Companies have the need to generate inventories to cover market requirements, as

demand is generally unpredictable. Imagine everything involved in producing goods:

production managers have to calculate how much material is required to meet
manufacturing forecast.

Production plan is based on a prediction of the requirements the market will consume,
and despite this prediction being based on market statistics, the company must be
prepared for surges in demand in order not to miss that opportunity for sales growth.

All the above gets more complicated when the company is serving different markets in
different regions, with a range of different products at the same time. Ideally the
company could have a big inventory to make sure they supply the market
independently of sudden changes in demand but remember that inventory is an
investment on working capital paid by the company, and it is only recovered once the
goods are sold. Thus, inventory levels should be kept as low as possible without
missing opportunities to satisfy the market demands; can you imagine now the
complexity of inventories?

Explanation

6.1 Justification of inventories and types of inventories

 Inventories are units of products a company
accumulates with the purpose of meeting the demand of its market, and whose
existence is derived from the uncertainty of the extent clients will require products, and
the difficulty to forecast demand.

Financially, inventories are a type of working capital recorded in the company's books
as circulating assets. This means that, although the inventory requires the company
spending to produce, acquire, or maintain it, this is not an expense, but an investment
on assets that will be recovered upon selling the merchandise, in most cases with a
return or profit additional to the capital invested on them.

That being said, and inventory being an investment stationed in the company's
warehouse, it becomes very important to plan inventories correctly for their levels to
be as close to potential sales in the short term, thus allowing the company to have a
constant cash flow, obtaining return on investment and reinvesting on inventory to
satisfy the demand of the following period.

The main foundation of inventories is meeting market demand, which translates

mainly into customer service. The higher the product availability, the higher the
efficiency in response time to satisfy client needs, which improves the way the market
perceives the service, which means higher customer loyalty and increased sales.

There are five main inventory types:

Inputs or raw materials

This type of inventory refers to the accumulation of all those materials used in the
production process of the finished product, the commercialization of which is not
regularly part of the company operations. They are just consumed for the creation of
the product or service the company offers as part of its major business.
Work in progress
This is inventory found in the process of producing the end product or in transition
from some intermediate transformation process.
Finished goods
This is the end product ready for commercialization. It may be found on the facility’s
production area, in company warehouses, in strategic distribution centers, in loading
yards, or displayed in a store.
In transit
This type of inventory is that located in the modes of transportation contracted or
operated by the company in some of its sections, whether to the production plant, to
one of its warehouses or distribution centers, or to the intermediary or end customer. It
may be finished product, product in progress, raw material, or inputs.
In consignment
This type of inventory is that found in the facilities of a distributor; however, they are
still the property of the manufacturer or marketer. Once the distributor commercializes
the product, they report the sale to the manufacturer, and accounts are reconciled.
Generally, the consignment time is limited, and after concluding the term, the
distributor is obligated to purchase the merchandise.
6.2 Inventory costs

Inventory-related costs require special attention due to three main reasons:

1. They generally represent a significant percentage of logistics costs.

2. Due to the direct impact of inventories on customer service level, it is
necessary to compare the benefits of increasing the customer service level
against increasing costs of maintaining a higher inventory level.
3. There is an inverse relation between transportation and inventory costs, that
is, as inventory costs decrease, transportation costs increase by covering the
decrease of inventory levels, therefore, it is necessary to reach an equilibrium
point.

The focus on costs related to inventories has led specialists to classify them according
to the process or activity for which they are generated. Coyle (2018) mentions the
following classification:

1. Inventory maintenance cost: These are the costs related to waiting for the
product to be used or commercialized.

a. Capital cost: It is known as opportunity cost. It is defined as the lost

opportunity of investing capital in something other than unused
inventory.
b. Storage room cost: Refers to the management costs associated to
the warehouse, such as rentals, utilities, and salaries, and related with
the space used during the time the inventory is maintained.
c. Inventory service cost: Related to the taxes applied by governments
on inventories and insurance premiums the company incurs to
maintain them.
d. Inventory risk cost: Refers to the risks of irrecoverable damage,
obsolescence risks, or theft risk.
 2. Ordering and preparation costs: These are secondary costs generated
additionally to the cost of products upon ordering or preparing production of
end products.

a. Ordering cost: Costs associated with placing orders comprising the

order preparation process, payment, special information systems, bank
commissions, among others.
b. Preparation cost: Cost associated with the preparation of the
production line to manufacture the article in the assembly line.

3. Expected stock-out cost: Cost related with having insufficient material or

product to continue production or to close a sale with a client. It is calculated
as lost sales cost.

4. Cost of inventory in transit maintenance: Costs incurred when inventories

are in transit, such as storage costs, customs duties, customs brokers fees,
maneuvering, special packaging, among others.

Conclusion

Given the uncertain conditions in market demand, and the need of companies to be
prepared for surges in customer requisitions, inventories are necessary. The
fundamental point of the efforts of a company in managing their inventories lies on
the capacity to operate efficiently and effectively with the minimum inventory level
possible due to the cost it represents for the company.

Even though having inventories generates a series of additional logistics costs,

companies find equilibrium points used to determine the level of inventories they can
maintain so the potential benefits they would have outweigh the costs associated with
them.
Efficient operation of a company depends on the sum of efforts of different areas to
reach the company’s strategic objectives. Although each area is essential to meet these
objectives, requisition planning has a special interest and approach, as it determines
the supply of finished goods to distribution centers the company designates
strategically to reach its market, or it determines the supply of raw materials for
production plants to manufacture products the company expects to sell in some time.

It is important to have product ready to sell as well as having clients to sell them,
mainly because being able to sell a product in the market depends mainly on it being
available where it is required.

That said, what do you think is the best way to coordinate the activities of a company
to have product available in the moment, place, and amount the market demands? Is
this the sole responsibility of logistics?

Explanation

7.1 Inventory requisition planning

Inventory requisition planning is a complex tax requiring the interaction of more than
one area in the company. Most companies establish requisitions based on demand
behavior statistics for each type of product they commercialize; they also combine
factors such as industry expert opinions, salesforce feedback, available production
capacities, to mention a common few.

Each company establishes requisitions based on the factors they consider most
important given their specific situation, and even though the likelihood of having a
100% correct forecast is low, there are methods that help managers have a support
guide.

Coyle (2018) mentions in his work the method developed by the Center for Supply
Chain Research, where the different areas of the company work on a consensus
forecast, which they called “sales and operations planning”. The process comprises five
steps:
 Source: Coyle, J. (2018). Administración de la cadena de suministro: Una perspectiva
logística (9th ed.). México: Cengage Learning.

1. Data and information are collected to develop a statistical forecast of future

sales.
2. The marketing and sales departments review the forecast and adjust it as a
function of promotion of existing products, introduction of new products, or
their elimination.
3. The operations personnel (manufacturing, forecast, and transportation)
examines the sales forecast and determines whether the existing capacity is
adequate to manage products. Production moments are also analyzed, and
aspects such as storage space issues, transportation or personnel availability
are considered, among others.
4. The sales, marketing, operations, and finance personnel meets to review the
initial forecast and try to solve any capacity issue arising from step 3.
5. Financial decisions are made regarding sales forecasts and capacity issues. By
accepting forecasts, they become operational plans for the organization.

With this method it is attempted to achieve an active participation of all areas within
the company, with the purpose of forming a joint commitment to meet operational
goals. To consolidate these efforts, the management creates individual goals and
indicators per area, which are assigned based on the results of collaborative
participation. Do not forget that an organization is the sum of efforts of employees,
and if they work individually in reaching their objectives, when they are added they will
be the organization's achievements.

Inventory planning is a crucial activity for a company's operations, just because a

company’s (producer or marketer of goods or services) raison d'être is precisely to
supply that merchandise or service to the market. This way, if inventory requisitions are
not well planned, the company will not be able to comply with its mission.

7.2 Purchase administration

Purchase administration is one of the activities related with planning and forecasting.
Just as there are efforts to form a joint responsibility throughout an organization to
create the operational forecasts where scope and goals are detailed, there are plans
itemized jointly in supply chain sourcing.

In the logistics department, a correct administration of supply chain links is a

fundamental task. Raw material requirements are determined by the production
forecast, and it is the task of the sourcing area to make it possible for materials to be in
time and kind in the right moment and place for processing. Likewise, if the company’s
distribution network uses a certain number of distribution centers with determinate
level of demand for each, the distribution area should be alert and make sure each of
these centers are replenished in a timely fashion to face all the requirements
demanded by the market.

In the task of planning company requisitions there are different methods adopted by
companies. The starting point of company supply decisions is developed in the sales
potential for each of the company's line of products.
Using numerical terms to exemplify the above, let us suppose a company sold on
average during recent months 2000 units of product A, 3500 of product B, and 400 of
product C. Considering product A is comprised of 50% input X, 25% of input Y, and
25% of input Z; product B contains 33% of X, 33% of Y, and 34% of Z; and C is made
15% of X, 80% of Y, and 5% of Z.

What is the number of pieces necessary to make a requisition to vendors for

input X, Y, and Z?

Based on the percentages provided above, we can determine the following amounts:

Product A (2000 units) = 1000 pieces of input X + 500 pieces of input Y + 500 pieces
of input Z.
Product B (3500 units) = 1155 pieces of input X + 1155 pieces of input Y + 1190
pieces of input Z.
Product C (400 units) = 60 pieces of input X + 320 pieces of input Y + 20 pieces of
input Z.

 Input X = 2215 pieces.

 Input Y = 1975 pieces.
 Input Z = 1710 pieces.

In coordination with the company's inventory policy, it must work to get sufficient
supplies of inputs X, Y, and Z and to be able to produce the necessary products A, B,
and C to meet their sales planning. Additionally, the company must consider the
seasonality of sales depending on the months, as in all industries there are month to
month variations that obey the changes inherent to the market conditions in each
industry.

A company needs to be able to react to sudden changes in the market, managing a

safety stock, both of inputs and of finished product. These inventories have the
purpose of facing any change in the market, or the standard deviation of the average
determined by the company based on historical sales.

In addition to this, within purchase administration planning, the company must include
in its operations the time it takes to vendors to supply placed orders, so orders must
be placed with enough time to meet their goals.

All this process is complex for the organization, as the task of managing supplies
magnifies when there are several components to produce a wide variety of products,
which have to be distributed in different regions through diverse channels of
distribution. Now, if this was not complex enough, you need to consider additional
variables that are very common nowadays due to globalization, when you may source
from any part in the world and commercialize with any region, with different
requirements for product characteristics, packaging, or packing.

In support of this complex task there are methods that attempt a collaboration
between the links in the supply chain, involving vendors as an important part in the
process. This methodology is known as “collaborative planning, forecasting, and
replenishment.” This business model involves the use of technology for collaboration
between retailers, distributors, and manufacturers in replenishment activities, allowing
commercial partners to work on a single joint forecast and all companies to work on
that same operational plan.

Collaborative forecasting is established using statistical, quantitative, and qualitative

information proper of the market conditions. This forecasting can range from simple
methods such as simple moving average and weighted moving average (adding
specific information of demand collected directly from suppliers, clients, government,
specialists, etcetera), to complex methods involving exponential smoothing of market
trends and seasonal influence on demand.

Coyle (2018) mentions there were methodologies aimed at creating a comprehensive

collaboration of supply chain participants, highlighting the following:

QR (Quick Response): Based on quick response to react to changes in consumption

levels trying to reduce lead times from the moment the purchase order is placed until
the end product is delivered, with the purpose of increasing customer satisfaction.

VMI (Vendor Management Inventory): Used by an organization to manage inventories

maintained in the client’s distribution centers.

1. The vendor and its client agree on what products will be managed using VMI.
2. An agreement is made on the points for new orders and the economic
amounts to place an order for each of these products.
3. As these products are shipped from the client's distribution center, the client
notifies the vendor of the shipped volumes in real time.
4. The vendor supervises available inventories in the client’s distribution centers,
and when the stock reaches the agreed point of new order, the vendor places
an order for replenishment, notifies the client’s distribution center of the
amount and time of delivery, and ships the order to replenish the distribution
center.
CRP (Continuous Replenishment Program): Based on communication and collaboration
between the members of the supply chain to supply products in real time by notifying
the manufacturer of the daily levels of sales, as well as shipments requested from the
distribution center, in order to manage continuous replenishment, avoiding any
production shutdowns.

ECR (Efficient Consumer Response): Involves a strategy to reduce the bullwhip effect
between the manufacturer, distributor, wholesaler, and retailer through frequent
deliveries, short lead times, and small production lots. Each of them represented
progress towards integration of supply chain, however, they would not have enough
commitment to company results.

The main contribution of the collaborative planning, forecasting and replenishment is

that companies participating and interacting in a single supply chain develop a joint,
not individual working plan, in such a way that they work as a true supply chain, with
all the links placed correctly. For this to work, participating companies need to
cooperate with data flow between them and provide continuous feedback.

Purchase administration based on collaborative planning, forecasting and

replenishment translates into a manufacturer production and replenishment program,
where the amounts and time periods are implicit. If this works correctly and according
to the programs, the manufacturer inventory must be reduced, by using resources in
cycles coordinated with vendors, generating savings on working capital and a more
efficient operation.

There are information technology systems that allow the sourcing area, and the
organization in general, to have elements to maintain order in scheduling the
necessary material and product requisitions. They were designed to calculate more
accurately what, when, and in what amounts to place orders, anticipating the needs.
These systems are, for instance, MRP (Material Requirements Planning), MRP II
(Manufacturing Resource Planning) and ERP (Enterprise Resource Planning). They will be
explained in depth in the following topics.

Conclusion

Requisition planning methods comprise collaborative efforts where the main areas of
the company involved in operation develop a joint working plan. This is one of the
most important activities for the organization's operation, as it determines short-term
goals, establishing activities of each area to reach these objectives.
As there is great responsibility in this area, and it is also very complex, there are
methods for intersectional engagement for forecasting developed by an area to be
validated by the other areas. That is, if the marketing and sales department determines
that sales levels will be of certain volume for a specific period, the production and
logistics areas must validate if these volumes are feasible to be attained with the
current productive, storage, and operative personnel capacities.