Inventory

• Inventory is an idle resource of any kind, which has some economic

value.

Inventory Control • Inventory is the material held in an idle or incomplete state awaiting
future sale, use, or transformation.
• Often they are a substantial part of total assets.
• Inventory management is responsible for planning and controlling
inventory from the raw material stage to the customer.

Inventory Functions of Inventory

Types • Inventory exists because supply and demand are difficult to
• Raw material - They include purchased materials, component parts, and synchronize perfectly and it takes time to perform material-related
subassemblies. operations
• Work-in-process inventory - Raw materials that have entered the • For several reasons, supply and demand frequently differ in the rates
manufacturing process and are being worked on or waiting to be worked
on. at which they respectively provide and require stock.
• Finished product – Ready to be sold as completed items. • These reasons - Four functional factors of inventory
• In addition, Items used in production that do not become part of the
product. These include hand tools, spare parts, lubricants, and cleaning
supplies, etc. (Referred as Maintenance, repair, and operational supplies
(MROs))

Functions of Inventory Functions of Inventory

• Time factor – • Discontinuity Factor (decoupling function of inventory) - Allows the
• Involves the long process of production and distribution required treatment of various dependent operations (retailing, distributing,
before goods reach the final customer. warehousing, manufacturing, and purchasing) in an independent and
economical manner
• Inventory enables an organisation to reduce the lead time in meeting
demand. • Inventories free one stage in the supply-production-distribution
process from next, permitting each to operate more economically.
• Profitability can be enhanced by a reputation of having products
available immediately.

1
Functions of Inventory Functions of Inventory
• Uncertainty Factor - Concerns unforeseen events that modify the • Economy Factor - Enables the organisation to purchase or produce
original plans of the organization. items in economic quantities.
• It includes errors in demand estimates, equipment breakdowns, • Bulk purchases - quantity discount, reduced transportation cost, etc.
shipping delays, etc.
• The organization gets some protection from unanticipated or
unplanned occurrences.

Inventory Inventory and economies of scale

• Based on its utility, major classification of inventory is: • The presence of fixed costs associated with ordering and
Working stock – cycle stock or lot size stock transportation, quantity discounts in product pricing, and short-term
discounts or trade promotions encourages different stages of a supply
Safety stock – buffer stock chain to exploit economies of scale and order in large lots.
Pipeline stock – in transit inventory
Psychic stock - inventory carried to stimulate demand • economies of scale means the cost advantages that enterprises
obtain due to their scale of operation, with cost per unit of output
decreasing with increasing scale (scale means “quantity”).

Properties of inventory Properties of inventory

• Demands • Demand – size or rate, pattern
• Replenishments • Deterministic – demand is known
• Constraints • Probabilistic – demand is not known, uses probability distribution
• Costs • Discrete and continuous probability distribution

2
Properties of inventory Properties of inventory
• Replenishment size - The quantity or size of the order to be received • Constraints are limitations placed on the inventory system.
into inventory. • Eg: space, capital, equipment, facility, workforce
• Replenishment lead time – length of time between the decision to • Management decisions – (never being out of stock)
replenish an item and its actual addition to stock and can be constant
or variable.
• Probability distributions can be used to describe variable lead time

Inventory costs
• The objective of inventory management is to have the appropriate
amounts of materials in the right place, at the right time and at low
cost.
INVENTORY COSTS • Inventory costs are the basic economic parameters to any inventory
decision model.
Purchase cost
Order/setup cost
Holding cost
Stockout cost

Purchase cost / Production cost Order/setup cost

Unit purchase price – cost of purchasing an item from an external • Expense of issuing a purchase order to an outside supplier or from
source, say, from a supplier. internal production setup costs
• Vary directly with number of orders or setups
For internally produced items, the corresponding cost is Unit • Order cost includes:
production cost. Transportation cost
Unit production cost includes direct labour, direct material and factory Buyer time and time for analysing vendors
overhead. Cost associated with writing purchase orders
Cost associated with Receiving materials, inspecting materials,
following up orders and doing the process necessary to complete the
transaction

3
Order/setup cost Holding Cost
• Setup cost – the costs of changing over the production process to • Cost associated with investing in inventory and maintaining the
produce the ordered item. physical investment in storage
• Includes preparing the shop order, scheduling the work, etc. • Contains capital costs, taxes, insurance, handling, storage,
obsolescence, and deterioration.
• Carrying cost.
• Usual simplifying assumption is that holding costs are proportional to
the size of the inventory investment.
• Holding cost is usually expressed as a percentage of unit purchase
cost.

Stockout cost Inventory control

• Economic consequence of an external or an internal shortage • The major goals of inventory management are to minimize inventory
• External shortage – when customer’s order is not filled investment and maximize customer service.
• Internal Shortage – When an order of a group or department is not filled • Conflicting goals
• External shortages can incur backorder cost, present profit loss and future
profit loss
• Internal shortage can result in lost production and delay in completion
date.
• If demand occurs for an item out of stock, the economic loss depends on
whether the shortage is backordered, satisfied by substitution of another
item or cancelled.
• The quantification of these costs has long been a difficult task.

DEPENDENT VS INDEPENDENT DEMAND INDEPENDENT DEMAND

• An important characteristic of demand relates to whether the • Customer surveys
demand is derived from an end item or is related to the item itself. • Forecasting techniques
• Independent demand: the demands for various items are unrelated
to each other.
• Dependent demand: the demand for any one item is a direct result of
the need for some other item, usually a higher-level item.
• It is relatively a straight forward computational problem.

4
Independent demand systems: deterministic Independent demand systems: deterministic
models models
• One of the major reasons for having inventory is to enable an organization • To determine an optimum inventory policy, information on each of
to buy or produce items in economic lot sizes. the following parameters is required:
• Determination of economic lot size Demands
• All the parameters and variables are known or can be calculated with Appropriate inventory costs
certainty.
Lead times
• Replenishment lead time is presumed constant and independent of
demand. • Variables are treated as continuous rather than discrete
• Even though the real world is seldom behaved as described by
deterministic models, these models are frequently good approximations,
or at least, good starting points for describing inventory phenomena.

Fixed order size systems Fixed order size systems

• How many to order? (Order quantity) • The stock level is reviewed with each transaction
Economic order quantity – The order size that minimizes the total • Whenever the inventory position reaches a predetermined point, an
inventory cost - Same number of items is ordered order for a fixed number of units is placed.
• This level of inventory at which an order is placed is called reorder
point.
• When to order? (Order timing) • This is because there is a time gap between placing an order and
receiving an order (Lead time)
Reorder point – The stock level is reviewed
• The Q system of inventory
• EOQ system

Fixed order size systems – Economic Order Fixed order size systems - THE EOQ MODEL
Quantity – single item
Demand
Assumptions Order qty, Q rate
• Demand for the product is known, constant, and continuous.
Inventory Level

• Lead time (time period between placing of order and receipt of items) is
known and constant.
• The entire order is received into inventory at same time
• The price per unit of product is constant.
• Inventory holding or carrying cost is based on average inventory. Reorder point, B
• Ordering cost per order is constant
• All demands for the product will be satisfied. 0 Lead Lead Time
time time
• A single product situation is considered. Order Order Order Order
• Sufficient space, capacity, and capital to procure the desired quantity Placed Received Placed Received

5
Lot sizing for a single product (to exploit fixed Lot sizing for a single product (to exploit fixed
costs) costs)
R: Annual demand • The purchasing manager makes the lot sizing decision to minimize the
C: Order Cost/order total variable cost per year the store incurs.
P: Cost per unit of the product • Three costs must be considered when deciding the lot size:
h: Holding cost per year as a fraction of unit product cost Annual material cost
H: Holding cost/unit/year = h*P Annual ordering cost
Q: Lot Size or Order quantity Annual holding cost
B: Re-order point
L: Lead time in months

Lot sizing for a single product (to exploit fixed Lot sizing for a single product (to exploit fixed
costs) costs)
Annual demand = R • From the equation it is observed that annual ordering cost declines
Annual purchase cost = P*R with an increase in lot size.
Number of orders per year = R/Q • Annual holding cost increases with an increase in lot size.
Annual order cost = (R/Q)*C • The material cost is independent of lot size since price per unit is
fixed.
Annual holding cost* = (Q/2)H = (Q/2)*h*P
• The annual cost thus first declines and then increases with an
Total annual cost = TC = P*R + (R/Q)C + (Q/2)*h*P increase in lot size.
• The optimal lot size is the one that minimizes the total cost.
*Annual holding cost = average inventory*holding cost/unit/year

Lot sizing for a single product (to exploit fixed

costs)
• The optimal lot size is refereed as EOQ or economic order quantity.
• It is denoted by Q*
• It is obtained by taking the first derivative of the total cost with respect to
Q and setting it equal to zero.
At minimum cost,
𝑑(𝑇𝐶) −𝐶𝑅 𝐻
• 𝑑𝑄
= 0+ 𝑄2
+ 2
=0
𝐻 𝐶𝑅
• 2
= 𝑄2
2𝐶𝑅 2𝐶𝑅
• 𝑄2 = Q* =
𝐻 𝐻

6
Fixed order size systems Example 1
• Demand for weighing machine in a retail store is 1000 units per month.
• Number of orders per year = m = R/Q* Store incurs a fixed order placement, transportation and receiving cost of
• Order interval = 1/m Rs. 4000 per order. Each machine costs Rs. 500 and the retailer has a
holding cost of 20 %. Evaluate the number of machines the store manager
• Reorder point = (R*L)/12 should order in each replacement lot so that the total cost is minimum.
Determine no. of orders per year, annual ordering and holding cost.

Example 1 - Solution Example 2

• Q*= 980 • The demand of a particular product is 200 units per year. The cost of
• No. of orders per year = 12000/980 = 12.24 (approximately) placing and receiving an order is Rs. 400. The cost of each unit is Rs.
100. The cost of carrying inventory is 16 % of the purchase cost of an
• Annual ordering and holding cost = holding cost + ordering cost item. Determine EOQ and Reorder point. Lead time 3 months.
980 12000
= 2
*.2*500 + 980
* 4000 = Rs. 97980 • [Ans: 100, 50 units]

Quantity discounts Economies of scale to exploit quantity discounts

• Lower unit prices on orders for larger quantities as an economic • A discount is lot size based if the pricing schedule offers discounts
incentive to buyers. based on the quantity ordered in a single lot.
• Seller benefits • A discount is volume based if the discount is based on the total
• Buyer benefits quantity purchased over a given period, regardless of the number of
lots purchased over that period.
• But buyer has to carry more inventory
• Two commonly used lot size based discount schemes are:
• Buyer has to identify the lot size that minimizes the total costs
All unit quantity discounts
Marginal unit quantity discount or multi-block tariffs

7
All unit quantity discounts All unit quantity discounts
• Purchasing larger quantities results in a lower unit price for the entire
lot.
• Same unit price for every item in a given lot.
• The quantities at which prices change are called price-break points.
• Total cost curve is not continuous

All unit quantity discounts

• The minimum cost point will be either a point of discontinuity or • The unit purchase cost is defined as:
where a derivative equals zero as determined by the EOQ.

U0 < U1 < U2 < U3…..Uj and P0 > P1 > …..Pj

All unit quantity discounts All unit quantity discounts

• Three possible conditions that might exist with a single price break. • Solid portion of the curve is feasible and dashed portion is infeasible.
• Because of the discontinuity of the curve, the least quantity cannot
always be found by differentiation.
• There is a separate total cost curve for each unit price.
• Even though, each curve has a minimum total cost point, it is not
necessarily valid (feasible).
• An EOQ is valid if it is within the quantity range corresponding to its
unit purchase cost.
• The overall optimum lot size can be narrowed to the feasible
economic order quantities and the price break quantities.

8
All unit quantity discounts All unit quantity discounts - Example 1
Determination of optimum lot size:
• Drugs online (DO) is an online retailer of prescription of drugs.
Step 1: Starting with the lowest unit cost, calculate the EOQ at each unit
cost until a valid EOQ is obtained.
Demand for vitamins at DO is 10000 bottles per month. Order cost is
Rs. 100. holding cost is 20 %. The price charged by the manufacturer
follows the all unit discount pricing as shown in the following Table.
Step 2: Calculate the total annual cost for the valid EOQ and all price-break
quantities larger than the valid EOQ (A price-break quantity is the lowest Evaluate the number of bottles that the DO manager should order in
quantity for which the price discount is available). each lot.

Step 3: Select the quantity with the lowest total cost in step 2 above

All unit quantity discounts All unit quantity discounts

Order quantity Unit Price Step 1
0-4999 Rs. 3.00 • For P = 2.92, Economic Order quantity =6411, it is not feasible.
• For P = 2.96,EOQ = 6367 units, feasible.
5000-9999 Rs. 2.96
Step 2
10000 or more Rs. 2.92 • Total annual cost for EOQ = 6367 & P = 2.96 is (355200+1884.7+1884.7) Rs.
358969.4
U0 = 0, U1 = 5000, U2 = 10000 • Determine the total cost for 10000 units as order quantity = Purchase cost
+ order cost + holding cost = 350400+1200+2920 = Rs. 354520.
P0 = Rs. 3.00, P1 = Rs. 2.96, P2 = Rs. 2.92 Step 3
R = 120000 units/year, C = Rs. 100/lot, h = 0.2 Solution:
• Thus, order quantity = 10000 and total annual cost = 354520

All unit quantity discounts - Example 2 All unit quantity discounts - Example 2
Step 1
• Annual demand for an item is 4800 unis. Ordering cost is Rs. 300 per • For P = 8, Economic Order quantity =1225, it is not feasible.
order. Inventory carrying cost is 24 % of the purchase price per unit, • For P = 9,EOQ = 1155 units, it is not feasible.
per year. The price breaks are as follows: • For P = 10, EOQ = 1095 units, it is feasible.
Step 2
Quantity Price (Rs.) • Total annual cost for EOQ = 1095 & P = 10 is (48000+1314+1315) Rs. 50629
0 ≤ Q < 1200 10 (approximately)
1200 ≤ Q < 2000 9 • Determine the total cost for 1200 & 2000 units as order quantity
2000 ≤ Q 8 • When Q = 1200, TC = Purchase cost + order cost + holding cost = 43200+1296+1200 = Rs.
45696.
• When Q = 2000, TC = Purchase cost + order cost + holding cost = 38400+1920+720 = Rs.
• Find the optimal order quantity 41040.
Step 3: Solution:
• Thus, optimum order quantity = 2000 and minimum total annual cost = Rs. 41040

9
Fixed Time Period System (P system) Fixed Time Period System (P system)
• Inventory is counted only at particular times. • A maximum inventory level (Order up to level) for the item is
• Periodic review system developed.
• Fixed order interval systems • It is based on the usage during both the lead time and the order
interval.
• Inventory level is reviewed periodically
• After a fixed period time (T) has passed, the stock position of the item
• Time based inventory system in which orders are placed at equally is determined.
spaced, predetermined points in time.
• An order is placed to replenish the stock.
• Order size is maximum inventory level minus inventory position at the
time of review

Fixed Time Period System (P system) Fixed Time Period System (P system)
• In deterministic fixed order interval systems, the order size is not • Two parameters are maximum inventory level (E) and fixed review
expected to vary, because demand is known and uniform. period (T)
• In other scenarios, Order quantities vary from period to period. • T system
• Counting inventory and placing orders periodically is desirable in • Order up to level E must be large enough to satisfy demand during
situations such as the subsequent order interval T and also during the lead time L
when vendors make routine visits to customers and take orders or • E = RT + RL = R (T + L)
when buyers want to combine orders to save transportation costs.

Fixed Time Period System (P system) Fixed Time Period System (P system)

10
 Fixed Time Period System (P system) –
Fixed Time Period System (P system)
Example 1
• The Williams manufacturing company purchases 8000 units of a
product each year at a unit cost of Rs. 1000. The order cost is Rs.
3000 per order, and the holding cost per unit per year is Rs. 300.
What are the economic order interval, the maximum inventory level,
and the total annual cost when the lead time is 10 days and there are
250 operating days in the year?
• Ans: T = 12.5 days
• E = 720 units
• TC = Rs. 8120000

Fixed Time Period System - Example 2 Batch type production systems

• The demand of a particular product is 200 units per year. The cost of • Products are often made to stock in lot sizes
placing and receiving an order is Rs. 400. The cost of each unit is Rs. • Multiple products are produced on the same equipment
100. The cost of carrying inventory is 16 % of the purchase cost of an
item. What is the economic order interval, the maximum inventory • Planning batch production involves the determination of the
level, and the total annual cost when the lead time is 3 months? optimum number of units to include in each production run to
minimise the total annual costs.
• [Ans: 6 months, 150 units, Rs. 21600]

Batch type production systems – single items Economic Production Quantity (EPQ)
• EOQ formulation assumptions are valid (modify it in terms of production). • The items are produced and added to the inventory gradually rather
• Purchase cost – production cost consists of direct labor, direct materials, than once.
factory overheads, etc. • The EOQ model must be revised to accommodate this change - EPQ.
• Ordering cost – setup cost • The inventory level will never be as large as the lot size.
• Setup cost is the cost of the time required to prepare the equipment or • Production and consumption simultaneously occur.
workstation to do the job and to dismantle it after the job is finished.
• Plant output can be substantially affected by the number and length of
setups.
• The assumption that the entire order is received into inventory at one time
is not valid

11
Economic Production Quantity (EPQ) Economic Production Quantity (EPQ)
• Production starts at time zero and ends at time tp
• During tp to t1, no production occurs and the inventory stock is
depleted.
• At time t1, a new production run is started.
• p – production rate, r – demand rate
• Max inventory level = (p-r)*tp
• tp = Q/p
• Average inventory
• Total annual cost minimisation = P*R + C*R/Q + H*Q*(p-r)/2p

Economic Production Quantity (EPQ) Economic Production Quantity (EPQ)

2𝐶𝑅𝑝 • The demand for an item is 20000 units per year, and there are 250 working
• Q* = days per year. The production rate is 100 units per day, and the lead time is
𝐻(𝑝−𝑟) 4 days. The unit production cost is Rs. 50, the holding cost Rs. 10 per unit
per year, and the setup cost is Rs. 20 per production run. What are the
• Optimum length of production run = Q*/p economic production quantity, the number of runs per year, the reorder
point, and the minimum total cost?
• Production reorder point = B = R*L/N = r*L • r = 80 units per day
• L – lead time in days • Q* = 632
• m = 31.6 runs per year
• N- number of working days in a year
• B = 320 units
• TC = Rs. 1001264

Independent demand systems: Probabilistic

Safety stock or safety inventory
scenario
• If demand and lead time are treated as constants, they are called • Safety inventory is inventory carried to satisfy demand that exceeds
deterministic the amount forecasted for a given period.
• If they are random variables – probabilistic • Safety Inventory is carried because:
• Basic probabilistic model assumes that demand remains Demand is not constant.
approximately constant with time and that it is possible to state the A Product Shortage may result if actual demand exceeds the
probability distribution of the demand. forecasted demand.
• Attention is focused on distribution of demand during lead time. • Safety inventory is the average inventory remaining when the
replenishment lot arrives
• Variations in demand and lead time are absorbed by provision for • Average inventory in the supply chain is therefore cycle inventory
safety stocks. (average working stock) plus safety inventory

12
Independent demand systems: Probabilistic
Safety inventory
models
Safety stocks will be larger for:
• High stockout costs or service levels
• Lower holding costs
• Larger variations in demand
• Larger variations in lead time

Realistic inventory model

Probabilistic Demand

Probability of Risk of a stockout

no stockout (5% of area of
95% of the time normal curve)

Mean ROP = ? kits Quantity

demand
350
Safety
stock
0 z
Number of
standard deviations
76

Normal distribution
• Bell shaped
• Symmetrical
• Spread is characterized by sigma
• Any normal distribution can be transferred into the standard normal
distribution.
• Mean=0, std. deviation=1
• Z-distribution
• Probability is measured by area under the curve.

77

13
 Probabilistic Demand Probabilistic Demand
Use prescribed service levels to set safety
stock when the cost of stockouts cannot be where Z = number of standard deviations
determined
s dlt = standard deviation of demand
during lead time
ROP = demand during lead time + Zsdlt s d = standard deviation of demand per day
s lt= standard deviation of lead time in days
where Z = number of standard deviations d = average daily demand
s dlt = standard deviation of demand L = average lead time in days
during lead time

Probabilistic Example Probabilistic Models

Average demand of a product during lead time = m = 350 units

Standard deviation of demand during lead time = s dlt = 10 units
5% stockout policy (service level = 95%). Determine ROP and SS

Using standard normal distribution table, for an area

under the curve of 95%, the Z = 1.645 1. Demand is variable and lead time is constant
Safety stock = Zs dlt = 1.645(10) = 16.45 kits 2. Lead time is variable and demand is constant
3. Both demand and lead time are variable
Reorder point = expected demand during lead time
+ safety stock
= 350 kits + 16.45 kits of safety
stock
= 366.45 or 367 kits

Other Probabilistic Models Probabilistic Example

Demand is variable and lead time is constant Average daily demand of a product (normally
distributed) = 15 units
Standard deviation of daily demand = 5 units
ROP = (average daily demand Lead time is constant at 2 days
x lead time in days) + Zs dlt 90% service level desired. Determine ROP and SS
Z for 90% = 1.28
where s d = standard deviation of demand per day
ROP = (15 units x 2 days) + Zsdlt From Table
s dlt = s d lead time = s d * 𝑳 = 30 + 1.28(5)( 2)
= 30 + 9.05 = 39.05 ≈ 39

Safety stock is about 9 units

14
 Other Probabilistic Models Probabilistic Example

Lead time is variable and demand is constant Daily demand (constant) = 10 units
Average lead time = 6 days
ROP = (daily demand x average lead Standard deviation of lead time = s lt = 3 days
98% service level desired. Determine ROP and SS
time in days) + Z x (daily
demand) x s lt Z for 98% = 2.055
ROP = (10 units x 6 days) + 2.055(10 units)(3)
where s lt = standard deviation of lead time in days = 60 + 61.55 = 121.65

Reorder point is about 122 units

Other Probabilistic Models Probabilistic Example

Average daily demand (normally distributed) = 150 units
Both demand and lead time are variable Standard deviation = s d = 16 units
Average lead time 5 days (normally distributed)
Standard deviation = s lt = 1 day
ROP = (average daily demand 95% service level desired. Determine ROP and SS
x average lead time) + Zs dlt
Z for 95% = 1.645
where s d = standard deviation of demand per day
ROP = (150 packs x 5 days) + 1.645sdlt
s lt = standard deviation of lead time in days
s dlt = (average lead time x s d2)
= (150 x 5) + 1.65 (5 days x 16 2) + (1502 x 12)
+ (average daily demand) 2s lt2 = 750 + 1.645(154) = 1,004 packs

EOQ sensitivity EOQ sensitivity

• Determines how the output of a model will be influenced by changes • EOQ model is robust
or errors in the input data (parameters). • That is the variations in setup costs, holding costs, and demand make
• If an input can assume a wide range of values without appreciably relatively modest differences in total cost.
affecting the output, the model is insensitive 𝑋𝐶 ∗𝑋𝑅
• Sensitive and insensitive models • Order quantity error fraction = (Q-Q*)/Q* = -1
𝑋𝐻
• Errors in calculating R, H, C will cause variations in output (EOQ and • TVC error fraction = 𝑋𝐶 ∗ 𝑋𝑅 ∗ 𝑋𝐻 - 1
total cost) 𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑑𝑒𝑚𝑎𝑛𝑑
• XR = 𝑎𝑐𝑡𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
= demand error factor, Similarly for XC, and XH

15
 EOQ sensitivity example 1 EOQ sensitivity example 1
• In a fixed-order size system, the estimated and actual parameter a) -29.3 %
values are given below. What is (a) the individual effect of the holding b) 41.4 %
cost error on TVC (Q*), (b) the combined effect of the parameter
errors on Q*, and (c) the combined effect of the parameter errors on c) -29.3 %
TVC(Q*)?
Parameter Estimate Actual
R 1000 2000
H 10 20
C 50 25

Selective inventory control

• An equally critical analysis of all items required in an organization will be
very expensive in the sense that there may not be any saving by control
process on low value items.
• This is because cost of time used by the personnel of the organization in
Selective inventory control the process will be more than that of the cost saving by inventory control.
• Selective inventory control is used to identify items, which bring
significant benefit by proper management from among hundreds and
thousands of items managed by an organization.

93 94

Selective inventory control ABC Analysis

• Determine the importance of items and thus allows different levels of • In an industry, large varieties of inventories are present.
control based on the relative importance of items. • Each variety may have different cost and volume.
• Selective inventory control is an essential part of materials
management.
• It is not economical to give uniform control to all the items.
• Some inventories are critical items while others may be non-critical
ones.
• According to the nature of the inventories carried by an organization, a
suitable method of classification should be chosen.

95 96

16
 ABC Analysis Procedural steps:
• This is a type of Pareto analysis. • Identify all the items used in an industry.
• List all the items as per their value.
• Classification based on cost and usage volume (Annual usage value). • Count the number of high valued, medium valued and low valued
items.
• The inventories are grouped into 3 groups, A, B, C. • Find the percentage of high, medium and low valued items.
• High valued items normally constitute for 70-80 % (around 10 % of the
total items) or so of the total inventory cost and medium and low
valued items, 15-20 % (15 to 20 % of the total items) and 5-10 %
(around 75 % of the total items) respectively.

97 98

A Type inventory: B Type inventory

• High valued items (normally limited in number). • Medium valued and their number lies in between A and C type items.
• This means that their annual consumption is very less but these are
very costly items. • They require moderate control.
• ABC analysis recommends careful control of A type inventory.
• Involvement of higher level of management is recommended in the
review process.
• They are purchased in small quantities and just before their use.
• This increases the procurement costs and involves a little risk of non-
availability.

99 100

C Type inventory ABC analysis

• Low valued, but maximum number of items.
• Do not need much control (or do not need any control).
• Controlling them is un-economical in many instances.
• Least important items like, clips, pins, washers, rubber bands, etc.
• Bulk purchase of items .
• Lesser number of orders.

101 102

17
VED ANALYSIS SDE analysis
• Vital, Essential, and Desirable • Scarce, difficult, easily available
• Vital items – non availability of item may cause serious production • Scarce items are short in supply, and their availability is scarce. (eg:
loss. Procurement lead time may be very high. imported items)
• Essential items – stockouts of these items may cost very high • Difficult items cannot be procured easily. These items may not be
• Desirable items – do not cause any immediate loss in production available in local market, there may be limited number of suppliers,
etc.
• All other items are easily available
• VED analysis helps in focusing on vital items and ensuring their
availability by frequent review.
• Best suited for spares inventory
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HML Analysis FSN ANALYSIS

• Items are classified as High, Medium and Low Price. • Fast moving, slow moving, non-moving
• Based on unit price or cost
• The items are listed according to the descending order of the unit • This form of classification identifies the items frequently issued, less
price for classification frequently issued and the items which are not issued for longer
• The cutoff costs are then specified for each category. period.

• Locates all fast moving items near the dispensing window to reduce
handling efforts.

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SOS analysis
• SOS analysis is based on seasonality of items and it classifies all the
items into two categories ‘Seasonal’ and ‘Off seasonal’.
• The analysis helps in: Identifying items that are available only during a
limited period of the year.
• Eg: raw mangoes are available during summers
• Their costs in offseason are relatively high
• Determines the right season for procuring an item.

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