Inventory Management

Chapter 1: Introduction
M. Econ Nguyen Hoang Long
 Agenda
Definition of Inventory Management, Types of inventory
1
Organizational categories and inventory problems
2
Functions of inventory
3
Inventory problem classifications, Properties of inventory, Inventory
4 costs, The inventory flow cycle
Overall Inventory Management
 1.Definition
The objective of inventory management is to strike a balance between inventory investment and
customer service

Inventory management is the activity which organizes the availability of items to the customers.
It coordinates the purchasing, manufacturing and distribution functions to meet the marketing
needs
Without inventory control procedures in place, the store or department can become overstocked or
understocked

A business can run smoothly its operating activities only when appropriate amount of inventory is
maintained

The word inventory is commonly used to describe the goods and materials that a business holds
for the ultimate purpose of resale
 1.Definition
The objective of inventory management is to maintain inventory at an appropriate level to avoid
excess or shortage of inventory.
A. Operating objectives: They are related to the operating activities of the
business like purchase, production, sales etc
a. To ensure continuous supply of materials.
b. To ensure uninterrupted production process.
c. To minimize the risks and losses incurred due to shortage of
inventory.
d. To ensure better customer services.
e. Avoiding of stock out danger.

B. Financial Objectives:

a. To minimize the capital investment in the inventory.

b. To minimize inventory costs.
c. Economy in purchase.
Exercise 1
Suppose you are the inventory manager of a firm dealing in dairy products. State what
would be your priority objectives of managing the inventory of dairy products.

Giang Le,
Le Bich,
Tuan Anh,
……………………………………………………………………………………… Minimize……………………………………………………………………
the inventory stock
Arranging goods and due to dairy Continuously with demand of
………….....................................................................................
prod cant stock
…………....................................................................................................................
customer. Uninterupt
material much ....................................................................................................
....................................................................................................................................
-Promotion ....................................................................................................
plan to sell more
....................................................................................................................................
-> impact........................................................................
to revenue
........................................................................
Ngoc Giau,
Check and ensure good.
Quang Anh, Kim Thanh,
Expiration date, Expiration date, Accurate
inventory to know abt logistic Tram,
situation. Link with strategy Make enough prod.
of that prod.
 Problems Caused by Inventory
• Inventory ties up working capital
• Inventory takes up space
• Inventory is prone to:
– Damage, Pilferage and Obsoles
cence
• Inventory hides problems
 Key Inventory Terms
 Lead time: time interval between ordering and receivin
g the order
 Holding (carrying) costs: cost to carry an item in invent
ory for a length of time, usually a year (heat, light, rent,
security, deterioration, spoilage, breakage, depreciatio
n, opportunity cost,…, etc.,)
 Ordering costs: costs of ordering and receiving invent
ory (shipping cost, preparing invoices, cost of inspecti
ng goods upon arrival for quality and quantity, moving
the goods to temporary storage)
 Set-up Cost: cost to prepare a machine or process for
manufacturing an order
 Shortage costs: costs when demand exceeds supply, t
he opportunity cost of not making a sale
12 - 12
 Amazon.com
 Amazon.com started as a “virtual” retailer –
no inventory, no warehouses, no overhead;
just computers taking orders to be filled by
others
 Growth has forced Amazon.com to become
a world leader in warehousing and
inventory management
 2.Types of Inventory
The inventory may be classified into three categories:

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

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

A Dependent Demand

B(4) C(2)

D(2) E(1) D(3) F(2)

Independent demand is uncertain. That is why it is forecasted.

Dependent demand is certain and it is calculated.

18
Regardless of the nature of demand (i
ndependent, dependent) two fundame
ntal issues underlie all inventory plann
ing:

How Much to Order?

When to order?

19 12 - 19
12 - 20
 Inventory Classifications

Inventory

Process Number & Demand

Other
stage Value Type

Raw Material A Items

Independent Maintenance
WIP B Items
Dependent Repair
Finished Goods C Items
Operating
 3.Functions of inventory
1. To decouple various parts of the production process by
covering delays
2. To protect the company against fluctuations in demand
3. Buffering against uncertainties in supply and demand
4. Geographical specialization
5. Preventing the cost of a stockout
 3.Functions of inventory

1.To decouple various parts of the production process by covering delays

Decoupling provides maximum operating efficiency in a logistics environment by keeping

inventories at different stages or different locations in the supply chain. Holding inventory at
different stages may lead to economies of scale.
 3.Functions of inventory
2. To protect the company against fluctuations in demand

Balancing supply and demand

Inventory is necessary to reconcile supply with the demand for a product. Balancing is
concerned with the elapsed time between consumption and manufacturing and links the
economies of manufacturing with variations in consumption.
The balancing function of inventory is most prominent in seasonal supply and/or
demand. This seasonality can take two forms:

• Seasonal production, but year‐round consumption

• Seasonal consumption, where supply must meet peak demand
 3.Functions of inventory
3. Buffering against uncertainties in supply and demand
The buffering function of inventory involves protecting the business or supply chain against
three types of uncertainty
• Uncertainty of future demand. This type of uncertainty results from the fact that demand
usually fluctuates from period to period; causing a probability that demand may be more
than the forecast. The more that demand varies from period to period, the more the
uncertainty and the more difficult it becomes to forecast demand accurately.
• Lead‐time uncertainty. Lead time refers to the elapsed time from order placement to
order receipt. This type of uncertainty results from variability in the lead time that may be
due to unforeseen delays in order processing or transportation.
• Uncertainty in supply. This refers to uncertainty about whether a specific product will be
available at the time it is needed from the supplier. For example, raw materials in excess
of those required for manufacturing can result from speculative purchases made because
of the possibility of a strike or the unavailability of natural resources.
 3.Functions of inventory
4. Geographical specialization

A major function of inventory in the supply chain is to provide for geographical specialization
of members of the supply chain. The economic location of factories is often based mostly on
the availability and cost of the factors of production, such as land, power, materials, water
and human resources.
 3.Functions of inventory
5. Preventing the cost of a stockout

The most important function of inventories is to ensure the availability of products – either
materials, semi‐finished goods or final products. If these are not available, the result is the
cost of a stockout.

There are three possible costs attached to a stockout. In order of severity, these are:
- The cost of a backorder
- The cost of a sale
- The cost of a lost customer
Section Break
Insert the title of your subtitle Here
 4. Inventory Management Problems
Demand: This is a key characteristic of an item in any inventory system.
Demand is generated by people outside the firm, and therefore is mostly uncontrollable
to address the inventory management problem of the firm. Table shows a list
of terms that may be used to describe demand

Replenishment Lead Time: Lead time is the time between placement of a replenishment order
and the actual receipt of stock. Just like in the case of demand, lead
times for an item may be constant, varying, or may be known with a probability
distribution. Theoretically, in some cases, the lead times may be very small and
insignificant. This case may be referred to as instantaneous replenishment.
 4. Inventory Management Problems
Inventory Level and Review Times: The inventory level of an item may be known
at all times. In some cases, it may not be possible (or may not be cost-effective)
to monitor the level of an item at all times. Instead, the level of items is reviewed
at certain predetermined times.

Lifetime & Reparability: An item may not always have an indefinite lifetime. Its
utility value may drop to zero at some point after which it may not have any
takers. Also, an item may fail but may be repairable.
 5. Inventory Cost
Inventory cost includes the costs to order and hold inventory, as well as to administer the related
paperwork. This cost is examined by management as part of its evaluation of how much inventory
to keep on hand

Ordering Costs
These costs include the wages of the procurement department and related payroll taxes and
benefits, and possibly similar labor costs by the industrial engineering staff, in case they must pre-
qualify new suppliers to deliver parts to the company. These costs are typically included in an
overhead cost pool and allocated to the number of units produced in each period.
 5. Inventory Cost
Holding Costs
These costs are related to the space required to hold inventory, the cost of the money needed to
acquire inventory, and the risk of loss through inventory obsolescence. Most of these costs are
also included in an overhead cost pool and allocated to the number of units produced in each
period. More specifically, holding costs include:
•Cost of space. Perhaps the largest inventory cost is related to the facility within which it is
housed, which includes warehouse depreciation, insurance, utilities, maintenance, warehouse
staff, storage racks, and materials handling equipment. There may also be fire suppression
systems and burglar alarms, as well as their servicing costs.
•Cost of money. There is always an interest cost associated with the funds used to pay for
inventory. If a company has no debt, this cost represents the foregone interest income associated
with the allocated funds.
•Cost of obsolescence. Some inventory items may never be used or will be damaged while in
storage, and so must be disposed of at a reduced price, or at no price at all. Depending on how
perishable the inventory is, or the speed with which technology changes impact inventory values,
this can be a substantial cost.
 5. Inventory Cost
Administrative Costs
The accounting department pays the wages of a cost accounting staff, which is responsible for
compiling the costs of inventory and the cost of goods sold, responding to other inventory
analysis requests, and defending their results to the company's internal and external auditors.
The cost of cost accounting personnel is charged to expense as incurred.
As the preceding list reveals, the cost of inventory is substantial. If not properly monitored and
adjusted, inventory costs can eat into profits and cash reserves.
 6. Inventory Cycle
Inventory cycle time—also called order cycle time (OCT) or Order Fulfillment Cycle
Time (OFCT)—covers the manufacturing process and related activities in three
phases:
•Ordering Phase (also known as Administrative Phase or Sourcing Phase)
• Raw materials ordered, received, and reviewed.
•Production Phase (also known as the Work-in-Process Phase or Manufacturing
Process Phase)
• Goods produced, finished, and packaged.
•Finished Goods/Delivery Phase
• Products delivered to the customer.
As an example, let’s say Company X has a 13-day ordering phase, a 30-days
production phase, and a 5-days delivery phase. Their total inventory cycle time is
48 days.
The Material Flow Cycle
The term inventory cycle refers to a three-phase process:
1.The ordering or administrative phase
2.The production phase
3.The finished goods and delivery phase.

Cycle time

95% 5%

Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time

12 - 38
 Important Issues in Inventory Management

1. Classifying inventory items

2. Keeping accurate inventory records
 Summary
In this chapter, we discussed the meaning of the term inventory and described the
different types of inventories – raw materials, work-in-process, finished goods, and
maintenance items – used by businesses. There are several reasons why businesses
hold inventories. Decoupling inventories are held to detach a process from another
while cycle and pipeline inventories are held for minimizing inventory costs. Buffer
or safety stocks are held to minimize uncertainty in demand.
We also learned in this chapter that inventory management revolves around
finding answers to three most important questions:
(a) How frequently should the inventory status for an item be reviewed?
(b) When should a replenishment order be placed? and
(c) What should be the order size?
Inventory managers need to consider the characteristics of items – such as
demand, replenishment lead time, the timing of review, and item lifetime – being
managed while answering these questions.
We also presented a classification of inventory models that gives the reader an
idea of the breadth of inventory management solutions.
 Assignment
Assessment
Types of Exams Content/ Topics Timeline
method
Group assignment: Essay (Group of 4-5 ppls)
Choose an enterprise in accordance with Week 1 -15 Essay - Report
the assigned type of inventory control to
Assign analyze the applied inventory model
ment#1 (describe, comment on strengths and
weaknesses)