MBA- I Sem II

204 (GC-UL) Operations and Supply Chain Management Unit IV

204 Operations and Supply Chain Management

Unit No. IV

Inventory Planning & Control

Contents of the Unit

4.1 Inventory Planning and Control: Continuous and intermittent demand System,
concept of inventory, need for inventory, types of inventory - seasonal, decoupling,
cyclic, pipeline, safety. Implications for Inventory Control Methods.
4.2 Inventory Costs: Concept and behavior of ordering cost, carrying cost, shortage
cost.

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4.3 EOQ: Basic EOQ Model - EOQ with discounts
4.4 Inventory control: Classification of material - ABC Analysis -VED, HML, FSN, GOLF,
SOS.
(Numerical expected on Basic EOQ, EOQ with discounts & ABC), Inventory turns ratios,
Fixed Order quantity Model - Periodic Review and Re-order Point
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Learning Objectives of the Unit

1. To develop understanding of the strategic importance of inventory

planning and how it can provide a competitive advantage in the
marketplace
2. To understand the relationship between inventory planning and profitability of
business.
3. To determine ABC analysis and economic order quantity (EOQ).
4. To develop knowledge of the issues related to inventory management and its
techniques to do so.

Introduction:

Inventory or stock is the goods and materials that a business holds for the ultimate
goal of resale (or repair).

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204 (GC-UL) Operations and Supply Chain Management Unit IV
Inventory management is a discipline primarily about specifying the shape and
placement of stocked goods. It is required at different locations within a facility or
within many locations of a supply network to precede the regular and planned course of
production and stock of materials.

The concept of inventory, stock or work-in-process has been extended from

manufacturing systems to service businesses and projects,

In the context of a manufacturing production system, inventory refers to all work that
has occurred – raw materials, partially finished products, finished products prior to sale
and departure from the manufacturing system. In the context of services, inventory
refers to all work done prior to sale, including partially process information.

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Definition

The scope of inventory management concerns the balance between replenishment lead
time, carrying costs of inventory, asset management, inventory forecasting, inventory
valuation, inventory visibility, future inventory price forecasting, physical inventory,
available physical space, quality management, replenishment, returns and defective
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goods, and demand forecasting. Balancing these competing requirements leads to
optimal inventory levels, which is an ongoing process as the business needs shift and
react to the wider environment.

Inventory management involves a retailer seeking to acquire and maintain a proper

merchandise assortment while ordering, shipping, handling and related costs are kept
in check. It also involves systems and processes that identify inventory requirements,
set targets, provide replenishment techniques, report actual and projected inventory
status and handle all functions related to the tracking and management of material. This
would include the monitoring of material moved into and out of stockroom locations
and the reconciling of the inventory balances. It also may include ABC analysis, lot
tracking, cycle counting support, etc. Management of the inventories, with the primary
objective of determining/controlling stock levels within the physical distribution
system, functions to balance the need for product availability against the need for
minimizing stock holding and handling costs.

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204 (GC-UL) Operations and Supply Chain Management Unit IV
 The stock of any item or resource used in an organization – Raw materials,
Packing Materials, Tools, Jigs, Finished products, Component Parts, Supplies and
work-in-process, resale goods etc.
 A stock of items held to meet future demand.
 Inventory is BLOOD of production.

Reasons for holding Inventory

 To run production activity
 To cope up with shortages, fluctuations in supply
 To satisfy demand during lead time
 To avoid loss due to stock outs
 To run production line continuously for seasonal products


 alTo prevent sale loss. (F.G.)

To minimize buying cost

Types of Inventory



Raw materials (RM)
Work-in-process (WIP)
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 Finished goods (FG)
 Components
 Distribution inventory – Inventory in transit
 Maintenance, repair, and operational (MRO) inventory(Supplies) – Oils,
lubricants, coolants, uniforms, gloves, packing material, tools, nuts, bolts, screws

Continuous demand system

It is the demand system where Regular & consistent demand to the products in the
market. In this demand system there is always threshold value for demand to the
products in the market. Usually this demand never declines but some time it rises
occasionally.
e. g. Most of the process industries like
• Sugar plant,
• Electricity generation plant,

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV
• Steel plant etc,
• FMCG products.

Characteristics of continuous demand system:

Following are the Characteristics of continuous demand system:

1. Demand for FG is regular and consistent
2. Inventory level is to be maintained throughout year
3. Constant supply of raw materials, consumables, supplies is required
4. Constant level of RM, WIP & FG.
5. Products are standardised
6. Products are produced on predetermined quality standards.

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7. The products are produced in expectation of demand

Intermittent demand system

It is the demand system where the flow of production is intermittent means not

continuous. Intermittent means something that starts & stops at irregular intervals.
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Example:- All jobbing production, project production products like Tailoring shop,
Fabrication workshop, Railways, Aero planes, Heavy machineries etc,

Characteristics of intermittent demand system:

Following are the Characteristics of continuous demand system:

1. Irregular flow of demand

2. More variety

3. Goods as per orders

4. Inventory is to be maintained as per order

5. Fluctuations in inventory level

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204 (GC-UL) Operations and Supply Chain Management Unit IV
6. Comparatively difficult to manage

7. Wide varieties of products are produced,

8. The volume of production is small,

9. General purpose machines are used i. e. these machines can be used to produce
different types of products,

10. The sequence of operation goes on changing as per the design of the product,

11. The size, shape, design etc, of the product depends on the customer’s orders.

Comparison of Continuous and Intermittent Demand System

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Intermittent demand systems

1. Project production

2. Jobbing production

3. Batch production
Continuous demand systems

1. Mass & flow production

2. Process production
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Concept of Inventory:
 Inventory costs a lot
 Method & procedures to determine inventory amount
 Estimate future sales, add some buffer amount
 Purchase as per requirement
 Process of managing inventory so that maximum benefit can be derived from it
 To minimize costs resulting from obtaining and holding inventory

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV

Types of Inventory
There are various types of inventories which are

Seasonal Decoupling

Types of
Inventory
Safety Cyclic

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1. Seasonal Inventory
Pipeline
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2. Decoupling Inventory
3. Cyclic Inventory
4. Pipeline Inventory
5. Safety Inventory

Seasonal Inventory
Is that inventory where,

Inventory is kept to meet fluctuations in demand because of seasonality In peak season(

festivals, holidays etc) demand increases In non-peak period inventory is built

Example – Consumer durables, restaurants.

Decoupling Inventory
Is that inventory where,

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 MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV
Raw Material passes through series of production & assembly workstations. Each stage
behaves individually different. Decouple stages using inventory at intermediate point
Each stage has Input, output and buffer.

Cyclic Inventory
Is that inventory where, Inventory is ordered in repeated cycles. Each cycle begins with
replenishment and ends with complete depletion.

If ‘Q’ is order quantity, then

Average cyclic inventory = Q/2

alCyclic inventory follows saw-tooth pattern

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Order Quantity

Quantity
Average Inventory

Out of Stalk
Time

Pipeline inventory
Is that inventory where,

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV
Lead time for inventory is not zero. The geographical distances, procedures are
considered. Inventory carried to take care of lead time is pipeline inventory

Pipeline inventory = Lead time × Mean consumption per unit time

Safety inventory
Is that inventory where,
The inventory required to buffer against uncertainties in supply of raw material &
components.
More safety stock – less stock outs
More uncertainty – More the need of safety stock
To reduce investment in safety stock – superior planning & forecasting system, able

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supplier development

400
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Units

Average
Inventory
Safety (300)
Stock
(100)
Time in Days, Weeks, Months

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV

Implications for inventory control methods

 Avoid too much non-moving items
 Have enough required items
 Beware of Non-moving items
 Avoid low turnover
 Do effective scheduling
 FG is most highest value item – so,
 Manage effectively
 Avoid unsold FG

Inventory Costs
 Purchasing of inventory – Ordering, sourcing, purchasing cost



alStoring on inventory – Carrying, holding cost
Shortage of inventory – Shortage, stock out cost

Ordering Cost
Paper work – Requisition, Quotations, PO etc.
Postage – Post expenses, Courier etc.
Follow up – Telephones, Faxes etc
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 Visit to vendor – Follow up visits
 Inspection & Testing – Destructive
 Administrative cost – Remuneration of staff
 Vehicles expenses – Vehicles for material movement

Inventory Carrying Cost

 Inventory Carrying Cost –
1. Capital Cost
2. Storage Cost – Space cost, Rent, maintenance & repairs, Record keeping cost etc
3. Deterioration – Limited shelf life. Example- Chemicals, Rubber items etc
4. Admin cost – Salary & wages of staff
5. Obsolescence – Item becomes unusable because of changes in product design
6. Insurance cost – Premium paid to Insurer

Shortage Cost

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204 (GC-UL) Operations and Supply Chain Management Unit IV
Reasons for shortages :

 Improper Inventory Management,

 Unusual higher demand,
 Delay in delivery,
 Transportation delays,
 Rejection in incoming goods,

Costs incurred due to shortage

1. Cost of idle manpower
2. Cost of profit loss due to no production
3. Cost of emergency actions

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4. Cost due to premium price
5. Cost due to overtime paid
6. Cost due to customer dis-satisfaction
7. Cost due to loss of orders

Behaviour of Inventory Costs

 As level of inventory increases – Ordering cost decrease – Inversely proportional
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 As level of inventory increases – Carrying cost also increases – Directly proportional
 Total cost (Ordering cost + Carrying cost ) is lowest at – Economic Order Quantity
(EOQ)
Behaviour of Inventory Costs

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV

Inventory Control
Selective Inventory Control
 Selective control means variations in method of control from item to item based on
selective basis.
 Criteria used may be cost of item, criticality, lead time, consumption etc.

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ABC Analysis
 Vital few: trivial many.
 A-Items: These are 5 -10 % of total items account for 70-75% of total money spend
on the materials. Need detailed & rigid control. Stocked in smaller quantities.
Frequently purchase in small quantities. Staggered supply lots.
 B – Items :- these generally 10-15% of total items & represent 10-15% of total
expenditure on the materials. These are intermediate items. Control need to be
medium.
 C – Items :- These are numerous i.e. 70-80% of total items, inexpensive i.e. 5-10% of
total annual expenditure. Don’t need strict control. Procured in big lots. Avail
discount & reduce workload.

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204 (GC-UL) Operations and Supply Chain Management Unit IV

Steps in conducting ABC analysis

 Enlist items.
 Estimate annual consumption – Unit wise.
 Determine unit price of each item – Rupee wise.
 Multiply 2) & 3) & obtain annual usage (Rs)
 Arrange in descending order.
 Calculate usage percentages.
 Graph cumulative usage percentage against cumulative item percentage.
 Segregate A,B& C categories.
 Decide control policies.

HML Analysis


alHML Analysis classifies inventory based on how much a product costs/its unit price.
The classification is as follows:
High Cost (H) – Item with a high unit value.

Medium Cost (M) – Item with a medium unit value.

Low Cost (L) – Item with a low unit value.

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It is based on Price of item. It has cut-off-limits decided by management for categories.
Also helps in assessing & security requirement of items & to decide buying policy. It
determines frequency of stock verification.

VED Analysis
This is an analysis whose classification is dependent on the user’s experience and
perception. This analysis classifies inventory according to the relative importance of
certain items to other items, like in spare parts.

In VED Analysis, the items are classified into three categories which are:

 Vital – inventory that consistently needs to be kept in stock.

 Essential – keeping a minimum stock of this inventory is enough.

 Desirable – operations can run with or without this, optional.

It is advantageous to use with ABC or other method.

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204 (GC-UL) Operations and Supply Chain Management Unit IV

GOLF/G-NG-LF
 Based on source of procurement.
 Government-Ordinary-Local-Foreign
 Source of procurement
 Government – PSU’s
 Ordinary(Non Government)
 Local suppliers
 Foreign suppliers

S-OS Analysis

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
Seasonal-Off seasonal
Based on seasonality of item.
Seasonal – Agricultural products
Off seasonal – All normally available items

FSN Analysis
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This analysis classifies inventory based on quantity, the rate of consumption and
frequency of issues and uses. Here is the basic depiction of FSN Analysis:

F stands for Fast moving, S for Slow moving and N for Nonmoving items.

 Fast Moving (F) – Items that are frequently issued/used

 Slow Moving (S) – Items that are issued/used less for a certain period

 Non-Moving (N) – Items that are not issued/used for more than a certain duration

It helps to identify items to be reviewed frequently & Surplus items with higher stocks.

Inventory Turns Ratio

 Definition :- A ratio showing how many times a company’s inventory is sold and
replaced over a period.
 The number of times that a companies inventory cycles or turns over per year.
 = Sales / Inventory

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204 (GC-UL) Operations and Supply Chain Management Unit IV
 = Cost of goods sold / Average inventory
 This ratio should be compared against industry averages.
 A low turnover implies poor sales and, therefore, excess inventory.
 A high ratio implies either strong sales or ineffective buying ( insufficient inventory)
 Example:
 Cost of Sales = Rs. 36,000,000.
 Average Inventory = Rs. 6,000,000.
 36,000,000 / 6,000,000 = 6 Inventory Turns
 Is this a poor performing company or is it world class? That depends on the industry.

Multi-Period Models
 Fixed–order quantity model

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
Also called the economic order quantity, EOQ, and Q-model
Event triggered
Event – reaching specific inventory level
Re-order point ‘R’
This can take place anytime depending on demand
Perpetual system – continuous check on inventory
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 Addition or deletion of inventory must be recorded
 Expensive items can be maintained as average level is low
 More appropriate for critical items
 Fixed–time period model
 Also called the periodic system, periodic review system, fixed-order interval
system, and P-model
 Time triggered
 After specific time order process is triggered
 Review is taken only at specific time
 Larger average inventory kept
 More appropriate for regular items

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204 (GC-UL) Operations and Supply Chain Management Unit IV

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Numerical on ABC analysis

1) A company producing the consumer goods wants to analyze its product range. The
goal of this analysis is to evaluate which product is of particular importance
and which products are less important. The management has decided to use the
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annual consumption value as the key figure to assess the product range. Carry out
the ABC analysis & guide the company.

Product annual consumption (in units per Price per unit annual consumption value
# item) (Rs) (Rs.)
1 1,480 6.1 9028
2 1,680 0.15 252
3 10,120 0.2 2024
4 3,520 0.4 1408
5 3,830 9.5 36385
6 4,368 0.25 1092
7 4,180 0.45 1881
8 3,590 0.9 3231
9 4,820 0.7 3374
10 6,000 0.02 120

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV
11 1,900 1.01 1919

12 2,980 4.2 12516

13 1,050 0.3 315
14 1,100 0.44 484
15 710 31.6 22436
16 4,700 0.38 1786

Solution: we arrange the raw data in decreasing order of the annual consumption value
& calculate the ratio of annual consumption and the ratio of annual consumption value
and cumulate it. We can use the classification proposed above to classify the goods into
A, B and C products.

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Product
#

5
15
Annual
consumption
(in units per
item)
3,830
710
Price
per
unit

9.50
31.60
Annual
consumption
value

36385
22436
% of annual
consumption

37.03%
22.84%
Cumulative
ratio of
consumption
value [%]
37.03%
59.87%
Product
group

A
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12 2,980 4.20 12516 12.74% 72.61%
1 1,480 6.10 9028 9.19% 81.80%
9 4,820 0.70 3374 3.43% 85.23%
8 3,590 0.90 3231 3.29% 88.52%
3 10,120 0.20 2024 2.06% 90.58% B
11 1,900 1.01 1919 1.95% 92.53%
7 4,180 0.45 1881 1.91% 94.45%
16 4,700 0.38 1786 1.82% 96.26%
4 3,520 0.40 1408 1.43% 97.70%
6 4,368 0.25 1092 1.11% 98.81%
14 1,100 0.44 484 0.49% 99.30% C
13 1,050 0.30 315 0.32% 99.62%
2 1,680 0.15 252 0.26% 99.88%
10 6,000 0.02 120 0.12% 100.00%
Here we have used <= 80% as A, <=95% as B & <=100% as c

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV

2) A company producing the consumer goods wants to analyze its product range. The
goal of this analysis is to evaluate which product is of particular importance
and which products are less important. The management has decided to use the
annual consumption value as the key figure to assess the product range. Carry out
the ABC analysis & guide the company.

annual consumption
Product Price per unit (Rs.)
(in units per item)
1 3,830 110
2 710 31
3 2,980 15
4 1,480 14
5 4,820 468
6 3,590 21

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8
9
10
10,120
1,900
4,180
4,700

Solution: we arrange the raw data in decreasing order of the annual consumption value
& calculate the ratio of annual consumption and the ratio of annual consumption value
2
214
374
56

and cumulate it. We can use the classification proposed above to classify the goods into
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A, B and C products.

Annual Cumulative
Annual % value of
consumption Price ratio of Product
Product # Consumption annual
(in units per per unit consumption Category
value consumption
item) value [%]
5 4,820 468 460980 44.29% 44.29%
A
9 4,180 374 223652 30.69% 74.98%
8 1,900 214 51574 7.98% 82.97%
B
10 4,700 56 36624 5.17% 88.13%
1 3,830 110 22000 8.27% 96.41%
6 3,590 21 11466 1.48% 97.89%
2 710 31 10075 0.43% 98.32%
C
4 1,480 14 7658 0.41% 98.72%
3 2,980 15 3225 0.88% 99.60%
7 10,120 2 512 0.40% 100.00%

Here we have used <= 80% as A, <=95% as B & <=100% as c

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MBA- I Sem II
204 (GC-UL) Operations and Supply Chain Management Unit IV

Important Questions

Explain Continuous & intermittent demand system with suitable examples.

 “Inventory is BLOOD of production”. Do you agree? Elaborate on this underlining the

importance of inventory.
 How can organization achieve the balance between inventory carrying cost &
holding cost? Explain.
 What is selective inventory control? What are the various types? Why selective
approach is followed in inventory control?
 Numerical on ABC analysis
 Numerical on EOQ

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Short Notes:
1. ABC Analysis
2. FSN, VED
3. Decoupling inventory
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4. Pipeline & Safety inventory
5. Reorder point

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