INVENTORY MANAGEMENT

BY: Rajeev Sharma

Inventory Management
It is not easy to deal with customer dissatisfaction , especially when customer is a 4-year-old Boy. A petulant toddler demanding the spider man costume for an upcoming party. If he cannot be transformed into spider man, he cannot attend the party. He is trying his best to convince his mother by crying is lungs out and flailing his arms wildly. The mother looks at her son and turns to glare at the apologetic sales executive. In face of such blatant blackmail she has no option but to hop across to the next mall. The store has lost another customer.

To keep pace with such demands retail chain outlets Like Shoppers stop manage a staggering 3,00,000 SKU at each outlet. Ensuring the availability of each SKU across 21 outlets in the country is a supply chain challenge. That is why SS has four RDCs at Delhi Mumbai Bangalore & Kolkota. Over four hundred vendors supply the DCs. SS has to decide as to how much inventory the RDC should carry and how much inventory Stores should carry. They will cannot risk non availability of a product as it will affect their reputation. On the other hand carrying to much inventory at Either Distribution centers or the stores multiplies the Inventory carrying cost and also the problem of obsolescence. When Asked How it manages the supply Chain?

Sanjay Badhe The Director of operations replied; There is no one in India that offers logistics, so we had to develop our own logistics department. We have linked every office in the country via leased lines & VSAT. Typically SC consist of multiple items and stock points where each stock point has a customer and a supplier. Given the supply and demand characteristics of suppliers and customers a decision maker at a stock point makes essentially two decisions: 1. How much to order 2. When to order.

Every participant in a supply chain , whether retailer, wholesaler, manufacturer or vendor, prefers to reduce inventories and yet maintain customer services so as not to lose customer because of non availability of goods. Huge inventories are drain on resources. As it blocks money and increase cost of operation. So reduction of inventory in supply chain is the need of the day. In the past the zero inventory slogan had attracted a lot of attention from financial controller of firms for some time because it gives them a illusion that it was possible to work with a zero inventory and improve financial performance.

Zero inventory was a very popular term in business literature but as we shall see zero inventory translate into zero business. So we have to bring out logic of why a business needs inventory and suggest possible ways of improving performance in this area.

Please watch out the figures given in next slide !

S.no Name of the Company

1. 2. 3 4. 5. 6. 7. 8. 9 Indian Oil Corporation Bharat Petroleum Corp. Ltd. HPCL SAIL BHEL RIL Tata motors Ltd. Tata Steels Ltd. MUL

ITR -1990 ITR-2006

8.00 14.00 10.00 2.00 2.00 2.00 4.00 2.50 4.5 6.50 8.00 8.00 3.60 3.50 6.00 8.50 3.50 12


1. 2.

Do you realize that

Companies are not from same industries While performance of few like HPCL, IOC, BPCL has deteriorated but for the other it is getting better. Even though the Sales( Data not given but you can very well understand the difference of the economy of the country) of the most of the companies have substantially improved between 10-15 folds, we are expecting a notable change in inventory too, which is not seen So why not to analyze data in different way

3.

Please look at this data ITR ---

Food & Beverages

Worst 1.2 1.2 1.9 1.2 2.1

Average 4.0 8.5 5.3 5.5 5.1 5.1 5.5

Best 31.0 32.5 45.2 17.1 78.1 44.1 42.5

Chemicals Textiles Machinery Transport

Non Metallic 2.0 Metal products 2.5

How would you like to express yourself after watching the data

Is it evident from the data , The best performer in each industry segment seems to be working with 10-20 times higher inventory ratio compare to the worst performer. This shows that within Indian firms there is a significant potential for reduction in inventory across the industries. Of course each of theses firm works with multiple SKUs and has multiple levels in supply chains. Firms like IOC work with thousand of SKUs and have to keep material at RM WIP and FG levels. Further it has to carry RM & WIP at multiple location and carry FG at various levels within the distribution channel. Given this complexity it is tempting to view that how these firms work with the optimal level of inventory or The question is How much inventory is good enough?

Once I had a opportunity to study one pulp making firm APR ltd. In great detail and I found that this firm used to carry about 4 months of wood inventory. Please guess this size of wood as inventory. Think of KATH GODAM One you may had seen in Kabhi Kabhi or Silsilae Please think ? I can make out what you will think if I ask you why such Inventory size is necessary ?

One view might be like this huge inventory carried by APR ltd is unnecessary and therefore carrying inventory at all is a waste Or

The other view might be since APR has always carried 4 months of inventory and on an average every firm in that industry carries same inventory, then its fine But let me tell you that each of the extreme does not serve the purpose

 When

we carried out the detail analysis of the purposes it came to the conclusion that it should be able to manage its affairs with just 18 days of inventory. Is this not a surprising factor. If yes Then I am going to introduce you to the concept called as ZERO BASED INVENTORY BUDGTING

How it works Its essentially a bottom up approach to inventory management. It starts as first step with classification of inventory based on the use or reason why the organization needs to carry inventory. Then as step two is to identify the driver of each such category of inventory based on the reason which factor instill variation in the inventory Then as step three carry out an analytical study to determine the appropriate level of inventory required for each of the identified driver. Then at last again make a decision at the product level regarding inventory size.. Here inventory is controlled through two decisions 1. How much to order 2. When to order

This exercise helps us to understand the various drivers that forces firms to maintain the current level of inventory. This type of analysis helps us to understand and improve both the turnover ratio and the service. Based on the assumption that decision maker follows the policy of continuous improve., Lets specify the type of inventory.

1st Cycle Stock : Because of the economies of scale involved in production and transportation it makes sense to produce and transport goods in batches. The is called as cycle stock. And order point problem as to size and order no. exist here. 2nd Safety stock : It is a safeguard against the uncertainties of demand and supply. 3rd Decoupling Stock: Since it is not possible to carry out supply chain operation with just one decision maker, the entire supply chain is usually divided into various decision making unit, the demarcation of decision making unit take place at both organizational and departmental boundaries, so it is not uncommon for organizational to hold large inventories at organizational as well as departmental level. This becomes decoupling inventories. So that flexibility at each level can be made.

1. 2.

4th Anticipation Stock : It consist of stock accumulated in advance of expected peak in sales or to take care of some special event that does not occur on regular basis. It is of two types Seasonal Stock Speculation Stock

5th Pipe line stock: Since production and transportation activities take certain finite time firms need to carry pipeline or in transit stock. Pipeline stock consist of good usually being worked upon (WIP) or being moved from one location to another in the chain( In transit Inventory).

6th Dead Stock: It refers to that part of the stock , that remain dormant or non moved over a long period of time . This stock is unlikely to be used in long run or in any part f supply chain.

Inventory management Inventory has its forms A.Raw material They may be Basic Raw material Consumables Stores & spares Packing material B. Work in progress C. Finished goods

These forms has their existence throughout the supply chain: Its stages They are Raw material During Inbound logistics
They

Work in progress during Operations

They

Finished goods during Out Bound Logistics

Closing Stocks or non moved forms of the inventory at every stage forms Working capital & current Assets of the company After Fixed Assets this is the most costly item in the balance sheet of the company. It is Better as the available working capital but is also dangerous as lot of capital is blocked in this form which is not converted into revenue Hence is a cost to the company in the form of blocked capital & also the interest & dividend cost which the company is bearing on the this blocked capital. So with the view to lower down this cost to the company INVENTORY MANGEMENT is focused

So inventory management is focused at lowering down the Cost of capital Invested and blocked in the inventory by 1. Increasing inventory turnover ratio & operating cycle of the company 2. Increasing stock to sales ratio 3. Maintenance of optimum current asset ratio

Inventory Management Has three areas In coming material control or Purchase control

In Stores control

Issue ( Issuance to production or retail outlet) Control

Stage 1 Purchase Control

Inventory Management Stage 2 Stage 3 Stores Issue Control Control

Inbound Logistics

Operation

Outbound Logistics

Purchase Control ;Stores Control & Issue Management Also called as ORDER POINT PROBLEM Answering 2 queries
1.

How much should be the size of the order ? 2. When should the order be placed ?

Lets Start with Stage 1 To understand this let's know the cost associated with the inventory 1. Ordering Cost: Is the cost of placing an order ( Called as per order cost) (Abv. as OC & o) This is the cost associated with the purchase of material and includes the following 1. Cost of paper work involved i.e. Order processing cost ,we mean Procurement order cost, intend, material requisition form, purchase order, receive note & various ledger entries etc. 2. Salary of the people involved in the above process 3. Depreciation, rent and opportunity cost of the offices & assets involved.

2. Carrying Cost ( Also called as Holding cost) Abbreviated as CC & c This is the cost associated with the Transport & Storage of material purchased and includes the following 1. Loading of material cost 2. Transport cost , octroi & levies 3. Unloading cost 4. Inspection cost 5. Material handling cost ( in house if any) 6. Storage cost ( In stores rental or depreciation) 7. Cost of damage , maintenance cost, cost of capital tied up in inventory It can be expressed in two ways: 1. Money spent in carrying a unit for duration in the ware house ( say a year , month or week) 2. Percentage of value of the average inventory during the given period of time

3. Cost of shortage or out of stock cost Abbreviated as G & k This is the cost associated with the stock out conditions of material and includes the following 1. Loss of potential profit 2. Loss of goodwill on the part of the customer Abbreviation OC = Total Ordering cost o= Ordering cost per order CC= Total carrying cost c= Carrying cost per unit per year ( Unit of time) G=Total shortage cost k= Shortage cost per unit

So to say what is the total cost of inventory It is = OC ( Ordering Cost) + CC ( Carrying cost) + G ( Stock out cost , if any) + Purchase price of the material Now HOW TO GO FOR ORDER POINT PROBLEM?

Let us understand that there are two methods of Managing inventory 1. Independent Demand Inventory management System 2. Dependent Demand Inventory Management System How are they different ? Suppose we are motor cycle manufacturer . For the next month demand forecast says 2000 motorbikes. In a motorbike two tyres, one speedometer, four side indicators are used. Therefore company orders 4000 tyres, 2000 speedometer & 8000 side indicators to its suppliers. Thus the demand of tyres, speedometer & side indicators id depended upon the demand of motorbikes Therefore inventory of these items is called , dependent demand inventory, and the inventory management system is aptly called as Dependent Demand IMS. On the other hand demand of motorbikes is determined directly by demand forecast and is not dependent upon the demand of any other item, Hence called as independent demand inventory and the system is called as independent demand IMS

Tools of IMS
For Dependent Demand IMS Three tools are available
1.

Material requirement Planning System

2.

Just in Time System Hybrid MRP-JIT System

3.

Tools of IMS
For Independent Demand IMS It has two Variables 1. For Manufacturers 2. For Retailers For Manufacturers Tool is EOQ/EBQ ( Economic Ordered/Batch Quantity) For Manufacturer

For Retailers Tool is At stage One Classification of Inventory Type 3 Categorize 1.Category A 3.Category C 2.Category B At Stage Two

Basic EOQ Model Application

Perpetual Inventory Management

As far as Basic EOQ models are concerned they are of Four Types
1.

EOQ model with Quantity Discount EOQ model with Differential discounting EOQ model with safety stock EOQ model with intentional Shortage

2.

3.

4.

Let's start with Retailers Independent demand IMS ABC Analysis In any Retail organization there are large numbers of inventories to be maintained. It is not practical to have very stringent inventory control system for each & every item. So with the modus of having an effective Purchase & stores control we implement ABC Inventory Classification model Known as Always Better Control (ABC) based upon Pareto rule ( 80/20 rule)

To Implement ABC Following steps involved: 1.Categorize the inventory into ABC using Consumption Value. 1.a. Consumption Value = Unit price of an item X no. of units consumed per annum. 1.b. A category will be the one having highest CV i.e. Lowest Consumption but highest value B Category will be the one with moderate C category will be the one having lowest CV i.e Largest inventory & lowest value 2. Inventory Management Policy 2.a. A category is subjected to stringent inventory control, via using VMI, DOLI, EOQ model to determine reorder level & size And also the proper issuing system to the final destination of usage.

2.b. For Category C Inventory control is meager and perpetual inventory management system is used Perpetual Inventory management system(PIMS) is the one which supports regular & periodic review of inventory. 2.c. For Category B it is moderate control. Some time with the view of doing Lean inventory management Within ABC category VED ( Vital , essential & desirable factor) is introduced with the view of further having effective control of inventory on the basis if its being critical. Where V (Vital) is the inventory where neither Substitute nor Variation Gap is allowed . E (Essential) is the inventory which allows either of the one to be changed D (Desirable ) is the one which can have variation in both of the parameters

e.g. Suppose customer asks for 150 gm HENKEL made

FA Shaving cream ,so non allowance either of the parameter i.e. Neither weight nor make is categorized as Vital and is likely to be maintained. Whereas if he allows Godrej, Or Palmolive Brand variation than is categorized as Essential & if he asks for weight as well as brand wavier then Desirable category .
A Category B Category A Category

Vital

AV AE AD

BV BE BD

CV CE CD

Essential

Desirable

With the view to further lean the store try to go for Certain parameters for each class on the basis of following parameters 1. Stock to sales ratio 2. GMROI 3. Contribution margin 4. Shrinkage = Difference between book and physical inventory . SKU Productivity -- To demonstrate the importance and contribution of best sellers in each class, category, etc. * SKU Contribution -- To show the relationship between the number of SKUs, purchases and sales per class, category, etc. * SKU Rationalization -- To evaluate the margin performance of individual SKUs vs. peers in the same class, category, etc. So that

We can take Decision as to how & under which category on the basis of 1. CV 2. VED 3. All parameters we can minimize the category of inventory by shifting them to the three lateral category to exercise effective control.

A Category

B Category

A Category

Vital

AV AE AD

BV BE BD

CV CE CD

Essential

Desirable

A Category

B Category

A Category

Vital

AV BE

Essential

Desirable

CD

Q. C3) What is ABC analysis? In case of NANZ LO` BILL shop following data of

inventory is recorded

S.No.

Product Type

Price /Unit

Qty Consumed Make

Type

.01 Shampoo .02 Hand wash .03 Mosquito repellent .04 Soap .05 Tea .06 Cold drink .07 Electronics gadgets .08 Watches

75.00 1000 Unknown 200 ml 50.00 2500 Unknown 150 ml 5.00 10000 Good knight 50ml 1.00 25000 Lux Unknown 10.00 500 TATA 250 gm 1.50 10000 Unknown unknown 150.00 1000 Philips 15 Amp 250.00 500 Titan electronics

Give ABC effects to this inventory taking into consideration criticalness? What other factors are considered to lean a stores inventory over & above the CV & Critical factors? Please explain the above inventory on the basis of lean factors?

ROL RE ORDER LEVEL

At this level of stock, next order is to be placed with the vendor Is the stock level of (Maximum Consumption X Maximum Lead time) Re Order Quantity Is The Economic order quantity ( Calculated with the view to minimize Carrying & ordering cost of the order)

MINIMUM ORDER LEVEL

This much quantity must always be maintained at the store to prevent out of stock condition Is the stock level of ROL ( Normal/Avg. Consumption X Normal/Avg. Lead time) This is below reorder level justifying the EOQ lead time with the Normal rate of consumption at normal lead time

MAXIMUM ORDER LEVEL

This is the quantity above which stock is not allowed to exceed Is the stock level of ROL + EOQ ( Minimum Consumption X Minimum Lead Time) Following factors are considered for this a. Maximum requirement for production at any moment of time b. Storage space available c. Risk of deterioration, obsolesce, evaporation & Price Fluctuation

Average inventory MIOL + EOQ Or (MIOL + MAOL) /2 Or ROL ( Max/Min/Nor Lead-time X Max/Min/Nor Consumption) + EOQ

MAOL
EOQ ( Min Consumption X Min LT)

ROL = EOQ
Avg. Consumption X Avg. LT

MIOL Danger Level

(Avg. consumption @ Max LT for urgent purchase)

Example : Given the following Consumption 25 75 Units/Week Lead time of vendor 4-6 weeks EOQ 300 units ROL = 75 X 6 = 450 MAOL = 450+300-(25X4)= 650 MIOL= 450-(50 X 5)= 200 Avg. Stock Level = (650+200)/2= 425

MAOL= 650 units

EOQ ( Min Consumption X Min LT)=200 units

ROL = 450 Units

Avg. Consumption X Avg. LT= 250 Units

MIOL=200 Units

EOQ
PLEASE

MOVE TO LINK

THANKS

Move to EOQ2

SAFETY STOCK Is required to be considered in some conditions They Arise because In practical situation
Demand

of items may fluctuate at any point of time

And

also suppliers always need some lead time to supply the goods

Lead time can easily be provided to supplier by placing order before inventory become zero. e.g.
Lead time is 10 days , so order can be placed 10 days before it becomes zero. Let the uniform consumption of inventory be 50 units per day therefore during the 10days of lead time 500 units will be consumed . Hence ROL can be fixed at 500 units. A Stock out may occur sometime due to either excessive consumption or due to undue stretching of lead time We know stock out is undesirable for the various reasons so to avoid it extra stock is maintained throughout thr year. This is called as Safety Stock

Inventory decreases at constant rate

I n v e n t o r y L e v e l

MAOL

Q
500 units

Re order level

Lead Time

10days

First Order

Second Order

Goods Received

Lead time being provided by fixing a reorder level

Inventory decreases at constant rate

I n v e n t o r y L e v e l

MAOL

Q
500 units
7 days

Re order level

Lead Time

10days

First Order

Second Order

Goods Received Excessive consumption of inventory during the lead time, leading L to stock out

Inventory decreases at constant rate

I n v e n t o r y L e v e l

MAOL

Q
500 units
7 days Lead Time

Re order level

800 units

0 L

Second Order Goods Received

Safety Stock

Safety Stock avoids a stock out caused by excessive consumption of inventory during lead time

Inventory decreases at constant rate

I n v e n t o r y L e v e l

MAOL

Q
Stock out

Re order level

500 units
Lead Time 10 days

800 units

Second Order
Goods Received Goods Received

Safety Stock

0 L

Undue stretching of lead time by the supplier, leading to stock out

Inventory decreases at constant rate d

I n v e n t o r y L e v e l

MAOL
t = Time period for one inventory cycle t1= time fraction during which customer are given inventory items, (Q-S)

t2 0 t1

(Q-S)

t2= time fraction during which back orders are received, S or stock out con d- is the rate of demand Q= are the items ordered in one inventory cycle

t
Goods Received

Time

Model of intentional shortage

Retailers intentionally creates shortage of expensive items B`cos CC of expensive items is very high, it may be so high that the cost of stock out may be very low comparatively. three cost are involved OC ; CC ; Shortage cost OC= Ao/Q CC= (Q-S)/2 cti G = S2k/2Q