Brunel School of Business and Management
BOLA : Business Open Learning Archive
Prev The Management of Inventory: Overview

Inventory incurs costs, ties up working capital, itconsumes space and must be managed in and out. Stocks can deteriorate or get stolen. Most operations, capacity planning and scheduling, depend on inventory. Stocks serve to smooth out timing gaps in the rates of supply and demand. Inventory offers insurance and good planning/ control can minimise the associated costs and satisfy efficiency/effectiveness requirements. This is the raison d'etre for a just-in-time approach to inventory.

Services generally are not stocked nevertheless in car repair services and retail distribution, inventory of support items are components of service transactions. For a central heating installation company, if a fitter has to drive to and queue at a supplier to obtain a minor part - this adds to service costs.

All organisations keep inventories - some trivil, some highly significant. Even the trivial can from another prespective e.g. health and safety take on a different degree of importance. What is trivial to one organisation is important to the next e.g. cleaning materials - trivial in a factory but essential to a supplier of cleaning materials. Spares, stationery, consumables are common inventory to all organisations.

Inventory values and decisions

Types of stock/inventory

Slack et al. Galloway
  • buffer/safety
  • raw materials
  • cycle
  • finished product
  • anticipation
  • work in progress
  • pipeline
  • consumables
    • -
  • spares
    • -
  • strategic stock holding

    • Single and multi-stage inventory systems

    A retail shop exemplifies a single stage inventory system. Supplier deliveries are taken into stock and sold. For a supermarket there are two stages. The supplier e.g. Nestle will supply, say, a Safeway regional distribution centre which supplies each supermarket. A washing machine manufacturer will transform raw material stocks through several stages with work in progress stock existing between each stage. Finally the whole of a supply network between companies making different ingredients to many products can be charted. Yarn manufacturers supply fabric firms who supply clothing firms. The cloth may be distributedto retailers via regional depots. Quantities of fabric may be sold direct to customers in the "factory shop".

    Out-of-stock situations
    Operations mostly depend on stock. Raw materials shortage in manufacturing means halting production, rescheduling to make something that has raw materials or quick action to secure alternative supply.

    Obviously average inventory for a stock item is represented by half the stock. A replenishment delivery is received (Q) and is added to any remaining stock. In an out of stock situation some of it may indeed be allocated already to outstanding (waiting) orders. The stock is now issued to jobs and orders and steadily depletes.

    A personal computer assembly line that runs out of memory chips must stop; if a Wimbledon runs out of strawberries might perhaps change to peaches. If a paper supplier is hit by strike action urgent approaches will be made to other suppliers.

    If finished goods are out of stock, or raw materials or consumables shortage affects the customer ("sorry, the soup is off today") then customers may go off elsewhere, orders may be cancelled. Loss of goodwill means that competitors develop a relationship with your customer. All stock outs involve costs.

    Costs of Inventory

    Costs are tied up in the inventory itself and in ordering and carrying the stock.

    Holding costs
    - expressed as a % of stock value and may be 15-30 % per annum.

    Acquisition/ordering costs
    Costs arise from ordering/acquiring goods regardless of the actual value of the goods. In both making to stock and making to order, stock acquisition costs are incurred. Replenishment and purchasing administration paid for. It may take a skilled operator an hour to set up equipment for a new order or scheduled batch. Material may be wasted in the set up process. On completion of the job, equipment must be cleaned and tools put away. The inventory associated set-up costs include labour, material wastage, associated loss of production time collecting or waiting for stores, paperwork and administration. The set-up cost may easily be £30-50 irrespective of the order or batch size.

    The purchasing order processing costs include receiving the goods, delivery for large or small orders and invoice processing. Precise costs per ordered unit are often elusive, but the staff and overhead costs are significant. In actual terms £40 may be incurred to initiate and process one purchase order.

    Ad hoc purchasing must be compared with long-term contracts involving regular deliveries perhaps with just-in-time supply or amounts that the operation can "call off" from a supply agreement over, say, a quarter. There are costs in

    Basic Inventory Mathematics

    Stock control mathematics are very straightforward and relate to the identification of re-order levels, calculation of economic order quantities, safety and service levels and so on. Generally the input and output sides of the inventory management system are separated and it is assumed that

    on the supply side
    - receipts go straight into available stock without delay.

    on the demand side
    - issues from stock are in small amounts relative to total usage e.g. if 2,500 boxes of computer paper are used per annum, they are issued/distributed to departments in lots of twenty or less, rather than say five issues of 500. A materials requirements planning approach is more suited for occasional, large discrete issues.

    Calculation of economic order quantity seeks to reconcile ordering and holding costs for an optimum order size. Costs of holding stock and ordering/acquiring it are involved. We need to evaluate whether safety stock and service/availability levels are needed and we need data on lead time and demand. The mathematics involve arithmetic and a basic understanding of normal distribution and standard deviation.

    Inventory Control Systems

    It is important to understand systems of inventory management. As demand and lead times vary we can order fixed quantities of stock at variable times or order variable quantities at fixed times. Each has implications for safety stock, operational responsiveness, the level of risk involved given variable demand and supply and security. Many factories will use a two-bin replenishment system. Stock records systems, computerised more often than not today, provide move detailed control over stock levels, issues and receipts. They are essential to stores management. The data content and flows of such systems are needed by just-in-time methods.

    We must be aware also that "the records say we have 5 in the warehouse but only three can be found and one of these is damaged".

    Pareto (ABC) Analysis

    Pareto analysis (a.k.a. ABC analysis or 80/20 rule) can be used to classify stock groups. Stock items are ranked in descending order of usage value, and plotted on a cumulative frequency curve. it is common to find that 20% of items account for 80 % of usage value, the next 30% has 15% of value. The final 50% have 5% of value.

    Pareto
    ABC or Pareto analysis points the way to where control efforts are best directed. Judgment is needed on critical inventory items or security matters that Pareto analysis in itself does not reveal.

    Monitoring Stock Turn and Coverage

    Stock-out ratio
    - we can compare the % of demand actually satisfied with the defined service level e.g. service eleve was 98.5%. Actual availability was 97.9%

    Stock turn and coverage
    These are relevant to holding costs and use of capital employed. Monitoring individual stock items will identify fast/slow movers and, depending on the industry, we can evaluate

    stock turn (annual usage / average stockholding)

    or coverage (stockholding x 52 weeks / annual usage).

    As use by value for an item is annual rate of use (units) x cost/unit, this gives the total amount of £ turnover for each stock item.

    Retailers are interested in a high stock turn (a small, continuously replenished stock of fast moving items). A stock turn of 13 means than total stock turns over every four weeks. If £100,000 is tied up in stock - this roughly means sales (not profit) of £1.3 million. This stock turn may be inadequate for some retailers as it may be a measure of the quality of the buying decisions - we have bought slow moving items. For a car showroom a stock turn of 6 means that the average stock on the car lot changes every 2 months. Of course, the car dealer is interested in which types of car do not turn over at all! Thus retailers undertake Pareto analysis routinely to compare turnover of items.

    References

    Maintained and developed by C Jarvis