INVENTORY MANAGEMENT

Inventory Management
• What is Inventory
• Role of Inventory in Supply chain
• Cost involved in Inventory
• Risk of holding inventory
• Techniques of Inventory control
• JIT concepts and Uses of Kanban
• Basics of EOQ model and ABC Analysis
• Inventory reduction approach in Source ,Make
and deliver
 INVENTORY
MEANING
• held for SALE
• Consumed in the PRODUCTION of
goods/services
 Forms of Inventory for Manufacturing Comp.
Raw materials, Work in process,
Finished goods and stores & spares
Why do we care?
At the firm level:

– Sales growth: right inventory at the right place

at the right time
– Cost reduction: less money tied up in
inventory, inventory management,
obsolescence

Higher profit
 What is Supply Chain Management?

• Supply Chain Management is a set of

approaches utilized to efficiently integrate
suppliers, manufacturers, warehouses, and
stores, so that merchandize is produced and
distributed at the right quantities, to the right
locations, and at the right time, in order to
minimize system-wide costs while satisfying
service-level requirements.
- Levi et. al.
 What is a Supply Chain?
Supply chain management is moving the right items to the right
customers at right time by the most efficient means

Transportation Transportation Customers

Warehousing

Information
flows
Factory

Transportation

Vendors/plants/ports
Warehousing Transportation
Supply Chain
 Role of Inventory in the Supply Chain

Understocking: Demand exceeds amount available

–Lost margin and future sales

Overstocking: Amount available exceeds demand

– Liquidation, Obsolescence, Holding

8
 Role of Inventory in the Supply Chain
f Inventory in the Supply Chain
Improve Matching of
Improve Matching of Supply
Supply
and Demand
and Demand
Improved
Forecasting

Cost Reduce Material Flow Availability

Efficiency Time Responsiveness
Reduce Waiting Time

Reduce Buffer Inventory

Economies of Supply / Demand Seasonal

Variability
Scale Variability

Cycle Inventory Safety Inventory Seasonal

Inventory
9
 Inventory Management

• Inventory : Stock of items kept to meet future demand

• A typical supply chain consists of multiple stages with each

stage have a customer.

• Each stage stocks inventory to meet the customer demand

and achieve target customer service level.

• However, huge inventories are drain on resources as it blocks

money and increase operational costs.
4-10
 Inventory Management

• Decision maker at any stage controls inventory with two

critical decisions:

1. How much to order?

2. When to order?

These decisions impacts inventory level.

4-11
 Inventory Management- objectives

• minimize investments in inventory

• meet the demand for products by

efficiently organizing the production &
sales operations
COSTS OF HOLDING INVENTORIES
• Ordering costs

• Inventory Carrying costs

• Opportunity costs of funds blocked

 Inventory Management
Ordering Costs:
• The ordering costs includes all fixed costs (components of costs
that do not vary with size of order) associated with placing the
order.

• Incremental costs incurred each time an order is placed.

• The main components include:

i. Administration Costs for requisition or purchase or Cost of
Buyer Time
ii. Fixed transportation costs:
iii. Fixed receiving, storage and inspection costs
iv. Accounting and auditing costs 4-14
 Inventory Management
Inventory-Carrying Costs or Inventory Holding Costs:

• It is the cost of carrying one unit of inventory for a specified

period of time.
• This captures all the actual and opportunity costs that are
incurred because of holding inventory.
• It is usually estimated as percentage of cost of product.

• The main components include:

i. Financing Costs
ii. Storage and handling Costs
iii. Inventory Risk or Obsolescence (Spoilage Costs) Costs
4-15
 Inventory Management
Material Costs:

• It is the average price paid per unit purchased.

• Key component in lot sizing decisions.

• Economies of scale: Material costs display economies of scale

and increasing lot size may decrease the material costs.

4-16
 Inventory Management
Computing Inventory Related Costs:

1. Ordering Costs are difficult to compute because they are not

captured at one place in the accounting books.

2. Typically, ordering costs can be anywhere from Rs 1000 to Rs

10000 per order in Indian context.

3. In India, inventory carrying costs varies between 20 to 30

percent of item cost. It varies from industry to industry based
on nature of industry, cost of funds etc.
 Inventory Management
4. Stockout costs are never captured in profit & loss accounts. This is
because stock out costs represent opportunity cost involved in losing an
opportunity to sell and impact on goodwill.

5. For items where substitutes are available, stock out costs are low but for
items where firm do not offer substitute item, stockout cost is high.

6. Since it is difficult to quantify stock out costs, firms find it easier to work
with target service level which an inventory system must meet.

4-18
 Inventory Management
• Service level is generally defined as the probability that all
orders will be filled from stock during the replenishment lead
time or during the reorder cycle.

• A target of 100 % service level requires that inventory system

meets all customer demands from inventory.

• Service levels of 90 to 99 % are commonly used in industry.

• Thus, instead of minimizing total inventory costs, target is to

minimize ordering plus inventory carrying costs plus
material costs meeting the target service level.
4-19
 RISK OF HOLDING INVENTORY
• Price decline

• Product Deterioration

• Product Obsolescence
TOOLS & TECHNIQUES OF INVENTORY
MANAGEMENT/ CONTROL
• ABC Analysis
• Economic Ordering Quantity (EOQ)
• Order Point Problem
• Two Bin Technique
• VED Classification
• HML Classification
• SDE Classification
• FSN Classification
• Order Cycling System
• Just In Time (JIT)
 Inventory Management

1. ABC Classification:
Items are classified on the basis of sales on value terms.
A = very Important
B = Moderate Important
C = Little Important

ABC analysis is used for a) allocation of management time b)

Improvement Efforts c) Setting up service levels d) Stocking
decisions – e.g. A category items at regional distribution
points, C category items at central warehouse, B category at
few regional locations
4-22
 ABC Classification

• Class A
– 5 – 15 % of units
– 70 – 80 % of value
• Class B
– 30 % of units
– 15 % of value
• Class C
– 50 – 60 % of units
– 5 – 10 % of value 13-23
 ABC Classification
Illustration:
The maintenance department for a small
manufacturing firm has responsibility for
maintaining an inventory of spare parts for the
machinery it services. The parts inventory, unit
cost, annual usage are given in following table.
The department manager wants to classify the
inventory parts according to the ABC system to
determine which stocks of parts should be
closely monitored. 4-25
ABC Classification- Illustration
PART UNIT COST ANNUAL USAGE/Demand

1 $ 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120

13-26
 ABC Classification
TOTAL % OF TOTAL % OF TOTAL
PART VALUE VALUE QUANTITY % CUMMULATIVE
9 $30,600 35.9 6.0 6.0
8 16,000 18.7 5.0 11.0
2 14,000 16.4 4.0
A 15.0
1 5,400 6.3 9.0 24.0
4 4,800 5.6 6.0 B 30.0
3 3,900 4.6 10.0 40.0
6 3,600 4.2 18.0 58.0
5 3,000 3.5 13.0 71.0
10 2,400 2.8 12.0 C 83.0
7 1,700 2.0 17.0 100.0
$85,400

13-27
 ABC Classification

% OF TOTAL % OF TOTAL
CLASS ITEMS VALUE QUANTITY
A 9, 8, 2 71.0 15.0
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0

Example 10.1
13-28
 Inventory Management

3. VED Classification:
• Items are classified on criticality:
• Vital = V,(high stock level) Essential =
E(moderate stock level) , Desirable =
D(minimum stock level)
• This type of classification is popular in
maintenance management.
• One can fix different service levels for
different items.
4-29
 Inventory Management

2. FSN classification
• Items are classified as Fast moving , slow
moving and non-moving.
• Slow moving items are stored centrally and
fast moving items are stocked de-centrally.
• Non-moving items are candidates for disposal.
• This type of classification is popular in retail
industry.
4-30
 Economic Ordering Quantity (EOQ)
• Level of Inventory at which

• Total Cost* of Inventory is MINIMUM

*(Ordering and Carrying Cost)
 EOQ MODEL
2D Co
Q =
Cc

Q = Economic Order Quantity

D = Annual usage/demand
Co = Cost of Placing an order
Cc = Storage cost per unit per order
* Where Storage cost is given in % , it is always calculated by
multiplying the % with the purchase price of raw material
per unit, i.e Storage cost = % X Purchase price of raw
material
BEHAVIOUR OF INVENTORY RELATED COSTS

Costs
Total costs

Carrying costs

Ordering costs
Quantity ordered
 Inventory Order Cycle

Order quantity, Q
Demand Average
rate inventory
Inventory Level

Q
2

Reorder point, R

0 Lead Lead Time

time time
Order Order Order Order
placed receipt placed receipt

Fixed Order Quantity Model ( Continuous Review Model)

Reorder point= L*d; Average cycle stock = Q/2 13-34
 If demand is known exactly, place an order when
inventory equals demand during lead time.

Order Q: When shall we order?

Quantity A: When inventory = ROP
Q Q: How much shall we order?
A: Q = EOQ
Inventory

Reorder
Point
(ROP)
ROP = LxD

Lead Time
Time
D: demand per period
Place Receive
L: Lead time in periods
order order
 Inventory Management
Ordering cost

• Since annual demand is D, the retailer will have D/Q such cycles in
an year.
• In each cycle, retailer incurs ordering costs of Co.
• Total annual ordering cost shall be Co x D/Q

• Total Annual Inventory Related Costs = Q/2 x Cc + Co x D/Q

Thus inventory carrying costs(or holding costs) increases linearly

with order size Q and Ordering costs decreases exponentially with
order size Q.
4-36
Inventory Management

Q/2 x Cc

Co x D/Q

4-37
 EOQ Cost Model
Annual
cost ($) Total Cost
Slope = 0
CcQ
Minimum Carrying Cost =
total cost 2

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt

13-40
 Inventory Management

Cycle Stock + Safety Stock

Inventor
y

Average Cycle Inventory

Inventory
Safety Inventory

Time

Average inventory carried by the firm is the average cycle inventory plus safety
inventory.
 EOQ- Example
• A firm’s annual inventory is 1,600 units. The cost of placing
an order is Rs 50, purchase price of raw material/unit is
Rs.10 and the carrying costs is expected to be 10% per unit
p.a. Calculate EOQ?

D=1600, Co= Rs. 50, Cc= .10 x Rs.10=Rs.1

EOQ = 2 x 1600 x 50
1

= 400 units
 Order Point Problem
• The re-order point is that level of inventory when a fresh order
should be placed with suppliers. It is that inventory level which is
equal to the consumption during the lead time or procurement
time.
• Re-order level = (Daily usage × Lead time) + Safety stock.
Alternately Maximum rate of consumption x maximum reorder
time
• Minimum level = Re-order level – (Normal usage × Average delivery
time).
• Maximum level = Reorder level – (Minimum usage × Minimum
delivery time) + Re-order quantity.
• Average stock level = Minimum level + (Re-order quantity)/2.
• Danger level = (Average consumption per day × Lead time in days
for emergency purchases).
 Two Bin Technique
• Control of Category ‘C’ inventories
• Two Bins/Groups
First Bin- just enough to last from the date a
new order is placed until it is received
for inventory.
Second Bin- enough to meet current demand
over the period of replenishment.
 HML Classification
• Material classified on the basis of UNIT VALUE

 H- HIGH VALUE
 M- MEDIUM VALUE
 L – LOW VALUE
 FSN Classification
• Inventory is classified based on the
MOVEMENT OF INVENTORIES from stores
• Inventory technique used to AVOID
OBSOLESCENCE
 F- Fast moving
 S- Slow moving
 N- Non moving
 Inventory Management
Pipeline Inventory:
• Also called in-transit inventory.
• It consists of materials actually being worked on (work-in-
process inventory) or being moved from one location to
another in the chain (on transit inventory).
• Pipeline inventory of an item between two adjacent
locations is the product of the process time or transport
time and usage rate of an item
• Pipeline inventory may be reduced by using faster rater of
transporting or by reducing manufacturing lead time.
4-50
 Inventory Management
Illustration :

LT -Shipment by air = 7 days

LT- Shipment by sea = 45 days
Average demand = 100/day
Pipeline Inventory ( Shipment by air) = 700 units
Pipeline Inventory ( Shipment by Sea = 4500 units
Supply Chain Management

JIT Essentials
• No inventory (finance) costs

• 100% accurate manufacturing quality (no defectives- Japanese story)

• Error Proof Processes

• Low set up times

• No warehousing costs

• Lower handling costs

• Closer buyer-seller relationships (partnership, external manufacturing)

• Worker participation (Q circles , Multiskilling

Internal | JaP/CLP | 6/23/2015 | © Bosch Limited 2015. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, 52
distribution, as well as in the event of applications for industrial property rights.
Supply Chain Management

JUST-In-Time Purchasing
Just-in-time (JIT) purchasing is the purchase
of goods or materials such that a delivery
immediately precedes demand or use.

Companies moving toward JIT purchasing

argue that the cost of carrying inventories
(parameter C in the EOQ model) has been
dramatically underestimated in the past.

Internal | JaP/CLP | 6/23/2015 | © Bosch Limited 2015. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, 53
distribution, as well as in the event of applications for industrial property rights.
Supply Chain Management

Vendor Management Inventory

• Other names:
 Continuous replenishment Planning (CRP)
 Supplier Managed Inventory (SMI)

• The supplier is responsible for maintaining the Customer’s Inventory Management.

• The supplier has access to the customers inventory data.

• The Supplier is responsible for generating purchasing orders.

Internal | JaP/CLP | 6/23/2015 | © Bosch Limited 2015. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, 54
distribution, as well as in the event of applications for industrial property rights.
 Inventory Management
Safety Inventory :
• Cycle Safety Inventory model assumed that there is no
uncertainty in demand and supply.

• Actual Demand may differ from the forecasted demand for a

given period due to demand fluctuations or forecast errors –
Demand Uncertainty

• Also, supplier lead time may be uncertain – Supply

Uncertainty

4-55
 Inventory Management

• Actual demand may exceed the demand forecasted for a

given period.

• The uncertainty in demand or supply may lead to a “stockout

situation”.

• To take care of stockout situations, firms carry safety

inventory

4-56
 Inventory Management

Cycle Stock + Safety Stock

Inventor
y

Average Cycle Inventory

Inventory
Safety Inventory

Time

Average inventory carried by the firm is the average cycle inventory plus safety
inventory.
INVENTORY REDUCTION APPROACH
Inventory Reduction to be applied in the whole supply
chain starting from supplier to customer
Area defined for Reduction in Inventory

• Monitor inventory coverage throughout the supply chain

• Follow clear process & target coverage in source , make &
deliver
• Reduce Lead time & eliminate waste in supply chain

JaP/PJ-PC | 03/11/2016
2 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.
Source
Approach followed for inventory reduction at
Source

JaP/PJ-PC | 03/11/2016
3 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.
Supply Chain Management

Internal | JaP/CLP | 6/23/2015 | © Bosch Limited 2015. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, 60
distribution, as well as in the event of applications for industrial property rights.
Make
Approach followed for inventory reduction at
Make Points to be focused
• Awareness at all levels in
shop floor for keeping
minimum inventory
• Improvement in OEE of
machines
• Reduction in cycle time
• Reduction in safety stock at
shop floor
• Pull loop concept within
shops
• Levelled production

JaP/PJ-PC | 03/11/2016
10 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.
Make
1.Production Leveling
• Production to be planned in a levelled way as per Customer requirement
• Runners to be produced more frequently
• Reduce the set time in order to increase the frequency
• Upstream components to be planned as per levelled plan & supermarket to
be defined based on lead time
• Exotics need not be planned for supermarket
• Through internal milk run in cyclic manner lead time from store to shop floor
to be reduced for issue of parts
• Minimum stock to be maintained at shop floor
• Higher the levelling maturity lesser is the pipeline inventory .i.e. Raw
material, WIP &FG
• Levelling ensures a defined way of production at a definite frequency
• Production quantity not to be produced more than customer requirement

JaP/PJ-PC | 03/11/2016
11 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.
 KANBAN SYSTEM
• a Japanese manufacturing system in which the
supply of components is regulated through the use
of an instruction card sent along the production line.
• an instruction card used in a kanban system.
• Essentially, kanban inventory management is a way
to have only the minimum amount of stock on hand
that is necessary at that time. This avoids purchasing
more than you need and having to allocate space to
warehouse that extra inventory. More than that,
kanban is a way to avoid bottlenecks in your
workflow.
 Kanban system
Kanban, the pull inventory system, provides a
number of benefits for your production line.
• Reduce Inventory & Product Obsolescence. ...
• Reduces Waste and Scrap. ...
• Provides Flexibility in Production. ...
• Increases Output. ...
• Reduces Total Cost.
• Increased visibility of the flow
• Improved delivery speed
• Improved predictability
• Improved dependencies management
• Increased customer satisfaction
Make
Production Leveling
Kanban Formula

K = RE + LO + WI + SA

SAfety Time coverage

Fluctuation & Problems
Withdrawal Peak coverage
Planned Customer
Withdrawal
Lot Size coverage
Lot size building
REplenishment time Coverage
Demand based on customer takt within replenishment time of
1 Kanban
Number of Kanban
Number of Kanban for SNR in Kanban loop

JaP/PJ-PC | 03/11/2016
12 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.
Deliver
Approach followed for inventory reduction at
Deliver

JaP/PJ-PC | 03/11/2016
14 © Bosch Limited 2016. All rights reserved, also regarding any disposal, exploitation, reproduction, editing, distribution, as well as in the event of applications for industrial property rights.