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Inventory management in small and medium enterprises: A study of machine tool

enterprises in Bangalore
N. Rajeev
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Inventory management in small Inventory

management in
and medium enterprises SMEs
A study of machine tool enterprises in
Bangalore 659
N. Rajeev
Department of Management Studies, Indian Institute of Science,
Bangalore, India
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Abstract
Purpose – The purpose of this paper is to provide guidelines for entrepreneurs for implementing
effective inventory management (IM) practices and presents the results of a survey of machine tool
enterprises in Bangalore, India.
Design/methodology/approach – A descriptive analysis is used to present aspects of the findings,
which reflect the current state of IM in machine tool enterprises. In addition, percentages, bar
diagrams and correlation analysis provide a more accurate assessment of this industry sector.
Findings – The study identified several major problems in the context of IM in machine tool
enterprises including the use of rule-of-thumb for IM, a low importance given to forecasting, random
ordering of materials, low levels of training and development, and low computer use as well as a low
importance given to purchasing and variable lead-time. The study confirmed the need for managers
in the machine tool sector to alter drastically their approach to IM.
Research limitations/implications – This study of 40 SMEs in Bangalore should be extended
using a larger sample representative of Indian SMEs in order to arrive at findings that are more
generalizable across the machine tool sector in India.
Practical implications – The managers of SMEs should consider seriously IM as a strategic
concept simply because effective IM positively influences productivity. There is profound scope
for improving the operations and performance of SMEs through the application of quality practices
in IM.
Originality/value – Considering the lack of studies about IM in the context of Indian small and
medium sized enterprises (SMEs), this paper helps fill a gap in the literature. A review of the policy
framework concerned with SMEs suggests that policymakers do not consider critically the role of IM
and related issues. It is significant to note that there is no exclusive reference to improvement in IM
within the policy documents. At the same time, the literature review suggests that effective
approaches to IM can improve the productivity and competitiveness of SMEs.
Keywords Small to medium-sized enterprises, Inventory management, India
Paper type Research paper

Introduction
Inventories are a significant portion of the current assets of any business enterprise
(Kruger, 2005). Inaccuracies in an inventory creates a range of problems, including loss
of productivity, the manufacturing of unwanted items, a reduction in the levels of
customer commitment, the accumulation of costly physical inventories and frustration
(Meyer, 1991). The costs of any of these inaccuracies can indeed be significant.
Therefore, the cost savings that accrue from improved practices in inventory
management (IM) are substantial (Meyer, 1991). IM and control are crucial to a firm
because mismanagement of inventory threatens a firm’s viability (Sprague and Management Research News
Vol. 31 No. 9, 2008
Wacker, 1996). The management of inventories influences a firm’s financial strength pp. 659-669
and competitive position because the approach taken to IM directly affects working # Emerald Group Publishing Limited
0140-9174
capital, production and customer service (Ng et al., 1993; Vergin, 1998). DOI 10.1108/01409170810898554
 MRN However, while the critical role of inventories to a firm’s survival is well recognized
31,9 in theory, IM does not necessarily drive practice in many SMEs. When business
strategies are formulated, IM is not generally treated as a critical or strategic activity
(Sprague and Wacker, 1996). In the context of SMEs in India and the formal IM
practices they adopt, very few studies deal in-depth with this issue. Therefore, this
paper begins to bridge this gap by investigating the status of IM in SMEs in Bangalore,
India.
660
IM and SMEs
While IM is defined in several different ways, the concept implies the establishment of
strategic objectives and the positioning for inventories (Sprague and Wacker, 1996). As
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such, IM is the active control program, which allows a firm to manage its
manufacturing, sales, purchases, distributions and payments (Lavely, 1996). This
paper examines these items with due consideration given to the specific features of
SMEs in Bangalore.
Small and medium sized enterprises are defined in numerous ways around the
globe. In India, the idea defining a SME is a recent notion. Until 2006, no definition for
medium enterprises existed in India, whereas small-scale enterprises were defined
under the Industries Development and Regulation Act, 1951 (IDR). The Micro, Small
and Medium Enterprises Development Act, 2006 (MSMED) defined for the first time
what a medium scale enterprise was along with a revised definition of a small
enterprise. The concept of a tiny enterprise gave way to ideas about a micro enterprise.
According to the MSMED, a micro enterprise in the manufacturing sector is an
enterprise with an investment in plant and machinery not exceeding Rs. 2.5 million. A
small enterprise is an enterprise with investment in plant and machinery more than Rs.
2.5 million but less than Rs. 50 million. A medium enterprise is defined as having
investment in plant and machinery more than Rs. 50 million but not exceeding Rs. 100
million. Thus, in India, all enterprises with investments in plant and machinery of up to
Rs. 100 million are SMEs. For the study reported here, SMEs are enterprises with a
current replacement value of capital in plant and machinery of up to Rs. 100 million.

An overview of literature
Inventory management has significance for any enterprise in an inventory intensive
manufacturing industry because effective practices in IM will allow an enterprise to
minimize inventory costs and therefore, avoid the dire consequences that come with a
shortage of material resources. This sequence of events has special significance in the
context of SMEs and IM. Eloranta and Raisanen (1988) argue that poor quality
forecasts are the main factors contributing to this sequence of events in SMEs. Chikan
(1990) observed that a sound IM system is a decisive factor in a firm’s success.
However, he found shortages of necessary inputs, irrespective of high-inventory
investments, in most SMEs.
Natarajan (1991) discussed the linkages between IM and competitive advantage,
bringing into focus the integration of strategic and competitive factors such as cost,
delivery and quality. Natarajan (1991) argues that reducing the throughput time by
faster value addition to the materials provides a firm with a distinct edge in
competitive environments. However, inventory costs are determined not only by their
level of inventory but also by the time the materials spend in the system.
 Mantho (1994) classified IM into three broad areas: Inventory
(1) Inventory record keeping: due to the availability of computers at a reasonable management in
price, SMEs have found it appropriate to automate their inventory records
through computerization.
SMEs
(2) Inventory decision-making: many models can be integrated into computer-
based inventory systems.
(3) Material requirement planning (MRP) system: MRP is an IM information system 661
concerned with getting the right materials to the right place at the right time.
However, contemporary IM systems are more challenging because of several variables.
In a fluid IM environment, these factors include high inflation rates at certain periods,
low availability of traditional materials, high costs of labour leading to less making and
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more buying, increasing numbers of suppliers entering the procurement market and
rapid development of micro-processors and software in decision-making support
systems. In addition, new technological innovations lead to the development of
substitutes (for example, smart materials replacing steel and aluminum), which add to
the challenges for IM (Mohanty, 1985). In this light, IM must be oriented to the quite
specific needs of the particular enterprise. Some of the fundamental problem areas in
IM, identified in several studies with recommendation for improvements are captured
in Table I. The extent to which these problems exist in SMEs in Bangalore provide
useful insights into the status of IM generally.
The IM practices of SMEs in Finland and Greece were studied by Chikan and
Whybark (1990) to identify the experiences of managers concerning IM. In Finland, 15
case studies of IM were undertaken, including examining the role of IM in corporate
planning, inventory decision-making and performance measurement. The findings
revealed that IM decisions are made at the operational level with minimal guidance
from the top. Furthermore, the lack of accurate, real-time and suitable aggregate
information of material flows and stock levels prevented these enterprises from setting
precise quantitative goals for IM. Furthermore, financial pressures forced the
enterprises to reduce their inventories, which eventually led to internal as well as
external stockouts (Chikan and Whybark (1990).
The second study included observations of 30 SMEs in northern Greece. A principal
finding was that while all firms had computerized information systems for the
purposes of inventory record keeping and accounting, no decision-making models were
applied in the process. The use of an integrated decision support system (DSS) was not
even considered by these Greek entrepreneurs – this was seen as being both
unnecessary and costly. The major restraint of the use of computers was not their cost
or the availability of software but rather, the attitudes and knowledge of managers and
workers (Chikan and Whybark, 1990). For Chikan and Whybark (1990), the SMEs were
slow to adopt and implement contemporary IM practices.
A well-operated integrated production-inventory system is a decisive success factor
under a variety of conditions (Chikan, 1990). However, concerning performance, SMEs
are often satisfied with the end-of-year stocktaking, trading and profit and loss
accounts. In most SMEs, the balance sheet rules even though many benefits can be
derived from implementing a perpetual inventory system. In systems of this type, all
stock items are periodically and randomly checked throughout the year. Given that
many SMEs lack professional expertise and generally take decisions based on intuition
and elementary IM practices (Mohanty, 1985), investments in inventory are not always
costed accurately or appropriately.
 MRN Inventory
31,9 problem causes Effects Recommended actions

1. Inventory record Loss of worker productivity, Perpetual inventory

inaccuracy manufacturing and ordering of control, cycle counting,
unwanted items, broken customer computerization.
commitments, physical inventory,
662 stock-outs, frustration (Meyer,
1991).
2. Informal Reduced productivity, improper Integrated material
practices and utilization of men, machines, management, outsourcing
measurement of materials, stock outs. certain components, which
IM make the job cheaper, ABC
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analysis.
3. Low purchasing Reduced competitive advantages Supplier empowerment,
effectiveness and benefits of quantity discount formation of a purchasing
reduced bargaining power with department, use of a
suppliers and customers, lack of purchasing service or
purchasing capabilities (Quayle, consortia, developing a
2002). purchasing function.
4. Management Poor service level, high cost, poor Application of DSS models.
effectiveness of turn over ratio (Pirttila and
inventory Virolainen, 1992).
decision
5. High set-up High inventory level, high Employees training,
costs production and inventory cost. automation.
Table I. 6. High throughput High production and inventory Automation, employee
Main problem areas and time cost. training.
recommendation for 7. Variable lead High inventory cost and increased Developing purchasing
improvement time through put time. expertise.

High inventories cannot be used by enterprises to deflect the effects of shortages of

necessary inputs. A cursory review of SMEs in India might lead one to conclude that
Indian managers generally do not give the required attention to IM. However,
considering the lack of substantial studies in IM in an Indian context, the study
reported here seeks to develop broader understandings about IM practices in the
machine tool enterprises, identifying problems and exploring prospects. As a prelude,
the characteristics of the SMEs studies in Bangalore are set out in Table II.

Background and methodology

The study is confined to machine tool enterprises (MTEs) in the City of Bangalore in
India. Machine tools enterprises and among the most important manufacturing
industries concentrated in and around Bangalore (PIA, 2003). The industry is
considered as an inventory intensive industry; individual MTEs have formal or
informal relationships with various large enterprises including the multinationals
(MNCs) located in the city. The quality and cost of engineering products depends on the
quality of parent machine tools and their levels of automation. Therefore, the
development of the machine tool industry is, therefore, of paramount importance for a
competitive and self-reliant Indian industrial structure.
As there is no systematic database of MTEs located in Bangalore, the study
identified 40 MTEs, all of which are also SMEs. From these 40 SMEs, primary data
 Size Inventory
Small 23 management in
Medium 17
Year of establishment SMEs
1980s 19
1990s 17
2000 þ 4
Education of entrepreneurs 663
Pre-degree 1
Diploma holder 8
Non technical graduate 5
B.Tech 22
M.Tech or MBA 4
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Family background of entrepreneur/s

Business 8
Govt./Pvt Job 15
Small entrepreneur 6
Agriculture 11
How became entrepreneur
Newly set up 34
Ancestral 6
Type of ownership
Proprietorship 15
Partnership 17
Private Ltd. 8
Type of unit
Independent 39
Subsidiary 1
Dominant manufacturing process
Continuous production 4
Mass production 4
Flow shop 5
Job shop 27
E-mail already in place
Yes 4
No 36 Table II.
Organization has web site Basic features of
Yes 20% machine tool enterprises
No 80% (n ¼ 40)

were gathered using a questionnaire. The questionnaire had five sections to gather
information about: the basic characteristics of enterprise, variety and quantities of
inventory, current IM practices, factors hindering or facilitating IM practices and
general problems relating to IM. Respondents were asked to gauge the extent to which
they agreed with various statements or propositions. Most items were constructed as
short statements and respondents were asked to provide their views on a five point
likert scale. The author between September 2006 and February 2007 executed the data
collection phase.
The methodology adopted for the study produced an analysis that was mainly
descriptive. The basic characteristics of the machine tool SMEs in Bangalore are set
out, highlighting share of inventory and material cost in the total output value. The
status of IM is described, the practices used for IM are explored and the reasons for low
inventory are offered. A correlation analysis was conducted to determine the
 MRN association between inventory performance (as captured by inventory turnover ratio
(ITR)) and other variables affecting IM performance of the enterprises. The average
31,9 practice level of some of the important IM activities was identified and, finally, a review
of the scope for IM in machine tool SMEs in Bangalore is presented.

Results and discussion

Table II presents the basic features of the machine tool SMEs surveyed. The greater
664 portion of the sample firms are small enterprise (57.5 per cent) with medium
enterprises accounting for 42.5 per cent of the sample. All the firms began business
after 1980. However, nearly half of them developed in the 1980s and another 40 per cent
in the 1990s. Around 10 per cent had begun business post 2000. Concerning the
educational attainments of the owners (the entrepreneurs of the SMEs), 65 per cent
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were technical graduates, postgraduates or held MBAs. The diploma holders

accounted for another 20 per cent, whereas non-technical graduates accounted for just
over 10 per cent. This suggests that ‘‘technopreneurs’’ are common in the machine tool
SMEs.
Among the 40 entrepreneurs, more than half have parents in business, Government,
private sector or public sector. More than a quarter had parents in the agriculture
sector. With the exception of six entrepreneurs who had parents in the business, all
others (n ¼ 34) had started their SME. With one exception, all are independent
operators. This profile suggests that SMEs are not formally linked to larger businesses
and are prone to the competitive pressures from other SMEs and the open market.
Regarding the communication systems within the SMEs, all had telephones and faxes
while 90 per cent had email capacity. This profile suggests that modern communication
systems are characteristic of the MTE in Bangalore. Nevertheless, only 20 per cent of
the SMEs surveyed had their own web site. The potential for using the World Wide
Web is yet to be realized by many SMEs in Bangalore.
In the context of this study, it is essential to determine whether the shares of
inventory and material costs contribute a major portion of the total sales of the SMEs
prior to the analysis of the current state of IM. These indicators (inventory and
material cost) are important for the SME entrepreneurs who are concerned with
reducing costs and increasing the value of output, a path to improved performance.
Improving competitiveness is a key to survival and growth in this sector. Improving
competitiveness in turn requires firms to reduce costs, including material costs in
addition to other measures. In this light, share of inventory costs and material cost in
the value of output is relevant. Figures 1 and 2 indicate the distribution of inventory
costs and material costs respectively as a percentage of the sales revenue. Inventory
costs were found to be up to 20 per cent of the sales costs. Material costs were found to

Figure 1.
Inventory cost as a
percentage of sales
 be up to 80 per cent. The study also identified shortages of necessary inputs, Inventory
irrespective of high-inventory investments by these SMEs.
management in
Status of IM SMEs
The relative health of IM practices is determined by calculating the ITR of enterprises.
This is because ITR is the most commonly used measure to determine the IM
performance of enterprises (Vastag and Whybark, 2005; Vergin, 1998). If the ITR is
strong, this suggests that the IM practices in place are effective (Vergin, 1998). Since
665
this study was interested in the relationship of IM to practice and performance, the use
of inventory turnover as a proxy seems quite appropriate (Vastag and Whybark, 2005).
Inventory turnover is calculated as total sales divided by total inventory value (raw
material, work in process and finished goods inventories). Figure 3 shows the turnover
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wide distribution of the Bangalore SMEs.

Vergin (1998) examined the trends in the ITRs of industrial enterprises in the USA
and found a large difference in ITRs by industry. A high ITR that averaged around 40
was observed in firms where instantaneous replenishment of stock is found.
Accordingly, low ITRs below two were observed in firms where products required a
good amount of time to acquire full value. He examined the ITR trends in various
industrial enterprises and found it reasonable to assert that ITRs are related to the
effectiveness of IM and that firms with better IM practices will generally have larger
ITRs. Among the ITR variations in many industrial sectors studied from 1986 to 1995,
MTEs showed a variation from 3.7 to 6.3. When all industry sectors are considered
together, the minimum and maximum ITR varied between a value below 2 and 40.

Figure 2.
Raw material cost as a
percentage of sales

Figure 3.
Enterprise wide inventory
turnover distribution
 MRN Inventory turnover ratio analysis of the studied SMEs indicated that it varied from one
31,9 to four. This suggests that IM needs further improvement in these SMEs. To determine
the reasons for the low-ITR value, it is important to analyze the nature of IM practices.
In the case studies, inventories were placed in a stock room and retrieved as necessary.
A store clerk, without interfacing with others in the enterprise, operated stock record
for physical counts for each item. The accounting system had also been established in
a manner that did not lend itself to the integration of physical inventory with
666 accounting records. The IM practices employed by the studied SMEs are shown in
Figure 4.
The enterprises studies fall into groups, ranging from those having no discernable
IM practices to those with minimal IM practices and some with a degree of
sophistication. The use of manufacturing resource planning (MRP), and just in time
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(JIT) were not observed. Practices such as economic order quantity, always better
control and vendor managed inventory have also failed to penetrate MTEs. Advanced
methodologies are not used and in most circumstances, rule of thumb is followed.
These rules are generally based on the entrepreneur’s experience. Maintaining accurate
inventory records was found to be a major problem with all the MTEs studied. This is
important because the formal production systems such as MRP, MRP 11 and JIT use
inventory records as a starting point for material planning calculations (Pacos and
Sinn, 1989).
To deepen our understanding, a correlation analysis was conducted to determine
the correlation between inventory performance (as captured by ITR) and other
variables affecting IM practices in the enterprises studies. The results of the correlation
analysis are presented in Table III. The ITR was found to be positively correlated with
value added/value of output and the number of IM practices in the enterprise, the level
of computerization and purchasing effectiveness. However, a negative correlation was
observed between ITR and lead-time. This finding adds weight to the argument that
IM help firms achieve better utilization of resource and hence achieve increases in
performance. It is essential for firms to practice a number of formal IM techniques. In
addition, lead-time reduction significantly contributes to the IM performance. Crandall

Figure 4.
Inventory practices
followed

Variables influencing IM performance

Correlation VAVAOUT LEADTIME NUMIMPRA COMPLEV PURCFFECT
Table III.
Correlation between IM IM performance (ITR) 0.911** 0.686** 0.667** 0.503** 0.521**
performance and the
variables influencing IM Notes: **Correlation is significant at the 0.01 level (two-tailed)
 and Burwell (1993) observed the role of lead-time reduction in improving the Inventory
performance of enterprises. management in
Current practice level of activities influencing the IM performance of SMEs SMEs
The mean level of the performance of the important IM activities are set out in Table
IV. The level of these inventory related variables was measured on a five point scale,
with their average value shown as the mean level of performance. The mean level of 667
performance in forecasting, inventory ordering policy, computerization, purchasing
effectiveness and employee training was found to be low, which indicates the low
status of IM within management thinking. However, the mean level performance in the
activities of resource availability, supplier empowerment and outsourcing level was
found to be comparatively high. The justification for this finding is explained below.
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Since the SMEs mainly produce to order, they believe that sales forecasts do not
play a very important role in the business process. The comparatively better mean
value for resource availability is a result of these SMEs mainly sourcing materials from
local suppliers within Bangalore and very rarely from suppliers in other Indian states.
As their capacity to purchase in quantity is low, they are not eligible to source their
materials from major suppliers. The local suppliers can provide the required quantity
of materials immediately to these SMEs. Because the SMEs rely on a few local
suppliers only for their materials, the suppliers are empowered. However, this is not
because of any supplier empowerment strategy per se. It is the result of the SMEs
having little bargaining power with their suppliers. Put simply, they are forced to buy
materials from the local suppliers.
A collaborative effort for material purchasing is a possible pathway to making
SMEs eligible to source materials from the major suppliers (Pittaway and Morrissey,
2003). Collaborative efforts improve the bargaining power of SMEs with suppliers and
make them eligible for other benefits including quantity discounts. Irrespective of this
positive outcome, the entrepreneurs are not ready to collaborate with other SMEs to
procure materials from major suppliers.
The SMEs also practice a random ordering policy for procuring materials and this
subsequently reduces their expertise in purchasing. The majority of SMEs did not have a
separate purchasing department. Computer use is also limited to word processing and
the application of information support systems is marginal. Improving the skills of
employees through programs in training and development (T&D) and human resource
development (HRD) certainly requires urgent attention. This is a logical step because
MTEs demand high levels of technical knowledge and employees capable of performing
multiple tasks.

S. No Activity Mean level of performance

1. Level of forecasting 1.58

2. Availability of resources 3.18
3. Inventory ordering policy 1.63
4. Level of computerization 1.45
5. Purchasing effectiveness 1.35 Table IV.
6. Supplier empowerment 3.28 Relative value of
7. Employee training 1.83 practices influencing
8. Level of outsourcing 3.13 inventory performance
 MRN The decision to make or buy is also an important strategic determination that can
31,9 influence IM. All the SMEs in the study practiced some level of outsourcing for several
reasons, including capacity constraints, demand variability or the non-availability of a
particular facility. However, according to the managers, their outsourcing activity is
not connected to their inventory planning.

668 Conclusion
The study of 40 SMEs in Bangalore indicated that even in an inventory intensive
manufacturing industry sector such as the machine tool industry, IM practices are
poor. The use of formal practices for managing inventories was also inadequate. Poor
IM practices are characterized by a lack of an integrated approach in the form of the
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absence of links between physical stock and accounting system. A lack of appreciation
for IM among the entrepreneurs and the lack of qualified staff are the two major factors
contributing to low IM practices. This situation is complicated further by other factors
such as constraints on working capital, a lack of T&D, a lack of progress in the area of
HRD and the organizational characteristics of the SMEs. The use of a formal inventory
ordering policy, such as fixed quantity ordering or fixed period ordering policy was not
observed in the SMEs. Instead, a random policy was followed by the SMEs for material
procurement. The study also identified the use of rule of thumb for IM, a low
importance given to forecasting and random ordering for material procurement, low
level use of computers and a low level of importance given to purchasing and variable
lead-time.
Three important aspects used to judge the quality of a firm’s IM practices are the
systematic character of the operation, the use of computers and the application of
modern methodology (Chikan, 1990). In this context, the level of computerization for
IM activities of the MTEs in Bangalore was low. While the SMEs were equipped
computers, the capabilities of software and hardware were not exploited to their full
potential. For the SMEs in the machine tool sector in Bangalore, there is a profound
scope for development in IM practices.

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