What is Inventory?

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 What is Inventory?

1. A physical resource that a firm holds in stock with the

intent of selling it or transforming it into a more
valuable state

2. Purpose of inventory management:

•How many units to order
•When to order
•When to return or replace

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 Reasons We Keep Inventory

• Improve customer service

• Maintain independence of the supply chain
• Bullwhip effect
• Seasonal or cyclical demand
• Hedge against the future (demand, price volatility…)
• Inventory provides independence from vendors
• Take advantage of price discounts
• Transportation discounts
• Protection from shocks (labor strikes, natural disasters, surges
in demand, etc.)

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 Reasons We Keep Inventory

Adding value through inventory:

Quality – Inventory can act as a buffer against poor quality.

Speed – Location of inventory can have a significant impact

on fulfilling customer demand

Flexibility – Location and level of anticipatory inventory

directly effect the firm’s flexibility to meet demand

Cost – Direct effect: purchasing, delivery, manufacturing

Indirect: inventory holding costs, stockouts

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 Reasons Against Inventory

Non-value added costs

Lost opportunity costs

Complacency

Inventory deteriorates, becomes obsolete, spoils, lost, stolen, etc.

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 Types of Inventory

• Raw materials
• Purchased parts and supplies
• Work-in-process (partially completed) products (WIP)
• Items being transported
• Tools and equipment

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 Two Forms of Demand

Dependent
A demand based on demand for another item

Independent
A demand that is not based on demand for another item
For example, The demand for the chairs of a table and the table
itself is based on the demand for the table. The table in this
example is the item with independent demand and the chairs
are the item with the dependent demand.

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 What is Inventory Management?

• Inventory management is the process of keeping track of inventory, and

having the delicate balance of supply and demand firmly mastered.

• Inventory management helps to ensure that proper inventory is

maintained at all times.
• Inventory costs money. Therefore, a company does not want to have too
much inventory or too little inventory.

• Inventory Management must be designed to meet the dictates of the

marketplace and support the company's strategic plan.

• Properly executed, inventory management helps ensure the company

will have exactly the amount of inventory needed.

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 Inventory Management

The basic building blocks of inventory management are:

Sales Forecasting/Demand Management

Sales and Operations Planning
Production Planning
Material Requirements Planning
Inventory Reduction

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 Inventory and Quality Management

• Customers usually perceive quality service as the availability

of goods they want when they want them

• Inventory must be sufficient in both quantity and quality to

provide high-quality customer service

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 Objectives of Inventory Control

Maximize the level of customer service by avoiding stockouts

Promote efficiency in production and purchasing by minimizing

the cost associated with providing an adequate level of customer
service

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 Inventory Costs

Carrying cost
cost of holding an item in inventory

Ordering cost
cost of replenishing inventory

Shortage cost
temporary or permanent loss of sales when demand
cannot be met

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 Economic Order Quantity (EOQ) Models

• EOQ
optimal order quantity that will minimize
total inventory costs

• Basic EOQ model

• Production quantity model

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 Assumptions of Basic EOQ Model

Demand is known with certainty and is constant over

time

No shortages are allowed

Lead time for the receipt of orders is constant

Order quantity is received all at once

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 Inventory Order Cycle

Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

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 EOQ Cost Model

Annual
cost ($) Total Cost
Slope = 0

Minimum Carrying Cost

total cost

Ordering Cost

Optimal order Order Quantity, Q

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 Production Quantity Model

• An inventory system in which an order is received gradually, as

inventory is simultaneously being depleted

• Non-instantaneous receipt model

– assumption that not all inventory is received at once

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 Production Quantity Model

Inventory
level

Maximum
inventory
level

Average
inventory
level

0
Begin End Time
order order
Order
receipt receipt
receipt period

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 Safety Stock

Safety stock
- buffer added to on hand inventory during lead time

Stockout
- an inventory shortage

Service level
- probability that the inventory which is available during lead
time will meet demand

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 Classifying Inventory Items

ABC Classification

A Items – very tight control, complete and accurate records,

frequent review

B Items – less tightly controlled, good records, regular review

C Items – simplest controls possible, minimal records, large

inventories, periodic review

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 Planning Supply Chain Inventory Levels
Two Methods
Anticipatory – Allocate supply to each warehouse based on a forecast
• Determine requirements by forecasting demand for the next
production run

• Establish current on-hand quantities

• Add appropriate safety stock based on stock availability levels and

uncertainty in demand levels

Response-Based (Demand) – Replenish based on the specific need of each warehouse

• Replenishment, production, or purchase of stock are made only when it

has a need exists downstream

• Requires shorter order cycle time, often more frequent, are lower volume
orders

• Determine stock level requirements to meet only most the immediate

planning period (short term)
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 Sales Forecasting/Demand Management
• Accurate sales forecasting allows a company to effectively control
inventory, production facilities, labor, inventory levels and logistics, and is the
base of which most all other operations within the company function.

• Sales forecasting allows a company to better negotiate contracts for raw

materials, logistics, and vendor supplied assemblies.

• An accurate sales forecast provides for a smother running operation

with fewer last minute rushes to fulfill customer requirements.

Production Planning
• Production planning is a complex process that covers a wide range of activities that
insures that material, capacity, and human resources are available when needed. It is
the foundation upon which the manufacturing/distribution organization operates.

• Yogi Berra said it best "if you don't know where you are going, you might not get
there"

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 Material Requirements Planning

• Material Requirements Planning or MRP involves getting material on hand when needed
for production or sales.

• The goal of the MRP or Material Requirements Planning document is to supply information that
will enable the company to have enough inventory on hand to fulfill demand, only when needed,
at a quality level that meets specification, and at the lowest price.

Inventory Reduction
• Inventory reduction is about eliminating excess inventory, improving inventory turn rates,
increasing inventory turnover, and meeting on time delivery.

• Excess inventory ties up money and needs to be reduced in order to free up cash for
investment in revenue-growth activities.

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 Guide to Inventory Accuracy
Think of inventory as $$$ sitting on the shelf
Creating the Culture for Inventor Accuracy

Attitude

Process Definition

Procedure Documentation

Employee Training

Monitoring Process for Compliance

Setting Standards

Tracking Accuracy

Count, Count, Count

Reevaluate
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 Creating the Culture for Inventor Accuracy

Attitude: Maintaining inventory accuracy must be an integral part of the attitude of the
organization. No compromising.

Process Definition: You will struggle to maintain your inventory if you do not clearly define
the processes throughout the organization that affect inventory.

Process Documentation: Document the previously defined processes.

Employee Training: Set a training schedule to train all employees. Make it clear the documented
process is the ONLY way to perform the task.

Employee Testing: Formally test the employees on the procedures. This is the only way to
know if they know and understand the processes.

Monitoring Processes for Compliance: Any observed actions which do not comply with the
written procedures must be addressed immediately.

Setting Standards: Establish minimum production and accuracy standards wherever

practical. Standards should be set high enough, yet be achievable.

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 Creating the Culture for Inventor Accuracy

Tracking Accuracy: Track accuracy on the individual level, department level and
organizational level. Measure as a percent of total transactions performed.

Accountability: Hold people accountable to the documented processes and standards.

Count, Count, Count: Cycle count to evaluate inventory accuracy and to identify areas requiring
additional focus. Cycle counting is often the first step in identifying problems in your
processes.

Reevaluate: Regularly reevaluate your processes and procedures. Again, cycle counting
will help direct you to inefficiencies within your processes.

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 Types of Cycle Counts

100% Audit: This can be done either all at once one time a year, or it can be done
throughout the year.

Forced Cycle Count: Usually done when there is an indication of a problem

with the accuracy of a give storage location.

Follow Up Cycle Count: This is done directly after a stocker or picker has visited
a location. The intent is to verify that the stockers and pickers are
working in compliance with the documented processes.

Random Cycle Count: Cycle Counts performed at random. Not a very effective
method to verify inventory accuracy.

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