Inventory

Planning
and
Control

1
Overview
• Introduction and Importance of Inventory in the system
• Understanding supply chain inventory
• Right reasons for investing in inventory
• Wrong reasons for investing in inventory
• Creating the lean supply chain
• Approaches for managing inventory investment
Inventory

All of the raw materials, work in

process (WIP), and finished goods
within the supply chain. Inventory
policies can dramatically alter a supply
chain’s efficiency and responsiveness.
Inventory
The objective - to achieve the desired customer
service with minimum inventory commitment,
consistent with lowest total cost.
Excessive inventories may be helpful in
compensating for deficiencies in network design
but ultimately result into higher total logistics
cost.
The best practice of inventory management -
achieve maximum turnover while satisfying
customer commitments.
 Goals of Inventory Management
• Maximize customer service (this requires carrying
substantial inventory).
• Minimize inventory investment (this requires
carrying little inventory).
• Customer service takes absolute precedence.
– Customer service must be a strategic issue.
– Leading edge discussion now centers on types of
customer service
• Shortened delivery time and visibility of stock movement
• Speed to market
• Design flexibility
 Factors Impacting Inventory Decisions
Business Inventories Supply Chains
oo Manufacturers
Manufacturers oo In
In Transit
Transit oo Domestic
Domestic
oo Global
Global
oo Wholesale
Wholesale oo Raw
Raw Materials
Materials
Distributors
Distributors oo WIP
WIP
oo Retailers
Retailers oo Finished
Finished Goods
Goods
oo e-Commerce
e-Commerce // oo MRO
MRO
Direct
Direct Consumer
Consumer

Business Processes Demand

Demand Inventory
oo Forecasting Patterns
Patterns
Forecasting Policies
oo Demand
Demand Planning
Planning oo Routine
Routine
oo Trend
oo SKU
SKU Stocking
Stocking
oo Capacity Trend
Capacity Management
Management oo Safety
Safety Stock
Stock
oo Seasonality
Seasonality
oo Inventory
Inventory Management
Management oo Cycle
oo Level
Level Shift
Shift Cycle Stock
Stock
oo Production
Production Scheduling
Scheduling oo One-time
One-time Event
Event //
oo SKU
SKU Discontinuation
Discontinuation Promotion
Promotion
oo Reverse
Reverse Logistics
Logistics oo New
New SKUs
SKUs
• Global economic turbulence and geo-political factors
positioning supply chain management (SCM) as a key
agenda in boardrooms across the world.
• Socio-economic challenges – Ethical Practices-
• Slave wages
• Child labor, and
• Questionable supplier management tactics
Globalization
• The global village is driven by the continued push for
• Better shareholder returns
• Higher business efficiencies
• It leads to exploit low-cost geographies
• Has created an outsourcing industry that has mushroomed beyond
imagination.
• Outsourced and offshore operations in turn created extended
supply chains
• In turn it has increased the complexity & risk
6 Global Supply Chain Challenges That one
cannot Ignore
1. Quality levels and defects.
2. Time zones.
3. Long-range logistics.
4. Accountability and compliance.
5. Delays.
6. Language barriers.
Types of Inventory

Cycle Stock : Economies of scale

Safety Stock

Anticipation Stock
• Seasonal Stock
• Speculative Stock

Pipeline Inventory

Dead stock
 Drivers of Inventory
Type of Inventory Driver ( Logic)
Cycle Stock Economies of Scale
Safety Stock Uncertainty in demand & Supply
Seasonal stock Mismatch between demand and supply
rate

Speculation Stock Uncertainty in price of material

Pipeline Stock Lead-time in
production/transportation process

Dead Stock Judgmental error/ Change in

economic or technological
environment
Forms of Inventories
• Raw Materials
• Maintenance, repair, and operating supplies
• Work-In-Process (WIP)
• Finished Goods
 Types of Inventories

• Raw materials
• Components
• Work-in-process
• Finished goods
• Vendor managed inventories
• Non-moving/slow moving stock
• Safety stock
• In-transit inventories
• Service parts/Consumables
 Functions of Inventory

• Decouple components of the

operations and distribution
• Uncertainties/variations in demand
• Flexibility in production smoothing
• Economies of scale in purchase and
production
• To help hedge against price increases
Inventory Management
• Efficient and effective inventory management is imperative to global
competitiveness
• Inventory management also applies to non-manufacturing industries
• Move towards lean supply chain
 Departmental Orientation
Towards Inventory
• Marketing
• Production
– Sell the product
– Make the product
– Good customer
– Efficient lot sizes
service
– Large inventory
– Large inventory
• Purchasing
• Finance
– Buy the required
– Provide working
materials
capital
– Low cost per unit
– Efficient use of capital
– Large inventory
– Low inventory
Right Reasons for Inventory
• Avoid disruptions in operational performance
• Support operational requirements
• Support customer service requirements
• Hedge against marketplace uncertainty
• Take advantage of order quantity discounts
Wrong Reasons for Inventory
• Poor quality and material yield
• Unreliable supplier delivery
• Extended order cycle times from global sourcing
• Inaccurate or uncertain demand forecasts
Wrong Reasons for Inventory
• Specifying custom items for standard applications
• Extended material pipelines
• Inefficient manufacturing processes
 Inventory Hides Problems Areas

Machine
downtime

Scrap Vendor
Tip of the Iceberg Analogy
Work in delinquencies Change
orders
process
queues Engineering design Design
(banks) redundancies backlogs

Paperwork Inspection Decision

backlog backlogs backlogs
High Levels of Inventory
• Result in …
• Higher carrying costs
• Reduced profit
• Diminished market share
• Hide other problems such as …
• Poor material quality
• Inaccurate demand forecasting systems
• Unreliable supplier delivery
High Levels of Inventory
• Result in …
• Higher carrying costs
• Reduced profit
• Diminished market share
• Hide other problems such as …
• Poor material quality
• Inaccurate demand forecasting systems
• Unreliable supplier delivery
Inventory Costs
Direct Costs
• Unit costs
• Ordering Costs
• Direct Labour Costs
• Material Handling and Storage Costs

Opportunity Costs
• Return on capital foregone for alternative investment
• Generally these costs are not recorded in financial
accounting

Sunk Costs
• Capital Expenditure
• Training Costs
• Shortage Costs
Unit Costs
• Price that buyer pays for each unit
• Actual costs of making or providing each unit
• Direct materials
• Direct labor
• Allocated overhead
Ordering Costs
• Associated with the release of material order
• Finalisation of specifications and vendor
• Generating and sending material release
• Transportation costs
• Any other cost of acquiring goods i.e. brokerage, C&F Costs
• With internal production, may include machine set-up costs
Carrying Costs
• Cost of capital – warehousing, material handling etc.
• Cost of storage
• Costs of obsolescence, deterioration, and loss
Costs of Storage
• Costs related to storage space, manpower, security and systems
• Insurance costs
• Costs of maintaining inventory, i.e., cycle counting
• Considered variable cost
• Vary with level of inventory
Inventory Carrying Costs
Element Average
Capital cost 15.00%
Taxes 1.00%
Insurance 0.05%
Obsolescence 1.20%
Storage 2.00%
TOTAL 19.25%
 Shortage Costs
• Costs arising out of pushing the order back and
rescheduling the production system to
accommodate these changes
• Rush purchases, uneven utilisation of available
resources and lower capacity utilisation
• Missed delivery schedules leading to customer
dissatisfaction and loss of good will
• The effects of shortage are vastly intangible, it is
indeed difficult to accurately estimate
Quality Costs
• Any cost associated with nonconforming items or
goods
• Types
• Field failure costs
• Rework
• Losses due to poor product yields
• Inspection
• Lost production
• Warranty costs
Determining Quality Costs
• Historical neglect of calculating total inventory costs
• Lack of cost accounting systems capable of identifying
quality-related costs
• Can use activity-based costing (ABC) to better
determine real costs
• New types of ERP systems to track inventory levels
 Concept of Total Logistical Cost
• All expenditures necessary to perform
logistical functions
• Includes variable and fixed costs
• Need to look at holistic picture
– At times the high variable cost may be offset by
reduction in inventory carrying costs
Inventory – Asset or Liability?
• Historically considered current asset
• Disregarded inventory carrying costs
• Negative impact on cash flow, working capital requirements, and profitability
• Inventory ≠ Cash and Receivables
• Need to translate real impact on organization’s financial measures
• Determine key performance indicators
 Linking Inventory and Financials
Firm A Firm B
Sales $200 $200
Profit Margin 6% 7%
Assets $10 $10
Cash $15 $15
Securities $ 8 $ 8
Receivables $20 $10
Inventory $75 $75
Plant and Equipment

Total Assets $128 $118

Inventory turns = Sales /
Inventories $200 / $20 = 10 turns/year $200 / $10 = 20 turns/year
Asset turnover = Sales / Total
assets $200 / $128 = 1.56 turns/year $200 / $118 = 1.69 turns/year
ROI = Profit margin x Asset
turnover 6% x 1.56 = 9.34% ROI 7% x 1.69 = 11.86% ROI
Impact of Inventory Activities
• Determine how inventory management effects….
• Earnings per share
• Economic value-add
• Return on assets
• Working capital
• Cash flow
• Profit margin
Why hold inventory?
Unexpected changes in customer demand (always hard to predict, and
uncertainty is growing)
• Short product life cycles
• Product proliferation
Why hold inventory?
Uncertain supply
• Quantity
• Quality
• Costs
• Delivery time
Why hold inventory?
What if there was no uncertainty in supply or demand—would it still be
necessary to hold inventory?
Inventory’s Impact
Inventory can significantly affect material flow/cycle/ throughput
time.

Little’s law: Inventory = flow time x throughput rate.

In other words: If you move your inventory faster, you don’t need as much
inventory (inventory velocity)
Types of Inventory Needed
• Seasonal Inventory
• Think bathing suits and snow-shovels or cotton for textile industry

• Inventory that is built up to meet predictable variation in demand.

• Amount of seasonal inventory depends on how quickly and inexpensively a
firm can change its rate of production
Types of Inventory
• Safety Inventory
• Random, unpredictable, unexpected
• Inventory held to counter uncertainty in demand or supply (“just-in-
case” inventory).
Types of Inventory
• Pipeline Inventory
• Work-in process or transit
• Inventory held to do business.
Types of Inventory
• Types of inventory
- Manufacturing inventory
- Wholesale inventory
- Retail inventory

Manufacturing inventory
- Manufacturer’s inventory commitment starts with
- Raw material and component parts
- Work-in-process
- Finished goods
- Manufacturer needs to transfer the finished goods inventory to
warehouses in closer proximity to wholesalers and retailers.
- Manufacturer’s inventory commitment is relatively deep and has long
duration.
 Wholesale inventory
- Wholesaler purchases large quantities from manufacturers and
sells small quantities to retailers in order to provide retail
customers with assorted merchandise from different
manufacturers in smaller quantities.
- Wholesaler risk exposure is narrower but deeper and of longer
duration than that of retailers.
- In case of seasonal goods, the wholesaler is forced to commit
inventory, far in advance of selling, thus increasing the depth
and duration of risk.
- The current trend of expansion of product lines has increased
the width of inventory risk.
Retail inventory
-Retailer inventory risk is wide but not deep.
-The emphasis is more on inventory velocity.
-Inventory velocity is measured by inventory
turns.
-The risk is undertaken on variety of products but
for a given product the risk is not deep.
- E.g. General merchandise and food store may carry around
25,000 SKUs
- full line department store may have as many as 50,000 SKUs
 Inventory Control Systems

• How often should the assessment of stock on hand be

made?
• When should a replenishment order be placed?
• What should be the size of the replenishment order?
 Basic Fixed-Order Quantity Model
and Reorder Point Behavior

Number
of units
on hand •Q •Q •Q

•R
•L •L

•R = Reorder Point •Time

•Q = Economic Order Quantity

•L = Lead Time
 The Inventory Order Cycle
Demand
rate

Inventory Level
Order qty, Q

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
Placed Received Placed Received
Lead time: It is the time lag between the recognition of the need of an
item and its availability. This includes the administrative time for
initiating action for procurement of an item, time for supplying
including transit and the time for receiving and inspection.
Zero Safety Stock Model

Inventory Management (cont.)

Stock Zero safety stock model

on hand
time

place receive
order order

order filling time

Buffer Uncertainties
- Safety stock protects against two types of
uncertainties:
• Demand in excess of forecast during the performance
cycle. For instance, customers’ request of more or less
units than planned
• Delays in the performance-cycle length itself. For
instance, delay in order receipt, order processing, or
transportation
Physical Distribution

Inventory Management (cont.)

stockout
If demand increases...
Stock
on hand
time

place safety stock

order
receive
order
Physical Distribution

Inventory Management (cont.)

If order filling time increases...

Stock stockout
on hand
time

place safety stock

order
receive
order
EOQ Model
A graphical representation
Sum of the two costs
Cost of Inventory
Total cost of carrying

Minimum Cost

Total cost of ordering

Economic Level of Inventory

Order Qty.
 Inventory Control Systems
Continuous Review System
System that keeps track of consumption from
inventory continuously, thus monitoring current
levels of each item
Periodic Review System
Physical count of items made at predefined periodic
intervals and replenishment is ordered to top up
the stocks
Periodic Review System or Replenishment
System
Replenishment Level
Inventory on hand P

P = B + D(L+T’)
P is Replenishment level
D(L+T’) B = Safety stock in units
D is Avg annual consumption
L is Lead time in weeks
T’ is Time between review in weeks.

B
L L L Safety Stock
T’

Time
 Fixed Time Period
(Periodic) Model
• Reviewed at fixed specified time interval.
• Place an order for a quantity that, when added to
the quantity on hand, will equal a predetermined
maximum level
• Independent demand is the usual situation.
• Difficult to record withdrawals and additions
from stock
• Does not follow EOQ
• Groups of items are purchased from a common
supplier
• Items that have limited shelf life.
 Fixed Time Period Model
• Small tools, manufacturing supplies
• Common commercial parts such as nuts,
bolts, washers
• Office supplies
• Perishable items such as dairy products
fruits and vegetables
• Chemicals, solvents used in the
manufacturing process
 Calculating Reorder Point

Reorder = Expected demand + Safety

point during lead time stock
 Two-Bin System
• Modification of fixed order quantity model
• Amount of stock equivalent to the order point is
physically segregated into a second bin and is
then sealed
• When all the open stock has been used up, the
sealed bin is opened and a new order is placed
• Practical method for keeping control of low-
value items
 Single-Bin System

• Special case of fixed time period model.

• Stock is periodically checked and each
item is ordered to a pre-established
stock level.
• Works well on floor stocks located near
the point of use, like large grocery stores.
Fixed Order Quantity System or Reorder
Point System
M
Inventory
on hand
Average Inventory

Reorder
point R R’ Reorder point
Q D – Avg. annual
DL consumption
Safety (B+Q/2)
(B+DL) in units
Stocks
in units B Safety Stock
O L
Lead time in yrs.

Time
Alternative Order Quantity and Average Inventory
Comparison between the 2 systems

Fixed Order Quantity System Periodic Review System

Order quantity is fixed and is equal to No flexibility in the order period and
EOQ. hence the fluctuations in the demand
must be taken care off by the Safety
stocks.
Useful when there is restriction on Preferred when the supplies are to
the order quantities be made on fixed dates

Requires perpetual auditing of Facilitates planning and control & is

inventory on hand preferable for multiplant organization
where bulk orders could be placed
covering the requirements of various
plants
Cost v/s Lot size
Total variable Costs

Carrying Costs

Minimum Costs
Annual Costs Rs.

Ordering Costs

Q = EOQ

Lot Size Q units

A few terms used in Inventory
Management
• Buffer stock= {Average lead time}x{Average usage rate}.
• Safety stock= Average usage during the extension of lead time.
• Reserve stock= Excess usage requirement during the average
lead time.
• Re-order level= B.S.+ S.S.+ R.S.
• Minimum Inventory Level= S.S.+R.S.
• Max. Inventory Level = {Minimum Level} + {Order quantity}
• Average Inventory Level= (Min. level+Max.level)/ 2
• In case of periodic review the buffer stock will be modified to
{Average consumption rate}x{Average lead time+Review period}

73
 Functions underlying inventory
commitments
Geographical Specialization
- It allows for geographical specialization for individual operating units.
- The need for geographical specialization arises because various factors of
production viz. power, materials, water, labour, manufacturing facilities are located
at a considerable distance from the major markets.
- For instance, tyres, batteries, transmission equipments and springs for an
automobile assembly. The production facilities for each of the these are traditionally
located near the source of materials to minimize transportation costs.
- This strategy leads to specialization of manufacturing each automobile component and
economies of scale.
- May also involve internal inventory transfer to completely integrate various components
into final assembly.
- Manufactured goods from various locations are collected at a single warehouse and
then combined as a consolidated/ assorted shipment.
- P&G uses distribution centers to combine products from its laundry, food, and
healthcare divisions to offer the customer a single integrated shipment.
- Economies gained through geographical specialization invariably offset increased
inventory and transportation costs.
Inventory Management Strategy
Companies can postpone positioning of inventory by
maintaining stock at the plants or they may decide
to place more products in local distribution
centres to have it closer to the market.
(a) Manage inventory at each distribution centre
independently.
(b) Consider inventory interdependence across distribution
sites by managing inventory centrally.
(c) Ensure more coordination and communication in case
of centralized inventory management.
Perpetual Review
• Inventory status is reviewed to determine
replenishment needs.
• Implemented through a reorder point and order
quantity.
ROP= D x T + SS, where
• ROP= reorder point in units
• D= average daily demand in units
• T= average performance-cycle length in days
• SS=safety or buffer stock in units.

78
Periodic Review
• The inventory status is reviewed at regular intervals such
as weekly or monthly.
• The re-order point is adjusted to consider the extended
intervals between reviews.
• The formula for calculating the periodic review reorder
point is
ROP= D( T + P/2) +SS, where
- ROP= re-order point
- D=average daily demand
- T= average performance cycle length
- P=review period in days
- SS= safety stock 81
• Average inventory for periodic review is
represented as I= Q/2 + (P x D)/2 + SS,
- I= average inventory in units
- Q= order quantity in units
- P= review period in days
- D= average daily demand
- SS= safety stock.
• Because of the time interval introduced by periodic
review, periodic control systems generally require
larger average inventories than perpetual system.

82
Inventory Allocation Methods

Distribution
Fair Share Requirement
Allocation Planning

83
 Fair Share Allocation
Plant Warehouse
Inventory- 600 units

Distribution Distribution Distribution

Centre-1 Centre-2 Centre-3

Inventory= 50 units Inventory= 100 units Inventory= 75 units

Daily use= 10 units Daily use= 50 units Daily use= 15 units

84
• Fair share allocation provides each distribution
facility with an equitable or fair share of available
inventory from a common source such as a plant
warehouse.
• Assuming that from a total inventory units of 600 it
is desirable to retain 100 units at plant warehouse;
500 units are available for allocation.
• First we need to determine the number of days’
supply.

85
DS = (A + Ij ) /  Dj , where
- DS= no. of days supply for distribution centre
inventories.
- A= inventory units to be allocated from the
warehouse
- Ij= inventory in units for distribution centre j.
- Dj = daily demand for distribution centre j
In the above example,
• DS = {500 + ( 50+100+75)} / (10+50+ 15)
• DS= {500 + 225} /75 =725/75 = 9.67 days

86
• Thus, fair share allocation means that each distribution centre
should be brought up to 9.67 days stock.
• The amount to be allocated to each distribution centre is
determined as under:
Aj = (DS – Ij /Dj ) x Dj, where
- Aj = amount allocated to distribution centre j
- DS= number of days supply that each distribution centre is
brought upto.
- Ij = inventory in units for distribution centre j
- Dj= daily demand for distribution centre j
- Thus, the amount allocated to distribution centre 1 will be
A1= (9.67- 50/10) x 10 = (9.67- 5) x 10= 4.67x 10= 46.7 or 47 units.

87
A2= (9.67-100/50)x50=(9.67-2.00)x50=383.5 or 384.00
A3= (9.67-75/15)x15=(9.67-5.00)x15=70 units.
• However, does not consider site specific factors.
- Difference in performance cycle.
- Economic order quantity.
- Safety stock requirements.

88
Distribution Requirements Planning
• Distribution requirements planning (DRP) is a
system for inventory management and distribution
planning
• Extends the concepts of MRP II
Uses of DRP
• Management uses DRP to plan and coordinate:
• Transportation
• Warehousing
• Workers
• Equipment
• Financial flows
 DRP in General
Purchase Production

Products
Central
Warehouse(s)

Information
Sales

Distribution
Center(s)

Local Depots

Sales Branches
 DRP
Purchase Production

Central MPS
Warehouse(s) MRP
PRP
Sales

Distribution
Center(s)
DRP

Local Depots

Sales Branches
Selective Control Techniques
• A B C Analysis
• Based on the Annual usage value of various items.
• It separates inventory items into 3 classes viz. A, B, C in the descending
order of usage value.
ABC Analysis
Inventory management Techniques
• A B C Analysis
100 Y

Annual Usage Value of Items %

X C

The 2 points X & Y where

the Curve changes its
shape provide the 3
A
segments A, B, C

0 100
No. of items %
Inventory Strategy after ABC Analysis
Rank by Percentage of Turnover
Inventory management Techniques
• A B C Analysis
• Helps to concentrate in efforts in area where it is needed
most
• Gives most effective and rewarding control with least
amount of supervision
• With ABC control it is possible to reduce investments in
inventories.
Inventory management
Techniques
• V E D Control:
• V: Vital items
• E: Essential items
• D: Desirable items
• The basis of control is the criticality of the item
ABC – VED combine control

ABC VED Classification

Classification V items E items D items

A items Regular stocks with Medium stock No Stock

constant control
B items Medium Stock Medium Stock Very low Stocks

C items High Stock Medium Stock Low Stock

Inventory management
Techniques
• X Y Z Control:
• X: Items with high inventory value
• Y: Items with moderate inventory value
• Z: Items with low inventory value
• The basis of control is the annual closing inventory value
ABC – XYZ combine control

ABC XYZ Classification

Classification X items Y items Z items

A items Attempts to Attempt to Items are with in

reduce stocks convert Z items control
B items Review Stock & Items are with in Review items bi-
consumption control annually
more often

C items Dispose of the Check & maintain Review annually

surplus control
Inventory management Techniques

• FNSD Control:
• F: Fast moving Items
• N: Normal moving Items
• S: Slow moving Items
• D: Dead items
• The basis of control is the Usage rate
Summary of Inventory
management Techniques

Selective Basis of classification Chief Use

Control
Technique
ABC Consumption value Controlling RM, WIP and
components

VED Criticality of item Determining the inventory level of

spare parts

XYZ Value of item in Reviewing the inventories & other

storage uses

FNSD Consumption rate of Controlling obsolescence

item
 Lot Control

• Lot
• Lot Data
 Original lot size
• By Unit
 Current lot inventory
• By Lot
 Date of first issue

• Lot Tracking
• Variable Lot Features
 Production process data
 Quality standards
•Customer
•Supplier

•Manufacturing