Inventory is a large and costly investment.

Better management of corporate inventories can improve cash flow and return on investment. Nevertheless, most
companies suffer through periodic inventory rituals; that is crash inventory reduction programs are instituted every year or so. However, the lack of
comprehensive understanding of inventory management techniques and trade-offs often causes customer service levels to drop, so the programs are
abandoned.

WHY HOLD INVENTORY

Inventory serves 5 purpose to the firm

1. It enables the firm to achieve economies of scale

2. It balances supply and demand
3. It enables specialization in manufacturing
4. It provides protection from uncertainties in demand and order cycle
5. It acts as buffer between critical interfaces within the channel of distribution.

Economies of Scale
Inventory is required if an organization is to realize economies of scale in purchasing, manufacturing, and transportation.

Finished goods inventory makes it possible to realize manufacturing economies. Plant utilization is greater and per-unit manufacturing costs are lower if a
firm schedules long production runs with few line changes. Manufacturing in small quantities leads to short production run with high changeover costs.

Seasonal Inventories
Balancing Supply and Demand

Seasonal supply and demand may make it necessary for a firm to hold inventory. The cost to establishing production capacity to handle the volume at these
peak periods would be substantial.

Specialization

Inventory makes it possible for each firm’s plants to specialize in the products that it manufactures. the finished goods will be shipped to field of warehouses
where they are mixed to fill customer orders.
Focused factories- specialization by facility

Protection from Uncertainties

Inventory is held as protection from uncertainties; that is to prevent a stockout in the case of variability in demand or variability in the replenishment cycle.
Another reason to hold raw materials inventory is to maintain the source of supply. The cost of holding inventory should be compared to the savings realized
or costs avoided by holding it.

Work in Process Inventory

It is often maintained between manufacturing operations within a plant to avoid shutdown if a critical piece of equipment were to break down, and to equalize
the flow since not all manufacturing operation produce the same rate. It permits maximum economies of production without work stoppage. Organizations
focuses on rebalancing production process to minimize or eliminate the need for work-in-progress inventory.

Inventory Planning

Inventory Planning is critical to successful manufacturing operations because a short-age of raw materials can shut down the production line or lead to
modification of the production schedule; these events may increase expenses or result in a shortage of finished product. While shortage of raw materials
can disrupt normal manufacturing operations, excessive inventories can increase inventory carrying costs and reduces profitability.

Balanced Inventory

If the inventory is balanced, increased inventory investment will enable the manufacturer to offer higher levels of product availability and less chance of a
stockout. A balanced inventory is one that contains items in proportion to expected demand.
 Types of Inventory
Cycle Stock

 Cycle Stock is an inventory that results from

replenishment of inventory sold or used in
production. It is required in order to meet demand
under conditions of certainty; that is, when the firm
can predict demand and replenished times (lead
time).
Types of Inventory

In-Transit Inventory

 Are items that are en route from one location to

another. They may be considered as part of the
cycle stock even though they are not available for
sale or shipment until after they arrive at the
destination.
 For the calculation of inventory carrying cost, In-
transit inventories should be considered as
inventory at the place of shipment origin since the
items are not available for use, sale or

subsequent reshipment.
Safety or Buffer Stock

 held excess of cycle stock because of

uncertainty in demand or lead time.
 Average inventory at a stockkeeping location
that experiences demand or lead time variability
is equal to half the order quantity plus the safety
stock.

 Time-definite delivery- Utilizing transportation

carriers that provide consistent on-time
deliveries will reduce lead time variability.
Speculative Stock

 inventory held for reasons other than

satisfying current demand.

Seasonal Stock

 form of speculative stock that involves the

accumulation of inventory before a seasonal
period begins. Often occurs with agricultural
products and seasonal items.
Dead Stock

 Refers to the items for which no demand has

been registered for some specific period of time.
 Might be obsolete throughout a company or only
at one stockkeeping location.
 The items can be transshipped to another
location to avoid the obsolescence penalty or
mark down at the current location.
 J.C Whitney Company sells parts of automobiles
that are no longer produced after the auto
manufactures get rid of their replacement part
inventories.

Basic Inventory Management

 Inventory is a major use of working capital. Accordingly, the objectives of inventory management are to increase corporate profitability through improved
inventory management, to predict the impact of corporate policies on inventory levels, and to minimize the total cost of logistics activities while meeting
customer service requirements.

Measures of Inventory Management Effectiveness

The key measure of effective inventory management is the impact that inventory has on corporate profitability. Effective inventory management can improve
profitability by lowering costs or supporting increased sales.

Inventory Turn-Over
Another measure of inventory performance.

It is measured as:

Annual dollar sales volume cost

Average dollar inventory investment

 turnover should not be used as the only measure of inventory effectiveness, but should be combined with other measures that reflect customer service
issues.

Fill Rate
Increased sales are often possible if high level of inventory lead to better in - stock availability and more consistent service levels.

Fill rate is a common measure of the customer service performance in inventory. Presented as the percentage of units available when requested by the
customer.

Impact of Demand Patterns on Inventory Management

Pull versus Push System

 are distinguished by the way the company’s

production is driven. If the company waits to
produce products until customer’s demand it, that
is pull system. Customer demand pulls the
inventory.
 If a firm produces to forecast or anticipate sales to
customer is a push system. the firm is pushing its
inventory in the market in anticipation of sales.
Independent versus Dependent Demand

 focuses on whether the demand for an item depends on demand for something else. An independent demand item is a finished goods, while dependent
demand items are raw materials and components that go into the production of the finished goods.
 Inventory managers must determine how much inventory to order and when to place the order.

Inventory Management under

Conditions of Certainty
Replenishment policy under conditioned of certainty
requires the balancing of ordering costs against
inventory carrying cost.

Components of Ordering Cost

Ordering costs for products purchased from an outside

supplier typically include

 the cost of transmitting the order

 the cost of receiving the product
 the cost of placing it in storage
 the cost of processing the invoice for payment
Components of Ordering Cost

In restocking its own field warehouse, a company’s

ordering cost typically include

 the cost of transmitting and processing the

inventory transfer
 the cost of handling the product if it is in stock
 the cost of receiving at the field location
 the cost of documentation

Economic Order Quantity

EOQ model is a concept which determines the optimal
order quantity on the basis of ordering and carrying cost.
When incremental ordering costs equal incremental
carrying costs, the most economic order quantity exists. It
does not optimize order quantity and thus the shipment
quantity, on the basis of total logistics costs, but only
ordering and carrying costs.

EOQ Formula: 2PD/CV

P= the ordering cost

D= annual demand or usage of product

C= Annual inventory carrying cost

V= Average cost or value of one unit inventory

Adjustments to the EOQ

where:

Q1= the maximum quantity that can be economically

ordered to qualify for a discount on unit cost

r= the percentage of price reduction if a larger quantity is

ordered

D= the annual demand in units

C= the inventory carrying cost percentage

Q0= The EOQ based on current price

Fixed Order Point VS Fixed

Order Interval Policy
Fixed Order Point

 it represents the EOQ

 the company order a fixed quantity each time based on EOQ.
 The automated inventory control system normally generates an order or at lest a management report when the reorder point is reached.

Fixed Order Interval

 reorder policy approach

 inventory levels are reviewed at a certain, set time interval
 many items are purchased from the same supplier

Inventories and Customer

Service
The establishment of a service level, and thus a safety stock policy, is a matter of managerial judgement. management should consider factors such as
customer relations, customer wants and needs, competitive service levels, and the ability of the firm to support continuous production process.

Management improves customer service levels by adding safety stock because the cost of carrying inventory is often not been calculated for the firm or has
been set arbitrarily ay an artificially low level.