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Inventory management in small and medium enterprises

A study of machine tool enterprises in Bangalore
N. Rajeev
Department of Management Studies, Indian Institute of Science, Bangalore, India
Abstract
Purpose The purpose of this paper is to provide guidelines for entrepreneurs for implementing effective inventory management (IM) practices and presents the results of a survey of machine tool enterprises in Bangalore, India. Design/methodology/approach A descriptive analysis is used to present aspects of the findings, which reflect the current state of IM in machine tool enterprises. In addition, percentages, bar diagrams and correlation analysis provide a more accurate assessment of this industry sector. Findings The study identified several major problems in the context of IM in machine tool enterprises including the use of rule-of-thumb for IM, a low importance given to forecasting, random ordering of materials, low levels of training and development, and low computer use as well as a low importance given to purchasing and variable lead-time. The study confirmed the need for managers in the machine tool sector to alter drastically their approach to IM. Research limitations/implications This study of 40 SMEs in Bangalore should be extended using a larger sample representative of Indian SMEs in order to arrive at findings that are more generalizable across the machine tool sector in India. Practical implications The managers of SMEs should consider seriously IM as a strategic concept simply because effective IM positively influences productivity. There is profound scope for improving the operations and performance of SMEs through the application of quality practices in IM. Originality/value Considering the lack of studies about IM in the context of Indian small and medium sized enterprises (SMEs), this paper helps fill a gap in the literature. A review of the policy framework concerned with SMEs suggests that policymakers do not consider critically the role of IM and related issues. It is significant to note that there is no exclusive reference to improvement in IM within the policy documents. At the same time, the literature review suggests that effective approaches to IM can improve the productivity and competitiveness of SMEs. Keywords Small to medium-sized enterprises, Inventory management, India Paper type Research paper

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Introduction Inventories are a significant portion of the current assets of any business enterprise (Kruger, 2005). Inaccuracies in an inventory creates a range of problems, including loss of productivity, the manufacturing of unwanted items, a reduction in the levels of customer commitment, the accumulation of costly physical inventories and frustration (Meyer, 1991). The costs of any of these inaccuracies can indeed be significant. Therefore, the cost savings that accrue from improved practices in inventory management (IM) are substantial (Meyer, 1991). IM and control are crucial to a firm because mismanagement of inventory threatens a firms viability (Sprague and Wacker, 1996). The management of inventories influences a firms financial strength and competitive position because the approach taken to IM directly affects working capital, production and customer service (Ng et al., 1993; Vergin, 1998).

Management Research News Vol. 31 No. 9, 2008 pp. 659-669 # Emerald Group Publishing Limited 0140-9174 DOI 10.1108/01409170810898554

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However, while the critical role of inventories to a firms survival is well recognized in theory, IM does not necessarily drive practice in many SMEs. When business strategies are formulated, IM is not generally treated as a critical or strategic activity (Sprague and Wacker, 1996). In the context of SMEs in India and the formal IM practices they adopt, very few studies deal in-depth with this issue. Therefore, this paper begins to bridge this gap by investigating the status of IM in SMEs in Bangalore, India. IM and SMEs While IM is defined in several different ways, the concept implies the establishment of strategic objectives and the positioning for inventories (Sprague and Wacker, 1996). As such, IM is the active control program, which allows a firm to manage its manufacturing, sales, purchases, distributions and payments (Lavely, 1996). This paper examines these items with due consideration given to the specific features of SMEs in Bangalore. Small and medium sized enterprises are defined in numerous ways around the globe. In India, the idea defining a SME is a recent notion. Until 2006, no definition for medium enterprises existed in India, whereas small-scale enterprises were defined under the Industries Development and Regulation Act, 1951 (IDR). The Micro, Small and Medium Enterprises Development Act, 2006 (MSMED) defined for the first time what a medium scale enterprise was along with a revised definition of a small enterprise. The concept of a tiny enterprise gave way to ideas about a micro enterprise. According to the MSMED, a micro enterprise in the manufacturing sector is an enterprise with an investment in plant and machinery not exceeding Rs. 2.5 million. A small enterprise is an enterprise with investment in plant and machinery more than Rs. 2.5 million but less than Rs. 50 million. A medium enterprise is defined as having investment in plant and machinery more than Rs. 50 million but not exceeding Rs. 100 million. Thus, in India, all enterprises with investments in plant and machinery of up to Rs. 100 million are SMEs. For the study reported here, SMEs are enterprises with a current replacement value of capital in plant and machinery of up to Rs. 100 million. An overview of literature Inventory management has significance for any enterprise in an inventory intensive manufacturing industry because effective practices in IM will allow an enterprise to minimize inventory costs and therefore, avoid the dire consequences that come with a shortage of material resources. This sequence of events has special significance in the context of SMEs and IM. Eloranta and Raisanen (1988) argue that poor quality forecasts are the main factors contributing to this sequence of events in SMEs. Chikan (1990) observed that a sound IM system is a decisive factor in a firms success. However, he found shortages of necessary inputs, irrespective of high-inventory investments, in most SMEs. Natarajan (1991) discussed the linkages between IM and competitive advantage, bringing into focus the integration of strategic and competitive factors such as cost, delivery and quality. Natarajan (1991) argues that reducing the throughput time by faster value addition to the materials provides a firm with a distinct edge in competitive environments. However, inventory costs are determined not only by their level of inventory but also by the time the materials spend in the system.

Mantho (1994) classified IM into three broad areas: (1) Inventory record keeping: due to the availability of computers at a reasonable price, SMEs have found it appropriate to automate their inventory records through computerization. (2) Inventory decision-making: many models can be integrated into computerbased inventory systems. (3) Material requirement planning (MRP) system: MRP is an IM information system concerned with getting the right materials to the right place at the right time. However, contemporary IM systems are more challenging because of several variables. In a fluid IM environment, these factors include high inflation rates at certain periods, low availability of traditional materials, high costs of labour leading to less making and more buying, increasing numbers of suppliers entering the procurement market and rapid development of micro-processors and software in decision-making support systems. In addition, new technological innovations lead to the development of substitutes (for example, smart materials replacing steel and aluminum), which add to the challenges for IM (Mohanty, 1985). In this light, IM must be oriented to the quite specific needs of the particular enterprise. Some of the fundamental problem areas in IM, identified in several studies with recommendation for improvements are captured in Table I. The extent to which these problems exist in SMEs in Bangalore provide useful insights into the status of IM generally. The IM practices of SMEs in Finland and Greece were studied by Chikan and Whybark (1990) to identify the experiences of managers concerning IM. In Finland, 15 case studies of IM were undertaken, including examining the role of IM in corporate planning, inventory decision-making and performance measurement. The findings revealed that IM decisions are made at the operational level with minimal guidance from the top. Furthermore, the lack of accurate, real-time and suitable aggregate information of material flows and stock levels prevented these enterprises from setting precise quantitative goals for IM. Furthermore, financial pressures forced the enterprises to reduce their inventories, which eventually led to internal as well as external stockouts (Chikan and Whybark (1990). The second study included observations of 30 SMEs in northern Greece. A principal finding was that while all firms had computerized information systems for the purposes of inventory record keeping and accounting, no decision-making models were applied in the process. The use of an integrated decision support system (DSS) was not even considered by these Greek entrepreneurs this was seen as being both unnecessary and costly. The major restraint of the use of computers was not their cost or the availability of software but rather, the attitudes and knowledge of managers and workers (Chikan and Whybark, 1990). For Chikan and Whybark (1990), the SMEs were slow to adopt and implement contemporary IM practices. A well-operated integrated production-inventory system is a decisive success factor under a variety of conditions (Chikan, 1990). However, concerning performance, SMEs are often satisfied with the end-of-year stocktaking, trading and profit and loss accounts. In most SMEs, the balance sheet rules even though many benefits can be derived from implementing a perpetual inventory system. In systems of this type, all stock items are periodically and randomly checked throughout the year. Given that many SMEs lack professional expertise and generally take decisions based on intuition and elementary IM practices (Mohanty, 1985), investments in inventory are not always costed accurately or appropriately.

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1.

Inventory problem causes Inventory record inaccuracy

Effects Loss of worker productivity, manufacturing and ordering of unwanted items, broken customer commitments, physical inventory, stock-outs, frustration (Meyer, 1991). Reduced productivity, improper utilization of men, machines, materials, stock outs. Reduced competitive advantages and benefits of quantity discount reduced bargaining power with suppliers and customers, lack of purchasing capabilities (Quayle, 2002). Poor service level, high cost, poor turn over ratio (Pirttila and Virolainen, 1992). High inventory level, high production and inventory cost. High production and inventory cost. High inventory cost and increased through put time.

Recommended actions Perpetual inventory control, cycle counting, computerization.

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2. Informal practices and measurement of IM Low purchasing effectiveness

3.

4.

5. Table I. Main problem areas and recommendation for improvement 6. 7.

Management effectiveness of inventory decision High set-up costs High throughput time Variable lead time

Integrated material management, outsourcing certain components, which make the job cheaper, ABC analysis. Supplier empowerment, formation of a purchasing department, use of a purchasing service or consortia, developing a purchasing function. Application of DSS models.

Employees training, automation. Automation, employee training. Developing purchasing expertise.

High inventories cannot be used by enterprises to deflect the effects of shortages of necessary inputs. A cursory review of SMEs in India might lead one to conclude that Indian managers generally do not give the required attention to IM. However, considering the lack of substantial studies in IM in an Indian context, the study reported here seeks to develop broader understandings about IM practices in the machine tool enterprises, identifying problems and exploring prospects. As a prelude, the characteristics of the SMEs studies in Bangalore are set out in Table II. Background and methodology The study is confined to machine tool enterprises (MTEs) in the City of Bangalore in India. Machine tools enterprises and among the most important manufacturing industries concentrated in and around Bangalore (PIA, 2003). The industry is considered as an inventory intensive industry; individual MTEs have formal or informal relationships with various large enterprises including the multinationals (MNCs) located in the city. The quality and cost of engineering products depends on the quality of parent machine tools and their levels of automation. Therefore, the development of the machine tool industry is, therefore, of paramount importance for a competitive and self-reliant Indian industrial structure. As there is no systematic database of MTEs located in Bangalore, the study identified 40 MTEs, all of which are also SMEs. From these 40 SMEs, primary data

Size Small Medium Year of establishment 1980s 1990s 2000 Education of entrepreneurs Pre-degree Diploma holder Non technical graduate B.Tech M.Tech or MBA Family background of entrepreneur/s Business Govt./Pvt Job Small entrepreneur Agriculture How became entrepreneur Newly set up Ancestral Type of ownership Proprietorship Partnership Private Ltd. Type of unit Independent Subsidiary Dominant manufacturing process Continuous production Mass production Flow shop Job shop E-mail already in place Yes No Organization has web site Yes No

23 17 19 17 4 1 8 5 22 4 8 15 6 11 34 6 15 17 8 39 1 4 4 5 27 4 36 20% 80%

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Table II.
Basic features of machine tool enterprises (n 40)

were gathered using a questionnaire. The questionnaire had five sections to gather information about: the basic characteristics of enterprise, variety and quantities of inventory, current IM practices, factors hindering or facilitating IM practices and general problems relating to IM. Respondents were asked to gauge the extent to which they agreed with various statements or propositions. Most items were constructed as short statements and respondents were asked to provide their views on a five point likert scale. The author between September 2006 and February 2007 executed the data collection phase. The methodology adopted for the study produced an analysis that was mainly descriptive. The basic characteristics of the machine tool SMEs in Bangalore are set out, highlighting share of inventory and material cost in the total output value. The status of IM is described, the practices used for IM are explored and the reasons for low inventory are offered. A correlation analysis was conducted to determine the

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association between inventory performance (as captured by inventory turnover ratio (ITR)) and other variables affecting IM performance of the enterprises. The average practice level of some of the important IM activities was identified and, finally, a review of the scope for IM in machine tool SMEs in Bangalore is presented. Results and discussion Table II presents the basic features of the machine tool SMEs surveyed. The greater portion of the sample firms are small enterprise (57.5 per cent) with medium enterprises accounting for 42.5 per cent of the sample. All the firms began business after 1980. However, nearly half of them developed in the 1980s and another 40 per cent in the 1990s. Around 10 per cent had begun business post 2000. Concerning the educational attainments of the owners (the entrepreneurs of the SMEs), 65 per cent were technical graduates, postgraduates or held MBAs. The diploma holders accounted for another 20 per cent, whereas non-technical graduates accounted for just over 10 per cent. This suggests that technopreneurs are common in the machine tool SMEs. Among the 40 entrepreneurs, more than half have parents in business, Government, private sector or public sector. More than a quarter had parents in the agriculture sector. With the exception of six entrepreneurs who had parents in the business, all others (n 34) had started their SME. With one exception, all are independent operators. This profile suggests that SMEs are not formally linked to larger businesses and are prone to the competitive pressures from other SMEs and the open market. Regarding the communication systems within the SMEs, all had telephones and faxes while 90 per cent had email capacity. This profile suggests that modern communication systems are characteristic of the MTE in Bangalore. Nevertheless, only 20 per cent of the SMEs surveyed had their own web site. The potential for using the World Wide Web is yet to be realized by many SMEs in Bangalore. In the context of this study, it is essential to determine whether the shares of inventory and material costs contribute a major portion of the total sales of the SMEs prior to the analysis of the current state of IM. These indicators (inventory and material cost) are important for the SME entrepreneurs who are concerned with reducing costs and increasing the value of output, a path to improved performance. Improving competitiveness is a key to survival and growth in this sector. Improving competitiveness in turn requires firms to reduce costs, including material costs in addition to other measures. In this light, share of inventory costs and material cost in the value of output is relevant. Figures 1 and 2 indicate the distribution of inventory costs and material costs respectively as a percentage of the sales revenue. Inventory costs were found to be up to 20 per cent of the sales costs. Material costs were found to

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Figure 1. Inventory cost as a percentage of sales

be up to 80 per cent. The study also identified shortages of necessary inputs, irrespective of high-inventory investments by these SMEs. Status of IM The relative health of IM practices is determined by calculating the ITR of enterprises. This is because ITR is the most commonly used measure to determine the IM performance of enterprises (Vastag and Whybark, 2005; Vergin, 1998). If the ITR is strong, this suggests that the IM practices in place are effective (Vergin, 1998). Since this study was interested in the relationship of IM to practice and performance, the use of inventory turnover as a proxy seems quite appropriate (Vastag and Whybark, 2005). Inventory turnover is calculated as total sales divided by total inventory value (raw material, work in process and finished goods inventories). Figure 3 shows the turnover wide distribution of the Bangalore SMEs. Vergin (1998) examined the trends in the ITRs of industrial enterprises in the USA and found a large difference in ITRs by industry. A high ITR that averaged around 40 was observed in firms where instantaneous replenishment of stock is found. Accordingly, low ITRs below two were observed in firms where products required a good amount of time to acquire full value. He examined the ITR trends in various industrial enterprises and found it reasonable to assert that ITRs are related to the effectiveness of IM and that firms with better IM practices will generally have larger ITRs. Among the ITR variations in many industrial sectors studied from 1986 to 1995, MTEs showed a variation from 3.7 to 6.3. When all industry sectors are considered together, the minimum and maximum ITR varied between a value below 2 and 40.

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Figure 2.
Raw material cost as a percentage of sales

Figure 3.
Enterprise wide inventory turnover distribution

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Inventory turnover ratio analysis of the studied SMEs indicated that it varied from one to four. This suggests that IM needs further improvement in these SMEs. To determine the reasons for the low-ITR value, it is important to analyze the nature of IM practices. In the case studies, inventories were placed in a stock room and retrieved as necessary. A store clerk, without interfacing with others in the enterprise, operated stock record for physical counts for each item. The accounting system had also been established in a manner that did not lend itself to the integration of physical inventory with accounting records. The IM practices employed by the studied SMEs are shown in Figure 4. The enterprises studies fall into groups, ranging from those having no discernable IM practices to those with minimal IM practices and some with a degree of sophistication. The use of manufacturing resource planning (MRP), and just in time (JIT) were not observed. Practices such as economic order quantity, always better control and vendor managed inventory have also failed to penetrate MTEs. Advanced methodologies are not used and in most circumstances, rule of thumb is followed. These rules are generally based on the entrepreneurs experience. Maintaining accurate inventory records was found to be a major problem with all the MTEs studied. This is important because the formal production systems such as MRP, MRP 11 and JIT use inventory records as a starting point for material planning calculations (Pacos and Sinn, 1989). To deepen our understanding, a correlation analysis was conducted to determine the correlation between inventory performance (as captured by ITR) and other variables affecting IM practices in the enterprises studies. The results of the correlation analysis are presented in Table III. The ITR was found to be positively correlated with value added/value of output and the number of IM practices in the enterprise, the level of computerization and purchasing effectiveness. However, a negative correlation was observed between ITR and lead-time. This finding adds weight to the argument that IM help firms achieve better utilization of resource and hence achieve increases in performance. It is essential for firms to practice a number of formal IM techniques. In addition, lead-time reduction significantly contributes to the IM performance. Crandall

Figure 4. Inventory practices followed

Correlation Table III. Correlation between IM performance and the variables influencing IM IM performance (ITR)

VAVAOUT 0.911**

Variables influencing IM performance LEADTIME NUMIMPRA COMPLEV 0.686** 0.667** 0.503**

PURCFFECT 0.521**

Notes: **Correlation is significant at the 0.01 level (two-tailed)

and Burwell (1993) observed the role of lead-time reduction in improving the performance of enterprises. Current practice level of activities influencing the IM performance of SMEs The mean level of the performance of the important IM activities are set out in Table IV. The level of these inventory related variables was measured on a five point scale, with their average value shown as the mean level of performance. The mean level of performance in forecasting, inventory ordering policy, computerization, purchasing effectiveness and employee training was found to be low, which indicates the low status of IM within management thinking. However, the mean level performance in the activities of resource availability, supplier empowerment and outsourcing level was found to be comparatively high. The justification for this finding is explained below. Since the SMEs mainly produce to order, they believe that sales forecasts do not play a very important role in the business process. The comparatively better mean value for resource availability is a result of these SMEs mainly sourcing materials from local suppliers within Bangalore and very rarely from suppliers in other Indian states. As their capacity to purchase in quantity is low, they are not eligible to source their materials from major suppliers. The local suppliers can provide the required quantity of materials immediately to these SMEs. Because the SMEs rely on a few local suppliers only for their materials, the suppliers are empowered. However, this is not because of any supplier empowerment strategy per se. It is the result of the SMEs having little bargaining power with their suppliers. Put simply, they are forced to buy materials from the local suppliers. A collaborative effort for material purchasing is a possible pathway to making SMEs eligible to source materials from the major suppliers (Pittaway and Morrissey, 2003). Collaborative efforts improve the bargaining power of SMEs with suppliers and make them eligible for other benefits including quantity discounts. Irrespective of this positive outcome, the entrepreneurs are not ready to collaborate with other SMEs to procure materials from major suppliers. The SMEs also practice a random ordering policy for procuring materials and this subsequently reduces their expertise in purchasing. The majority of SMEs did not have a separate purchasing department. Computer use is also limited to word processing and the application of information support systems is marginal. Improving the skills of employees through programs in training and development (T&D) and human resource development (HRD) certainly requires urgent attention. This is a logical step because MTEs demand high levels of technical knowledge and employees capable of performing multiple tasks.
S. No 1. 2. 3. 4. 5. 6. 7. 8. Activity Level of forecasting Availability of resources Inventory ordering policy Level of computerization Purchasing effectiveness Supplier empowerment Employee training Level of outsourcing Mean level of performance 1.58 3.18 1.63 1.45 1.35 3.28 1.83 3.13

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Table IV.
Relative value of practices influencing inventory performance

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The decision to make or buy is also an important strategic determination that can influence IM. All the SMEs in the study practiced some level of outsourcing for several reasons, including capacity constraints, demand variability or the non-availability of a particular facility. However, according to the managers, their outsourcing activity is not connected to their inventory planning. Conclusion The study of 40 SMEs in Bangalore indicated that even in an inventory intensive manufacturing industry sector such as the machine tool industry, IM practices are poor. The use of formal practices for managing inventories was also inadequate. Poor IM practices are characterized by a lack of an integrated approach in the form of the absence of links between physical stock and accounting system. A lack of appreciation for IM among the entrepreneurs and the lack of qualified staff are the two major factors contributing to low IM practices. This situation is complicated further by other factors such as constraints on working capital, a lack of T&D, a lack of progress in the area of HRD and the organizational characteristics of the SMEs. The use of a formal inventory ordering policy, such as fixed quantity ordering or fixed period ordering policy was not observed in the SMEs. Instead, a random policy was followed by the SMEs for material procurement. The study also identified the use of rule of thumb for IM, a low importance given to forecasting and random ordering for material procurement, low level use of computers and a low level of importance given to purchasing and variable lead-time. Three important aspects used to judge the quality of a firms IM practices are the systematic character of the operation, the use of computers and the application of modern methodology (Chikan, 1990). In this context, the level of computerization for IM activities of the MTEs in Bangalore was low. While the SMEs were equipped computers, the capabilities of software and hardware were not exploited to their full potential. For the SMEs in the machine tool sector in Bangalore, there is a profound scope for development in IM practices.
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Meyer, H. (1991), An eight-step approach to inventory accuracy: a case study at Leviton manufacturing company, Production and Inventory Management Journal, Vol. 32 No. 2, pp. 40-2. Mohanty, R.P (1985), Inventory problems under multiple constraints: some studies, Engineering Costs and Production Economics, Vol. 9, pp. 355-67. Natarajan, R. (1991), Inventory management the big picture, Production and Inventory Management Journal, Vol. 32 No. 4, pp. 29-31. Ng, S., Partington, E. and Sculli, D. (1993), A computer system for inventory management of lighting products: a case study, Computers in Industry, Vol. 22, pp. 71-9. Pacos, R. and Sinn, J. (1989), An evaluation of the finished goods inventory system at Westinghouse electrical systems division, Production and Inventory Management Journal, Vol. 30 No. 4, pp. 45-8. Peenya Industrial Association (PIA) (2003), Technical Directory, Peenya, Bangalore. Pirttila, T. and Virolainen, V. (1992), An overview of the state and problems of inventory management in Finland, International Journal of Production Economics, Vol. 26, pp. 217-20. Pittaway, L. and Morrissey, B. (2003), A study of procurement behavior in small firms, Lancaster University Management School Working Paper, 2003/078, available at: www.lums.co.uk/publications. Quayle, M. (2002), Purchasing in small firms, European Journal of Purchasing and Supply Management, Vol. 8, pp. 151-9. Sprague, L.G and Wacker, J. (1996), Macroeconomic analyses of inventories: learning from practice, International Journal of Production Economics, Vol. 45, pp. 231-7. Vastag, G. and Whybark, D. (2005), Inventory management: is there a knock-on effect?, International Journal of Production Economics, Vol. 93-94, No. 1, pp. 129-38. Vergin, R.C. (1998), An evaluation of inventory turnover in the fortune 500 industrial companies, Production and Inventory Management Journal, Vol. 39 No. 1, pp. 51-6. Corresponding author N. Rajeev can be contacted at: rajeevn@mgmt.iisc.ernet.in

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