itl lecture-12 & 13 (inventory management)

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By :

Prof. Amit Kumar

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“Logistics has advanced from warehousing and transportation to boardrooms of the successful leading companies across the world. Due to increasing importance of business logistics, it becomes necessary for the student pursuing management education from IILM- Graduate School of Management, to understand logistics, its basic framework and practical utility.”

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Importance of this course

International Trade Logistics

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Course: International Trade Logistics1. Logistics - At the Centre of World Trade

2. Supply Chain Management

3. Warehousing: A Role Beyond Storage

4. Material Handling & Storage System

5. Inventory Management

6. Transportation: Backbone of Logistics

7. Logistics Packaging

8. Logistics Information System

9. Global Logistics & Outsourcing

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International Trade Logistics

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International Trade Logistics Inventory Management

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Contents• Inventory Flow-Bullwhip Effect• Inventory- Assets or Liability?• Inventory Decisions & Costs• Inventory Expectations• Inventory Functionality• Inventory Controls

ABC Analysis, VED Analysis SAP Analysis, FSN Analysis Inventory Decision Matrix Case: Inventory Reduction by Supply Chain

Reengineering at Asian Paint• Inventory Management System

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• Inventory is technically an asset, but it is indirectly taxing on the profitability of the firm.

• Corporations across the world always finding different methods ad techniques to reduce the investments in inventory.

• It is probably common sense that inventory should be hold only when the benefits of holding inventory exceed the cost of holding it.

Introduction: Inventory Management

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Bullwhip Effect• While customer demand for specific products does not vary much• Inventory and back-order levels fluctuate considerably across

their supply chain • P&G’s disposable diapers case

Sales quite flat Distributor orders fluctuate more than retail sales Supplier orders fluctuate even more

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• Inventory constitutes the second largest item after fixed asset in the financial balance sheet of a company.

• From a financial perspective, inventory is one of the major current assets that can contribute to maximizing the value of the firm and no significant disadvantages are seen in carrying more inventory.

• But investments in inventory carry cost.

Today, inventory management is viewed as a supply chain cost driver rather than as a material asset. Hence, the lean supply chain operating on material requirement

planning (MRP) or JIT system is preferred.

Inventory- Assets or Liability?

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Inventories may be held for a variety of purposes, but in general, there are five types of inventories that an organization can use for serving these purposes. Theseare:

1. Movement Inventories2. Buffer Inventories3. Anticipation Inventories4. Decoupling Inventories5. Cycle Inventories

Types of Inventory

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Movement inventories are also called transit or pipeline inventories. Their existence owes to fact that transportation

time is involved in transferring substantial amounts of resources.

For example, when coal is transported from the coalfields to an industrial town by trains, then the coal, while in transit,

cannot provide any service to the customers for power generation or for burning in furnaces.

Types of Inventory: Movement

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Buffer inventories are held to protect against the uncertainties of demand and supply. An organization

generally knows the average demand for various items it needs. However, the actual demand may not exactly match

the average and could well exceed it.

To meet this kind of situation, inventories may be held in excess of the average or expected demand.

Types of Inventory: Buffer

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Similarly, the average delivery time( that is, the time elapsing between placing an order and having the goods in stock ready to use, and technically called as the lead time) may be known. But unpredictability events could cause the

actual delivery time to be more than the average.

Thus, excess stocks might be kept in order to meet the demand during the time for which the delivery is delayed.

This stock is also known as safety stocks.


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The idea of keeping buffer stocks is to render a higher level of customer service and consequently reduce the number of stock outs and back-orders. A stock out occurs when a

customer is denied fulfillment of an order because the inventory of the item(s) has run out. In some situations

back-ordering is possible(i.e. the order for goods demanded may be fulfilled as soon as the next shipment of

the item(s) is received while in others it is not and the demand might be lost forever leading to

temporary/permanent loss of the customer goodwill.

The optimum level of the buffer stocks to be held can be determined.


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Anticipation inventories are held for the reason that a future demand for the product is anticipated. Production of

specialized items like crackers well before Diwali, umbrellas and raincoats before rains set in, fans while summers are

approaching, are all examples.

The idea is to smoothen the production process producing for a longer duration on a continuous scale rather than

operating with excessive overtime in one period and then let the system to be idle or close down for the reason of

inadequate/ no demand for another period.

Types of Inventory: Anticipation

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The idea of the decoupling inventories is to dis-couple or disengage, different parts of the production system. As we

can observe easily, different machines/equipment and people normally work at different rates: some slower and some faster. A machine, for example, might be producing half of the output of the machine on which the item being handled to be processed the next. Inventories in between the various machines are held in order to disengage the processing on those machines. In the absence of such inventory, different machines and people cannot work

simultaneously on a continuous basis. When such inventories are held, then, even if a machine breaks down,

the work on others would not stop.

Types of Inventory: Decoupling

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Cycle inventories are held for the reason that purchases are usually made in lots rather than for the exact amounts which may be needed at a point of time. If purchases are

made frequently and in small numbers, then the cost involved in obtaining the items would be very large.

As the cycle inventories are related to the purchases in lots, they are also called lot-size inventories.

Types of Inventory: Cycle

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In an inventory control situation, there are three basic questions to be answered. They are:

1.How much to order? That is to say, what is the optimal quantity of an item that should be ordered whenever an order is placed?2.When should the order to be placed?3.How much safety stock should be kept? (buffer stock)

Inventory Decisions

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Inventory as Percentage of Sales

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Company

Sales turnover

(Rs millions)

Raw material & components

(% of sales)

Work in progress

(% of sales)

Finished goods (% of sales)

Total inventories

(% of sales)

L & T 179006 2.24 13.14 1.37 16.75

M & M 102450 6.81 0.37 4.37 11.55

Raymond 13749 4.36 6.30 9.86 20.52

Godrej 7581 5.02 2.82 7.62 15.46

Ranbaxy 40713 10.17 5.38 8.42 23.97

Sterlite Ltd 124576 7.84 6.60 0.40 14.84

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Inventory Expectations

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Inventory Expectations

Finance Department• Lower inventory levels• Low cost of operations• Higher inventory turnover• Lower cost of delivery

Sales & Marketing• Quick Delivery• No stocks outs• Varieties and volumes• Frequent & small deliveries

Manufacturing Department• Less varieties• Economic batch quantity• Quick off takes• No rejection and cancellations

Top Management• Higher inventory turnover• Lower operating cost• Excellent customer service

Not only external customers make demands on the inventories but internal customers such as top management,

finance, manufacturing also have different expectation.

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Irrespective of its location in the supply chain, product inventory essentially serves the following functions:

• Balancing Supply and Demand• Periodic variation• Scale Economics

Inventory Functionality

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Reasons for Carrying Inventories

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• Meeting Production Requirements• Supporting Operational Requirements• Customer Service Considerations• Hedge Against Future Expectation

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Inventory-Related Costs

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Inventory Related Costs

Inventory Costs

Exchange Rate Costs

Ordering Costs

Warehousing Costs

Carrying Costs

Damages, Loss,Pilferage Cost

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The classical inventory analysis identifies four major cost components:1.Purchase Cost2.Ordering Cost / Set-up Cost

• Ordering cost is incurred whenever the inventory is replenished. It includes cost associated with the processing and chasing of the purchase order, transportation, inspection for quality, expediting overdue orders and so on.

• It is also known as procurement cost.• Parallel to the ordering cost when units are produced within the

organization is the set-up cost. It refers to the cost incurred in relation to developing the production schedules, the resource employed in making the production system ready and so on.

Inventory Costs

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3. Carrying Cost / Holding Cost• Also known as holding cost or storage cost. Carrying cost

represents the cost that is associated with storing an item in inventory. It is proportional to the amount of inventory and the time over which it is held.

• The element of carrying cost include the opportunity cost of capital invested in the stock, the cost directly associated with storing goods (like, store men's salary, rates, heating and lighting, racking and pelletisation, protective clothing, store’s transport etc), the obsolescence cost (including scrapping and possible rework), deterioration costs and costs incurred in preventing deteriorations; and fire and general insurance.

• The carrying cost is usually expressed as a rate per unit or as a percentage of inventory value.

4. Stock-out Cost

Inventory Costs

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Inventory Controls

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• The variability in customer demand if not conveyed properly with distortion as it travels upstream in supply chain- the phenomenon called bullwhip effect- cause either stock-outs or inventory pile-ups.

• Bullwhip effect is a deformation in information when it goes upstream in the supply chain. The ripple effect of demand volatility results in inventory problems impacting on profitability and customer service of the firm.

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Inventory Controls

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The after-effects of bullwhip phenomenon can be minimized by using the latest inventory control

techniques supported by an efficient and effective information flow for the supply chain.

The ultimate objective of the inventory control program is to provide maximum customer service

at minimum cost.

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Inventory ControlsInventory Reduction by Supply Chain

Reengineering at Asian Paints

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With the industry business becoming complex, most companies have restructured. At Asian Paints this

was essential in order to tighten inventory controls and simultaneously achieve customer satisfaction.

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Color dispensing machines, both computerized and manual, have transformed the business, particularly

on the manufacturing and distribution sides.

Earlier, paint companies were required to manufacture all the shades (30-50 depending on the product line) in all the packs (5-8 packs). The

result was a drastic reduction in plant-level finished goods inventory.

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The demand pattern was difficult to predict even with the support of historical data/trends, as consumer

preferences were changing fast.Machines altered the production pattern from shades

to producing bases thus providing economies of scale, reduced inventory level and eliminate

redundancy of stocks.This has helped expand the range of shades for each

product category, offering a choice of shades to consumers in the hundreds

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There are approximately 11,000 color- tinting machines installed at the dealers’ end, including multiple

machines at some counter.

With the strategy of ‘postponement’ of finished goods making at the demand point rather than at the

manufacturing plant, Asian Paints reduced its finished goods variety and volumes at plant level.

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Inventory ControlsSelective Control Techniques

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In these methods the degree of control varies with the importance of the item in the supply chain.

Following are the methods in practice:1. ABC Analysis2. VED Analysis3. SAP Analysis4. FSN Analysis

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Inventory ControlsSelective Control Techniques: ABC Analysis

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• ABC inventory classification method is used to recognize inventory into groups based upon certain activity characteristics.

• It is a process of classification of products per the level of importance in terms of their relative criteria such as purchase or sales volume.

• Examples of ABC classification include: ABC by velocity (times sold) ABC by sales in rupees ABC by quantity sold or consumed ABC by average inventory investment ABC by margin

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Inventory ControlsSelective Control Techniques: VED Analysis

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• These relates to Vital, Essential and Desirable status of inventory items.

• As the term implies, certain parts and items are considered to be vital for meeting operational requirements and this aspect is taken into consideration while making the forecast.

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Inventory ControlsSelective Control Techniques: SAP Analysis

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• Scarce, Availability and Plenty status of inventory item is used for planning and forecasting of inventory requirement.

• The ordered quantity is governed by the scarcity factor.

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Inventory ControlsSelective Control Techniques: FSN Analysis

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• Fast, Slow or Normal determines the consumption pattern of an item.

• However, a consumption pattern where the production run is slowed down for various reasons may not give a realistic picture for procurement action. these

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Inventory ControlsInventory Decision Matrix

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Continuous reviewProcure as neededHigh safety stockLow order quantity

Continuous reviewProcure as neededLow safety stockLow order quantity

Periodic reviewHigh safety stockHigh order quantity

Periodic reviewLow safety stockHigh order quantity

HighV E D

A

C

B

High Low

Low

Critically of Item

ConsumptionValue

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Inventory ControlsInventory Decision Matrix

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• For all these control techniques, the degree of control varies with the importance of the items.

• For the A class vital, scarce and fast moving items perpetual reviews are recommended.

• While for B class essential, medium moving items, periodic review will be OK.

• In the case of Class C desirable, slow moving items, the periodicity of review will be longer.

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Basically, there are two inventory management systems. They are:1.Fixed order quantity system, in which a level called the re-order level is determined. As soon as the stock level reaches this point, an order for a predetermined number of units is placed.2.Periodic review system, where inventories are replenished at fixed intervals of time. Whereas the size of the order is fixed in the previous system and the time is not, in this system the time after which the supplies are ordered is fixed but not the quantity to be ordered.3.There is another system, called Ss system, which combines the features of both of these.

Inventory Management System

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The fixed-order quantity system of inventory management is also called the Q-system.

Under this system a re-order point is established and as soon as the stock level reaches this point, a fresh order for supplies is triggered. We shall consider this system under conditions of certainty (i.e. when the demand and the lead

time are known with certainty) and then extend it to probabilistic conditions when demand and lead time are

uncertain.

Fixed Order Quantity System

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According to this, our cost model would, assuming a period of one year, be

T(Q) = O(Q) + H(Q)

Where, Q = the ordering quantityT(Q) = total(variable ) annual inventory costO(Q) = total annual ordering costH(Q) = total annual holding cost


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Let us develop this model with the following examples, LG Electronics Ltd produces 2000 TV sets in a year for which it needs an equal number of tubes of certain type. Each tube costs Rs 10 and the cost to hold a tube in stock for a year is Rs 2.40. besides, the cost of placing an order is Rs. 150, which is not related to its size. Now, if an order for 2000 tubes is placed, only one order per annum is required. When 1000 units are ordered for, 2 orders in a year are required, while if 500 units are ordered to be supplied, then total of 4 orders per annum are required.


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Naturally, as the numbers of orders places increases the ordering cost goes up. More order, however, would also imply smaller order quantity and, therefore decreasing holding costs. Thus we have a trade-off between the ordering and the holding cost. What we attempt in our EOQ model is, the, to find the order size that minimizes that cost function T(Q). TOTAL ANNUAL ORDERING COST O(Q) = N * AThe value


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itl lecture-12 & 13 (inventory management)

Leadership & Management