Inventory Management
Functions of Inventory Management
• There are different shapes of inventory in a company
and the function of inventory management is:
1. To “decouple” or separate various parts of the
production process from suppliers.
2. To provide a stock of goods that will provide a
selection for the customers as in a retail shop.
3. To take advantage of quantity discounts.
4. To hedge against inflation and upward price trends/
changes.
Shapes of Inventory
• Raw Materials.
• Work In Process.
• Maintenance/ Repair/ Operating Supply
(MRO) inventory.
• Finished goods Inventory.
However it is important to understand:
• How inventory items can be classified?
• How accurate records of inventory can be
maintained?
Classifications of Inventory
• The Pareto Principal states:
“Critical Few and Trivial Many” the idea is to focus on
few critical/costly inventory parts and not trivial many.
ABC analysis is one of the techniques of classifying
Inventories:
• Class “A” Those items which may be just 10-15% of the total
inventory volume but they represent 70- 80% of the total
financial volume in inventory.
• Class “B” Those items which may be up to30% of the total
inventory volume but they represent 15 – 20% of the total
financial volume in inventory.
• Class “C” Those items which may be up to 50% of the total
inventory volume but they represent 5 - 10% of the total
financial volume in inventory.
Advantages of Classification
It helps making policy for controlling Inventory.
For example ABC classification guides us to:
• Purchasing resources expended on supplier development
should be much higher for item in category “A” as
compared to those in “B” or “C”.
• “A” items as compared to “B” or “C” should have tighter
inventory control. May be they are kept in a more secure
area and accuracy of inventory record for “A be more
critical than “B” or “C”.
• Forecasting items under category “A” may be very
careful as compared to items under “B” or “C”.
Record Accuracy
• Record accuracy allows organizations to focus on
those items only that are needed, rather than
setting for being sure that, “some of everything” is
in inventory.
• Accuracy of inventory record can help
organizations make precise decisions about reordering, scheduling, shipping and making
contractual commitments with clients.
Cycle of Counting
Determining the frequency of verification of inventory is known
as Cycle of Counting and it depends upon the category:
• For category “A” the frequency may be every month
• For category “B” the frequency may be every quarter
• For category “C” the frequency may be every six months
we have these cyclic audits as above it can help the organization to:
• Avoid shutting down the facility for a couple of days
• Eliminate annual inventory adjustments
• Allows the cause of error to be identified and remedial action
taken.
• Trained personal audit the accuracy
• Helps maintaining an accurate inventory record.
Such audits don’t have to be pre decided but can be surprise audits
OR the stocks can be verified each time something i.e; issue or receipt
is recorded.
Control of Inventory in Services
• General Stores, departmental stores, food shops etc. are form of
services where inventory is maintained and therefore needs to
have a system to control it. Because:
Inventory that is un accounted for between receipt and time of sale is a
loss. This loss could be because of:
Damage of the missing articles, theft or mistake in counting while
receiving.
A loss of inventory in a retail shop can be more than 3%, however, if it is
1% of sale, it is considered to be good.
For having a tight control over inventory in a store, it requires:
1. Honest people are selected and properly trained and disciplined.
2. There is a tight control over the incoming shipments.
Inventory Models
• Independent Demand: This means the inventory
that is not dependent upon any other inventory.
• Dependent Demand: This means the inventory of
an item is dependent upon another.
Volume of Inventory
• It is believed that the smaller the volume of the inventory,
better is your Supply Chain and the Inventory Management.
• However there are certain factors which demand high
inventory level, similarly there are factors which demand low
inventory levels.
• The factors which demand low Volumes of inventory are
the “ holding Costs “.
• The factors which demand high volumes of inventory are:
1. Ordering Cost
2. Labour and Equipment Cost
3. Transportation Cost
Types of Inventory
• Cycle Inventory: The portion of total inventory that
varies with the lot size is called Cycle Inventory.
• Safety Stock Inventory: Holding inventory slightly
more than the requirement.
• Anticipation Inventory: When there is a threat
from supply line of higher rates, non-availability in
the near future, or uncertainty in demand or peak
demand is seasonal
• Pipeline Inventory: The inventory consisting of
orders that have been placed but not received yet.
Inventory Reducing Tactics
• There are few tactics which could be utilized
for reduction of inventory, which are in two
steps:
• Primary Leavers: These are the ones which
must be activated if the inventory is to be
reduced.
• Secondary Leavers: Are the ones which counter
the penalty costs of applying the primary
leavers.
Inventory Control Systems
– Periodic review system: Known as “P” system.
– Continuous Review System: Known as “Q” system.
This is also known as the Re-Order Point system
Comparison of Both systems
• Advantages Of “P” system:
• Administration is easier because the replishments are made
periodically. Easier for the employees to spare some time for
the review once after every interval.
• Order for multiple items from the same supplier could be
combined into a single purchase order. This approach
reduces ordering and transportation expenses and gives the
edge to the buyer to claim a rebate as well.
• The inventory position is needed to be known only after fixed
intervals and not continuously as in the case of Continuous
Review “Q”
Advantages Of “Q” System:
• The review frequency can be individualized/ tailored for each item
depending upon its frequency and volume being used. This will
reduce ordering and holding costs.
• Fixed lot sizes if in large size may result in discounts on quantity
basis.
• Lower safety stocks result in savings.
Lean Distribution Framework
Formal service policies
• All organizations have some established "norms"
and guidelines for customer service, but few
examine and formalize policies to optimize the
entire supply chain. The formal policies required
for Lean Distribution revolve around articulated
customer needs and key internal capabilities.
Lean Distribution Enablers
Lean Distribution Enablers
• Support for Pull : Customers seek dependable service and
generally are willing to allow suppliers more latitude and
responsibility to deliver. Support for Pull signifies that the
customer recognizes the advantages and allows requirements
to flow to the supplier without undue modification or hedging.
• Isolate variability: Variability exists in all environments and
requires at least some buffer to isolate both customers and
internal operations from daily problems in forecasts and
orders. The trick is to have buffers in the most advantageous
places rather than in many or all places customer demand
occurs. Strategically placing and managing buffers enables
Operations and Sourcing to hit more stationary targets rather
than the ever-changing and moving target of a forecast-based
plan.
(Conti………)
Cont ……….
• Cost trade-offs: Assess and decide cost trade-offs on a structural
level rather than for specific transactions every day. It may seem
counterintuitive to increase profit by cost optimization of the
distribution paths rather than individual replenishment
shipments. This more structural approach addresses the
variability that is a major barrier to most forecast- and orderdriven cost reduction.
• Linkage for Pull: Making the links between customer usage or
consumption and distribution replenishment processes is the
tactical connection required to synchronize the supply chain to
consistently meet customer requirements. Pull is more than a
kanban or an "ordering" signal; Pull is the philosophy for
replenishment and customer service excellence.
• Reduced lead times: Lead times are generally too long. Lead times
for internal operations and from suppliers include a high level of
safety time to accommodate unforeseen events. Lean helps reduce
lead times, improving flexibility and responsiveness. Short lead
times enable many wonderful cost and service improvements in
distribution, particularly when paired with Pull.
Cont……
• Reduced variability: Despite variability existing in all processes, few
organizations focus on quantifying and reducing variation in the
supply chain. The typical focus is product quality. The first step is to
quantify the current variation in order to operate distribution
processes based on the limits of current capabilities. For example,
distribution center replenishment times may vary, causing Planning to
use a "high-end" time for all planned shipments "just to be safe." This
longer lead time results in excess inventories and a realization that not
all orders must be shipped on the day planned, requiring expediting
and overrides to ensure priority orders are shipped when needed.
• Reduced lot sizes: The quantity produced or sourced at one time or lot
size has a direct relationship to flexibility and total costs. Larger lot
sizes appear to lower costs in sourcing or production but can increase
cost and reduce service across the rest of the supply chain. Lean
Manufacturing practices help reduce lot sizes while eliminating waste,
thereby enabling both low product and supply chain costs.
Cont……
• These enablers combine to form a cohesive system to
improve distribution costs, asset utilization, and customer
service. These enablers must be linked and implemented to
leverage the overall approach and not as a series of disjoint
cost reduction initiatives.
• The approach is tied together by the Lean waste reduction
philosophy and the transition away from forecasts to serve
daily customer needs. The end result is a new paradigm to
view profitability and customer relationships. As lead time,
variation, and lot sizes decrease, profit approaches gross
margin (excluding other general expense items). When
these factors decrease sufficiently, there is a net addition to
profit above gross margin from the effect of negative
working capital, an example being Dell Computer (where
accounts payable is three times the amount of inventory and
accounts receivable combined).
Inventory Placement
• This is one of the duties of the distribution
manager to decide where to stock the finished
goods inventory.
• Backward placement
• Forward placement
Measures Of Supply Chain
Performance
• Average Aggregate Inventory Value: It is the total
value of all the inventory lying in the firm at the time
of measurement. It is measured by the following two
formulas:
Average Aggregate Inventory Value
• Weeks of Supply = -----------------------------------------------Average weekly sales at cost
(Continued)
Measures of Supply Chain performance:
Annual Sales at Cost
• Inventory Turnovers: ---------------------------------------------Average Aggregate Inventory Value
Where:
Total sales for the year
Average weekly sales = -------------------------------------- ------No. of Operational weeks during the year
Average Aggregate Value = No. of units of item “A” lying in
inventory X Value per unit + No. of units of item “B” X Value per unit +
………... so on for all the items in inventory be that a raw material, work in
process or finished goods.
Links to Financial Measures
• Operational Measures
Low High Financial Measures
1. Average Agg. Inv. Value
Current Assets
2. Weeks of Supply
Working Capital
3. Inventory Turns
Working Capital
4. Production & Material Cost
Contribution/ Profit
5. Percentage Defects
Contribution/ Profit
6. On time Delivery
Revenue
7. New Product Development
Revenue
8. Suppliers Lead Time
Working Capital