cost fundamentals - variable cost, fixed cost and semi veriable cost

Variable cost : These are the costs which tend to vary directly with volume of output. These are also known as direct costs. These costs vary in total but remain fixed per unit.
Examples : a) Direct materials;
b) Direct labour;
c) Direct Expenses;
d) Variable overheads such as consumable stores, fuel etc.
Fixed Cost : It refers to the cost which tends to remain unaffected by variations in volume of output. This cost remains fixed during a given period and within a given range of activity. So, fixed cost is known as period cost. This cost remains fixed in total, but varies per unit.
Examples : a) Rent and rates of factory building;
b) Salary of works manager, General Manager or Sales manager;
c) Depriciation of buildings,
d) Insurance;
e) Interest on capital (if included in costs)
Semi-variable cost - Those are the costs which are partly fixed and partly variable. Both fixed and variable elements are present in semi-variable cost. This is also known as semi-fixed cost.
Examples :
a) Normal maintenance of building and plant;
b) Salary of supervisors;
c) Depreciation of plant and machinery;
d) Service department wages etc.

PRODUCTION COST, FACTORY COST & ADMN. COST & SELLING & DISTRIBUTION COSTS

Production Cost : These are the costs incurred for sequence of operations in production. Production cost includes the following :
a) Direct materials
b) Direct labour
c) Direct Expenses
d) Factory overheads which include factory indirect materials, indirect labour and indirect expenses.

B) Administration cost.: These are the costs incurred for formulating policies, directing the organisation and controlling the operations of the undertaking. These costs are usually in the nature of indirect expenses and are not directly related to production or selling or distribution or research or development function of the organisation.
Administration cost generally includes the following :
a) Salaries of office staff, accountants, directors, etc,;
b) Maintenance of assets of office;
c) Rent, rates and depreciation of office building;
d) Postage, stationery, telephone etc.
e) Office supplies and expenses;
f) General Administration expenses.
C) Selling and Distribution Cost :
Selling cost is the cost of seeking to create and stimulate demand and of securing orders.
Distribution cost is the cost incurred in connection with the distribution or delivery of the goods to customers after manufacturing is completed.


Selling and Distribution Costs are in the nature of indirect cost and include the following :
a) Salaries and commission of salesman and sales manager;
b) Expenses on advertisement;
c) Salaries of warehouse staff and transport staff;
d) Rent & Rates of show room & Sales office;
e) Cost of insurance, freight out, export duty, packing, shipping etc.
f) Maintenance of transport vans;

WHAT IS COST & WHAT ARE ITS COMPONENTS

In general, cost means the amount of expenditure incurred on a product or service attributable to it. To take an example, if furniture manufacturer makes a chair by spending Rs.1200/- for timber, Rs.100/- for wages to the carpenter and Rs.300/- as rent and other expenses, then we can say that the chair costs him Rs.1600/-

Meaning of Cost Classification :

Cost classification is the process of grouping costs according to their common characteristics. Costs can be classified according to:

a) Elements
b) Functions
c) Behaviour

Classification of cost by elements:
Costs are classified primarily according to the elements or factors upon which expenditure is incurred. These elements are:
a) Materials cost : It is the cost of commodities supplied to an undertaking.
b) Labour cost or wages: It is the cost of remuneration of the employees of an undertaking which includes wages, salaries, commission, bonus, etc.
c) Expenses: It is the cost of services provided to an undertaking.
The above elements of cost can be further sub-divided as :
1. Direct Expenditure in
a) Materials, b) Labour, c) Experses
2. Indirect Expenditure in

a) Materials, b) Labour, c)Expenses.
Direct Expenditure means the expenditure which can be identified with and allocated to cost centres or cost units. On the other hand, the term “Indirect Expenditure” means that expenditure which cannot be allocated to or absorbed by cost centres or cost units. Thus the different elements of cost are:
a) Direct materials, b) Indirect materials, c) Direct labour, d) Indirect labour, e) Direct expenses and f) Indirect Expenses.
Each of the above elements of cost is discussed in brief as below :
a) Direct Materials :These are the materials which can be conveniently identified with a product or cost centre. These are the basic materials which enter into and form part of the product.
Examples : Clay in brick laying, wood in furniture making, leather in shoe manufacturing etc.
Direct materials also include the following :-
i) All materials specially purchased or requisitioned for a particular process, job or production order,
ii) All components used,
iii) All materials passing from one process or operation to the other,
iv) All primary packing materials like card board boxes, wrappings, cartoons etc.
b) Indirect Materials : These are the materials which cannot be traced as a part of the finished product. Indirect materials are also known as on cost materials or Expense materials.
Example : i) Fuel, lubricating oil etc. required for operating and maintaining plant and machinery;
ii) Small tools for general use;
iii) Materials consumed for repair and maintenance work;
iv) Sundry stores of small value used in the factory like thread in shirt making, nails in shoe-making etc.
c) Direct wages : It is the cost of wages paid to workers engaged directly in altering the construction, composition, conformation or condition of the product manufactured by a concern. It is that part of wages which is paid to workers who help in converting raw-materials into finished products. When a concern does not manufacture, but in stead renders a service, then the wages paid to those who directly carry out the service will be treated as direct wages. For example, in case of Transport services, wages paid to driver, conductor etc. will be treated as direct wages. Direct wages are also called direct labour, productive labour, process labour, operating labour, prime cost labour etc.
Sometimes, some indirect wages may be treated as direct wages. For example, a supervisor’s wages specifically incurred for a particular job only, shall be treated as direct wages.
d) Indirect wages : Wages which cannot be directly identified with a job, process or operation, are generally treated as indirect wages. It represents the cost of labour employed in the works ancillary to production.
Examples : i) Wages of Inspectors, supervisors,
ii) Wages of maintenance workers such as work shop cleaners, mechanics etc.
iii) Wages of internal transport men;
iv) Idle time wages, overtime premium, night shift and holiday work bonus;
v) Miscellaneous allowances to labour;
vi) Wages payable to store keeper, works clerical staff, watch and ward etc.
e) Direct Expenses : These are the expenses other than direct materials and direct labour, but are directly identifiable with a job, process or operation. Direct expenses are otherwise known as chargeable expenses or prime cost expenses or productive expenses.
Examples : i) Hire charge of a special concrete mixer required for civil engineering job;
ii) Cost of special pattern, drawing or lay out;
iii) Royalty payable on production;
iv) Cost of rectifying defective goods;
v) Maintenance costs of Special tools required for the execution of a job or contract.
f) Indirect Expenses : Expenses which cannot be charged to production directly and which are neither indirect materials cost nor indirect labour cost are regarded as indirect expenses.
Examples : i) Rent, rates and taxes;
ii) Insurance;
iii) Canteen expenses;
iv) Hospital and dispensary expenses;
v) Depreciation, repairs, maintenance etc. on plant and machinery;
vi) Power, lighting and heating etc.

VARIOUS TYPES OF COSTS

We have various types of costs like opportunity cost, financial cost, accounting cost, cost as per cost accounting etc. Let us look at total cost from cost accounting perspective. Total cost of a product is the combination of direct costs and indirect costs. The direct costs are termed as prime cost and indirect costs are termed as overheads. However, the total cost incurred in relation to a product can be analysed into the following components which are discussed below:

1) Prime cost : It is the sum of all direct costs, i.e. direct materials, direct labour and direct expenses. It is also known as flat cost, basic cost or first cost. The following models are useful in the calculation of prime cost.
a) Prime cost : Direct materials + Direct Labour + Direct Expenses.
b) Direct materials or Materials consumed = opening stock of raw-materials + Net purchase of raw-materials - closing stock of raw-materials.
2) Factory cost : Factory cost is otherwise known as works cost or mill cost or production cost or manufacturing cost. Factory cost is calculated by adding factory overheads to prime cost. Factory overheads or factory indirect expenses usually cover the following :
a) Cost of indirect materials used in the factory such as lubricants, oil, cotton, spare parts etc.
b) Indirect labour such as works manager’s salary, foreman’s wages, supervision charges etc.
c) Indirect factory expenses such as factory rent, factory insurance, factory lighting etc.

The following models are useful in the calculation of factory cost.

a) When there is no opening or closing balances of W.I.P.
b) When there is opening and closing balances at WIP,

Factory Cost = Prime Cost + Factory Over heads
Factory cost = Prime cost + Factory Overheads + Opening balance of W.I.P - Closing balance of W.I.P.

3) Cost of production : Cost of production is otherwise known as Gross Cost Or Office cost. This cost is calculated by adding Office and Administration Overheads to Factory Cost. Administration overheads or Office Expenses include the following expenses :

a) Indirect materials used for office such as printing and stationery materials;
b) Indirect labour such as salary payable to clerks and office staff;
c) Indirect Expenses such as rent, insurance, lighting of office premises etc.

The following model is useful in the calculation of cost of production
Cost of production = Factory cost + Administration overheads

4) Cost of goods sold : Cost of goods sold means the cost of production of the quantity of goods sold. Its calculation becomes necessary only when there is opening stock and closing stock of finished goods. These stocks of finished goods must have to be adjusted with cost of production to arrive at cost of goods sold.
The following model is useful for this purpose.

Cost of goods sold = Cost of production + Opening stock of finished goods - Closing stock of finished goods

5) Total cost : This cost is otherwise known as Final cost or Selling cost or Cost of Sales. Total cost can be calculated by adding selling and distribution overheads to cost of production or cost of goods sold. Selling and Distribution overheads include the following expenses :
a) Indirect materials used in selling and distribution such as packing materials;
b) Indirect labour such as salaries of salesmen;
c) Indirect Expenses such as advertisement, etc.

The following models are useful in the calculation of Total Cost :-

a) When there is no opening stock and closing stock of finished goods :-
Total cost = Cost of production + Selling and Distribution overheads
b) When there are opening stock and closing stock of finished goods: :
Total cost = Cost of goods sold + Selling and Distribution overheads

Items not included in cost :
There are some expenses which are considered under financial accounting for calculation of profit or loss, but these expenses are excluded from the purview of cost as these are not related to production either directly or indirectly.

The expenses of following natures are excluded from cost accounting :

a) Capital expenditure
b) Capital losses
c) Distribution of profits
d) Pure financial items

The examples of expenses excluded from cost are given as below:

i) Expenses relating to issue of shares such as Brokerage, Underwriting commission, Discount on issue of shares etc.
ii) Income tax
iii) Expenditure to acquire fixed assets like land and building, plant & machinery etc.
iv) Loss on sale of fixed assets
v) Abnormal losses relating to materials or labour
vi) Transfer to reserves and funds;
vii) Interest on capital;
viii) Dividends;
ix) Writing off goodwill, preliminary expenses etc.
x) Interest on debentures
xi) Bonus payable to directors or managers on profit;

There are some items of incomes which are considered under financial accounting but excluded from cost accounting. These are :
i) Interest received on investment
ii) Discount received
iii) Transfer fees
iv) Rent received
v) Dividend received

HOW TO PREPARE COST SHEET

A cost sheet is a memorandum statement of cost. It shows the total cost as well as the cost per unit for a given period. A cost sheet is prepared usually for a period which may be a week or a month or a quarter or a year. Logical arrangement of costs is made in the cost sheet along with proper classification and sub-division of costs. As such, cost sheet is accepted as a statement to show various components of total cost in a classified manner i.e. Prime cost, Works Cost, Cost of production, Cost of goods sold and Total cost. Cost sheet is otherwise known as statement of cost.

Nature of cost sheet :

i) It is a statement designed to show output and costs incurred for the output during a period.
ii) A cost sheet does not follow any fixed form to prepare it.
iii) It is a memorandum statement & does not follow the rules of double entry.
iv) It incorporates data from financial accounting for ascertainment of total cost.
v) It also uses pre-determined rates for preparation of cost sheet.

Purposes of cost sheet :

The purposes of preparing a cost sheet can be studied from its advantages which are given as below :

i) It reveals total cost and unit cost of output.
ii) It shows the logical division of the total costs into different elements of cost.
iii) It facilitates control over cost of current year’s cost data in relation to that of the previous year element wise.
iv) It helps in the estimation of costs for preparation of tenders and quotations.
v) It helps in fixation of selling price.
vi) It helps the manufacturer in formulating a definite useful production policy.
vii) It helps to minimise the cost of production in a competitive market.

Proforma of a Cost Sheet :

COST SHEET OR STATEMENT OF COST OF ___________
for the month ending _______________ 2008

Output : ___________ units
Total Cost Cost per unit
Rs. Rs.
Direct materials ________ _______
Direct labour ________ _______
Direct Expenses _______ ______
PRIME COST ________ _______
Add: Factory /works
overheads ________ _______
FACTORY COST /
WORKS COST ________ _______
Add : Administration
overheads _______ _______
COST OF PRODUCTION _______ _______
Add: Selling and
Distribution overheads ______ ______
TOTAL COST (OR
COST OF SALES) _______ _______
Add: Profit (or minus loss) ______ ________
SALES __________ ________

ACCOUNTING AND RECORDING OF OVERTIME PAYMENTS & ANALYSIS

Overtime occurs when a worker works beyond his normal working hours. Generally, over time is paid at a higher rate than the normal time rate. The additional amount paid on overtime work is known as “overtime premium.”
Causes of overtime work :
Generally overtime work is required for the following reasons.
a) To complete a work within a specific period as requested by the customer.
b) To make up the time Lost due to breakdown of machinery, power failure or any other unaviodable reasons.
c) To work as a matter of policy e.g due to general rush of work, labour shortage etc.
d) For completing the work delayed due to departmental inefficiency.
Treatment of overtime :
The treatment of overtime depends on the reason for which overtime premium has been paid. However the following treatments are recommended by cost accountants:
It should be directly charged to the job concerned and treated as direct wages. But in case reason of overtime is not known, then the premium paid should be treated as excess cost . It should be treated as overhead which would be allocated and recovered from the jobs completed during the period. If the overtime premium has been paid due to causes known, then the premium should be treated as a part of labour cost. In case of known causes, the excess cost is charged directly to the concerned department.
When overtime is worked on account of abnormal conditions like strikes, flood etc. the premium payable should be charged to costing profit and loss account.
Control of Overtime :-
Overtime work should be avoided because job done in overtime cost more as compared to the jobs done during normal hours. Moreover, the overtime work is done at late hours when the efficiency of the worker is generally falling after working normal hours. The workers may also develop the tendency of postponing the normal work to be done in overtime. So, overtime work should be strictly controlled and practice of working overtime should be discouraged. Overtime should be permitted only in emrgency situation. Overtime work if necessary, must have a prior permission and sanction of the competent authority.

Cost of production and worker's idle time

It is important to record cost data, analyse them and prepare proper cost records. Workers time on production should be analysed and proper cost should be identified.
Time keeping should be distinguished from time booking. While time keeping is the recording of attendance time or gate time, time booking is the recording of time spent on a job or process and is also known as work time or activity time.
Every worker engaged on a job or activity of direct nature, must allocate his time to jobs, products, service or some other cost units which should still be job or operation, while indirect workers are engaged on work of indirect nature such as supervision cleaning, maintenance, etc. Sometimes, even a diret worker may be engaged on work of indirect nature for a part of the work. There may also be occasions when a direct worker is unable to do any work at all because he is waiting for materials or instructions. In any case, the whole of a direct worker’s time should be analysed. This is done by time booking or recording activity time.

OBJECTS OF TIME BOOKING
The various objects of time booking are :
a) Ascertainment and Allocation of labour cost.
In order to arrive at the true cost of products or jobs, it is necessary to ascertain the labour time spent on it and evaluate in terms of money. Labour time in terms of money is the labour cost of the job or product.
b) Proper Utilisation of Attendance Time.
Since workers are paid on the basis of clock time, the employer is interested in knowing whether the whole of attendance time is utilised for a job or product. In other words, attendance time should be equal to activity time as otherwise, the employer stands to lose since he is paying for the time not utilized on production.
c) Ascertainment of idle Time.
In practice, time clocked will seldom be equal to the time spent on production. The difference between the two is known as idle time. While idle time usually occurs for various reasons, the management is interested not merely in its ascertainment but control also. Time booking helps in the ascertainment of idle time and its control.
d) Apportionment of Overhead.
Activity time, or time spent on production in terms of labour hours, is one of the methods of approtioning factory overheads amongst jobs or departments. Time booking facilitates computation of overhead rates on the basis of labour hours.
e) Introduction of Incentive Wage Schemes.
Time booking becomes necessary for computing wages for the time taken and bonus for the time saved under the incentive systems of wage payment.
f) Comparison of Labour Cost
For cost control and cost reduction, every employer would like to study the incidence of wages on the cost of jobs. Similarly, for evaluation of labour performance, actual labour time may be compared with the standard or the budgeted time.
IDLE TIME
Idle time is that time for which the worker has been paid without giving any production to the employer. For example, if a worker is supposed to work for eight hours in the factory, but his job card shows only seven hours spent on jobs, one hour will be the idle time in such a case.
Causes of Idle Time :
For effective control over labour costs, it is necessary for the management to identify the reasons for the idle time. Idle time usually arises due to
i) Normal causes
ii) Abnormal causes
i) Nromal causes:

Whatever precautions may be taken, some idle time is unaviodable. Normal causes for which idle time arises are
a) Time lost between factory gate and place of work.
b) Time taken in picking up the work for the day.
c) The interval between completion of one job and commencement of another job.
d) Time taken for personal needs and tea breaks.
e) Time taken for maintenance of machines.
II) Abnormal Causes:
Idle time may also arise due to some abnormal factors which can be avoided if proper precautions are taken. The abnormal causes are :
a) Power failure,
b) Breakdown of machinery
c) Non-availability of Raw materials
d) Waiting for instructions.
e) Strikes, lock-outs, floods, fire etc.
Treatment of idle time cost :
The treatment of idle time in cost accounting depends on the nature of idle time.
Treatment of normal idle time costs can be made in the following two ways in the cost accounting :
a) The labour cost of normal idle time can be treated as a part of the cost of production. Normal idle time cost of direct workers is treated as direct wages.
b) The entire normal idle time cost can be treated as an item of factory expenses and can be recovered as indirect charges. For example, if a worker is engaged for eight hours in a factory @ Rs.50 per hour and out of this eight hours, two hours are the normal idle time, Rs.100/- (Rs.50 x 2) which is normal idle time cost, is treated as factory expenses, Rs. 300 is treated as direct wages. But in the first method, normal idle time cost Rs.100 was treated as direct wages.
Treatment of Abnormal idle Time Cost :
Abnormal idle time costs do not form a part of cost of production. It can be treated in the following two ways:
a) The abnormal idle time cost can be treated as an item of factory expenses.
b) The abnormal idle time costs are transferred to the Costing Profit and Loss Account. In this method abnormal idle time costs are not treated as a cost but treated as a loss.
The choice of the method of treatment of idle time depends much on the policy of the Management.

Time keeping, accounting and information system

Now time keeping is integrated and is useful for HR, Marketing, Accounting, Costing, and Finance. IT department provides latest tools for time keeping and recording, which helps the organisation to keep proper record of timing.


Time-keeping is the function of recording workers’ time of arrival and departure. In a small concern, this function is accomplished by the pay-roll department. However, time-keeping is the responsibility of a separate department. The time-keeping department, as it is called, function on the basis of employee records supplied by the personnel department. In turn, it supplies the necessary information to the pay-roll department to enable the latter to prepare the wages sheet.

The numbner of hours an employee is present at his place of work should be recorded so that the wages due to him can be calculated. Thus the attendance record forms the basis of wage payment. It is the time-keeping department that provides an assurance through the attendance record to the payroll department that the hours shown in the record were actually worked. Hence, the chief object of time-keeping is the preparation of the payroll with a view to ascertaining the wages of workers who are paid @ so much amount per unit of time, i.e. hour or day.
Although time-keeping is necessary in the case of workers who are paid on the basis of time, it is equally necessary in the case of those who are paid on the basis of output produced. In fact, according to the Indian Factories Act, 1948, no workers can be made to work for more than 9 hours a day or 48 hours a week. This statutory requirement can be complied with only by the maintenance of attendance record. This record also assists the cost accounting department in ascertaining the loss of labour time, which is known as idle time. Again, this record becomes necessary to satisfy social legislation and taxation laws. Thus, the various objects of time-keeping are:
a) For preparing the payroll,
b) For satisfying statutory requirements,
c) For ascertaining the labour cost,
d) For ascertaining idle time,
e) For calculating overtime,
f) For overhead distribution,
g) For labour cost control, and
h) For disciplinary purposes.

accounting for labour turnover

Labour turnover means the rate at which the employees leave our company and join another company. Higher the labour turnover - higher the cost of the company. There are many reasons for labour turnover :
1. dissatisfaction
2. better opportunity elsewhere
3. personal family reason
4. unfair treatment
5. lack of growth in the present company
etc.

The Cost of Labour turnover can be studied under the following two heads :
(i) Preventive costs,
(ii) Replacement costs,
Preventive Costs :
These are the costs which are incurred to check excessive labour turnover. The purpose of incurring such cost is to keep the workers satisfied. These costs include :-
(a) Cost of providing housing, medicals, recreational facilities to workers,
b) Cost of revision of grades and scales of pay,
c) Cost of providing good working conditions.
(d) Cost of providing educational facilities to the children of the workers,
e) Cost of providing perquisites and other bnenefits
f) Cost of safety measures against working hazards.
g) Cost of providing other welfare facilities.
Replacement costs :
Replacement costs mean the costs that arise from the replacement of labour. Replacement needs selection, appointment, training etc of new workers. Thus replacement costs include :-
a) cost of recuitment of new workers,
b) cost of training to new workers,
c) Loss arising from inefficiency of new workers like higher spoilage of materials and outputs, breakage of tools etc.
d) Cost of additional supervision for new workers,
e) Loss due to interruption in production,
f) Decrease in profit due to loss of production.
Treatment of cost of labour turnover :
The cost of labour turnover is not a direct charge to any job or workorder. So, it is to be treated as an iterm of overhead expense. As such, the preventive cost of labour turnover should be apportioned among different departments on the basis of average no. of exployees in each department.
Replacement costs may be either charged directly to the department where replacements take place or these costs may be distributed among different departments on the basis of the actual no. of workers replaced in each department.

CONCEPT OF PROFIT CENTRE IN FINANCE, ACCOUNTING & COSTING

A profit centre is a part of an activity or a basic activity of a business which requires expenses to be incurred to give revenue. It gets independent say in decision making within broad corporate guidelines. For example, if we set up branches of AFTERSCHOOOL, they will work as profit centers. Thus profit or loss of such an activity can be disclosed from such expenses and revenue. The purposes of forming a profit centre are as follows :-

i) To delegate responsibility to individuals.
ii) To measure the performance of individuals.

Differences between a Cost centre and a Profit centre :
The differences between a cost centre and a profit centre can be studied under the following main points :
i) Meaning :
A Cost cantre is the smallest unit of activity or area of responsibility for which costs are collected.
Profit centre is the segment of activity which is responsible both for revenue and expenses.

ii) Purpose :

The purpose of creating Cost centres is to gain accounting conveniences of cost and their control.

The purpose of creating a Profit centre is to delegate the responsibility to individuals who have greater knowledge of the local conditions.

iii) Autonomy:
Cost centres are not autonomous but Profit centres are autonomous.

iv) Target:

A Cost centre does not have cost target, but efforts are made to minimise costs and keep them within a target.

A Profit centre usually has a profit target and necessary policies are adopted by the business for its achievement.

v) Number of centres :

There may be a number of Cost centres in a Profit centre such as production cost centres or personal cost centres or impersonal cost centres.

A profit centre may be a subsidiary company within a group or division in a company.

IT, MANUFACTURING & ERP IMPLEMENTATION

Manufacturing management systems have evolved in stages over the past 30 years from a simple means of calculating materials requirements to the automation of an entire enterprise. Around 1980, over-frequent changes in sales forecasts, entailing continual readjustments in production, as well as inflexible fixed system parameters, led MRP (Material Requirement Planning) to evolve into a new concept : Manufacturing Resource Planning (or MRP3) and finally the generic concept Enterprise Resource Planning (ERP)The initials ERP originated as an extension of MRP (material requirements planning, and then manufacturing resource planning) and CIM (computer-integrated manufacturing) and was introduced by research and analysis firm Gartner. ERP systems now attempt to cover all basic functions of an enterprise, regardless of the organization's business or charter. Non-manufacturing businesses, non-profit organizations and governments now all use ERP systems.


ERP

An ERP system is a an application software and a single database the data needed for a variety of business functions such as Manufacturing, Supply Chain Management, Financials, Projects, Human Resources and Customer Relationship Management.
An ERP system is based on a common database and a modular software design. The common database can allow every department of a business to store and retrieve information in real-time. The information should be reliable, accessible, and easily shared. The modular software design should mean a business can select the modules they need, mix and match modules from different vendors, and add new modules of their own to improve business performance.

To be considered an ERP system, a software package must provide the function of at least two systems. For example, a software package that provides both payroll and accounting functions could technically be considered an ERP software package.
However, the term is typically reserved for larger, more broadly based applications. The introduction of an ERP system to replace two or more independent applications eliminates the need for external interfaces previously required between systems, and provides additional benefits ranging from standardization and lower maintenance (one system instead of two or more) to easier and/or greater reporting capabilities (as all data is typically kept in one database).
Examples of modules in an ERP which formerly would have been stand-alone applications include: Manufacturing, Supply Chain, Financials, Customer Relationship Management (CRM), Human Resources, Warehouse Management and Decision Support System.


Some organizations — typically those with sufficient in-house IT skills to integrate multiple software products — choose to implement only portions of an ERP system and develop an external interface to other ERP or stand-alone systems for their other application needs. For example, one may choose to use human resource management system from one vendor, and the financial systems from another, and perform the integration between the systems themselves.
This is very common in the retail sector[citation needed], where even a mid-sized retailer will have a discrete Point-of-Sale (POS) product and financials application, then a series of specialized applications to handle business requirements such as warehouse management, staff rostering, merchandising and logistics.
Ideally, ERP delivers a single database that contains all data for the software modules, which would include:
Manufacturing
Engineering, Bills of Material, Scheduling, Capacity, Workflow Management, Quality Control, Cost Management, Manufacturing Process, Manufacturing Projects, Manufacturing Flow
Supply Chain Management
Order to cash, Inventory, Order Entry, Purchasing, Product Configurator, Supply Chain Planning, Supplier Scheduling, Inspection of goods, Claim Processing, Commission Calculation
Financials
General Ledger, Cash Management, Accounts Payable, Accounts Receivable, Fixed Assets
Projects
Costing, Billing, Time and Expense, Activity Management
Human Resources
Human Resources, Payroll, Training, Time & Attendance, Rostering, Benefits
Customer Relationship Management
Sales and Marketing, Commissions, Service, Customer Contact and Call Center support
Data Warehouse
and various Self-Service interfaces for Customers, Suppliers, and Employees
Enterprise Resource Planning is a term originally derived from manufacturing resource planning (MRP II) that followed material requirements planning (MRP). MRP evolved into ERP when "routings" became a major part of the software architecture and a company's capacity planning activity also became a part of the standard software activity.[citation needed] ERP systems typically handle the manufacturing, logistics, distribution, inventory, shipping, invoicing, and accounting for a company. Enterprise Resource Planning or ERP software can aid in the control of many business activities, like sales, marketing, delivery, billing, production, inventory management, quality management, and human resource management.
ERP systems saw a large boost in sales in the 1990s as companies faced the Y2K problem in their legacy systems. Many companies took this opportunity to replace their legacy information systems with ERP systems. This rapid growth in sales was followed by a slump in 1999, at which time most companies had already implemented their Y2K solution.
ERPs are often incorrectly called back office systems indicating that customers and the general public are not directly involved. This is contrasted with front office systems like customer relationship management (CRM) systems that deal directly with the customers, or the eBusiness systems such as eCommerce, eGovernment, eTelecom, and eFinance, or supplier relationship management (SRM) systems.
ERPs are cross-functional and enterprise wide. All functional departments that are involved in operations or production are integrated in one system. In addition to manufacturing, warehousing, logistics, and information technology, this would include accounting, human resources, marketing, and strategic management.
ERP II means open ERP architecture of components. The older, monolithic ERP systems became component oriented.[citation needed]
EAS — Enterprise Application Suite is a new name for formerly developed ERP systems which include (almost) all segments of business, using ordinary Internet browsers as thin clients Before
Prior to the concept of ERP systems, it was not unusual for each department within an organization to have its own customized computer system. For example, the human resources (HR) department, the payroll department, and the financial department might all have their own computer systems.
Typical difficulties involved integration of data from potentially different computer manufacturers and systems. For example, the HR computer system (often called HRMS or HRIS) would typically manage employee information while the payroll department would typically calculate and store paycheck information for each employee, and the financial department would typically store financial transactions for the organization. Each system would have to integrate using a predefined set of common data which would be transferred between each computer system. Any deviation from the data format or the integration schedule often resulted in problems.

ERP software, among other things, combined the data of formerly separate applications. This simplified keeping data in synchronization across the enterprise, it simplified the computer infrastructure within a large organization, and it standardized and reduced the number of software specialties required within larger organizations.
To implement ERP systems, companies often seek the help of an ERP vendor or of third-party consulting companies. These firms typically provide three areas of professional services: consulting, customization and support. The client organisation may also employ independent program management, business analysis, change management and UAT specialists to ensure their business requirements remain a priority during implementation.
Data migration is one of the most important activities in determining the success of an ERP implementation. Since many decisions must be made before migration, a significant amount of planning must occur. Unfortunately, data migration is the last activity before the production phase of an ERP implementation, and therefore receives minimal attention due to time constraints. The following are steps of a data migration strategy that can help with the success of an ERP implementation: [4]
1. Identifying the data to be migrated
2. Determining the timing of data migration
3. Generating the data templates
4. Freezing the tools for data migration
5. Deciding on migration related setups
6. Deciding on data archiving

ERP vendors have designed their systems around standard business processes, based upon best business practices. Different vendor(s) have different types of processes but they are all of a standard, modular nature. Firms that want to implement ERP systems are consequently forced to adapt their organizations to standardized processes as opposed to adapting the ERP package to the existing processes.[5] Neglecting to map current business processes prior to starting ERP implementation is a main reason for failure of ERP projects.[6] It is therefore crucial that organizations perform a thorough business process analysis before selecting an ERP vendor and setting off on the implementation track. This analysis should map out all present operational processes, enabling selection of an ERP vendor whose standard modules are most closely aligned with the established organization. Redesign can then be implemented to achieve further process congruence. Research indicates that the risk of business process mismatch is decreased by:
• linking each current organizational process to the organization's strategy;
• analyzing the effectiveness of each process in light of its current related business capability;
• understanding the automated solutions currently implemented.
ERP implementation is considerably more difficult (and politically charged) in organisations structured into nearly independent business units, each responsible for their own profit and loss, because they will each have different processes, business rules, data semantics, authorization hierarchies and decision centers.[9] Solutions include requirements coordination negotiated by local change management professionals or, if this is not possible, federated implementation using loosely integrated instances (e.g. linked via Master Data Management) specifically configured and/or customized to meet local needs.
A disadvantage usually attributed to ERP is that business process redesign to fit the standardized ERP modules can lead to a loss of competitive advantage. While documented cases exist where this has indeed materialized, other cases show that following thorough process preparation ERP systems can actually increase sustainable competitive advantage.
Configuring an ERP system is largely a matter of balancing the way you want the system to work with the way the system lets you work. Begin by deciding which modules to install, then adjust the system using configuration tables to achieve the best possible fit in working with your company’s processes.
Modules - Most systems are modular simply for the flexibility of implementing some functions but not others. Some common modules, such as finance and accounting are adopted by nearly all companies implementing enterprise systems; others however such as human resource management are not needed by some companies and therefore not adopted. A service company for example will not likely need a module for manufacturing. Other times companies will not adopt a module because they already have their own proprietary system they believe to be superior. Generally speaking the greater number of modules selected, the greater the integration benefits, but also the increase in costs, risks and changes involved.
Configuration Tables – A configuration table enables a company to tailor a particular aspect of the system to the way it chooses to do business. For example, an organization can select the type of inventory accounting – FIFO or LIFO – it will employ or whether it wants to recognize revenue by geographical unit, product line, or distribution channel.
So what happens when the options the system allows just aren’t good enough? At this point a company has two choices, both of which are not ideal. It can re-write some of the enterprise system’s code, or it can continue to use an existing system and build interfaces between it and the new enterprise system. Both options will add time and cost to the implementation process. Additionally they can dilute the system’s integration benefits. The more customized the system becomes the less possible seamless communication becomes between suppliers and customers.
Many organizations did not have sufficient internal skills to implement an ERP project. This resulted in many organizations offering consulting services for ERP implementation. Typically, a consulting team was responsible for the entire ERP implementation including planning, training, testing, implementation, and delivery of any customized modules. Examples of customization includes additional product training; creation of process triggers and workflow; specialist advice to improve how the ERP is used in the business; system optimization; and assistance writing reports, complex data extracts or implementing Business Intelligence.
For most mid-sized companies, the cost of the implementation will range from around the list price of the ERP user licenses to up to twice this amount (depending on the level of customization required). Large companies, and especially those with multiple sites or countries, will often spend considerably more on the implementation than the cost of the user licenses -- three to five times more is not uncommon for a multi-site implementation.[citation needed]
Customization Services involves any modifications or extensions that change how the out-of-the-box ERP system works.
Customizing an ERP package can be very expensive and complicated. Some ERP packages are not designed to support customization, so most businesses implement the best practices embedded in the acquired ERP system. Some ERP packages have very generic features, such that customization occurs in most implementations. It is also often possible to extend the standard ERP package by purchasing third party software to provide additional functionality.
Customization work is usually undertaken as bespoke software development on a time and materials basis.
Customization can be further classified into: Core system customization or custom extensions in custom libraries
Core system customization is where customers change the software vendors’ proprietary code. This means that the software will no longer be supported by the vendor for the particular function that was customized as the code would be modified to the customers need. The customers IT department will then normally support the code in-house or subcontract a consulting organization to do so.
Custom extensions are where a customer build bolt on custom applications that run parallel to the standard system i.e. custom extended applications. Modules that are extended but core code not changed remain supported but the extensions will have to be supported by the customers IT department or subcontracted consulting organization

Maintenance and Support Services involves monitoring and managing an Operational ERP system. This function is often provided in-house using members of the IT department, but may also be provided by specialist external consulting and services companies.

In the absence of an ERP system, a large manufacturer may find itself with many software applications that do not talk to each other and do not effectively interface. Tasks that need to interface with one another may involve:
• design engineering (how to best make the product)
• order tracking from acceptance through fulfillment
• the revenue cycle from invoice through cash receipt
• managing interdependencies of complex Bill of Materials
• tracking the 3-way match between Purchase orders (what was ordered), Inventory receipts (what arrived), and Costing (what the vendor invoiced)
• the Accounting for all of these tasks, tracking the Revenue, Cost and Profit on a granular level.Change how a product is made, in the engineering details, and that is how it will now be made. Effective dates can be used to control when the switch over will occur from an old version to the next one, both the date that some ingredients go into effect, and date that some are discontinued. Part of the change can include labeling to identify version numbers.
Some security features are included within an ERP system to protect against both outsider crime, such as industrial espionage, and insider crime, such as embezzlement. A data tampering scenario might involve a disgruntled employee intentionally modifying prices to below the breakeven point in order to attempt to take down the company, or other sabotage. ERP systems typically provide functionality for implementing internal controls to prevent actions of this kind. ERP vendors are also moving toward better integration with other kinds of information security tools.
Challenges with ERP
Problems with ERP systems are mainly due to inadequate investment in ongoing training for involved personnel, including those implementing and testing changes, as well as a lack of corporate policy protecting the integrity of the data in the ERP systems and how it is used.
Disadvantages
• Customization of the ERP software is limited.
• Re-engineering of business processes to fit the "industry standard" prescribed by the ERP system may lead to a loss of competitive advantage.
• ERP systems can be very expensive leading to a new category of "ERP light" s

INVENTORY MANAGEMENT

"Inventory" to many small business owners is one of the more visible and tangible aspects of doing business. Raw materials, goods in process and finished goods all represent various forms of inventory. Each type represents money tied up until the inventory leaves the company as purchased products. Likewise, merchandise stocks in a retail store contribute to profits only when their sale puts money into the cash register. In a literal sense, inventory refers to stocks of anything necessary to do business. These stocks represent a large portion of the business investment and must be well managed in order to maximize profits. In fact, many small businesses cannot absorb the types of losses arising from poor inventory management. Unless inventories are controlled, they are unreliable, inefficient and costly.
The word inventory simply means the goods and services that businesses hold in stock. There are, however, several different categories or types of inventory. The first is called materials and components. This usually consists of the essential items needed to create or make a finished product, such as gears for a bicycle, microchips for a computer, or screens and tubes for a television set. The second type of inventory is called WIP, or work in progress inventory. This refers to items that are partially completed, but are not the entire finished product. They are on their way to becoming whole items but are not quite their yet. The third and most common form of inventory is called finished goods. These are the final products that are ready to be purchased by customers and consumers. Finished goods can range from cakes to furniture to vehicles. Most people think of the finished goods as being part of an inventory stock, but the parts that create them are held accountable in inventory as well.
Consignment Inventory is inventory that is in the possession of the customer, but is still owned by the supplier. In other words, the supplier places some of his inventory in his customer’s possession (in their store or warehouse) and allows them to sell or consume directly from his stock. The customer purchases the inventory only after he has resold or consumed it. The key benefit to the customer should be obvious; he does not have to tie up his capital in inventory. This does not mean that there are no inventory carrying costs for the customer; he does still incur costs related to storing and managing the inventory. So what’s in it for the supplier? This is where the benefits may not be so obvious—or may not even exist. Let’s start with a classic consignment model that has significant benefits for the supplier.
In business management, inventory consists of a list of goods and materials held available in stock. An inventory can also mean self-examination, a moral inventory. In computing, inventories can comprise physical and non-physical components. Logistics or distribution the logistics chain includes the owners (wholesalers and retailers), manufacturers' agents, and transportation channels that an item passes through between initial manufacture and final purchase by a consumer. At each stage, goods belong (as assets) to the seller until the buyer accepts them. Distribution includes four components:
Manufacturers' agents: Distributors who hold and transport a consignment of finished goods for manufacturers without ever owning it. Accountants refer to manufacturers' agents' inventory as "material" in order to differentiate it from goods for sale.
Transportation: The movement of goods between owners. The seller owns goods in transit until the buyer accepts them. Sellers or buyers may transport goods but most transportation providers act as the seller's agents.
Wholesaling: Distributors who buy goods from manufacturers and other suppliers (farmers, fishermen, etc.) for re-sale work in the wholesale industry. A wholesaler's inventory consists of all the products in its warehouse that it has purchased from manufacturers or other suppliers. A produce-wholesaler (or distributor) may buy from distributors in other parts of the world or from local farmers. Food distributors wish to sell their inventory to grocery stores, other distributors, or possibly to consumers.
Retailing: A retailer's inventory of goods for sale consists of all the products on its shelves that it has purchased from manufacturers or wholesalers. The store attempts to sell its inventory (soup, bolts, sweaters, or other goods) to consumers.
Inventories also play an important role in national accounts and the analysis of the business cycle. Some short-term macroeconomic fluctuations are attributed to the inventory cycle. Wholesaling consists of the sale of goods/merchandise to retailers, to industrial, commercial, institutional, or other professional business users or to other wholesalers and related subordinated services (WTO - World Trade Organization). According to the United Nations Statistics Division, Wholesale is the resale (sale without transformation) of new and used goods to retailers, to industrial, commercial, institutional or professional users, or to other wholesalers, or involves acting as an agent or broker in buying merchandise for, or selling merchandise, to such persons or companies. Wholesalers frequently physically assemble, sort and grade goods in large lots, break bulk, repack and redistribute in smaller lots, for example pharmaceuticals; store, refrigerate, deliver and install goods, engage in sales promotion for their customers and label design." (UNSTATS - United Nations Statistics Division).
















Successful inventory management involves balancing the costs of inventory with the benefits of inventory. Many small business owners fail to appreciate fully the true costs of carrying inventory, which include not only direct costs of storage, insurance and taxes, but also the cost of money tied up in inventory. This fine line between keeping too much inventory and not enough is not the manager's only concern. Others include:
Maintaining a wide assortment of stock -- but not spreading the rapidly moving ones too thin;
Increasing inventory turnover -- but not sacrificing the service level;
Keeping stock low -- but not sacrificing service or performance.
Obtaining lower prices by making volume purchases -- but not ending up with slow-moving inventory; and
Having an adequate inventory on hand -- but not getting caught with obsolete items.
The degree of success in addressing these concerns is easier to gauge for some than for others. For example, computing the inventory turnover ratio is a simple measure of managerial performance. This value gives a rough guideline by which managers can set goals and evaluate performance, but it must be realized that the turnover rate varies with the function of inventory, the type of business and how the ratio is calculated (whether on sales or cost of goods sold). Average inventory turnover ratios for individual industries can be obtained from trade associations.
There's many different ways that companies handle their inventory. Overall it depends on what kind of business it is. For example, a food manufacturer who makes canned fruit may take into account every single piece of that can in its inventory. The materials used to make the can, the labels, the fruit, and the sugary filling could all be part of the overall analysis of inventory. Keeping track of inventory can be a complex process. The term for watching inventory is called logistics. Logistics is a detailed process by which all inventory is tracked and logged. Several different people are involved in logistics. This can include everything from the owner of the company to the transportation company that delivers the goods to the manufacturing plant. By using complex systems such as barcode integration, every piece of inventory from the smallest parts to the largest finished product can be tracked and observed. You may wonder why companies keep such a close eye on their inventory. The answer is really simple: the bottom line. Without inventory control, millions of dollars could be lost each year just because there was no accountability for everything involved in making a product.
Of course, inventory is also important on the checks and balances side. Accountants keep an eye on inventory counts in order to be sure that fraud or embezzlement is not occurring. This also serves as a backup to check and be sure that everything is in its place and nothing out of the ordinary is taking place. There have actually been books written on how to reconcile inventory, keep accurate stock counts, reasons that errors occur, tools to use to help make sure inventory is on time and in its place, and much more (http://www.accuracybook.com/). Once you learn about the various forms of inventory and the importance of making sure it is logged properly, the process of tracking it should be fairly streamlined and simple, giving your business a cost-effective and competitive edge.
Departmentalizing and Inventory Management in a Retail Store
The breaking down of a retail store into departments can have a number of benefits to the retail operation. Included in these benefits is the ability to help organize and manage your store's inventories more effectively. More importantly, it can contribute significantly to the overall profitability of the store.
The following are suggestions on the basic steps that could be followed in organizing a retail store by departments:
Categorize the merchandise into groupings of "Like" kinds of merchandise. Examples of this could include grouping all giftware together, all house wares together, all food related products together, etc.
Assign a stock number to each item in the store which would follow some logical sequence and then be recorded to avoid potential duplication.
Ticket all merchandise to include all or part of the following:
Department numbers
A stock aging number/letter to help you to know when the stock came into the store
Retail price
Other suggested coding/combinations could be: supplier, style, size and color, cost stock keeping unit (S.K.U. number).
Set up the cash register to record sales based on the department breakdown
Set the record keeping up to match to the departments
Merchandise the sales floor to the departments
Plan and analyze sales and purchases to the departments
NOTE: The breaking down of a store into departments should be done keeping the following in mind:
Break the groupings down to the level that relevant information is provided to you on their individual department performances.
Do not break them down to levels so small that they do not make sense.
Ensure that the work, cost, and time in managing this system is not greater than the benefits you want from it.
Ensure your cash register (point of sale) and your record keeping system (management information system or M.I.S.) have the ability to handle these department information breakdowns.
Ensure all staff members are aware of what you are doing and the importance of it.
The following are additional points to be noted in this process:
All stock should be organized on the sales floor according to these departments, keeping the groupings in proximity to each other, re-ticketing the stock if necessary, and then taking a physical inventory by department to establish an inventory cost by the department. At year end, a closing inventory would also be taken by department.
If the record keeping system has been set up properly, purchases should also have been recorded by the departments.
A point to keep in mind when organizing by departments is to remember that it is not always a cut and dry procedure, particularly when you have suppliers shipping a range of merchandise that may cover different departments, and invoicing all on one invoice. Your option in these situations is to manually pull the information off the invoice by department, or more simply, to order merchandise on separate purchase order numbers done by department. A cost of goods sold and gross margin can then be calculated for each department. The department's performance can then be measured. If successes or problems are identified, the category can be analyzed for the reasons.
Once the categorizing to these levels has been completed, a system of reordering should be put in place. Reordering in many situations is done by the "eyeballing of the inventory" method but this method may not give you the accuracy and control you may require and want.
A more reliable way is to set up a manual item stock records system. It can be very basic and record information by department, manufacturer, season, item, item cost, and retail and units sold. Regular stock counts can take place weekly, monthly, etc. as the product turnover dictates. Departments can then be summarized at determined intervals for analysis from the stock counts. If completed for departments at least once a month, an extension of the units and cost can give you an estimate of the dollar inventory on hand. If a physical inventory is done, a comparison between what should be there and what is actually there can also be done. If there is a shortfall, a stock shortage or shrinkage is created and the cause should be determined.
This basic system can be taken one step further to include a plan to estimate sales for a product and project quantities to buy, thereby attempting to reduce potential stock outs. A potential danger is to over estimate projected sales quantities, which may create stock problems. A key part of this total process is the use of purchase order forms, including order numbers, shipping and cancellation dates, item listings, costs, terms, shipping instructions, and whether or not substitutions will be accepted. At the same time, it is important that all merchandise arriving into the store is checked against the invoice and the purchase order.
Stock counts should be done by staff familiar with the products areas, and should include identifying damaged or problem stock for action, housekeeping, etc. Sales representatives from companies can potentially also be a source of help. Counts can be done on a rotational basis with other departments through the month, and do not have to be done all at the same time. A caution is to not get this to the level that it does not make sense, and thereby requires time and effort that the results cannot justify. As well, it should also be watched that staff do not get so involved in counting of stock that customers are ignored.
Computer inventory link-ups to cash registers, if workable, can be of benefit. An evaluation of the system, labour and other associated costs should be weighed against the benefits needed, and the performance of your current manual system. It may not be advisable to convert your system. A manual system should be established first. Get it working and be comfortable with it before considering moving to a computer system.
From this, category and individual item sales and purchase planning can now be done. This can be referred to as a "Buying Plan". This can help to identify planned dollar purchases by month and by department, and can be broken down to make allowances for purchase of basic items, promotional items, seasonal placing, and opportunity buys. This would be maintained on an ongoing basis and be adjusted, for example, based on sales results, stock levels, shipping problems, etc.
Once the purchasing requirements have been established, they can be now worked into the basic cash flow planning process to determine requirements. To this point, this has been a bottom up process. It is conceivable that cash flow limitations from a top down look can restrict or force a reconsideration of purchasing requirements. This would then have to be worked back down, and decisions made accordingly.
Criteria for the selection of suppliers
Retailers regularly confront with the issue of locating a new supplier for the existing merchandise or identifying a new supplier for fresh merchandise introduced. A supplier’s initial assessment will be made according to his ability to satisfy retailers in four main areas (see Fig. 2.1) together with the kind of indicators that would determine the likelihood of supplier meeting criteria. The existing suppliers may be retained because they have given particularly good service in the past, or because there is no identifiable competition.
The main areas of supplier assessment criteria are:


Delivery


Service


Price

Product range and quality

Selection criteria
Fig. 2.1 selection criteria for suppliers
Product range and suppliers
Retailers will assess the product range available with the supplier and the quality standard maintained while manufacturing or delivering. Retailers will consider the following parameters to judge the standing of a particular supplier: technical capability, design expertise, quality benchmarks, samples, and nil-defect delivery.
Price
Retailers will always have relative assessment of the different suppliers while deciding the purchase. At the same time, retailers as per the norms prevailing in their industry look forward to credit terms, payments options, penalties, discounts(cash and trade),and price levels and price points. Retailers will also evaluate the offer from the perspective of a consumer in terms of value for money and consistent price policy.
Delivery
In order to avoid sales loss, a retailer is generally interested in the assessment of a supplier’s capacity to deliver ordered goods in time as per specification. Retailers also evaluate the performance of the suppliers or gather information on these parameters to ascertain delivery capacity, such as minimum order quantities, lead times, workforce stability and response, and ability to collaborate on consumer led response initiative.
Service
This encompasses all those facilities and support extended by the supplier to add value to the goods or services, or assistance in the sale of the goods. It includes pre and post sales services by the supplier. Retailers will be interested to assess the working of the supplier on parameters such as innovation, speed of new product or variant introduction , sampling service, marketing support( advertising and promotion), and handling queries and complaints.
A list of suppliers should be available and kept fully up to date, showing lines supplied by each. This will aid the process of review of suppliers and lines, so that suppliers performing well may be rewarded with larger orders.



THE PURCHASING PLAN
One of the most important aspects of inventory control is to have the items in stock at the moment they are needed. This includes going into the market to buy the goods early enough to ensure delivery at the proper time. Thus, buying requires advance planning to determine inventory needs for each time period and then making the commitments without procrastination.
For retailers, planning ahead is very crucial. Since they offer new items for sale months before the actual calendar date for the beginning of the new season, it is imperative that buying plans be formulated early enough to allow for intelligent buying without any last minute panic purchases. The main reason for this early offering for sale of new items is that the retailer regards the calendar date for the beginning of the new season as the merchandise date for the end of the old season. For example, many retailers view March 21 as the end of the spring season, June 21 as the end of summer and December 21 as the end of winter.
Part of your purchasing plan must include accounting for the depletion of the inventory. Before a decision can be made as to the level of inventory to order, you must determine how long the inventory you have in stock will last. For instance, a retail firm must formulate a plan to ensure the sale of the greatest number of units. Likewise, a manufacturing business must formulate a plan to ensure enough inventories are on hand for production of a finished product.
In summary, the purchasing plans details:
· When commitments should be placed;
· When the first delivery should be received;
· When the inventory should be peaked;
· When reorders should no longer be placed; and
· When the item should no longer be in stock
Well planned purchases affect the price, delivery and availability of products for sale.
Merchandise Budget:
Merchandise budget is referred to as a financial plan that indicates how much to invest in product inventories, usually stated in rupees per month. Earmarking of merchandising budgets is considered to be a vital tool component of the planning phase. Usually, a budget states the amount allocated for each product, based on the pre-set profitability or other performance measures. The four important components of the merchandise budget plan, shown in Fig. 3.1, are as follows.
Merchandise budget plan
Projected sales
Inventory plan
Estimated reduction
Estimated purchase
Fig. 3.1 components of merchandise budget plan
These aspects of merchandise budget require due consideration from the retailer or the concerned decision-maker.
Projected sales
Budget planning starts with the development of a sales plan, this shows the expected or projected rupees volume of sales for each merchandise or department. Sales forecasting helps the management in a forecast of a projected sales. Without having information on how much is to be sold, the retailer can’t determine how much to buy. Mistakes made at this stage will be reflected in the entire budgeting plan and may incur huge losses to the management in future. The understanding of category life cycle stage helps in predicting sales. It indicates clearly that the stage of life cycle a particular product category enjoys will indicate the sales expected in future.

Inventory plan
Inventory management plan provides information regarding sales velocity, inventory availability, ordered quantity, inventory turnover, sales forecast, and quantity for specific SKU (stock keeping unit). Inventory plan assists retailers in scheduling orders to vendors after considering trade off between carrying cost versus the cost of ordering and handling the inventory. The more they purchase at one time, the higher the carrying cost, but the lower the buying and handling costs.
The inventory plan helps to devise the stock support levels for a specific sales period. Most widely used methods to determine the stock support levels that are:
Beginning-of-the-month ratios
Percentage variation method
Week’s supply method
Basic stock method

Method to determine stock support level
Fig. 3.2 methods to determine stock support levels
The stock/sales ratio (BOM) method relates inventory on the first of the month of the planed sales for that month. This method is quite easy to use but requires retailers to have a BOM stock-to-sales ratio. This ratio informs the retailers about the quantity of inventory needed at the beginning of the month to support the month’s estimated sales. The ratio is calculated as follows:
BOM=planned monthly sales*desired stock/sales ratio
A ratio of 1.5, for example, would indicate retailers that they should maintain one and one-half times that month’s forecasted sales on hand in inventory at the beginning of the month.
Stock-to-sales can be obtained from internal or external sources. In the Indian context this is not possible in case of retailers belonging to the unorganized sector as they do not maintain a good accounting system. At the same time, there are very limited or no retail trade association which maintain such data. Recently, a few fashion, grocery, and pharmaceutical retail stores have been banking on this method to determine the amount of the stock necessary to support the projected sales.
The week’s supply method is for determining stock levels that states that the inventory level should be set equal to a predetermined number of week’s supply, which is directly related to the desired rate of stock turnover. The predetermined number of week’s supply is directly related to the stock turnover rate desired. It is the most widely used by the retailers in the urban and rural areas, where inventories are planned or a weekly basis and in which sales do not fluctuate substantially.
Number of weeks to be stocked = number of weeks in the period/stock turnover rate for the period

Average weekly sales=estimated total sales for the period /number of weeks in the period

BOM stock=average weekly sales*number of weeks to be stocked

This method allows a retailer to replenish stock frequently; preventing stock outs, and therefore avoids inconvenience to the customers.
Percentage variation method is for planning necessary stock support levels in which stock levels are adjusted based on actual variations in sales. This method is more appropriate for the categories which experience frequent fluctuations and high yearly turnover rates such as six or more times a year.
Percentage variation method assumes that percentage fluctuations in monthly stock from average stock should be half as much as the percentage fluctuations in monthly sales from average sales.
BOM stock=average inventory*1/2 [1+ (planned sales for the month/average monthly sales)]

Basic stock method is preferred when retailers believe that it is necessary to have a given level of inventory available at all times. It is the most compatible approach for the retail stores or department with low inventory turnover rates such as less than 6.0 annually. The basic stock method can be calculated as follows:

BOM stock= planned sales for month + average inventory – average monthly sales
Estimated reductions
Retailers are required to provide for retail reductions along with sales forecast and inventory support levels. Retail reduction is anticipated sales below the list price. Retail reductions are classified into three types of below sales prices: markdowns, discounts and shortages. Markdown is defined as reduction in the original list price to encourage sales of the product. Discounts are reduction in the original retail price given to special customer groups, such as loyal customers. Shortage is reductions in the total value of inventory that results from damages to merchandise, shoplifting or pilferage. The retailers on the bases of their past experience on retail reductions make adequate arrangements while evolving merchandise budgets.
Estimated purchase levels
At this stage a retailer is supposed to devise an actual budget for planned purchase. In other words, planned purchases refer to planned purchase that must be made at the beginning of each month. Here a retailer or planner uses information compiled at the initial stage of merchandise budget planning.
Planned purchases are calculated as follows:
Planned monthly sales
+ planned monthly reductions
+ Desired end-of-the-month stock

= total stock needs for the month
- planned BOM stock

= planned monthly purchases
The planned monthly purchases figure informs buyers how much they ned to spend to support anticipated sales levels considering existing inventories.






















CONTROLLING YOUR INVENTORY
To maintain an in-stock position of wanted items and to dispose of unwanted items, it is necessary to establish adequate controls over inventory on order and inventory in stock. Stock control, otherwise known as inventory, is about how much stock you have at any one time, and how you keep track of it. There are several proven methods for inventory control. They are listed below, from simplest to most complex.
· Visual control enables the manager to examine the inventory visually to determine if additional inventory is required. In very small businesses where this method is used, records may not be needed at all or only for slow moving or expensive items.
· Tickler control enables the manager to physically count a small portion of the inventory each day so that each segment of the inventory is counted every so many days on a regular basis.
· Click sheet control enables the manager to record the item as it is used on a sheet of paper. Such information is then used for reorder purposes.
· Stub control (used by retailers) enables the manager to retain a portion of the price ticket when the item is sold. The manager can then use the stub to record the item that was sold.
As a business grows, it may find a need for a more sophisticated and technical form of inventory control. Today, the use of computer systems to control inventory is far more feasible for small business than ever before, both through the widespread existence of computer service organizations and the decreasing cost of small-sized computers. Often the justification for such a computer-based system is enhanced by the fact that company accounting and billing procedures can also be handled on the computer.
· Point-of-sale terminals relay information on each item used or sold. The manager receives information printouts at regular intervals for review and action.
· Off-line point-of-sale terminals relay information directly to the supplier's computer who uses the information to ship additional items automatically to the buyer/inventory manager.
The final method for inventory control is done by an outside agency. A manufacturer's representative visits the large retailer on a scheduled basis, takes the stock count and writes the reorder. Unwanted merchandise is removed from stock and returned to the manufacturer through a predetermined, authorized procedure.
A principal goal for many of the methods described above is to determine the minimum possible annual cost of ordering and stocking each item. Two major control values are used: 1) the order quantity, that is, the size and frequency of orders; and 2) the reorder point, that is, the minimum stock level at which additional quantities are ordered. The Economic Order Quantity (EOQ) formula is one widely used method of computing the minimum annual cost for ordering and stocking each item. The EOQ computation takes into account the cost of placing an order, the annual sales rate, the unit cost, and the cost of carrying inventory. Many books on management practices describe the EOQ model in detail.






DEVELOPMENTS IN INVENTORY MANAGEMENT
In recent years, two approaches have had a major impact on inventory management: Material Requirements Planning (MRP) and Just-In-Time (JIT and Kanban). Their application is primarily within manufacturing but suppliers might find new requirements placed on them and sometimes buyers of manufactured items will experience a difference in delivery.
A material requirement planning is basically an information system in which sales are converted directly into loads on the facility by sub-unit and time period. Materials are scheduled more closely, thereby reducing inventories, and delivery times become shorter and more predictable. Its primary use is with products composed of many components. MRP systems are practical for smaller firms. The computer system is only one part of the total project which is usually long-term, taking one to three years to develop.
Just-in-time inventory management is an approach which works to eliminate inventories rather than optimize them. The inventory of raw materials and work-in-process falls to that needed in a single day. This is accomplished by reducing set-up times and lead times so that small lots may be ordered. Suppliers may have to make several deliveries a day or move close to the user plants to support this plan.
Inventory Management SoftwareEffective management of finished product inventory is quite essential for running a business efficiently and profitably. Inventory strategies and decisions become particularly important in businesses where inventory costs form a sizeable part of total marketing costs.
Carrying inventories becomes inescapable in most businesses, because the producing activities and consuming activities take place at different times, in different locations and at different rates. Inventories are made up of several elements: operational stocks kept for meeting the ready demand at different consumption centers. Some stock will be in transit at any given point of time, while other stock will be awaiting shipments. Finally, there are kept for meeting emergencies. All these make up the total inventory.
While discussing inventory management software, it is important to keep an eye on the elements of inventory costs. A variety of costs are incurred in carrying the inventories. They include interest on capital tied up in the inventory, warehouse rent, staff salaries, insurance, rates and taxes, stationery, postage and communication charges, administrative overheads, costs of handling, unloading and stacking, loss due to damage and deterioration while on storage and cost of order processing.
In businesses where the turnaround of inventories is rather slow, interest on the capital tied up in the inventory becomes the most significant element of the total inventory carrying costs. In fact, inventory cost causes the most worry to manufacturers today. Increased competition has resulted in the accumulation of stock in a number of industries. Inventory carrying costs are on the increase not merely because of increased level of inventories. Every increase in the price of the products pushes up the inventory carrying costs as the value of the locked up product goes up in the process. Similarly, every increase in the interest rates also pushes up the inventory carrying costs.
Inventory Software provides detailed information on Home Inventory Software, Inventory Accounting Software, Inventory Management Software, Inventory Software and more. Inventory Software is affiliated with Fleet Maintenance Software Reviews.







TIPS FOR BETTER INVENTORY MANAGEMENT
AT TIME OF DELIVERY
Verify count -- Make sure you are receiving as many cartons as are listed on the delivery receipt.
Carefully examine each carton for visible damage -- If damage is visible, note it on the delivery receipt and have the driver sign your copy
After delivery, immediately open all cartons and inspect for merchandise damage. When damage is discovered
Retain damaged items -- All damaged materials must be held at the point received.
Call carrier to report damage and request inspection.
Confirm call in writing--This is not mandatory but it is one way to protect yourself. Carrier inspection of damaged items
Have all damaged items in the receiving area -- Make certain the damaged items have not moved from the receiving area prior to inspection by carrier.
After carrier/inspector prepares damage report, carefully read before signing. After inspection
Keep damaged materials -- Damaged materials should not be used or disposed of without permission by the carrier.
Do not return damaged items without written authorization from shipper/supplier.

SPECIAL TIPS FOR MANUFACTURERS
If you are in the business of bidding, specifications play a very important role. In writing specifications, the following elements should be considered.
Do not request features or qualities that are not necessary for the items' intended use.
Include full descriptions of any testing to be performed.
Include procedures for adding optional items.
Describe the quality of the items in clear terms.

The following actions can help save money when you are stocking inventory:
Substitution of less costly materials without impairing required quality;
Improvement in quality or changes in specifications that would lead to savings in process time or other operating savings;
Developing new sources of supply;
Greater use of bulk shipments;
Quantity savings due to large volume, through consideration of economic order quantity;
A reduction in unit prices due to negotiations;
Initiating make-or-buy studies;
Application of new purchasing techniques;
Using competition along with price, service and delivery when making the purchase selection decision




INVENTORY MANAGEMENT IN SUPPLY CHAIN
Supply chain management (SCM) is the process of planning, implementing, and controlling the operations of the supply chain with the purpose to satisfy customer requirements as efficiently as possible. Supply chain management spans all movement and storage of raw materials, work-in-process inventory, and finished goods from point-of-origin to point-of-consumption. The term supply chain management was coined by consultant Keith Oliver, of strategy consulting firm Booz Allen Hamilton in 1982.
The definition one America professional association put forward is that Supply Chain Management encompasses the planning and management of all activities involved in sourcing, procurement, conversion, and logistics management activities. Importantly, it also includes coordination and collaboration with channel partners, which can be suppliers, intermediaries, third-party service providers, and customers. In essence, Supply Chain Management integrates supply and demand management within and across companies.
Supply chain event management (abbreviated as SCEM) is a consideration of all possible occurring events and factors that can cause a disruption in a supply chain. With SCEM possible scenarios can be created and solutions can be planned.
Some experts distinguish supply chain management and logistics, while others consider the terms to be interchangeable. Supply chain management is also a category of software products.
Supply chain management problems
Supply chain management must address the following problems:
Distribution Network Configuration: Number and location of suppliers, production facilities, distribution centers, warehouses and customers.
Distribution Strategy: Centralized versus decentralized, direct shipment, Cross docking, pull or push strategies, third party logistics.
Information: Integrate systems and processes through the supply chain to share valuable information, including demand signals, forecasts, inventory and transportation etc.
Inventory Management: Quantity and location of inventory including raw materials, work-in-process and finished goods.
Supply chain execution is managing and coordinating the movement of materials information and funds across the supply chain. The flow is bi directional.
Activities/Functions
Supply chain management is a cross-functional approach to managing the movement of raw materials into an organization and the movement of finished goods out of the organization toward the end-consumer. As corporations strive to focus on core competencies and become more flexible, they have reduced their ownership of raw materials sources and distribution channels. These functions are increasingly being outsourced to other corporations that can perform the activities better or more cost effectively. The effect has been to increase the number of companies involved in satisfying consumer demand, while reducing management control of daily logistics operations. Less control and more supply chain partners led to the creation of supply chain management concepts. The purpose of supply chain management is to improve trust and collaboration among supply chain partners, thus improving inventory visibility and improving inventory velocity.
Several models have been proposed for understanding the activities required to manage material movements across organizational and functional boundaries. SCOR is a supply chain management model promoted by the Supply-Chain Management Council. Another model is the SCM Model proposed by the Global Supply Chain Forum (GSCF). Supply chain activities can be grouped into strategic, tactical, and operational levels of activities.
Strategic
Strategic network optimization, including the number, location, and size of warehouses, distribution centers and facilities.
Strategic partnership with suppliers, distributors, and customers, creating communication channels for critical information and operational improvements such as cross docking, direct shipping, and third-party logistics.
Product design coordination, so that new and existing products can be optimally integrated into the supply chain, load management
Information Technology infrastructure, to support supply chain operations.
Where to make and what to make or buy decisions
Align Overall Organizational Strategy with supply strategy
Tactical
Sourcing contracts and other purchasing decisions.
Production decisions, including contracting, locations, scheduling, and planning process definition.
Inventory decisions, including quantity, location, and quality of inventory.
Transportation strategy, including frequency, routes, and contracting.
Benchmarking of all operations against competitors and implementation of best practices throughout the enterprise.
Milestone Payments.
Operational
Daily production and distribution planning, including all nodes in the supply chain.
Production scheduling for each manufacturing facility in the supply chain (minute by minute).
Demand planning and forecasting, coordinating the demand forecast of all customers and sharing the forecast with all suppliers.
Sourcing planning, including current inventory and forecast demand, in collaboration with all suppliers.
Inbound operations, including transportation from suppliers and receiving inventory.
Production operations, including the consumption of materials and flow of finished goods.
Outbound operations, including all fulfillment activities and transportation to customers.
Order promising, accounting for all constraints in the supply chain, including all suppliers, manufacturing facilities. distribution centers, and other customers.
Performance tracking of all activities.
Supply Chain Management
Organizations increasingly find that they must rely on effective supply chains, or networks, to successfully compete in the global market and networked economy. In Peter Drucker's (1998) management's new paradigms, this concept of business relationships extends beyond traditional enterprise boundaries and seeks to organize entire business processes throughout a value chain of multiple companies.
During the past decades, globalization, outsourcing and information technology have enabled many organizations such as Dell and Hewlett Packard, to successfully operate solid collaborative supply networks in which each specialized business partner focuses on only a few key strategic activities (Scott, 1993). This inter-organizational supply network can be acknowledged as a new form of organization. However, with the complicated interactions among the players, the network structure fits neither "market" nor "hierarchy" categories (Powell, 1990). It is not clear what kind of performance impacts different supply network structures could have on firms, and little is known about the coordination conditions and trade-offs that may exist among the players. From a system's point of view, a complex network structure can be decomposed into individual component firms (Zhang and Dilts, 2004). Traditionally, companies in a supply network concentrate on the inputs and outputs of the processes, with little concern for the internal management working of other individual players. Therefore, the choice of internal management control structure is known to impact local firm performance (Mintzberg, 1979).
In the 21st century, there have been few changes in business environment that have contributed to the development of supply chain networks. First, as an outcome of globalization and proliferation of multi-national companies, joint ventures, strategic alliances and business partnerships were found to be significant success factors, following the earlier "Just-In-Time", "Lean Management" and "Agile Manufacturing" practices. Second, technological changes, particularly the dramatic fall in information communication costs, a paramount component of transaction costs, has led to changes in coordination among the members of the supply chain network (Coase, 1998).
Many researchers have recognized these kinds of supply network structure as a new organization form, using terms such as "Keiretsu", "Extended Enterprise", "Virtual Corporation", Global Production Network", and "Next Generation Manufacturing System".In general, such a structure can be defined as "a group of semi-independent organizations, each with their capabilities, which collaborate in ever-changing constellations to serve one or more markets in order to achieve some business goal specific to that collaboration" (Akkermans, 2001).
Supply Chain Business Process Integration
Successful SCM requires a change from managing individual functions to integrating activities into key supply chain processes. An example scenario: the purchasing department places orders as requirements become appropriate. Marketing, responding to customer demand, communicates with several distributors and retailers, and attempts to satisfy this demand. Shared information between supply chain partners can only be fully leveraged through process integration.
Supply chain business process integration involves collaborative work between buyers and suppliers, joint product development, common systems and shared information. According to Lambert and Cooper (2000) operating an integrated supply chain requires continuous information flows, which in turn assist to achieve the best product flows. However, in many companies, management has reached the conclusion that optimizing the product flows cannot be accomplished without implementing a process approach to the business. The key supply chain processes stated by Lambert (2004) are:
Customer relationship management
Customer service management
Demand management
Order fulfillment
Manufacturing flow management
Supplier relationship management
Product development and commercialization
Returns management
One could suggest other key critical supply business processes combining these processes stated by Lambert such as:
Customer service Management
Procurement
Product development and Commercialization
Manufacturing flow management/support
Physical Distribution
Outsourcing/ Partnerships
Performance Measurement
a) Customer service management process
Customer service provides the source of customer information. It also provides the customer with real-time information on promising dates and product availability through interfaces with the company's production and distribution operations.
b) Procurement process
Strategic plans are developed with suppliers to support the manufacturing flow management process and development of new products. In firms where operations extend globally, sourcing should be managed on a global basis. The desired outcome is a win-win relationship, where both parties benefit, and reduction times in the design cycle and product development is achieved. Also, the purchasing function develops rapid communication systems, such as electronic data interchange (EDI) and Internet linkages to transfer possible requirements more rapidly. Activities related to obtaining products and materials from outside suppliers. This requires performing resource planning, supply sourcing, negotiation, order placement, inbound transportation, storage and handling and quality assurance. Also, includes the responsibility to coordinate with suppliers in scheduling, supply continuity, hedging, and research to new sources or programs.
c) Product development and commercialization
Here, customers and suppliers must be united into the product development process, thus to reduce time to market. As product life cycles shorten, the appropriate products must be developed and successfully launched in ever shorter time-schedules to remain competitive. According to Lambert and Cooper (2000), managers of the product development and commercialization process must:
coordinate with customer relationship management to identify customer-articulated needs;
select materials and suppliers in conjunction with procurement, and
develop production technology in manufacturing flow to manufacture and integrate into the best supply chain flow for the product/market combination.
d) Manufacturing flow management process
The manufacturing process is produced and supplies products to the distribution channels based on past forecasts. Manufacturing processes must be flexible to respond to market changes, and must accommodate mass customization. Orders are processes operating on a just-in-time (JIT) basis in minimum lot sizes. Also, changes in the manufacturing flow process lead to shorter cycle times, meaning improved responsiveness and efficiency of demand to customers. Activities related to planning, scheduling and supporting manufacturing operations, such as work-in-process storage, handling, transportation, and time phasing of components, inventory at manufacturing sites and maximum flexibility in the coordination of geographic and final assemblies postponement of physical distribution operations.
e) Physical Distribution
This concerns movement of a finished product/service to customers. In physical distribution, the customer is the final destination of a marketing channel, and the availability of the product/service is a vital part of each channel participant's marketing effort. It is also through the physical distribution process that the time and space of customer service become an integral part of marketing, thus it links a marketing channel with its customers (e.g. links manufacturers, wholesalers, retailers).
f) Outsourcing/Partnerships
This is not just outsourcing the procurement of materials and components, but also outsourcing of services that traditionally have been provided in-house. The logic of this trend is that the company will increasingly focus on those activities in the value chain where it has a distinctive advantage and everything else it will outsource. This movement has been particularly evident in logistics where the provision of transport, warehousing and inventory control is increasingly subcontracted to specialists or logistics partners. Also, to manage and control this network of partners and suppliers requires a blend of both central and local involvement. Hence, strategic decisions need to be taken centrally with the monitoring and control of supplier performance and day-to-day liaison with logistics partners being best managed at a local level.
g) Performance Measurement
Experts found a strong relationship from the largest arcs of supplier and customer integration to market share and profitability. By taking advantage of supplier capabilities and emphasizing a long-term supply chain perspective in customer relationships can be both correlated with firm performance. As logistics competency becomes a more critical factor in creating and maintaining competitive advantage, logistics measurement becomes increasingly important because the difference between profitable and unprofitable operations becomes narrower. A.T. Kearney Consultants (1985) noted that firms engaging in comprehensive performance measurement realized improvements in overall productivity. According to experts internal measures are generally collected and analyzed by the firm including
Cost
Customer Service
Productivity measures
Asset measurement, and
Quality.
External performance measurement is examined through customer perception measures and "best practice" benchmarking, and includes 1) Customer perception measurement, and 2) Best practice benchmarking.
Supply Chain and Inventory Management
Distribution Centers and Warehouses
Manufacturing Plants
Raw Material
Facilities
Retail Stores
Inventory Flow in a Supply Chain
(Raw materials, work-in-progress and finished inventory)
Consumers
Supplying the right
products
At the right
moment
At minimal
cost
To achieve objectives of SCM
In the right quantities










RFID – RADIO FREQUENCY IDENTIFICATION
EPC/RFID Solutions
EPC (Electronic Product Code) RFID (Radio Frequency Identification) Solutions can help organizations boost productivity, improve customer service, and lower costs
Solutions
Description
Warehousing -
Automated Shipping & Receiving
Tagging items at the case and pallet level with RFID tags. Readers placed at warehouse dock doors record the items loaded and unloaded from trucks; backend system verifies contents against PO and ASN.
Retail -
Item-Level Shelf Monitoring
Tagging at the item-level, along with ‘smart shelves’ – units with RFID readers built in, provide immediate feedback for replenishment, in addition to notification of misplaced items.
Manufacturing -
Work-In-Process Tracking
High value items and highly regulated items that require data gathered at various points in the production line are excellent targets for RFID tagging. Record safety test data at each step in the process, automatically.
Companies heavily dependent on fast and reliable transportation are actively looking into mobile and wireless technologies that make it easier and less time consuming to track and monitor sealed container shipments worldwide. One of the technologies that show a lot of promise is radio frequency identification, or RFID, and the use of tags that are equipped with such technology. Wal-Mart Stores has canceled testing for an experimental wireless inventory control system, ending one of the first and most closely watched efforts to bring controversial radio frequency identification technology to store shelves in the United States. Radio frequency identification (RFID) technology uses microchips to wirelessly transmit product serial numbers to a scanner without the need for human intervention.

• Visibility of real time info
• Decrease in supply chain volatility
• Lead time reduction
• Improved supply chain throughput
• Inventory days on hand
• Safety stock
• Transit inventory
• Recurring inventory carrying costs
• Promotion management

Inventory
• Access to outbound load density through better information, planning and improved throughput
• Freight costs
• Reverse logistics costs

Transport
• Increased throughput
• Better tracking and tracing of assets
• Fewer assets required
• Utilization of assets
• Depreciation of charge on distribution owned
• Total distribution of asset base
• Brand management

Assets
• More time to complete manual processes
• Improved validation and audit processes
• Labour productivity
• Supply chain throughput

Labour
• Better tracking and tracing of high value items
• Access to real time info flow
• Reduced human error
• Error related shrink
• Internal/external theft

Shrink
Variables Benefits
Levers Impacted
Component
Why are Organizations Looking at EPC/RFID?




















The technology is seen as an eventual successor to bar-code inventory tracking systems, promising to cut distribution costs for manufacturers and improve retailing margins. But the technology has drawn barbs from consumer privacy groups that worry about potential abuses if product-tracking tags are allowed to follow people from stores into their homes. Wal-Mart’s proposed smart-shelf system was designed to pick up data transmitted from microchips embedded in Gillette product packaging, alerting store managers via computer when stock is running low on the shelf or when items may have been stolen–two informative and powerful measurements in the retail business.
The Power of Wireless Technologies
Barcode
RFID
Wireless
Data Collection &
Communication
Technologies
Business
Applications
Major
Customer Benefits

Increase Supply Chain Management efficiency
Increase workers’ productivity
Increase data recording accuracy
Reduce inventory cost
Enhance assets tracking capability
Increase inventory control efficiency


Enterprise Asset Management Software

Warehouse Management Systems Software


Applications
Software

Combining
with
To
deliver
Increase asset management efficiency

Asset Management


Asset & Location Tracking


Inventory Management in Supply Chain

WLAN
WWAN
To
support

Applying Mobility to Business and Operational Process
Those ambitious plans now are likely to take a backseat to proposals to upgrade warehouse operations with RFID technology, which will require fewer chips and less computational power. Wal-Mart, the world’s largest retail chain with more than 4,700 stores around the globe, said that it is urging its top 100 suppliers to attach RFID chips to cases and pallets of products that they ship to Wal-Mart warehouses. Gillette and Wal-Mart had lauded the use of RFID systems to track merchandise in stores. Both said they were eager to explore the technology’s potential to boost the profits of retailers and manufacturers by ensuring that products are always available to consumers and by deterring theft.
Key Solution Components
• Tags (or Transponders) :
• Active vs. Passive
• Read Only vs. Read/Write
• Frequency (LF, HF, UHF, Microwave)
• Read Range
• Data Capacity
• Readers
• Middleware
• Application Software
Key Drivers
New Technology
New Standards
Industry Mandates
New Economics
Business Applications





EPC Class 1 Label
Packaged
Product
Encode/Apply Printer
Manufacturing
(Crate/Box Level)
Warehouses and
Distribution Center
(Pallet Level)
Retail Outlet
(Unit Level)
ExpressVu boxes with
EPC Class 1 Labels
Antennas
Shelves
Application of RFID in Inventory Management
EPC RFID Portal and EPC RFID tags
The Cost of Being Smart - Sensors are coming down, but it's still too high for many.
The Auto-ID Center, which is creating a universal electronic product code for radio frequency identification technology, has trumpeted the idea that RFID tags and readers will be able to track items from the far end of the global supply chain right to store shelves. The center's vision has led many industry observers to assume that the technology would be rolled out in the supply chain and stores virtually simultaneously. In fact, the center has always envisioned that RFID would be deployed first in the supply chain, and that it might take ten years or more for RFID readers in stores to monitor individual items on so-called smart shelves in real time.
A decade or more Chalk it up to the price of RFID tags and readers. Each smart shelf might require one or more readers, which cost $1,000 or more today. And each item would need its own tag. The Gillette Co. announced in January that it ordered 500 million tags from Alien Technology Corp. Gillette VP Dick Cantwell says the company paid "well under ten cents" for each tag. But suppliers that place smaller orders might have to pay 40 cents or more per tag—too expensive to put on most products in supermarkets.
At current price levels, it's only cost-effective for RFID tags to be used to track individual items that cost $15 or more. Retailers and suppliers are particularly interested in tagging high-priced items that are often lost, stolen or counterfeited, including computer games, DVDs, music CDs and prescription drugs. British retailer Tesco has been tracking all the DVDs in one store, but the company says it's too early to determine whether the system is cost-effective.
Clothes will certainly be among the first items to be tracked in stores with RFID tags. Marks & Spencer Group, a major British retailer, has announced plans to put RFID tags on all the clothing items this fall in one of its stores to determine the benefits of RFID tracking. And at press time, Benetton Group, the Italian clothing company, was planning to tag all of the clothes in one of its mega stores in Rome. Increased sales are expected to offset the cost of the tags. A pilot run by the Gap Inc. last year found sales jumped by 15 percent, thanks to better inventory management, which, in turn, let staff spend more time assisting customers.
There also may be some benefit to tagging fast-moving consumer goods, such as six-packs of beer (better tracking should reduce out-of-stocks). But if an RFID tag can't be put on every single item in the store, retailers can't have automated checkout stands, and they'll have to continue to do physical inventory counts for some products.
The Auto-ID Center estimates that using conventional technology, volumes will likely have to reach 30 billion RFID tags a year before the price falls to five cents per tag (and that's just the cost of a very simple tag with a serial number; read-write tags will be more expensive). It will take at least three to five years to reach that level. And even at five cents per tag, it's not going to be economically viable to tag many inexpensive items, such as bars of soap, packs of gum and cans of soda.
Kevin Turner, Wal-Mart's former CIO and current head of its Sam's Club division, has said that the retailer believes the price of tags must be no more than a penny apiece before they can be used on every item. The Auto-ID Center research shows that the price of a simple RFID tag can theoretically be brought down to 3.5 cents if the tags are manufactured in massive volumes. So it will still take a technological breakthrough before RFID can become ubiquitous.
Many companies are doing research that could lead to such a breakthrough. Flint Ink Corp., the world's second-largest producer of commercial inks, set up a separate business unit to develop and commercialize conductive inks that can be used to print RFID antennas (a tag is comprised of a copper antenna and a microchip). If antennas could be printed during the normal commercial printing process, it would greatly reduce the price of tags.
Researchers at Infineon Technologies AG, a German semiconductor company, have found a way to print integrated circuits on the foil wrappers that keep potato chips and other products fresh. The system is probably five years away from commercialization. But it's quite possible that in 10 or 15 years, the entire RFID tag—circuits and antenna—will be printed on packaging, just like a bar code is today.
The End of Privacy?
Mauro Benetton, director of marketing for the company that bears his name, admits the flap caught him off guard. In March, a group called CASPIAN (Consumers Against Supermarket Privacy Invasion and Numbering) called for a boycott of the Italian apparel company after learning that it planned to use radio frequency identification tags to track its clothing. CASPIAN feared the tagged clothing would enable Benetton Group to surreptitiously gather information on customers' shopping habits. Mauro Benetton says his company isn't backing off its plans to test RFID. But it will take steps to educate the public and give them the option of removing RFID tags.
Then, in July, press reports suggested that privacy advocates forced Wal-Mart Stores Inc. to back off an in-store "smart-shelf" test (see main story). Wal-Mart refused to comment, but no one can say that the company was caught off guard. In fact, it was Wal-Mart that proposed that the Auto-ID Center, a nonprofit RFID research organization, include a "kill" command in its specifications for a universal electronic product code (EPC), so the RFID tags could be permanently disabled at checkout.
The Auto-ID Center has been researching the privacy issue for three years and recently issued a position paper that establishes three bedrock policies all users of EPC technology should follow:
Consumers will always have the right to know when they are in a location where EPC readers are in use, and that the products they are buying contain EPC tags.
Consumers will always have the right to have EPC tags in the products they buy permanently deactivated, without cost or penalty.
Consumers will always have the right to buy EPC-tagged products without having their personal information electronically linked to the EPC number in the product.

"The companies we are working with all want to do the right thing," says Kevin Ashton, executive director of the Auto-ID Center. "Our primary recommendation is that if you can assure people that they have those three rights, then you are giving them the right to choose, and privacy concerns pretty much go away."
Stephen Keating, executive director of the Privacy Foundation, a nonprofit group in Denver, welcomes the center's proposals. But he says the technology raises some complex issues and problems in implementing policies. "When does the decision [to opt out] occur and how do you implement it?" he asks. "Can I say I want some purchases tracked but not others?"
It will be up to the Uniform Code Council, which is taking over commercialization of the EPC under its AutoID Inc. subsidiary, to turn the Auto-ID Center's principles into a coherent set of guidelines for retailers. Keating believes that educating consumers will be key. Shoppers will need to understand the potential benefits they will receive if they agree to allow retailers to track their purchases. "On the perimeter, you will have privacy advocates and civil libertarians screaming about it," Keating says, "but when it comes to consumer acceptance; it's about the economic value."
Instant eye on inventory
Retailers are ever watchful for ways of improving the balance between inventory supply and consumer demand. They want to make sure there are enough products on the shelves to meet demand but not so much that they are sitting in a warehouse taking up costly inventory space. The use of RFID technology is viewed as one of the more promising tools to improve visibility of inventory almost instantly. But companies have only dipped their toes into the water, examining installation behind the scenes in warehouse settings. The smart-shelf trial by blue-chip company Wal-Mart was viewed as a potentially aggressive endorsement of an in-store application because of the company’s ability to influence its suppliers and push the adoption of new technologies–something it helped to do with bar-code scanning technology in the 1980s. The unexpected cancellation of the test is letting some of the steam out of the market, but that may be a good thing, according to one analyst. “The RFID industry has been floundering in a sea of science projects, which is what these trials have been to date,” said Jeff Woods, an analyst with research firm Gartner. “This is one of the most over hyped technologies out there, and this can be viewed as a precursor to the bubble bursting for RFID.” Soon after Wal-Mart first discussed its smart-shelf trial, privacy advocates began to raise concerns about the technology. The main questions: Would retailers and manufacturers be able to monitor products after consumers purchased them? Could the technology be misused by hackers and criminals or exploited for government surveillance? In answer, several RFID chip manufacturers pledged to incorporate a “kill switch” into their chips in a move to relieve consumer fears of the technology. The kill switch would let retailers and consumers disable the chips at the checkout counter.
Not-so-cheap chip
Economics may have played a role in Wal-Mart’s decision to shelve its in-store RFID test. RFID chips are still too expensive for wide-scale use with consumer merchandise. While today’s price of around 10 cents a chip is cheap enough to fuel initial trials, the cost of the chips have to fall to a fraction of a penny if they are to become ubiquitous in stores. And that will take about 10 to 15 years, he added. Privacy concerns, though they’ve been overblown, have become significant enough to be a factor in the development of the technology and market and push the technology farther.
Another issue for companies looking to test RFID technology is the strain on their inventory networks. For a company Wal-Mart’s size, it could have more than a billion products worth of data being collected, stored and sent through its inventory network, which means an extremely sophisticated system, would have to be in place to properly process the data.
The Network Effect
The “network effect” is a term used by technologists to describe the way some devices grow more useful as more people use them. The classic example is the telephone. More recently, e-mail has followed the same trajectory in going from a device used primarily by university researchers in the 1970s to ubiquitous public use in the 1990s.
In contrast to the situation for Retail RFID, recent press reports about ship-container tracking have all been positive. Despite the heavy reliance of proprietary technology in tracking shipping containers, this market is growing as clients eagerly adopt the technology. Retail RFID, on the other hand, has adopted an open-standards approach to spurring the market; but despite this growth is slow and imposed primarily by big-box retail mandates. The root cause is the network effect. Due to the incomplete infrastructure of EPC RFID tools, the retail RFID market is currently not big enough to drive significant value-add to all participants in the supply chain. Companies are right to moderate their investments in this area while carefully choosing pilot programs to prepare themselves for the future.
RFIDs in particular are being adopted widely by retail majors. “If somebody steals goods without paying, it is the public who ends up paying for it. We identify compulsive shoplifters and often catch them three or more times in the same month. We try not to involve the police especially when teenagers are involved. This is where RFIDs are useful in protection of goods,” says Biyani, Director, and Pantaloon. Dharmesh Lamba, Country Head, Checkpoint echoes the sentiments. He points out that India’s organized retail is only 3 percent while 97 percent is unorganized. “India is the second largest growing economy in retail, after China. Around 300 plus shopping malls are coming up in 2006 alone. New products launched globally are now launched simultaneously in India as well,” says Lamba. In this context it is interesting to see that players like Checkpoint are entering the Indian market with their RFID solutions. John Davies, President, Global Apparel, Checkpoint plans to manufacture RFIDs and CCTV solutions in India. “As the retail segment in India keeps growing exponentially, RFID and other retail security products will play a more prominent role to control and combat retail shrinkage,” says Davies. However, RFID has its own share of defects. Some RFID tags cannot be detected by the antennas if they are shielded by the hand or the body. A solution suggested is that the RFID label should be integrated in the package or the product itself so the exact location of the RFID tag is not known. Another issue is threat to privacy. RFID can be used to trace customer behavior or find customer specific information. The tags can be read even if they are kept in the cars or homes of the customer. RFID is responsible for transforming the retail scenario in India from traditional to modern. The concept of shopping malls is gradually getting accepted not only in large metros but also in small townships. Consumers get a prominent display and open access to products, while RFID protects the retailer by providing product identification and security to prevent retail shrinkage.