dr Rajiv Ratan Page 1

facilities to point of sale. Inventory control means efficient management of capital
invested in raw materials and supplies, work- in – progress and finished goods.

1.5 Significance of holding inventory

Inventory is considered to be one of the most important assets of a business. Its

management needs to be proactive, accurate and efficient. Inventory is essentialfor
every organization to ensure smooth running of the production process, to reduce
the ordering cost of inventory, to take advantage of quantity discount, avoid
opportunity loss on sales, to utilize and optimize the plant capacity and to reduce
the overall price. Thus, it can be said that inventory is inevitable and has to be
maintained in appropriate quantity. However, the concept of Just In Time (JIT) is
becoming popular which is an inventory strategy companies employ to increase
efficiency and decrease waste by receiving goods only as they are needed in the
production process, thereby reducing inventory costs. This method requires
producers to forecast demand accurately.

1.6 Objectives of Inventory Management

The objective of inventory management is to maintain inventory at an appropriate

level to avoid excess or shortage of inventory. Inventory management systems
reduce the cost of carrying inventory and ensure that the supply of raw material and
finished goods remains continuous throughout the business operations. The
objectives specifically may be divided into two categories mentioned below:

A. Operating objectives: They are related to the operating activities of the

business like purchase, production, sales etc.

a. To ensure continuous supply of materials.

b. To ensure uninterrupted production process.
c. To minimize the risks and losses incurred due to shortage of
inventory.
d. To ensure better customer services.
e. Avoiding of stock out danger.

KMBI 602 SCM – Dr Rajiv Ratan Page 2

 B. Financial Objectives:
a. To minimize the capital investment in the inventory.
b. To minimize inventory costs.
c. Economy in purchase.

Apart from the above objectives, inventory management also emphasize to bring
down the adverse impacts of holding excess inventory. Holding excess inventory
lead to the following consequences:
 Unnecessary investment of funds and reduction in profit.
 Increase in holding costs.
 Loss of liquidity.
 Deterioration in inventory.

1.7 Factors affecting the level of inventory

The level of inventory should be appropriate. The appropriateness of the amount

of inventory depends upon a number of factors. Some significant factors affecting
the level of inventory are explained as follows:

1. Nature of business: The level of inventory will depend upon the nature of
business whether it is a retail business, wholesale business, manufacturing
business or trading business.

2. Inventory turnover: Inventory turnover refers to the amount of inventory

which gets sold and the frequency of its sale. It has a direct impact on the
amount of inventory held by a business concern.
3. Nature of type of product: The product sold by the business may be a
perishable product or a durable product. Accordingly, the inventory has to
be maintained.
4. Economies of production: The scale on which the production is done also
affects the amount of inventory held. A business may work on large scale in
order to get the economies of production.
5. Inventory costs: More the amount of inventory is held by the business, more
will be the operating cost of holding inventory. There has to be a trade-off
between the inventory held and the total cost of inventory which comprises
KMBI 602 SCM – Dr Rajiv Ratan Page 3
 of purchase cost, ordering cost and holding cost.
6. Financial position: Sometimes, the credit terms of the supplier are rigid and
credit period is very short. Then, according the financial situation of the
business the inventory has to be held.
7. Period of operating cycle: If the operating cycle period is long, then the
money realization from the sale of inventory will also take a long duration.
Thus, the inventory managed should be in line with the working capital
requirement and the period of operating cycle.
8. Attitude of management: The attitude and philosophy of top management
may support zero inventory concept or believe in maintaining huge
inventory level. Accordingly, the inventory policy will be designed for the
business.

1.8 Techniques of inventory control

Inventory control refers to a process of ensuring that appropriate amount of stock

are maintained by a business, so as to be able to meet customer demand without
delay while keeping the costs associated with holding stock to a minimum.
Inventory control signifies a planned approach of finding when to shift, what to
shift, how much to shift and how much to stock so that costs in buying and storing
are optimally minimum without interrupting production or affecting sales. To solve
these problems of inventory management various techniques are there.

These techniques are divided into two categories – modern techniques and
traditional techniques.

(1) MODERN TECHNIQUES

(a) Economic Order Quantity (EOQ)

(b) Re-Order Point (ROP)

(c) Fixing Stock Levels

(d) Selective Inventory Control

(i) ABC Analysis

(ii) VED Analysis

KMBI 602 SCM – Dr Rajiv Ratan Page 4

 (iii) SDE Analysis

(iv) FSN Analysis

(2) TRADITIONAL TECHNIQUES

(a) Inventory Control Ratios

(b) Two Bin System

(c) Perpetual Inventory System

(d) Periodic Order System

1.9 Modern Techniques

Modern techniques of inventory control refers to those techniques which are

evolved through a scientific process. These techniques involve the use of a formula
or a method which is logically derived to keep control on the inventory levels. These
techniques are explained as below:

(a) ECONOMIC ORDER QUANTITY (EOQ)

The optimal size of an order for replenishment of inventory is called economic order
quantity. Economic order quantity (EOQ) or optimum order quantity is that size of
the order where total inventory costs (ordering costs + carrying costs) are
minimized. Economic order quantity can be calculated from any of the following
two methods:

 Formula Method
 Graphic Method
Formula Method: It is also known as ‘SQUARE ROOT FORMULA’ or
‘WILSON FORMULA’ as given below:

EOQ = 2RO

Where, EOQ = Economic Order Quantity

R = Annual Requirement or consumption in units
O = Ordering Cost per order
C = Carrying Cost per unit per year
KMBI 602 SCM – Dr Rajiv Ratan Page 5
No. of orders = R/EOQ
Time gap between two orders = No. of days in a year/No. of orders
Total Cost = Purchase Cost + Carrying Cost + Order Cost
= (R x Unit Price) + (EOQ/2 x C) + (R/EOQ x O)
Graphic Method

The economic order quantity can also be determined with the help of graph. Under
this method, ordering costs, carrying costs and total inventory costs according to
different lot sizes are plotted on the graph. The intersection point at which the
inventory carrying cost and the ordering cost meet, is the economic order quantity.
At this point the total cost line is also minimum.

EOQ

Total Inventory Cost

Carrying Cost

Cost

Ordering Cost

O X

Assumptions: The following assumptions are made:

 The rate of consumption of inventory is assumed to be constant.

 Costs will not change over time.
 Lead time is assumed to be known and constant.
 Per order cost, carrying cost and unit price are constant.
 Carrying or holding costs are proportionate to the value of stock held.
 Ordering cost varies proportionately with the price.

(b) RE-ORDER POINT

After determining the optimum quantity of purchase order, the next problem is to
specify the point of time when the order should be placed. Re-order level is that

KMBI 602 SCM – Dr Rajiv Ratan Page 6

level of inventory at which an order should be placed for replenishing the current
stock of inventory. The determination of re-order point depends upon the lead time,
usage rate and safety stock. These terms are explained below:

1. Lead Time: Lead time refers to the time gap between placing the order
and actually receiving the items ordered.

2. Usage Rate: It refers to the rate of consumption of raw material per day.

Usage Rate = Total annual consumption / No. of days in a

year

3. Safety Stock: It is the minimum quantity of inventory which a firm

decides to maintain always to protect itself against the risk
and losses likely to occur due to stoppage in production and
loss of sale, due to non- availability of inventory.

Formulae:

Re Order Point = (Lead Time x Usage Rate) + Safety Stock or

Re Order Point = Maximum usage x Maximum Re Order Period

Safety Stock = Usage Rate x Days of safety

Note: ROL – Re Order Level

ROQ – Re Order Quantity

ROQ is also known as EOQ (Economic Order Quantity)

(c) SELECTIVE INVENTORY CONTROL

Controlling all inventory in the stock is a very difficult task especially where huge
inventories are maintained of variety of items. In such circumstances, following
smart techniques for managing and controlling the different types of inventories
held are as follows:

KMBI 602 SCM – Dr Rajiv Ratan Page 7

 (i) ABC Analysis: ABC analysis may be defined as a technique where
inventories are analyzed with respect to their value so that costly items
are given greater attention and care by the management. Three
categories are created namely A, B and C. Following table represents
the approximate classification of items along with their value and
quantity.
Category % of % of Total
Total Quantity
Value

A 70-80 5-10

B 20-25 20-30

C 5-10 60-70

(ii) VED Analysis: VED stands for Vital, Essential and Desirable. Highest
control is over vital items, medium control is exercised over essential
items and least control is inferred over desirable items.
(iii) SDE Analysis: SDE stands for Scarce, Difficult and Easy. Highest
control is over scarce items, medium control is exercised over difficult
items and least control is inferred over easily available items.
(iv) FSN Analysis: FSN stands for Fast Moving (F), Slow Moving (S) and
Non Moving (N). Highest control is kept over fast moving items,
medium control is exercised over slow moving items and least control
is inferred on non-moving items.

1.10 Practice Problems

Q.1. Calculate the economic order quantity from the following particulars:

Annual requirement =2,000 units

Cost of materials per unit =Rs. 20

Cost of placing and receiving one order= Rs. 40

KMBI 602 SCM – Dr Rajiv Ratan Page 8
 Annual carrying cost of inventory, 20% of inventory value.

Solution: Here, R = 2,000 O = 40 Unit Price = 20

C = 20% of Unit Price = 20% of 20 = 4

EOQ = √2RO / C

= √2(2000)(40) / (4) = 200 units

Q.2. Compute EOQ and the total variable cost from the following information:

Annual demand = 4,000 units

Units Price = Rs. 40

Order Cost = Rs. 20

Storage Rate = 7% Per annum

Interest Rate = 3% Per annum

Solution: Here, R = 4,000 O = 20 Unit Price = 40

C = 10% of Unit Price = 10% of 40 = 4

EOQ = √2RO / C

= √2(4000)(20) / (4) = 200 units

Total Variable Cost = Carrying Cost + Order Cost

= (EOQ/2 x C) + (R/EOQ x O)

= (200/2 x 4) + (4000/200 x 20) = 400 + 400 = Rs. 800

Total Cost = Purchase Cost + Carrying Cost + Order Cost

= (R x Unit Price) + (EOQ/2 x C) + (R/EOQ x O)

= (4000 x 40) + (200/2 x 4) + (4000/200 x 20) = 1, 60,000 + 400 + 400 = Rs.

1, 60,800
KMBI 602 SCM – Dr Rajiv Ratan Page 9
 Inventory Cost and ABC Analysis

Learning Objectives

After completion of the unit, you should be able to:

 Explain the meaning and purpose of ABC analysis.

 Describe the Pareto principle and criteria for ABC classification.
 Understand the detailed steps for classifying the items into A, B and C
categories.
 Know the applications of ABC Analysis
2 Introduction

Inventory management is very essential for every organization especially

manufacturing and trading organizations. Optimization of the investment in
inventory and managing the level of inventory are the key objectives of inventory
management. Inventory control is essential to keep a track on the types of
inventories held and the cost involved. Many techniques are used to control the
inventory namely traditional techniques and modern techniques. This unit will
focus upon the most popularly used selective inventory control technique – ABC
Analysis.

2.1 Meaning of Inventory Cost

Maintaining varied types of inventories involve different costs associated with

them. Some inventory items are low priced, some are medium priced and some
are very expensive. Thus, inventory costs has to be looked into first before deciding
the type of control to be exercised on it. The costs associated with inventory include
the purchase cost, ordering cost and the holding cost. In case of selective inventory
control technique – ABC analysis, inventory cost plays a very significant role as the
category classification and the kind of control exercised, completely depend upon
the cost of inventory.

2.2 Meaning and purpose of ABC Analysis

Inventory ABC Classification, known as ABC Analysis, is a term used to define

an inventory categorization method used in materials management to exercise

KMBI 602 SCM – Dr Rajiv Ratan Page 10

selective inventory control.

The ABC Classification provides a mechanism for identifying the inventory items
that captures the significant portion of the overall inventory cost. It also provides a
mechanism for identifying different categories of stock on which different
inventory policy and inventory control practices can be used.

ABC analysis divides the inventory items into three categories namely A, B and
C. The classification is based on their cost. Costly items are categorized ‘A’ and
highest control is exercised on these items. Least valuable items are categorized

‘C’ and least control is exercised on them and remaining items are categorized as
‘B’ on which moderate control is exercised.

The basic purpose of ABC Analysis is to provide basis for material management
processes and helps to define how stock is to be managed. Further, it can form the
basis for various activities comprising plans on alternative stock arrangements and
reorder calculations. It also helps to determine at what intervals inventory checks
should be carried out. For instance – ‘A’ class items are to be checked more
frequently than ‘C’ class items. Thus, ABC analysis forms the basis of many such
activities and policy frameworks.
ABC analysis also serves the following purposes directly or indirectly:

 Significant reduction in investment in inventory.

 Protection against stock outs.
 Reducing the work load involved in different activities such as ordering,
procuring, receiving, inspecting, handling and storage of inventory items.
 Reduction in obsolescence losses.
 Increase in profits.

2.3 The Pareto Principle

The Pareto Principle is developed by Vilfredo Pareto (1848 - 1923). According to

Pareto Analysis, critical few is separated from the trivial many. Pareto principle is
also known as the 80/20 rule. Pareto principle is based upon the theory that 20%
of the population owns 80% of the nation’s wealth, most of the businesses get 80%

KMBI 602 SCM – Dr Rajiv Ratan Page 11

of their sales revenue from 20% of the customers, 80% of the problems are caused
because of 80% of the employees and 20% of the items accounts for 80% of the
firms expenditure.

Therefore, the classification of the inventory is done on the basis of the Pareto
principle, in which 20% of the impactful items should fall into ‘A’ classification
category.

This rule, in general, applies well and is frequently used by inventory managers to
put their efforts where greatest benefits, in terms of cost reduction as well as
maintaining a smooth availability of stock, are required.

The principle emphasizes on working out the rupee value of each individual
inventory item on annual consumption basis. Then the ratio between the number
of items and the currency value of the items is calculated and the following
categorization is done:

 10-20% of the items ('A' class) account for 70-80% of the consumption
 the next 15-25% ('B' class) account for 10-20% of the consumption
 the balance 65-75% ('C' class) account for 5-10% of the consumption

ABC Classification & The Pareto Rule for Inventory Management

KMBI 602 SCM – Dr Rajiv Ratan Page 12

The above figure depicts the classification according to the Pareto principle. All the
items are divided into three broad categories – A, B and C, according to the
calculation of the above mentioned ratio.

2.4 Criteria for ABC classification

The ABC analysis suggests that inventories of an organization are not of equal
value. It specifies that the company should rate the inventory items from A to C,
based upon their quantity and value. The three categories A, B and C possess the
following characteristics:

"A" Category

 These items generally represent approximately 15%-20% of an overall

inventory by quantity, but represent 80% of the value of an inventory.
 These are high value items and are extremely important.
 By paying close attention to the optimization of these items in inventory, a
significantly positive impact may be created with a nominal increase in the
inventory management costs.
 Very strict control is kept on these items.
 Accurate records need to be maintained for these items.
 Because of the high value of these items, frequent value analysis is required.
 Appropriate order pattern should be chosen such as ‘Just- in- time’ to avoid
excess capacity

"B" Category

 These items represent 30%-35% of inventory items by item type, and about
15% of the value.

 These are intermediary value items.

 These items can generally be managed through period inventory and should
be managed with a formal inventory system.
 Comparatively less control than ‘A’ category items is needed.
 Proper records should be maintained for these items.

"C" Category
KMBI 602 SCM – Dr Rajiv Ratan Page 13
 These items represent 50% of actual items but only 5% of the inventory
value.
 These are low value items and are marginally important.
 Most organizations can afford a relatively relaxed inventory process
surrounding these items.
 Least amount of control is required.
 Minimum possible records should be maintained in the simplest form.
2.5 Steps for Classification of Items

The categorization of the inventory items requires a particular process to be

followed. The inventory items are first classified, then their total cost is ascertained,
thereafter ranking is done followed by the computation of ratio or percentages. Then
finally the A, B and C categories are determined. The process generally consist of
six basic steps as explained below:

1. Identify the objective for ABC analysis. An ABC analysis can accomplish
one of two primary goals: to reduce procurement costs or to increase cash
flow by having the right items available for production.
2. Collect data related to the inventory under analysis. The data can beobtained
from standard accounting if used in the organization. The data required is
the raw material purchased or weighted cost including allordering costs and
carrying costs.
3. Rank the inventory in decreasing order of their cost.
4. Calculate the cumulative impact for all inventory items by dividing item
annual cost by total inventory annual expenditure, then adding that amount
to the cumulative total of percentage spent.

5. Draw a curve of percentage items and percentage value. Take a holistic view
taking into account the Pareto principle.
6. Mark the limits bifurcating the three classes as A, B and C rationally.
Analyze classes and make appropriate decisions. The key to this step is
follow-up and tracking. The periodic review should be done formonitoring
the success or failure of the decisions and categorization done.

2.6 Difference between A, B and C class items

KMBI 602 SCM – Dr Rajiv Ratan Page 14

There is a difference in the various classes A, B and C. Following differences
present the suggested policy guidelines for different categories which may differ
for different businesses:

Basis A class items B class items C class items

Control Very strict control Moderate control Least control
Safety stock No or very low Low safety stock High safety stock
safety stock
Order delivery weekly Once in three Once in six months
months
Control report Weekly Control Monthly Control Quarterly Control
report report report
Follow up Maximum follow Periodic follow up Optional
up
Sources of Should have as Should have two or Should have two
supply many sources as more reliable reliable sources
possible sources
Forecast Accurate forecasts Estimates based on Rough estimate is
are needed past data are required
sufficient
Purchasing Should have May have Should have
function centralised centralised or decentralised
purchasing decentralised or a purchasing function
function combination of both
purchasing function
Officers Should be handled Should be handled Can be delegated to
by senior officers by middle level lower level staff.
officers

KMBI 602 SCM – Dr Rajiv Ratan Page 15

2.7 Applications of ABC Analysis

The ABC classification system leads to grouping of items according to their annual
issue value. Apart from exercising varying degree of control over the inventory
items, there are other applications where ABC analysis has proved to be useful.
Following represent some applications of ABC analysis:

 It highlights specific items on which efforts can be concentrated profitably.

 It provides a sound basis on which the allocation of funds and time is done.
 It helps in reviewing the stock levels especially minimum and maximum
levels of the inventory items. ‘A’ items will generally have greater impact
on projected investment and purchasing expenditure, and therefore should
be managed more aggressively in terms of minimum and maximum
inventory levels. The inactive items will fall at the bottom of the ‘C’
category. It is the best place to start when performing a periodic
obsolescence review.
 The frequency of usage can be worked out and accordingly the time gap
between orders is decided. ‘A’ category items are very frequently used and
their accurate record balances need to be kept. Thus, frequent stock taking
is done for these items. Accordingly, the strategy is planned for B and C
category items.
 It helps in identifying the inventory items for potential consignment or
vendor stocking.

KMBI 602 SCM – Dr Rajiv Ratan Page 16

  Separate inventory goals may be specified for each category of inventory
items.

2.8 Practice Problems

Q. The following data is related to Paroma Ltd.:

Item 11 12 13 14 15 16 17
No.
U nit 5 10 14 7 6 15 20
C ost
A nnual 47000 1500 200 700 4700 1100 17000
D emand

Categorize the items according to ABC analysis.

Solution:

Total Spending per year

Total
Cost
Item Unit Annual per
No. Cost Demand year
11 5 47000 235000
12 10 1500 15000
13 14 200 2800
14 7 700 4900
15 6 4700 28200
16 15 1100 16500
17 20 17000 340000

KMBI 602 SCM – Dr Rajiv Ratan Page 17

Usage of item in total usage

Total
Cost % of
Item Unit Annual per Total
No. Cost Demand year Usage
11 5 47000 235000 36.58%
12 10 1500 15000 2.33%
13 14 200 2800 0.43%
14 7 700 4900 0.76%
15 6 4700 28200 4.38%
16 15 1100 16500 2.56%
17 20 17000 340000 52.92%
642400 100%

Sort the items by usage

% of Cumulative
Item Unit Annual Total Cost per Total % of total
No. Cost Demand year Usage
17 20 17000 340000 52.92% 52.92%
11 5 47000 235000 36.58% 89.50%
15 6 4700 28200 4.38% 93.88%
16 15 1100 16500 2.56% 96.44%
12 10 1500 15000 2.33% 98.77%
14 7 700 4900 0.76% 99.53%
13 14 200 2800 0.47% 100%
642400 100%

ABC classification

Category Items % Action

usage Needed
A 17, 11 89.5% Close
control
B 15,16,12 9.27% Regular
review
C 14, 13 1.23% Infrequent
review

KMBI 602 SCM – Dr Rajiv Ratan Page 18

2.9 Let’s Sum-up

ABC analysis is a valuable tool to enable companies dedicated to strategic cost

management to measure the current status for their materials management system
and introduce certain changes in the inventory control policies in such a manner
that it yields the largest cost management benefits in the near and middle term
periods. ABC analysis is based upon the Pareto principle which focuses on the
concept ‘Critical Few Trivial Many’. ABC analysis divides the inventory items into
three categories - A, B and C. These categories are identified on the basis of the
number of items and the total value in rupees for each inventory item. The process
starts from the classification of inventory, then ascertaining their cost and assigning
ranks which is followed by the calculation of percentages. On the basis of these, the
categories A, B and C are determined. After determining the categories, the
inventory management policies, control mechanisms, procurement and
warehousing policies are framed for each category in a different manner according
to their impact on overall inventory cost. Thus, ABC analysis suggests that
inventories of an organization are not of equal value and so different policies and
treatment should be given in order to minimize the efforts and time as well as
maximize the profits through savings in cost.

2.10 Key Terms

Inventory Cost: It refers to the costs associated with the inventory including the
purchase cost, ordering cost and the holding cost.

ABC Analysis: It is a term used to define an inventory categorization method used

in materials management to exercise selective inventory control.

Pareto Principle: According to Pareto Analysis, critical few is separated from the
trivial many. Pareto principle is also known as the 80/20 rule. It says that 20% of
the impactful items should fall into ‘A’ classification category and accordingly the
other categories may be determined.

KMBI 602 SCM – Dr Rajiv Ratan Page 19

 Logistics and Supply Chain Management

3.1 Introduction

It has been noticed that there has been a drastic change in the manner in which
business was conducted many years ago and now. Due to the improvement in the
technology, significant developments in all the areas of business have been made.
Supply Chain Management also evolved as an improvement over Logistics
Management, from past years. Logistics and supply chain are sometimes used
interchangeably. Both these terms are closely related to each other and plays a
significant role in the firm’s value chain process. This unit will discuss about
logistics and supply chain management, the relationship among them and the key
points of difference between them.

3.2 Meaning & Concept of Logistics Management

The management process which integrates the movement of goods, services,

information and capital, right from the sourcing of raw material, till it reaches its
end consumer is known as Logistics Management.

According to Phillip Kotler, “Market logistics involve planning, implementing and

controlling physical flow of material and final (finished) goods from the pointof
origin to the point of use to meet customer requirements, at a profit.”

The objectives of logistic management are stated as below:

 To provide the right product with the right quality at the right time in the
right place at the right price to the ultimate customer.
 To offer best service to the consumers.
 To reduce the cost of operations and maximize the profits.
 To maintain transparency in operations.

The 7 R’s of logistics are as follows:

 Right product
 Right customer
 Right quantity
KMBI 602 SCM – Dr Rajiv Ratan Page 20
  Right condition
 Right place
 Right time
 Right cost

The activities covered under logistic management are illustrated as follows:

(i) Network Design

It is required to determine the number and location of manufacturing plants,

warehouses, material handling equipment’s etc. on which logistical efficiency
depends.

(ii) Order Processing

Order processing includes activities for receiving, handling and recording of orders.
Efforts are made to minimize the time between receipt of orders and date of
dispatch of the consignment to ensure speedy processing of the order. Delays in
execution of orders can become serious grounds for customer dissatisfaction;
which must be avoided.

(iii) Procurement

It is related to obtaining materials from suppliers. It includes supply sourcing,

negotiation, order placement, inbound transportation, receiving and inspection,
storage and handling. Its main objective is to support manufacturing, by providing
timely supplies of qualitative materials, at the lowest possible cost.

(iv) Material Handling

It involves activities such as handling raw-materials, parts, semi-finished and

finished goods into and out of the manufacturing plant, warehouses and
transportation terminals. Efforts should be made to minimize losses due to
breakage, spoilage etc.

KMBI 602 SCM – Dr Rajiv Ratan Page 21

(v) Inventory Management

The basic objectives of inventory management are to minimize the amount of

working capital blocked in inventories, minimize the holding costs and ensure
continuous flow of materials and goods. Inventory for raw material, semi-finished
goods and finished goods has to be maintained.

(vi) Packaging and Labelling

Packaging and labelling are an important aspect of logistics management.

Packaging involves enclosing a product into suitable packets or containers, for
convenient handling of the product. Good and attractive packaging, acts like a silent
salesman.

Labelling means putting identification marks on the package of the product. A label
provides information about the date of packing and expiry, weight or size of
product, ingredients used, instructions for safe handling of the product, price
payable by the buyer etc.

(vii) Warehousing

Warehousing creates time utility by storing goods from the time of production till
the time they reaches to the ultimate consumers. Here, the management has to
decide about the number and type of warehouses needed as well as the locationof
the warehouses.

(viii) Transportation

Transportation is that logistical activity which creates place utility. Transportation

is needed for the movement of raw-materials from suppliers to the manufacturing
unit, movement of work-in-progress within the plant and movement of finished
goods from plant to the final consumers.

3.3 Types of Logistics

The logistic activities are divided into two broad categories as mentioned below:

KMBI 602 SCM – Dr Rajiv Ratan Page 22

 Inbound Logistics: Inbound Logistics refers to movement of goods and raw
materials from suppliers to the company. It include the activities which are
concerned with procurement of material, handling, storage and transportation.
 Outbound Logistics: Outbound Logistics refers to movement of finished
goods from your company to customers. It include the activities which are
concerned with the collection, maintenance, and distribution or delivery to the
final consumer. The following figure illustrates the concept:

In the above figure, purchasing and warehouse function communicates with

suppliers and can be referred as supplier facing function. Customer service and
transport function communicates with customers and thus, referred as customer
facing function.

Logistics may be of various kinds depending upon the purpose for which it is used,
the kind of organization by which it is used and the objective it is requiredto
achieve. Following are the different types of logistics:

KMBI 602 SCM – Dr Rajiv Ratan Page 23

Business Logistics: It is the part of the supply chain process that plans, implements
and controls the efficient flow and storage of goods and services from point of origin
to point of use or consumption.

Military Logistics: The design and integration of all aspects of support for the
operational capability of the military forces as well as the reliability and efficiency
of the equipments used by them.

Event Logistics: The network of activities, facilities and personnel required to

organize, schedule and deploy the resources for an event are referred as event
logistics.

Service Logistics: The activities related to acquisition, scheduling and management

of the facilities, personnel and material with the objective to support and sustain a
service operation or business are termed as service logistics.

International logistics: International Logistics, also known as Global Logistics,

focuses on how to manage and control overseas activities effectively as a single
business unit. Therefore, company should try to transform the value of overseas
product, services, marketing, R&D into competitive advantage.

3PL or Third Party Logistics: 3PL or Third Party Logistics refers to the
outsourcing of logistics activities, ranging from a specific task to broader activities
serving the whole supply chain such as inventory management, order processing
and consulting.

KMBI 602 SCM – Dr Rajiv Ratan Page 24

4PL or Fourth Party Logistics: Fourth Party Logistics or 4PL is the concept
proposed by Accenture Ltd in 1996. It refers to a party who works on behalf of
client to finalise the contract negotiations and management of performance of 3PL
providers including the design of the whole supply chain network and controlling
the routine operations performed by them. The reasons for using 4PL by a company
are lack of technology to integrate supply chain process, the increase in operating
complexities and sharp increase in global business operations.

3.4 Meaning and Concept of Supply Chain Management

Supply Chain Management (SCM) is a series of interconnected activities related

to the transformation and movement of raw material to the finished goods till it
reaches to the end user. It is the outcome of the efforts of multiple organisations
that helped in making this chain of activities successful.

‘Supply Chain is the network of organisations that are involved, through upstream
and downstream linkages, in the different processes and activities that produce
value in the form of products and services in the hands of the ultimate consumer.’
- By Martin Christopher

‘Supply chain management (SCM) refers to the coordination of production,

inventory, location, and transportation among the participants in a supply chain to
achieve the best mix of responsiveness and efficiency for the market being served.’
- By Michael Hugos

The most commonly used supply chain concept is shown below:

Supplier Manufacturer Wholesaler Retailer

KMBI 602 SCM – Dr Rajiv Ratan Page 25

Supply Chain Management has a multi-dimensional approach which manages the
flow of raw materials and work in progress within the organisation and the final
product outside the organisation till it reaches the hands of the final consumer. All
the activities are done keeping in view the customer requirements.

The activities included in SCM are stated as follows:

 Integration
 Performance measurement
 Product development
 Logistics
 Information sharing
 Procurement & Manufacturing
 Customer service
 Sourcing
 Supplier relationship management
 Order fulfilment
 Returns management
 Transportation
 Warehousing
 Demand management
 Customer relationship management

The significant components of supply chain management are as follows:

 It is a Network: Many companies have the department that controls various

activities within the supply chain. Supply Chain Management is the
planning, implementing and controlling of the networks.
 Information Flow: supply chain management involves the flow of material,
information and finance. The most important one is information flow or
information sharing. When information is shared from retailer down to
supplier, everyone in the supply chain is not required to maintain heavy
stocks which further results in lower costs for everyone.

KMBI 602 SCM – Dr Rajiv Ratan Page 26

  Coordination: Information sharing requires coordination or integration
among the various network partners.
 Avoid Conflicting Objectives: In the supply chain network, the different
parties involved might have conflicting objectives or in the same
organization different departments may have conflicting objectives. For
example, purchasing people always place the orders to the cheapest vendors
(with a very long lead-time) but production people needs material more
quickly. To avoid conflicting objectives, it must be decided whether to
adopt time-based strategy, low cost strategy or differentiation strategy. A
clear direction is needed so people can make the decisions accordingly.
 Balance between cost and service: When efforts are made to improve
service, cost goes up. When efforts are directed to cut cost, service suffers.
Thus, there should be a balance between cost and service.
 Foster long-term relationship: To work as the ‘supply chain team’, long-
term relationship is a key. Focus should be on creating long-term
relationship with suppliers of key products and items with limited source
of supply because these are people who can make or break the supply chain.

3.5 Objectives of Supply Chain Management

Supply chain focuses on ensuring economic supply of goods, supplies, and

services to keep the company in operation. SCM contribute to profit, growth and

competitive advantage by efficiently managing the supply activities with an aim to

reach company‘s corporate goals.

Supply chain management has the fundamental objective to ‘add value’. Apart
from this objective, it focuses on the accomplishment of the following strategic
objectives:

 Reducing working capital

 Build a competitive infrastructure
 Accelerating cash-to-cash cycles
 Increasing inventory turns
 Leveraging worldwide logistics
 Synchronizing supply chain demand

KMBI 602 SCM – Dr Rajiv Ratan Page 27

  Measuring performance globally
 Cost Quality improvement
 Shortening the lead time
 Minimize the total system cost
 Satisfy customer service requirements
 Improve standardization
 Face global competition
 Enhance organizational responsiveness

3.6 Difference between logistics and supply chain management

Logistics Management is a part of Supply Chain Management which deals with

the management of goods in an efficient and effective manner. To understandthe
conceptual differences between logistics and supply chain management, the
following points are discussed:

 The flow and storage of goods inside and outside the firm is known as
Logistics. The movement and integration of supply chain activities isknown
as Supply Chain Management.

 The main aim of logistics is customer satisfaction. On the other hand, the
main aim behind supply chain management is to gain a substantial
competitive advantage.
 There is only one organisation involved in logistics while multiple
organisations are involved in SCM.
 Supply Chain Management is a new concept as compared to Logistics.
Sometimes, it is said that SCM is the refinement of the old concept of
logistics. Thus, SCM is a modern concept.
 Logistics deals with strategy and coordination between the marketing and
production functions of the organization. On the other hand, supply chain
management focuses more on purchasing and procurement along withother
functions.
 SCM include factors relating to inventory, materials and production
planning also. On the contrary, logistics includes factors relating to demand

KMBI 602 SCM – Dr Rajiv Ratan Page 28

 management and forecasting.

Thus, it can be concluded that supply chain management takes care of the design,
planning, execution, control, and monitoring of supply chain activities with the sole
objective of creating net value and leveraging worldwide logistics. Whereas the
concept of logistics covers the management of the flow of goods and the services
between the point of origin and the point of consumption in order to meet the
requirements of customers.

3.7 Key Essentials of Supply Chain

Supply chain to be successfully managed has certain pre-requisites to be fulfilled.

Since, many organizations are involved it is difficult to bring harmony in their
operations and establish common objectives which will provide benefit to all the
parties. Thus, in order to make the supply chain competitive enough to gain market
leadership, the following key essentials are required:

1. The firm should try to lower down the end user prices.
2. The firm must focus on reducing the percentage of supply chain
costs in the overall cost in order to make the supply chain more
competitive.
3. End user metrics are necessary to know the level and extent of
customer satisfaction and their involvement.
4. Identify the key areas which might lead to reduction in time and cut
the overall supply chain cycle that moves a product through the
supply chain.
5. Collaborative planning among trading partners, with shared
management of resources, is required.
6. There should be focus on visibility of usage, forecasts, orders,
shipments, and inventories.

3.8 Principles of Supply Chain

Supply Chain Management has become a distinct and important discipline in the
field of management. Thus, there is a need to specify certain key underlying

KMBI 602 SCM – Dr Rajiv Ratan Page 29

principles of SCM which provides a crucial base for managing the activities
involved in the supply chain management. The seven principles as articulated by
Andersen Consulting are as follows:

1. Segment customers on the basis of their service needs: Effective supply-

chain management groups customers by distinct service needs without
considering their industry. Then, they provide them the customized services to
each group.

2. Customise the Supply Chain Management network: In designing their

Supply Chain Management network, companies need to focus intensely onthe
service requirements and profitability of the customer segments identified.
Thus, every company frames its own supply chain network which is unique and
based on customized requirements.
3. Identify the market demand pattern and plan accordingly: Sales and
operations planning of the company should include a mechanism wherein it
could detect early warning signals of changing demand in ordering patterns,
customer promotions etc. This demand-intensive approach leads to more
consistent forecasts and optimal resource allocation.
4. Differentiate product closer to the customer: The companies need to
postpone product differentiation in the manufacturing process closer to actual
consumer demand.
5. Strategically manage the sources of supply: Companies should work with
the suppliers strategically to reduce the overall costs associated with materials
and services. The supply chain management leaders enhance margins both for
themselves and their suppliers. Now, the focus should be on sharing of the
gains.
6. Develop a supply-chain-wide technology strategy: The company should
make efforts to develop information technology which support multiple levels
of decision making. It should be capable enough to provide a clear view of the
flow of products, services, and information which will in the long run leadto a
successful SCM.
7. Adopt channel-spanning performance measures: In order to make theSCM
of an organization better than the others, it should monitor the internal functions
and adopt measures that apply to every link in the supply chain.

KMBI 602 SCM – Dr Rajiv Ratan Page 30

When the above mentioned principles are followed consistently and
comprehensively, then they will bring a host of competitive advantages for the
company. Thus, every organization must strive for implementing as many
principles as possible to improve the supply chain and enhance the benefits arising
from it.

3.9 Logistics – An Integral Component of Supply Chain Management

Logistics refers to the activities that occur within the boundaries of a single
organization and supply chains refer to networks of companies that work together
and coordinate their actions to deliver a product to market. Logistics focuses its
attention on activities such as procurement, distribution, maintenance, and
inventory management. Supply Chain Management includes not only logistics but
also the activities such as marketing, new product development, finance, and
customer service. Thus, logistics is an integral part of SCM.

Logistics is the backbone on which supply chains are driven. Logistics facilitates
the management of the flow of goods and supplies involving information, data and
documentation between two entities. Logistics plays important role in post
procurement function also. The goods flow through a network of transportation by
road, rail, air or ship and intermediary warehouses to hold inventories before
moving to the forward locations. The entire activity involves multi-tier suppliers,
and agencies including freight forwarders, packers, customs department,
distributors and logistics service providers, etc.

Supply chain design in an organization would detail, plan and strategize the
procurement strategy, manufacturing location selection, design and develop
distribution network and strategy for finished goods. While logistics planning

KMBI 602 SCM – Dr Rajiv Ratan Page 31

would deal with the details of procurement logistics, finished goods distribution,
sales order fulfilment, and inventory management, etc.

In the case of finished goods distribution, SCM strategy will define overall network
design for stock holding and other channels of distribution. Logistics deals with the
entire designing of the transportation network, partnering with 3rd party logistics
providers to establish distribution centres and warehouses, planning inventory
management and operations process including packing, promotional bundling and
at the end the complete documentation and information process for the entire chain
of activities.

Logistics planning drives the strategic direction and framework for its design
planning from SCM Strategy. Logistics therefore is an integral component of
Supply Chain Management.

3.10 Let’s Sum-up

Logistics is a very old term, firstly used in the military, for the maintenance, storage
and transportation of army persons and goods. Nowadays, a new term has evolved
namely Supply Chain Management. It is said that SCM is an addition over Logistics
Management as well as SCM comprises of logistics. Both are inseparable. Hence
they do not contradict but supplement each other.

The management process which integrates the movement of goods, services,

information and capital, right from the sourcing of raw material, till it reaches its
end consumer is known as Logistics Management. On the other hand, SCM refers
to the series of interconnected activities related to the transformation and movement
of raw material to the finished goods till it reaches to the end user. Logistics include
activities like warehousing, transportation, procurement, material handling, order
processing etc. There are various kinds of terms associated with logistics like
inbound logistics, outbound logistics, service logistics, event logistics and
international logistics.

SCM includes the coordination and management of the supply chain network
partners. The simplest form of supply chain includes supplier, manufacturer,

KMBI 602 SCM – Dr Rajiv Ratan Page 32

wholesaler and retailer. Thus, logistics is a sub-component and extension of Supply
Chain.

In contemporary times, supply chains can be sources of competitive advantage as

efficient management of the supply chain leads to cost savings and synergies
between the components of the supply chain leads to greater profitability for the
firms.

3.11 Key Terms

Logistics: Logistics is the management of the flow of things between the point of
origin and the point of consumption in order to meet requirements of customers or
corporations.

Logistics Management: Logistics management is the part of supply chain

management that plans, implements, and controls the efficient, effective forward,
and reverse flow and storage of goods, services, and related information between
the point of origin and the point of consumption in order to meet customer's
requirements.

Supply Chain: A supply chain is the network of all the individuals, organizations,
resources, activities and technology involved in the creation and sale of a product,
from the delivery of source materials from the supplier to the manufacturer,through
to its eventual delivery to the end user.

Supply Chain Management: Supply Chain Management (SCM) is a series of

interconnected activities related to the transformation and movement of raw
material to the finished goods till it reaches to the end user.

1. Logistic management has the following objectives:

(i) Cost Reduction and Profit Maximization:

Logistics management results in cost reduction and profit maximization due to:
 Improved material handling
 Safe, speedy and economical transportation
 Optimum number and convenient location of warehouses
(ii) Efficient Flow of Manufacturing Operations:
KMBI 602 SCM – Dr Rajiv Ratan Page 33
Inbound logistics helps in the efficient flow of manufacturing operations, due to on-
time delivery of materials, proper utilisation of materials and semi-finished goods
in the production process.
(iii) Competitive Edge:
Logistics provide, maintain and sharpen the competitive edge of an enterprise by:
 Increasing sales through providing better customer service
 Arranging for rapid and reliable delivery
 Avoiding errors in order processing
(iv) Effective Communication System:
An efficient information system is a must for sound logistics management. As such,
logistics management helps in developing effective communication system for
continuous interface with suppliers and rapid response to customer enquiries.
(v) Sound Inventory Management:
Logistics management automatically leads to sound inventory management.

2. The basic purpose of supply chain management is to enhance the organization’s

competitive position by cost optimization, asset utilization and value creation.
SCM aims to achieve the following key objectives:
 To support operational requirements i.e. providing an uninterrupted
flow of high quality goods and services that internal customers require.
 To manage the purchase process efficiently and effectively.
 To manage the supply base i.e. to select, develop, and maintain sources
of supply.
 To develop strong relationship with other functional groups.
 To support organizational goals and objectives i.e. aligning sourcing
and corporate goals.
 To develop integrated purchasing strategies that support organizational
strategies.

KMBI 602 SCM – Dr Rajiv Ratan Page 34

 Reverse Supply Chain Management
: Amit Karamchandani and Samir K Srivastava
Reverse supply chain management (RSCM) is defined as the effective implementation of the series of
activities involved in collecting a product from any stage of the forward supply chain to either dispose it or
recover value. In reverse supply chain, there are a sequence of steps required to pick up the used product and
to carry out the most suitable product disposition strategy like reuse, remanufacturing and/or recycling. The
reverse supply chain initiates with accumulation of products from different stages of supply chain which
includes firms as well as customers. These members of supply chain are generally widely dispersed
geographically.
From a broader perspective, when the forward and reverse supply chains are combined, it forms a closed
loop supply chain. Reverse Logistics is a part of such reverse supply chains.

Product Disposition alternatives in a Reverse Supply Chain

There are a wide array of products, which in the forward supply chain reach at the end of their supply chain
before even reaching the consumer. These products need to be transported back to the initiating stages of
forward supply chain for product disposition. Some such products are:
 Broken down products which are repairable or reusable,
 Obsolete products which still have some remnant value,
 Products unsold at retail stores,
 Products withdrawn from sale,
 Products that cannot be used for their main function but which can be used in alternate ways
 Waste which can be collected and used for energy production like waste wood, etc.
 Packages which need to be returned back to their point of origin or point of consolidation
Reverse Supply Chain Process
Reverse supply chains despite being different in its each unique case, generally has following five key
processes:
1. Product acquisition,
2. Reverse logistics
3. Inspection
4. Product disposition
5. Sale and distribution
1-Product Acquisition
At acquisition stage, the product is collected from the customer. There are three main sources of product
acquisition: from forward supply chains, which is associated with collection of defective or damaged
products; from an established RSC, called market-driven systems; or from the waste stream, where the
consumer has discarded the product. Market-driven systems have less variation since they follow a minimal
standard in quality. Although reverse supply chain may include the same contact partners as the forward
supply chain, generally the reverse flows are partially or entirely supported by alternative channel partners
such as junkmen, scavengers, dealers, brokers and non-OEM remanufacturers.
2-Reverse Logistics
Due to growing concern of going green, sustainable development, fierce globalised competition, future
legislation, increased product returns, environmental consciousness of customers and so on, reverse logistics
(RL) has gained increasing attention among researchers and practitioners worldwide. It is “the process of
planning, implementing, and controlling the efficient, cost effective flow of raw materials, in-process
inventory, finished goods, and related information from the point of consumption to the point of origin for
the purpose of recapturing or creating value or proper disposal". RL involves planning, implementation and
controlling backward flows of raw materials, in-process inventory, packaged and finished goods, from a
manufacturing, distribution or end-use point, to a point of recovery or to a point of proper disposal.

According to the Reverse Logistics Executive Council, the cost of reverse logistics and disposition method
determination is $35 billion annually for US firms. Remanufacturing constitutes $50 billion per year
industry in the US. The implementation of reverse logistics can be categorised as a part of firm’s
environment management practices, specifically environmental recycling practices, as it promotes reuse and
recycling of materials. Complexity in product disposition process requires expertise of skilled labour which
drives up the cost of inspection and disposition.
3-Inspection
The core objective of inspection is to know the quality level of returning material and to select appropriate
product disposition strategy for the same.
4- Product disposition
If product upgrade is found to be the most suitable disposition plan for a product, it is assigned to a
reconditioning operation, such as refurbishing, repair, or remanufacturing. Disassembly operation involves
complications. Due to difficulty involved in separating and sorting the components, and the diverseness and
complexity of materials, the process is predominantly manual. There are four kinds of product disposition
strategies which have further sub-types in each of them:
• Direct Reuse: It involves reuse or reselling the product immediately.
• Product upgrade: It implies repairing, repackaging, remanufacturing or refurbishing the product. “Repair”
involves returning the used products to "working condition”. “Refurbishing” involves evolving used
products up to a defined quality level. “Remanufacturing” involves evolving the used products up to new
product like quality standards.
• Materials recovery: It includes cannibalization and recycling. Cannibalization involves recovering a
limited set of reusable parts from used products or components. For example, Aurora a US firm cannibalizes
integrated circuits. The firm separates the parts it needs from a computer and then tests, straightens, redips,
polishes, and sells the chips.
• Waste management: It includes incineration and landfilling the product for proper disposal.

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 Information Technology in SCM

Information Functionality – The Supply Chain

Information is one of the greatest facilitators in supply chain management. Supply Chain
information is a critical component of a firm’s ability to respond rapidly to the end
consumer demand in today’s highly competitive marketplace. Timely and accurate
information is also critical for three reasons:
 Information on order status, product availability, delivery schedule, and invoices is
perceived by customers as a necessary element of total customer service;
 Information can reduce inventory by minimizing demand uncertainty; and
 Information increases flexibility with regard to how, when, and where resources may
be utilized for strategic advantage.

Information integrates supply chain activities by building on four levels of

functionality:
 Transaction,
 Management control,
 Decision analysis, and
 Strategic planning systems.

Comprehensive Information System Integration

A comprehensive information system initiates, monitors, assists in decision making, and

reports on activities required to complete logistics operations and planning. There are many
components that must be combined to form an integrated information system, and there
are many ways to organize and illustrate the combined components. The major system
components include:
(1) Enterprise Resource Planning (ERP) or legacy systems,
(2) Communication systems,
(3) Execution systems, and
(4) Planning systems.

ERP or Legacy Systems

The ERP or legacy systems are the backbone of most firms’ supply chain information
systems. This backbone maintains current and historical data and processes transactions to
initiate and track performance. Legacy systems refer to the mainframe applications that were
developed prior to 1990 to automate transactions such as order entry, order processing,
warehouse operations, inventory management, transportation, and related financial
transactions.

Example: Systems related to customer orders were often labelled Order

Management Systems (OMS) since they managed the order fulfilment process. In addition to
order information, legacy systems typically maintain information regarding customers,
products, inventory status, and facility operations.
In many cases, these legacy systems represent independently developed software modules
that lack integration and consistency; consequently, problems with data reliability and
integrity abound. These problems are further complicated by the fact that multidivisional
firms often use different legacy systems for each division or country.

Communication Systems
The communication module facilitates information flow between functional areas within
the firm and between supply chain partners. The major communication components
required for supply chain operations. Logistics information consists of real time data on
company operations inbound material flows, production status, product inventories,
customer shipments, and incoming orders.
From an external perspective, firms need to make order, shipment, and billing information
available to suppliers, financial institutions, transportation carriers, and customers.
Internal operating units must be able to share and exchange information on production
schedule and status. Typical supply chain communication technologies include bar coding,
scanning, Electronic Data Interchange (EDI), satellite communication, radio frequency,
and the Internet.

Execution Systems
Enterprise execution systems work in conjunction with the firm’s ERP to provide specific
functionality to support logistics operations. While some ERP systems include reasonable
logistics functionality, many lack the capabilities to facilitate contemporary warehouse and
transportation operations. Most execution systems are “bolted-on” or integrated into the ERP
system to facilitate data exchange. In addition to facilitating standard warehouse management
functionality such as receiving, storage, shipping, and warehouse automation, Warehouse
Management Systems (WMS) typically include management reporting, support for value
added services, and decision support capability.
building, consolidation, and management of reverse logistics activities as well as scheduling

Planning Systems
While the ERP system processes transactions to execute specific logistics activities,
transaction systems in general don’t evaluate alternative strategies or assist with decision
making. Supply chain planning systems, now being termed Advanced Planning and
Scheduling (APS) systems, are designed to assist in evaluating supply chain alternatives and
advise in supply chain decision making. Sophisticated supply chain planning systems are
becoming increasingly common to allow for consideration of complex alternatives under
tight decision time constraints. Typical supply’ chain planning applications include
production scheduling, inventory resource planning and transportation planning. Using the
historical and current data maintained in the data warehouse, APS software systematically
identifies and evaluates alternative courses of action and recommends a near optimal
solution within the constraints imposed. Typical constraints involve production, facility,
transportation, inventory, or raw material limitations.
Planning systems can generally be grouped into two categories, strategic and tactical.
Strategic planning systems are designed to assist in analyses where there is a large number of
alternatives and data outside the range of current history is required. Examples of strategic
planning applications include supply chain network design and structural analyses such
as which combination of supplier, production, and distribution facilities should he used
and how product should flow between existing or potential facilities.

Communication Technology
Information technology is also critical for information sharing to facilitate logistics and
supply chain planning and operations. Historically, coordination of logistics has been
difficult since logistics activities are often performed at locations distant from information
technology hardware. As a result, information was not available at the location of
essential work in terms of both time and content. The past decade has witnessed
remarkable advances in logistical communication systems capability. EDI, the Internet,
Extensible Markup Language (XML), and satellite technology exist to facilitate
communication between firms and facilities.
 Electronic Data Interchange

Electronic Data Interchange (EDI) involves the swapping of business documents in a

standard format from computer-to-computer. It presents the capability as well as the practice
of exchanging information between two companies electronically rather than the traditional
form of mail, courier, & fax.
The major advantages of EDI are as follows −

 Instant processing of information

 Improvised customer service
 Limited paper work
 High productivity
 Advanced tracing and expediting
 Cost efficiency
 Competitive benefit
 Advanced billing

Enterprise Resource Planning (ERP)

The ERP system has now become the base of many IT infrastructures. Some of the ERP tools
are Baan, SAP, PeopleSoft. ERP system has now become the processing tool of many
companies. They grab the data and minimize the manual activities and tasks related to
processing financial, inventory and customer order information.
ERP system holds a high level of integration that is achieved through the proper application
of a single data model, improving mutual understanding of what the shared data represents
and constructing a set of rules for accessing data.
With the advancement of technology, we can say that world is shrinking day by day. Similarly,
customers' expectations are increasing. Also companies are being more prone to uncertain
environment. In this running market, a company can only sustain if it accepts the fact that their
conventional supply chain integration needs to be expanded beyond their peripheries.

Enterprise Resource Planning (ERP) and enterprise

execution systems are the major software components
of logistics information systems. ERP provides the
database and the transaction capability to initiate, track,
monitor, and report on customer and replenishment
orders. ERP systems provide firms with information
consistency, economies of scale, and integration. ERP
system design includes the central database and
application modules to facilitate supply chain, financial
and human resource management. Supply chain system design includes components for
planning/coordination, operations, and inventory deployment. The planning/coordination
component manages firm and supply chain resources including production, storage, and
transportation resources. The operations component controls transaction processing to initiate,
manage, fulfil, and ship both customer and replenishment orders. Inventory deployment
manages firm and increasingly supply chain inventory resources.
Enterprise execution systems provide the interface between the ERP and the day-to-day
operations with the customer, transportation, and the warehouse. Customer relationship
management systems offer insight regarding the firm’s activity level and performance
with key customers. Transportation management systems initiate shipments and record
movements to monitor the firm’s transportation performance and cost. Warehouse
management systems initiate warehouse activities, control material handling equipment,
monitor labour performance, and report warehouse performance levels and cost.

Tactical planning focuses on operational issues as constrained by short-term resource

constraints such as production, facility, or vehicle capacity. The information support for
tactical planning is typically available from a firm’s data warehouse. Tactical planning
processes evaluate customer requirements and identify an operational combination of
production, inventory, facilities, and equipment utilization that can he applied within
capacity constraints. The result is an action plan to guide short term operations.

Bar Coding and Scanning

Auto Identification (ID) systems such as bar coding and electronic
scanning were developed to facilitate logistics information collection
and exchange. Typical applications include tracking receipts at
warehouses and retail sales. These ID systems require significant
capital investment for users, but necessarily replace former paper-based information
collection and exchange processes that were error-prone and time-consuming. In fact,
increased domestic and international competition is driving shippers, carriers, warehouses,
wholesalers, and retailers to develop and utilize Auto ED capability to compete in today’s
marketplace.
Auto ID allows supply chain members to quickly track and communicate movement
details with a low probability of error, so it is fast becoming a fundamental service
requirement for freight tracking by carriers. Both consumers and B2B customers expect
to be able to track the progress of their shipment using the Web-based system offered by
carriers such as United Parcel Service and FedEx.
We can see the application of barcode scanners in the checkout counters of super market. This
code states the name of product along with its manufacturer. Some other practical applications
of barcode scanners are tracking the moving items like elements in PC assembly operations
and automobiles in assembly plants.
Bar coding is the placement of computer readable codes on items, cartons, containers,
pallets, and even rail cars. Most consumers are aware of the Universal Product Code
(UPC) that is present on virtually all consumer products. UPC bar codes, used first in 1972,
assign a unique 12- digit number to each manufacturer and product. Standardized bar codes
reduce errors when receiving, handling, or shipping product.

Example: A bar code distinguishes package size and flavour. European Article
Numbering (EAN) is the European and United Nations standard for bar coding of items.
It is likely that the UPC and EAN systems will become more harmonized due to pressures
of global trade.

Radio Frequency Exchange

Radio Frequency Data Communication (RFDC) technology is used within relatively
small areas, such as distribution centres, to facilitate two-way information exchange. A
major application is real time communication with mobile operators such as forklift
drivers and order selectors. RFDC allows drivers to have instructions and priorities
updated on a real time basis rather than using a hard copy of instructions printed hours
earlier. Real time instructions to guide work flow offer increased flexibility and
responsiveness and have the potential to improve service using fewer resources.

Did u know? Logistics RFDC applications also include two-way communication of

warehouse selection cycle count verification and label printing.
Advanced RFDC capabilities in the form of two-way voice communication are finding
their way into logistics warehouse applications. Instead of requiring warehouse operations
personnel to interface with a mobile or handheld computer, voice RFDC prompts
operators through tasks with audible commands and waits for verbal responses or
requests. United Parcel Service uses speech-based RFDC to read zip codes from incoming
packages and print routing tickets to guide packages through their newer sortation
facilities. The voice recognition systems are based on keywords and voice patterns of
each operator. The primary benefit of voice-based RFDC is easier operator interface;
since keyboard data entry is not required; two hands are available for order picking.
Radio Frequency Identification (RFID) is a second form of radio frequency technology.
RFID can be used to identify a container or its contents as it moves through facilities or on
transportation equipment. RFID places a coded electronic chip in the container or box. As
the container or box moves through the supply chain, it can be scanned for an identifying
code or even for the list of contents. Retailers are beginning to use RFID to allow entire
cartloads of merchandise to be scanned simultaneously. The U.S. Department of Defense
uses RFID to list the contents of pallets so that they can be tracked as they are loaded on
transportation equipment or move through facilities.
 BULL WHIP Effect

The Bullwhip Phenomenon

Volatility amplification along the network
 Increase in demand variability as we move
upstream away from the market
 Mainly because of lack of communication and
coordination
 Delays in information and material flows
 Bullwhip effect occurs because of various
reasons:
 Order Batching - Accumulate orders
 Shortage gaming- Ask for more than what is
needed
 Demand forecast updating
 Bull Whip Effect

 Each organisation seek to solve the problem from its

own perspective
 Small changes in consumer demand result in
large variations in orders placed upstream
 Dramatic order size variation
 Amplification of order size variation as one moves
up the supply chain

Delay 2 weeks Delay 2 weeks Delay 2 weeks

Supplier Manufacturer Distributor Retailer Customer

Orders 40 Orders 25 Orders 15 Buys 10

Causes
 Little or no communication between supply
chain partners.
 Delay times between order processing,
demand, and receipt of products.
 Over reacting to the backlog orders.
 Inaccurate demand forecasts.
Supply Chain Management and Uncertainty
 Inventory and back-order levels fluctuate considerably across
the supply chain even when customer demand doesn’t vary
 The variability worsens as we travel “up” the supply chain
 Forecasting doesn’t help!

Multi-tier Wholesale
Suppliers Manufacturer Distributors Retailers Consumers

Sales

Sales
Sales

Sales

Time Time Time

Time

Bullwhip Effect
Factors Contributing to the Bullwhip
 Demand forecasting practices
 Min-max inventory management (reorder points to bring
inventory up to predicted levels)
 Lead time
 Longer lead times lead to greater variability in estimates of
average demand, thus increasing variability and safety stock
costs
 Batch ordering
 Peaks and valleys in orders
 Fixed ordering costs
 Impact of transportation costs (e.g., fuel costs)
 Sales quotas
 Price fluctuations
 Promotion and discount policies
 Lack of centralized information
Taming the Bullwhip
Four critical methods for reducing the Bullwhip effect:
 Reduce uncertainty in the supply chain
 Centralize demand information
 Keep each stage of the supply chain provided with up-to-date
customer demand information
 More frequent planning (continuous real-time planning the goal)
 Reduce variability in the supply chain
 Every-day-low-price strategies for stable demand patterns
 Reduce lead times
 Use cross-docking to reduce order lead times
 Use EDI techniques to reduce information lead times
 Eliminate the bullwhip through strategic partnerships
 Vendor-managed inventory (VMI)
 Collaborative planning, forecasting and replenishment (CPFR)
 THE ROLE OF FORECASTING IN A SUPPLY CHAIN

Various functional areas based on demand forecast are

1. Production
2. Marketing
3. Finance
4. Human resource

Production is concerned with scheduling inventory planning and control and aggregate
planning
Marketing is concerned with sales force allocation sales promotion and new product
launching
Finance is concerned with capital investment in plant and equipment and budgeting
Human resource is concerned with the manpower planning, hiring, layoff etc

Demand forecast can be of can be classified on the basis of time Horizon

1. Long term forecast
2. Medium term forecast and
3. Short term forecast
Long term forecast are for a period of three or more than 3 years. These forecast are of
long term nature and especially for strategic business planning. Long term forecast have
at times not very accurate and they have high rate of error.

The medium term or the intermediate term forecast are for a period of 1 to 3 years.
The short term forecast are for short interval time which can run from few weeks to few
months and they are generally more accurate. Various category of forecast includes
Demand forecast
Sales forecast
Price forecast

The objectives of the forecast are

1. To manage uniform level of production
2. To avoid the situations of out of the stocks
3. To lower the safety stock reserves
4. To take the benefit of price discount in bulk purchase
5. To manage product getting obsolete and also
6. To manage the transportation cost
 Demands can be based on nature of demand anticipation i.e push based demand or
pull based command. A company must be knowledgeable about numerous factors that
are related to the demand forecast, including the following:

The demand also depends upon

1. The past demand
2. The lead time required to fulfil the demand
3. Any planned advertising or marketing activities
4. Prevailing Trends in the market ( Fashion )
5. Seasonal factors
6. State of the economy
7. Any planned discounts to be offered and
8. Demand also depends upon the action of the computers in case for example pepsi
offers buy 1 get 1 free then the coke has to come up with the similar offer which
will increase the demand for the product based on the promotion scheme offered
by the competition

Demand forecasts form the basis of all supply chain planning. All push processes in the
supply chain are performed in anticipation of customer demand, whereas all pull
processes are performed in response to customer demand. For push processes, a manager
must plan the level of activity, be it production, transportation, or any other planned
activity. For pull processes, a manager must plan the level of available capacity and
inventory but not the actual amount to be executed. In both instances, the first step a
manager must take is to forecast what customer demand will be.

Product demand also depends upon the various stages of the product life cycle PLC.
The demand of the product varies from one stage to another stage. In the nascent stage
which is the introductory stage the demand may be low and the demand may subsequently
increase when the product enters into the growth stage. The demand saturates or remains
the same at the saturation stage and may even subsequently decrease in the decline stage.

Bull-Whip effect refers to the fluctuation in the orders which increase as they move up
the supply chain from retailers to manufacture and finally to the suppliers The error in
demand forecast increases from one stage to the another stage as we move we move up
the supply chain, this effect is known as the Bull Whip effect.
 Forecasting methods are classified according to the following four types:
1. Qualitative: Qualitative forecasting methods are primarily subjective and rely on human
judgment. They are most appropriate when little historical data are available or when
experts have market intelligence that may affect the forecast. Such methods may also be
necessary to forecast demand several years into the future in a new industry.
2. Time series: Time-series forecasting methods use historical demand to make a forecast.
They are based on the assumption that past demand history is a good indicator of future
demand. These methods are most appropriate when the basic demand pattern does not
vary significantly from one year to the next. These are the simplest methods to
implement and can serve as a good starting point for a demand forecast.
3. Causal: Causal forecasting methods assume that the demand forecast is highly corre-
lated with certain factors in the environment (the state of the economy, interest rates, etc.).
Causal forecasting methods find this correlation between demand and environmental
factors and use estimates of what environmental factors will be to forecast future
demand. For example, product pricing is strongly correlated with demand. Companies
can thus use causal methods to determine the impact of price promotions on demand.
4. Simulation: Simulation forecasting methods imitate the consumer choices that give rise
to demand to arrive at a forecast. Using simulation, a firm can combine time-series and
causal methods to answer such questions as: What will be the impact of a price promotion?
What will be the impact of a competitor opening a store nearby? Airlines simulate customer
buying behavior to forecast demand for higher fare seats when there are no seats available
at the lower fares.

5. Market research method : This is a planned approach to determine the product demand
by conducting a survey and taking the customer experience into consideration. This
method is used to forecast demand for medium term and long term. Market research or
consumer survey provides the first hand information which helps in estimating the
product demand. This method can be expensive and time-consuming. The quality of the
forecast also depends upon the questionnaire used for the survey

6. Delphi Method : In this method views of the experts are taken into consideration. The
frontline staff has first-hand knowledge of the market and are better aware with the
ground realities. This group provides necessary information to the decision makers
involved in the process of demand forecasting. The forecast is prepared on the general
consensus. In this process panel of experts is made and their inputs are taken into
consideration for making the forecast. This process can be time consuming may also
lead to errors arising because of poorly designed questionnaires
UMass Lowell 63.371
College of Management T. Sloan

Forecasting Example Problems with Solutions

1. The Instant Paper Clip Office Supply Company sells and delivers office supplies to companies, schools, and
agencies within a 50-mile radius of its warehouse. The office supply business is competitive, and the ability
to deliver orders promptly is a big factor in getting new customers and maintaining old ones. (Offices
typically order not when they run low on supplies, but when they completely run out. As a result, they
need their orders immediately.) The manager of the company wants to be certain that enough drivers and
vehicles are available to deliver orders promptly and that they have adequate inventory in stock. Therefore,
the manager wants to be able to forecast the demand for deliveries during the next month. From the records
of previous orders, management has accumulated the following data for the past 10 months:

Month Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct.
Orders 120 90 100 75 110 50 75 130 110 90

a. Compute the monthly demand forecast for February through November using the naive method.
b. Compute the monthly demand forecast for April through November using a 3-month moving average.
c. Compute the monthly demand forecast for June through November using a 5-month moving average.
d. Compute the monthly demand forecast for April through November using a 3-month weighted moving
average. Use weights of 0.5, 0.33, and 0.17, with the heavier weights on the more recent months.
e. Compute the mean absolute deviation for June through October for each of the methods used. Which
method would you use to forecast demand for November?

Solution:

a. The naive method simply uses the demand for the current month as the forecast for the next month:
Ft+1 = Dt . So for February we would have FFeb. = DJan. = 120. Similarly, FNov. = DOct. = 90. See the
table below for the other months.
b. For a simple 3-month moving average, we take the average of the previous three months’ demand
Dt + Dt−1 + Dt−2
as our forecast for next month: Ft+1 = . Since we need at least three months to
3
compute the average, and we only have data beginning in January, April is the earliest month for
DMar. + DFeb. + DJan. 100 + 90 + 120
which we can compute the forecast: FApr. = = = 103.3. The
3 3
forecasts for the other months are reported in the table below.
c. The 5-month moving average is similar to the 3-month moving average, except now we take the
average of the previous five months’ demand. We start with the forecast for June (since we need
DMay + DApr. + DMar. + DFeb. + DJan.
at least five months’ worth of previous demand): FJun. = =
5
110 + 75 + 100 + 90 + 120
= 99.0. The forecasts for the remaining months are computed similarly,
5
and the values are reported in the table below.
d. Simple moving averages (like parts b and c above) place an equal weight on all of previous months.
A weighted moving average allows us to put more weight on the more recent data. For a weighted
3-month moving average we have Ft+1 = w1 Dt + w2 Dt−1 + w3 Dt−2 . (Note that the weights should
add up to 1.) Using the weights specified in the question, the forecast for April is computed as
FApr. = 0.5(DMar. ) + 0.33(DFeb.) + 0.17(DJan. ) = 0.5(100) + 0.33(90) + 0.17(120) = 100.1. Forecasts for
May through November are reported in the table below.

1 Spring 2007
 Forecast
Naive 3-Month 5-Month 3-Month
Month Orders Method Moving Avg. Moving Avg. Weighted Avg.
Jan. 120 — — — —
Feb. 90 120 — — —
Mar. 100 90 — — —
Apr. 75 100 103.3 — 100.1
May 110 75 88.3 — 85.8
Jun. 50 110 95.0 99.0 96.8
Jul. 75 50 78.3 85.0 74.1
Aug. 130 75 78.3 82.0 72.7
Sep. 110 130 85.0 88.0 98.3
Oct. 90 110 105.0 95.0 110.7
Nov. ? 90 110.0 91.0 103.4

e. Mean absolute deviation is one measure of how close the forecast is to the actual demand. Recall that
forecast error is simply Et = Dt − Ft , and that the absolute deviation is simply the absolute value of
error: |Et |. For example, the error for the Naive Method for June is EJun. = DJun. − FJun. = 50 − 110 =
−60. To compute the mean absolute deviation, take P the absolute value of each error term, add them
|Et |
up, and divide by the number of terms: MAD = . (Note: You must take the absolute value of
n
each error term before adding them up!) In this case, we compute the mean over five months. The
error and MAD for the months June through October are reported below. In general, the forecast
accuracy increases as more information is incorporated into the forecast.

Error (Et = Dt − Ft )
Naive 3-Month 5-Month 3-Month
Month Orders Method Moving Avg. Moving Avg. Weighted Avg.
Jun. 50 −60 −45.0 −49.0 −46.8
Jul. 75 25 −3.3 −10.0 0.9
Aug. 130 55 51.7 48.0 57.3
Sep. 110 −20 25.0 22.0 11.8
Oct. 90 −20 −15.0 −5.0 −20.7
MAD 36.0 28.0 26.8 27.5

2. PM Computer Services assembles customized personal computers from generic parts. Formed and operated
by part-time UMass Lowell students Paulette Tyler and Maureen Becker, the company has had steady
growth since it started. The company assembles computers mostly at night, using part-time students.
Paulette and Maureen purchase generic computer parts in volume at a discount from a variety of sources
whenever they see a good deal. Thus, they need a good forecast of demand for their computers so that
they will know how many parts to purchase and stock. They have compiled demand data for the last 12
months as reported below.

Period Month Demand Period Month Demand

1 January 37 7 July 43
2 February 40 8 August 47
3 March 41 9 September 56
4 April 37 10 October 52
5 May 45 11 November 55
6 June 50 12 December 54

2
 a. Use exponential smoothing with smoothing parameter α = 0.3 to compute the demand forecast for
January (Period 13).
b. Use exponential smoothing with smoothing parameter α = 0.5 to compute the demand forecast for
January (Period 13).
c. Paulette believes that there is an upward trend in the demand. Use trend-adjusted exponential
smoothing with smoothing parameter α = 0.5 and trend parameter β = 0.3 to compute the demand
forecast for January (Period 13).
d. Compute the mean squared error for each of the methods used.

Solution:

a. The formula for exponential smoothing is: Ft+1 = Ft + α(Dt − Ft ). To determine the forecast for
January, F13 , we need to know the forecast for December, F12 . This, in turn, requires us to know
the forecast for November, F11 . So we need to go all the way back to the beginning and compute the
forecast for each month. For Period 2, we have F2 = F1 +α(D1 −F1 ). But how do we get the forecast for
Period 1? There are several ways to approach this, but we’ll just use the demand for Period 1 as both
demand and forecast for Period 1. Now we can write F2 = F1 + α(D1 − F1 ) = 37 + 0.3(37 − 37) = 37.
For Period 3 we have F3 = F2 + α(D2 − F2 ) = 37 + 0.3(40 − 37) = 37.9. The forecasts for the
other months are show in the table below. For Period 13 we have F13 = F12 + α(D12 − F12 ) =
50.85 + 0.3(54 − 50.85) = 51.79.
b. For α = 0.5 we follow the same exact procedure as we did in part a. See the table below for the
forecast values.
c. Incorporating a trend simply requires us to include a bit more information. The formula is: Ft+1 =
At + Tt where At = αDt + (1 − α)(At−1 + Tt−1 ) and Tt = β(At − At−1 ) + (1 − β)Tt−1 . Once
again we need to go back to the beginning in order to find the necessary values to plug into the
formula, and once again we need to make some assumptions about our initial values. For Period 2,
we have F2 = A1 + T1 , so to get the process started, let A0 = 37 and T0 = 0. We can now
compute A1 and T1 as follows: A1 = αD1 + (1 − α)(A0 + T0 ) = 0.5(37) + (1 − 0.5)(37 + 0) = 37,
and T1 = β(A1 − A0 ) + (1 − β)T0 = 0.3(37 − 37) + (1 − 0.3)(0) = 0. Therefore, the forecast for
Period 2 is F2 = A1 + T1 = 37 + 0 = 37. For Period 3, we first compute A2 and T2 as follows:
A2 = αD2 + (1 − α)(A1 + T1 ) = 0.5(40) + (1 − 0.5)(37 + 0) = 38.5, and T2 = β(A2 − A1 ) + (1 − β)T1 =
0.3(38.5 − 37) + (1 − 0.3)(0) = 0.45. The forecast for Period 3 is F3 = A2 + T2 = 38.5 + 0.45 = 38.95.
The forecasts for the remaining months are reported in the table below.

Expon. Expon. Trend-Adjusted Expon.

Smooth. Smooth. Smooth. (α = 0.5, β = 0.3)
Period Month Demand α = 0.3 α = 0.5 At Tt Ft
1 Jan. 37 37.00 37.00 37.00 0.00 37.00
2 Feb. 40 37.00 37.00 38.50 0.45 37.00
3 Mar. 41 37.90 38.50 39.98 0.76 38.95
4 Apr. 37 38.83 39.75 38.87 0.20 40.73
5 May 45 38.28 38.38 42.03 1.09 39.06
6 Jun. 50 40.30 41.69 46.56 2.12 43.12
7 Jul. 43 43.21 45.84 45.84 1.27 48.68
8 Aug. 47 43.15 44.42 47.05 1.25 47.11
9 Sep. 56 44.30 45.71 52.15 2.41 48.31
10 Oct. 52 47.81 50.86 53.28 2.02 54.56
11 Nov. 55 49.07 51.43 55.15 1.98 55.30
12 Dec. 54 50.85 53.21 55.56 1.51 57.13
13 Jan. ? 51.79 53.61 57.07
3
 e. To compute the mean square error, first compute the error for each period:
P 2 Et = Dt − Ft . Take that
Et
number and square it, then take the average over all periods: MSE = . (Note: You must square
n
the error terms before adding them up!) Take the Exponential Smoothing method with α = 0.3, for
example. In the month of April, the error is EApr. = DApr. − FApr. = 37 − 38.83 = −1.83. We square
this value, add it to the other squared error terms, and divide by 12 to get the mean. The error,
squared error, and MSE for each of the methods are reported below. The trend-adjusted forecast,
which incorporates the most information, has the highest accuracy (lowest MSE).

Expon. Smooth. Expon. Smooth. Trend-Adj.

α = 0.3 α = 0.5 α = 0.5, β = 0.3
Month Demand Et Et2 Et Et2 Et Et2
Jan. 37 0.00 0.00 0.00 0.00 0.00 0.00
Feb. 40 3.00 9.00 3.00 9.00 3.00 9.00
Mar. 41 3.10 9.61 2.50 6.25 2.05 4.20
Apr. 37 −1.83 3.35 −2.75 7.56 −3.73 13.93
May 45 6.72 45.14 6.63 43.89 5.94 35.24
Jun. 50 9.70 94.15 8.31 69.10 6.88 47.33
Jul. 43 −0.21 0.04 −2.84 8.09 −5.68 32.26
Aug. 47 3.85 14.86 2.58 6.65 −0.11 0.01
Sep. 56 11.70 136.85 10.29 105.86 7.69 59.20
Oct. 52 4.19 17.55 1.14 1.31 −2.56 6.55
Nov. 55 5.93 35.19 3.57 12.76 −0.30 0.09
Dec. 54 3.15 9.94 0.79 0.62 −3.13 9.78
MSE 31.31 22.59 18.13

Forecasting Formulas

Simple Moving Average Weighted Moving Average

Dt + Dt−1 + Dt−2 + · · · + Dt−n+1
Ft+1 = Ft+1 = w1 Dt + w2 Dt−1 + · · · + wn Dt−n+1
n

Exponential Smoothing Trend-Adjusted Exponential Smoothing

Ft+1 = αDt + (1 − α)Ft Ft+1 = At + Tt

= Ft + α(Dt − Ft ) where At = αDt + (1 − α)(At−1 + Tt−1 )

and Tt = β(At − At−1 ) + (1 − β)Tt−1

Error Mean Squared Error Mean Absolute Deviation

P 2 P
Et |Et |
Et = Dt − Ft MSE = MAD =
n n

4
 Deming's 14-Point Philosophy
A Recipe for Total Quality

Find the right balance between quality and speed.

The concept of quality is at the core of many of our ideas about effective management and leadership, and
programs like Total Quality Management and Six Sigma have been at the heart of many companies'
success.
Before things like globalization and technological advances became so important, competitive pressures
were typically much lower, and companies were usually satisfied with focusing their quality efforts on the
production process alone.
Now, quality is often thought to start and end with the customer, and all points leading to and from the
customer must aim for high-quality service and interaction.
But to be truly successful, quality needs to be built into every level of a company, and become part of
everything the organization does. From answering the phone to assembling products and serving the end
customer, quality is key to organizational success.
Deming's 14-Point Philosophy is a great tool you can use to build quality in at every level of your business.
In this article, we'll look at Deming's Philosophy in more detail and how you can use it.
What Is Deming's 14-Point Philosophy?
Dr. W. Edwards Deming is largely credited with the focus on quality within business to achieve success. A
statistician who went to Japan to help with the census after World War II, Deming also taught statistical
process control to leaders of prominent Japanese businesses. His message was this: By improving quality,
companies will decrease expenses as well as increase productivity and market share.
After applying Deming's techniques, Japanese businesses like Toyota, Fuji, and Sony saw great success.
Their quality was far superior to that of their global competitors, and their costs were lower. The demand
for Japanese products soared – and by the 1970s, many of these companies dominated the global market.
American and European companies realized that they could no longer ignore the quality revolution.
So the business world developed a new appreciation for the effect of quality on production and price.
Although Deming didn't create the phrase "Total Quality Management," he's credited with starting the
movement. He didn't receive much recognition for his work until 1982, when he wrote the book now titled
"Out of the Crisis," which summarized his famous 14-point management philosophy.
There's much to learn from these 14 points. Study after study of highly successful companies shows that
following the philosophy leads to significant improvements. That's why these 14 points have since become
a standard reference for quality transformation.
Note:
To achieve this Deming created a 14-Point strategy (also known as Deming's 14-Point Philosophy) that
organizations can use to improve quality across their business. It includes the following:
1. Create a constant purpose toward improvement.
2. Adopt the new philosophy.
3. Stop depending on inspections.
4. Use a single supplier for any one item.
5. Improve constantly and forever.
6. Use training on the job.
7. Implement leadership.
8. Eliminate fear.
9. Break down barriers between departments.
10. Get rid of unclear slogans.
11. Eliminate management by objectives.
 12. Remove barriers to pride of workmanship.
13. Implement education and self-improvement.
14. Make "transformation" everyone's job.

Taken as a whole, the 14 points are a guide to the importance of building customer awareness, reducing
variation, and fostering constant continuous change and improvement throughout organizations.
Deming's points apply to any type and size of business. Service companies need to control quality just as
much as manufacturing companies. And the philosophy applies equally to large multinational corporations,
different divisions or departments within a company, or even single-person operations.
The 14 Points
1. Create a Constant Purpose Toward Improvement
Plan for quality in the long term.
Resist reacting with short-term solutions.
Don't just do the same things better – find better things to do.
Predict and prepare for future challenges, and always have the goal of getting better .
2. Adopt the New Philosophy
Embrace quality throughout the organization.
Put your customers' needs first, rather than react to competitive pressure – and design products and services
to meet those needs.
Be prepared for a major change in the way business is done. It's about leading, not simply managing.
Create your quality vision , and implement it.
3. Stop Depending on Inspections
Inspections are costly and unreliable – and they don't improve quality, they merely find a lack of quality.
Build quality into the process from start to finish.
Don't just find what you did wrong – eliminate the "wrongs" altogether.
Use statistical control methods – not physical inspections alone – to prove that the process is working.
4. Use a Single Supplier for Any One Item
Quality relies on consistency – the less variation you have in the input, the less variation you'll have in the
output.
Look at suppliers as your partners in quality. Encourage them to spend time improving their own quality
– they shouldn't compete for your business based on price alone.
Analyze the total cost to you, not just the initial cost of the product.
Use quality statistics to ensure that suppliers meet your quality standards.
5. Improve Constantly and Forever
Continuously improve your systems and processes. Deming promoted the Plan-Do-Check-Act approach
to process analysis and improvement.
Emphasize training and education so everyone can do their jobs better.
Use kaizen as a model to reduce waste and to improve productivity, effectiveness, and safety.
6. Use Training on the Job
Train for consistency to help reduce variation.
Build a foundation of common knowledge.
Allow workers to understand their roles in the "big picture."
Encourage staff to learn from one another, and provide a culture and environment for effective teamwork.
7. Implement Leadership
Expect your supervisors and managers to understand their workers and the processes they use.
Don't simply supervise – provide support and resources so that each staff member can do their best. Be
a coach not a policeman.
Figure out what each person actually needs to do their best. For example, hardware, software, other tools,
and training.
Emphasize the importance of participative management and transformational leadership .
Find ways to reach full potential, and don't just focus on meeting targets and quotas.
8. Eliminate Fear
Allow people to perform at their best by ensuring that they're not afraid to express ideas or concerns.
Let everyone know that the goal is to achieve high quality by doing more things right – and that you're not
interested in blaming people when mistakes happen.
Make workers feel valued, and encourage them to look for better ways to do things.
Ensure that leaders are approachable and that they work with teams to act in the company's best interests.
Use open and honest communication to remove fear from the organization.
9. Break Down Barriers Between Departments
Build the "internal customer" concept – recognize that each department or function serves other
departments that use their output.
Build a shared vision.
Use cross-functional teamwork to build understanding and reduce adversarial relationships.
Focus on collaboration and consensus instead of compromise.
10. Get Rid of Unclear Slogans
Let people know exactly what you want – don't make them guess. "Excellence in service" is short and
memorable, but what does it mean? How is it achieved? The message is clearer in a slogan like "Always
be striving to be better."
However, don't let words and nice-sounding phrases replace effective leadership. Outline your expectations,
and then praise people face-to-face for doing good work.
11. Eliminate Management by Objectives
Look at how processes are carried out, not just numerical targets. Deming said that production targets can
encourage high output but result in low quality.
Provide support and resources so that both production levels and quality are high and achievable.
Measure the process rather than the people behind the process.
12. Remove Barriers to Pride of Workmanship
Allow everyone to take pride in their work without being rated or compared.
Treat workers equally, and don't make them compete with colleagues for monetary or other rewards. Over
time, the quality system will naturally raise the level of everyone's work to an equally high level.
13. Implement Education and Self-Improvement
Improve the current skills of workers.
Encourage people to learn new skills to prepare for future changes and challenges.
Build skills to make your workforce more adaptable to change, and better able to find and achieve
improvements.
14. Make "Transformation" Everyone's Job
Improve your overall organization by having each person take a step toward quality.
Analyze each small step, and ask yourself how it fits into the bigger picture.
Use effective change management principles to introduce the new philosophy and ideas in Deming's 14
points.
 Juran’s Quality Trilogy
The famous Quality Trilogy was first developed and written by Joseph M. Juran. As you all know, Juran is
a management consultant and an Engineer, specialized in Quality management.
The Quality Trilogy explained by Juran is: Any organization taking up a journey in Quality Management
will have to have three Processes in place, which are: i) Quality Planning ii) Quality Control and iii) Quality
Improvement. Though the above three may sound similar, they have different objectives and serve different
purposes of Quality Management.
Let us have a look at these components one by one:

i. Quality Planning: As with all management activities and processes,

Quality journey begins with planning the activities that needs to be done
to adhere to the Vision, Mission and Goals of the organization and to
comply with customer and compliance requirements.
Quality Planning comprises of
i) Understanding the customer,
ii) Determining their needs,
iii) Defining the product/service features, specifications
iv) Designing the product/service
v) Devising the processes that will enable to meet the customer needs.

ii. Quality Control: Once the processes are defined, the responsibility is now with operations, to adhere
to the processes and specifications required by the product/service. For this purpose periodic checks
and inspection has to be done, metrics need to be tracked, to ensure that the process is in control and
meets specifications and the metrics need the set target. Wherever there is a defect a corrective and
preventive action needs to be done, and root cause has to be arrived at. Also the deviation in the
metrics and process audit results need to be monitored and corrected for meeting the required target as
specified by the processes.

iii. Quality Improvement: However robust the process design and the product features are, there are
chances that it may fail to meet customer requirements and design targets. It might be due to some
special causes that are present in the system and might be due to change in business scenarios,
customer requirements, market completion and many more forces. The role of Quality Improvement
is to identify and prove the need for improvement from the exiting performance levels even though
they meet the target and devise means and ways to achieve the new target and implement them
successfully.

All the three processes are interlinked and will affect one another in due course of the journey. Thus the
processes are corrected individually and streamlined to help each other in Quality Management journey,
the end objective.
 Plan-Do-Check-Act in the ISO 9001 Standard
What is the best way to view the ISO 9001 Quality Management System requirements in order to make the
individual processes within your system more compatible with each other? Each individual process can be
improved by applying a Plan-Do-Check-Act approach, but the overall system can also benefit by this
philosophy. By looking at the separate processes as being linked in one large cycle for improvement, you
can help focus the improvement of the individual processes toward one greater good for the company.

Where does Plan-Do-Check-Act come from?

Plan-Do-Check-Act (also called “PDCA”) is a cycle that was originated by Walter Shewhart and made
popular by Edward Deming – two of the fathers of modern quality control. This concept is a cycle for
implementing change which, when followed and repeated, would lead to repeated improvements in the
process it was applied to. An example that we might all relate to would be when you choose a wireless
carrier: you Plan to have no problems with dropped calls; the Do phase is when you start using the phone
service; the Check phase is when you monitor the real performance and get some dropped calls; and the
Act phase is when you decide what to do – e.g., accept the number of dropped calls, call the provider to try
to correct the situation, or change wireless carrier.

“Kaizen” refers to a Japanese word which means “improvement” or “change for the better”. Kaizen is
defined as a continuous effort by each and every employee (from the CEO to field staff) to ensure
improvement of all processes and systems of a particular organization.

Work for a Japanese company and you would soon realize how much importance they give to the process
of Kaizen. The process of Kaizen helps Japanese companies to outshine all other competitors by adhering
to certain set policies and rules to eliminate defects and ensure long term superior quality and eventually
customer satisfaction.

Kaizen works on the following basic principle.

“Change is for good”.

Kaizen means “continuous improvement of processes and functions of an organization through

change”. In a layman’s language, Kaizen brings continuous small improvements in the overall processes
and eventually aims towards organization’s success. Japanese feel that many small continuous changes in
the systems and policies bring effective results than few major changes.

Kaizen process aims at continuous improvement of processes not only in manufacturing sector but
all other departments as well. Implementing Kaizen tools is not the responsibility of a single individual
but involves every member who is directly associated with the organization. Every individual, irrespective
of his/her designation or level in the hierarchy needs to contribute by incorporating small improvements
and changes in the system.
 Following are the main elements of Six Sigma:

 Teamwork
 Personal Discipline
 Improved Morale
 Quality Circles
 Suggestions for Improvement

Five S of Kaizen
“Five S” of Kaizen is a systematic approach which leads to foolproof systems, standard policies, rules and
regulations to give rise to a healthy work culture at the organization. You would hardly find an individual
representing a Japanese company unhappy or dissatisfied. Japanese employees never speak ill about their
organization. Yes, the process of Kaizen plays an important role in employee satisfaction and customer
satisfaction through small continuous changes and eliminating defects. Kaizen tools give rise to a well
organized workplace which results in better productivity and yield better results. It also leads to employees
who strongly feel attached towards the organization.

Let us understand the five S in Detail:

1. SEIRI - SEIRI stands for Sort Out. According to Seiri, employees should sort out and organize
things well. Label the items as “Necessary”, ”Critical”, ”Most Important”, “Not needed now”,
“Useless and so on. Throw what all is useless. Keep aside what all is not needed at the moment.
Items which are critical and most important should be kept at a safe place.
2. SEITION - Seition means to Organize. Research says that employees waste half of their precious
time searching for items and important documents. Every item should have its own space and must
be kept at its place only.
3. SEISO - The word “SEISO” means shine the workplace. The workplace ought to be kept clean.
De-clutter your workstation. Necessary documents should be kept in proper folders and files. Use
cabinets and drawers to store your items.
4. SEIKETSU-SEIKETSU refers to Standardization. Every organization needs to have certain
standard rules and set policies to ensure superior quality.
5. SHITSUKE or Self Discipline - Employees need to respect organization’s policies and adhere to
rules and regulations. Self discipline is essential. Do not attend office in casuals. Follow work
procedures and do not forget to carry your identity cards to work. It gives you a sense of pride and
respect for the organization.

Kaizen focuses on continuous small improvements and thus gives immediate results.
 This is a model for improvement that is sustained, rather than just a one-time
quick fix, and it is for this reason that it is applied to the ISO 9001 standard.
The ISO 9001 standard has, as a main goal, the continual improvement of the
Quality Management System.

How Plan-Do-Check-Act is found in the ISO 9001 Standard Requirements

In the introduction to ISO 9001, there is an explanation of the Process

Approach and how important this is to implementing a Quality Management System that is compliant with
the ISO 9001 requirements. In addition to this, there is a note about the methodology know as “Plan-Do-
Check-Act” being applied to all processes. It then shows a graphic, which shows a very rough overview of
how the standard requirements fit within a PDCA cycle. Below I will describe how the cycle of
improvement works within the QMS (with the ISO 9001 clause numbers in brackets).

Plan – Planning is one of the biggest parts of the QMS and starts with understanding the context of the
organization and the needs of parties interested in the QMS (4.1 & 4.2), which is then used to define the
scope of the QMS and the QMS processes (4.3 & 4.4). This is followed by the commitment of leadership
in the company to drive the organization to a customer focus by defining the organizational roles and
responsibilities and by establishing a quality policy to give the overall QMS a focus (5.1, 5.2 & 5.3). The
next level of planning is to identify and address risks and opportunities of the QMS, including setting and
planning for quality objectives and changes to support continual improvement (6.1, 6.2 & 6.3). The final
level of planning is to identify and implement the support structure to allow you to carry out your plans.
This includes resources (7.1), identifying competence (7.2), awareness (7.3), communication (7.4) and to
set the processes for creation and control of documented information (7.5).
Do – Planning is useless unless the plan is carried out. Controls need to be identified for the QMS
operations, product or service requirements need to be identified (8.2), designs developed (8.3), controls
placed on externally provided processes, products and services (8.4). The process of producing the product
or service needs to be carried out with control of product and service release (8.5 & 8.6), any non-
conforming products or services need to be addressed (8.7). In short, the activities of creating and providing
products or services to the customers need to be done.
Check – There are several requirements in the standard to check the processes of the Quality Management
system to ensure they are functioning properly as they have been planned. There is a need to monitor,
measure, analyze and evaluate the products or services to ensure they meet requirements, the processes
used are adequate and effective, and customer satisfaction is being met (9.1). Internal Audit (9.2) of the
processes is the key way to assess the effectiveness of the system. Further is the Management Review
process (9.3), which reviews and assesses all of the monitored data to make changes and plans to address
the issues.
Act – Action in this case involves the actions needed to address any issues found in the check step.
Improvement (10.1 & 10.3) is the overall heading for these action steps (10.1) with the activities of
addressing nonconformity and Corrective Actions (10.2) to eliminate the causes of actual or potential
nonconformities as the first step in acting to improve the system.
Plan – As stated, this cycle starts again to ensure there are plans in place for further improvement. Findings
during the Internal Audit in the “Check” phase may have led to corrective actions from the “Act” phase,
which in turn will require changes in planning to meet the updated requirements in the next “Do” phase.
The Management Review looks at the outcomes of Internal Audit, Corrective Actions and outputs resource
plans to support any changes. Resources are assessed and increased, decreased or re-assigned as the
business needs dictate. This leads into another round of Doing, and the cycle continues.
An example would be if your company planned to reduce scrap by 5% by making certain changes to a
process, the changes were made and the process ran, checking of the process showed that you reduced the
amount of scrap by 3%, and you acted to make further changes to improve. The next planning for this
process might be to make further changes and reduce the scrap by a further 4% in the following year.

What Is Total Productive Maintenance?

A key component of Lean Management/Manufacturing, total productive maintenance embraces a

comprehensive strategy for optimizing facility maintenance with the primary goal of eliminating resource
waste, employee accidents, product defects, and unplanned downtime. These objectives are achieved
through preventive maintenance, continuous training, and effective collaboration between production and
maintenance personnel.
With equipment effectiveness at its core, total productive maintenance empowers equipment operators with
skills training, proactive maintenance programs, and productivity benchmark assessments, so that they can
fully take charge of the maintenance of assets assigned to them. Higher levels of workforce autonomy
decrease over-dependence on breakdown/reactive maintenance.

What Are the Benefits of Total Productive Maintenance (TPM)?

By implementing and leveraging TPM principles, such as scheduling preventive maintenance tasks and
involving machine operators to perform equipment maintenance activities, organizations can reap the
following benefits of total productive maintenance:
 Minimal malfunctions of equipment
 Elimination of unforeseen downtime
 Enhanced performance and output
 Lower operating costs
 Cleaner and healthier work environment
 Improved workplace safety due to stricter adherence to safety regulations
 Intensified skill development
 Greater employee empowerment
 Higher collaboration and sharing of knowledge between departments and teams
 Reduced risks of accidents
 Better compliance with environmental laws and guidelines
 Increased satisfaction among all stakeholders

What Are the 5s Foundation of Total Productive Maintenance?

The "5s" are the core elements of total productive maintenance, which serve as the foundation for TPM.
When implemented correctly, the 5s help create a clean, safe, efficient, and organized workplace that boosts
equipment effectiveness, improves efficiency, and reduces waste. The 5s of total productive maintenance
are as follows:
 Sort: Separate important tools, materials, and equipment from the less-important ones, and remove
unnecessary items from the workspace.
 Straighten: Organize everything that's important and make sure that they are always available at the right
time and in the right place.
 Shine: Inspect and clean the workplace at all times, including tools and equipment, to avoid equipment
breakdowns.
 Standardize: Develop a framework and establish clear standards to facilitate the implementation of the
above 3 Ss.
 Sustain: Ensure long-term sustainment of the 5s methodology through continuous improvement and
regular audits of safety regulations.
To set up a wholescale maintenance program, 5s should be applied together with the “8 pillars” of total
productive maintenance listed below.

The 8 Pillars of TPM (Total Productive Maintenance)

TPM consists of 8 pillars that mainly focus on preventive and proactive maintenance practices aimed at
improving equipment performance and reliability. The 8 pillars of total productive maintenance are:

Autonomous Maintenance
The concept of autonomous maintenance refers to routine, preventive maintenance activities to be
performed by operators, such as lubricating, cleaning, and servicing production lines. Giving operators a
greater level of responsibility ensures early detection of equipment issues before they develop into critical
problems.

Kaizen (Focused Improvement)

Kaizen, which means "continuous improvement" in Japanese, is a business philosophy that views
productivity enhancements as a methodical and gradual progression. It promotes collaboration among
teams for incremental process improvements and problem solving through cross-functional approaches,
with the common intention of creating an organizational culture of focused, continuous improvement.

Planned Maintenance
Scheduled maintenance activities based on failure-rate datasets. Planned maintenance extends machine life,
minimizes malfunctions, and reduces the risk of a breakdown.

Early Equipment Management

A process that capitalizes on existing knowledge of current equipment to develop improved and more
efficient new machines. Having a prior understanding of the new machines in operation not only helps
achieve optimized performance levels, but it also simplifies maintenance tasks dramatically.

Quality Maintenance
The primary objective of quality maintenance is to enhance production quality by eliminating the
underlying cause of failures and defects. It focuses on making fault diagnosis an integral part of the overall
production process.

Training and Education

One of the main goals of total productive maintenance is to provide continuous and adequate training to
address the skills gap of all personnel. This ensures that the entire workforce, be it production managers,
machine operators, or maintenance technicians, remains highly trained to meet TPM standards.
TPM in Office Environment
TPM is not just limited to production facilities - it also intends to improve office and administrative
operations. Companies should keep in mind that the principles of total productive maintenance need to be
adopted throughout an organizational structure, including offices, which will facilitate waste elimination
and increase administrative efficiency in procurement, order processing, and scheduling.

SHE (Safety, Health, Environment)

The top priority of total productive maintenance is to offer a healthy and safe ecosystem for all employees.
Planned maintenance activities eliminate the risk of mishaps, ensuring accident-free workplace
environments.