1.

Inventory and Inventory management

2. Lead time
3. Reserve stock and safety stock
4. Reorder level
5. Economic order quantity
6. Trade off between total costs of inventory
and order quantity
7. Customer Service levels
8. Average inventory
9. Selective Inventory Control
10. Pareto’s rule
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 1. Quadrant technique
2. Non-Performing Asset
13. ABC analysis
14. Vendor managed Inventory
1.
2.
3.
15. Inventory Turn Over Ratio
Quadrant technique
Non-Performing Asset
ABC analysis
4.
5. 16. Review Period
Vendor managed Inventory
Inventory Turn Over Ratio
6. Review Period

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* What is Inventory?

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• A list of items being held in stock
• An asset not participating in conversion or not
getting sold
• Any NPA, considered to be an asset & part of
working capital

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 Why do we have inventory?
• Due to mindset - reluctance to dispose off
• Consequence of redundancy of products
• Built-up as a means of customer satisfaction, as
a cushion against uncertainties
• To overcome disadvantages of poor
infrastructure
• 9 to 12 months of sales in India, a few days in
Japan and a month in US/Europe
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 Importance of Inventory
Decades of 1980 & 1990 brought inventory in
focus
Why? Emergence of Japan as a economic super
power in 1980s
Visual evidence of success of Japanese systems
Ford Motors carried 15 times more WIP
inventory than what Toyota did! A benefit Toyota
enjoyed over Ford in cost management
Impact on product cost, 5 to 35% of product
cost are logistical costs & 35% of logistical costs
are inventory costs
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  Effect on product quality
Facilitates production
Protects the conversion process from
uncertainties of market
Has a major impact on product cost - a source of
cost and bad quality
 Measure of managerial performance
Signs of poor inventory management
An increase in back orders
Rising inventory investments
High customer turn over
Increase in order cancellation
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 Insufficient storage space
Increase in rupee & number of obsolete products
Objectives of Inventory Management
To increase corporate profitability
To anticipate impact of corporate policies on
inventory levels and act proactively
To minimize logistical costs while meeting
customer service requirement
Functions of Inventory [Rationale for
Inventory]
Overcomes geographical separation
Decoupling internal process – reducing
dependence 9
•

Balancing supply and demand

Buffers uncertainties of lead time, demand and
poor infrastructure
Acts like a cushion against unusual events like
strike or war
Technical requirement of batch production
Facilitates price discounts

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 Inventory related costs
Procurement Costs - management and staff
time, order preparation and dispatch, follow up,
transport from vendor, receiving, handling
storage
Carrying Costs - capital, opportunity, space,
tax, security, insurance, spoilage and
preservation, obsolescence
Out of stock costs - emergency transport, lost
sale, lost customer
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 Types of Inventory
Location inventory-Inventory at a fixed
location
In transit inventory[pipeline inventory]-Being
transported and or waiting to be transported
Manufacturing inventory
R/M, components, WIP, F/G, MRO
[Maintenance, repairs and operating supplies]
Risk due to commitment of resource to
manufacturing is deep and long.
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 Wholesale inventory
Stock of large quantities and sold in small
quantities to retailers
Stock of seasonal products, products to satisfy
assorted, small and urgent needs of retailers
Generally risk is narrow & deep, when the
product line expands risk is wider and deeper.
Retailers inventory
Variety of products to satisfy demand
Retailers push the inventory backwards to
wholesalers and reduce the depth of risk although
the risk is wide
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  Average inventory
Average level of inventory in the organization
R/M, parts, WIP, finished goods
Following inventory concepts are used in
calculating average inventory
1. Cycle inventory: result of replenishment process,
also known as base stock or lot size stock, Q/2
2. Safety stock Inventory: Stock held to safe guard
against variations in lead-time & or consumption
3. Transit Inventory: Either moving or awaiting
movement
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  Economic order quantity
 Assumptions of Wilson’s Lot size formula or
Classical EOQ model
3. Demand is at a known constant rate and
continuous
4. Lead time is known and constant
5. Demand is fully satisfied, no shortages are
allowed
6. All costs are time invariant
7. Quantity discounts are not considered
8. Replenishment is instantaneous, there is no
transit inventory
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 * Process is continuous
* No constraints are imposed on quantities
ordered, storage capacity, budget etc.
 EOQ derivation
 All assumptions in tact
EOQ=√2AD/h
Relax instantaneous replenishment
EOQ=√2AD/h(1-D/P)
 Limitations of classical EOQ model- major
limitations are the assumptions made
 If the concept of EOQ is applied without taking
into account the limitations, results can be
disastrous 16
 Adjustments to EOQ
EOQ model does not consider economics of
transportation
# Transportation costs are sensitive to weight of
consignment
Quantity discount-Quantity discounts can upset
the benefit of EOQ if we don’t evaluate the
situation from total cost perspective

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 Other EOQ adjustments
Production lot size: Mismatch between
buyer’s EOQ and supplier’s EBQ. Some
adjustment is needed.
Multiple items purchase
# Combination of products are sourced from a
supplier
# Impact of quantity discounts and
transportation costs on total cost when a
combination of products is purchased
# So adjustment is required to EOQ
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 Limited capital
# Significant role of budgetary allocation
# Budget has to satisfy the requirement of entire
product line
# EOQ of various items requires adjustment
Private trucking
# Getting a full truck (FTL) becomes significant
from cost perspective as against EOQ
Standard package
# Standard package and EOQ

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 Inventory Classification
* Ranking of Inventory to facilitate selective
management control
* Dates back to 1951- GE
* Pareto’s rule: 80-20 rule, separate vital few from
trivial many
* ABC Analysis
Vital 20%
few 80%
Trivial 80%
many 20%

Inventory Inventory
Items Value
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 *An example of ABC analysis
Logistics Perspective of selective management
control
ABC analysis has one chosen parameter like
cost or value in focus
‘A’ category is priority from the perspective of
this particular parameter
Prioritization in inventory management has to
consider other factors as well
VED Analysis
FSN Analysis
HML 21
 SDE [Scarce, Difficult to procure, Easy to
procure]
SOS [Seasonal Off Seasonal]
GOLF [Government, Open market, Local &
Foreign Source]
XYZ analysis
Quadrant technique

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 Distinctives Criticals
High risk, low value High value customized
items: customized items items not available easily
not expensive but not
available easily, single
supplier and long lead-
Stock time
out Generics Commodities
Risk Low value easily High value standard
available items, standard items, basic production
items items, standard
packaging items

Value or Profit potential

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 Fundamental approaches to managing
inventory
Traditional approach has been deciding when to
order?
But challenge of today - to find answers to the
questions ‘where?’ to stock the material, how
much? and when?
Inventory decisions influences customer
satisfaction level
High level of inventory & higher customer
satisfaction level
Cost of high inventory is obviously high
Modern challenge is high customer satisfaction at
minimum inventory 24
Fixed Order Quantity Approach (condition
of certainty)
The order quantity is fixed at EOQ
Another stock level fixed is Re Order Level
(ROL or ROP) which triggers ordering
ROL is fixed by calculating lead time
consumption
Inventory cycles can be conceptualized by
looking at the figure drawn in the class
EOQ Model – discussed already

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 Q D
ROL
IS LEAD TIME CONSUMPTION
INV

SAFETY STOCK

Lead Lead Lead

Time Time Time

INVENTORY INVENTORY INVENTORY

CYCLE TIME CYCLE TIME CYCLE TIME

Q - MODEL

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SOME IMPORTANT CONCEPTS
ROL = SAFETY STOCK [FOR EXTENSION OF LEAD TIME] +
RESERVE STOCK [FOR INCREASE IN DEMAND] +
BUFFER STOCK[LEAD TIME CONSUMPTION]
3. SAFETY STOCK: Dave X [Lmax-Lave]
4. RESERVE STOCK: Lave X [Dmax – Dave]
ROL = Dave Lave + K√σd2 L +σl2 D2
• K=1…………15.87%
• K=2…………2.28%
• K=3…………0.13%
• K=0…………50%

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 Salient Features of the above approach
1. widely used technique
2. requires constant monitoring of stock levels
3. limited by the assumptions made – cost of in
transit inventory, volume transportation rates, use
of private carriage
4. Combines the concepts of push & pull
Min-Max Approach – a modification to EOQ
model
• Order for EOQ is released when ROL is reached

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• Assumption is stock depletion is at a specific rate
‘D’ during replenishment cycle.
• In reality when stock depletions can be high
• Min-Max Approach suggests that the actual
order quantity should be the sum of EOQ and the
difference between ROL and actual stock on
hand at the time ROL occurs.
• Fixed Order Quantity Approach (condition of
uncertainty)
When demand and lead time vary
• Fixed Order Interval Approach
Decisions about review period & S
• Optional replenishment Approach
Decisions about review period, S and s 29
 TIME

Q D

I2
I1
INV

SAFETY STOCK

Lead Lead Lead

Time Time Time

T T

P- MODEL
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 Some Inventory related definitions
1. Inventory policy:
• 5W-1H questions about buying and controlling
inventory. What to stock? How much? When? Where?
What method? Approach?
• Centralized or decentralized control
2. Service levels: performance objectives of inventory
function
• Order cycle time: release of a purchase order & receipt
of the shipment at customer’s place
• Case fill rate: percentage of cases deliverable against
the number of cases customer ordered
• Line fill rate: product lines fully delivered to the product
lines ordered is the line fill rate.

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• Order fill rate: percentage of orders
completely fulfilled to orders received
• Average inventory
a. Cycle inventory
b. Safety stock Inventory
c. Transit Inventory also known as Pipe Line
Inventory

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 Inventory Strategy – a long term plan to
control inventory
What is controlled? Selective management
control, quadrant approach
When do we move inventory? Kanban system in
JIT, DRP, MRP
Where and at how many places? Centralized or
decentralized? Warehouse location, square root
law
Why? Customer satisfaction at minimum cost

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How do we manage? Inventory approaches,
push methods? pull methods?
How do we measure performance? Inventory
turns, fill rates, perfect orders

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