Topic: Introduction to Inventory Management

Textbook chapter: 12

Session 2

Thursday, 19th January 2023

Session plan

Topics to be discussed
Inventory Management
Other types of inventory
Accounting practices for inventory
Functions of inventory
Inventory replenishment policies
Periodic review
Continuous review

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 Other types of inventory

Hotel Rooms
Hotels refer to unsold guest rooms for a given night as inventory.
Airline Seat Inventory
Airlines identify unsold seats in each ticket class, for each flight, each day, as inventory.

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Accounting practices for inventory

Inventory in practice

Check the annual reports of firms for inventory reporting on the balance sheet.
Inventory is reported under current assets on the balance sheet.
Inventories almost always appear under ”Current assets” because firms consider
them relatively liquid assets.
The designation means these assets will, or could, convert to cash in the near term.
Example?
https://reports.shell.com/annual-report/2018/consolidated-financial
-statements/balance-sheet.php

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 Functions of inventory
Balancing supply and demand
Holding inventory allows an organization to intermittently produce batches of prod-
ucts, instead of having to produce at exactly the same time and rate as demand.
Inventory is used to satisfy demand for a product during the periods when it is not
being produced.
Example? Cycle stock, Seasonal stock
Cycle stocks enable firms to produce or ship inventories in batches (or production
“cycles”) to take advantages of economies of scale.

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Functions of inventory . . .

To decouple operations
Manufacturing firms use inventories as buffers between successive operations to main-
tain continuity of production that would otherwise be disrupted by events such as
breakdowns of equipments and accidents that cause a portion of the operations to
shut down temporarily.
The buffers allow other operations to continue temporarily while the problem is re-
solved.
Example?
Cost vs. usefulness tradeoff

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 Functions of inventory . . .

To hedge against price increase

Sometimes a firm will suspect that a substantial price increase is about to occur and
purchase larger than normal requirement to beat the increase.
Example? Pharma sector APIs

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Functions of inventory . . .

To reduce the risk of stockout

Delayed deliveries and unexpected increases in demand increase the risk of shortages.
Example? Safety stock, Chip shortage

Taken from: https://www.newindianexpress.com/business/2021/dec/26/chip-production-a-long-way-to-go-2399744.html

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 Functions of inventory . . .

To enable quantity discounts

Often suppliers offer price discounts to customers to purchase larger quantities.
Other positive implication? Large quantities may result in economies associated with
transporting larger quantities at one time.

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Key takeaway

“Rocks” below the surface represent operations problems and wastes.

Sea represents the inventory level.
Implications of the inventory level
Positive implication? Too much inventory allows production to continue in spite
of problems.
Negative implication? It makes flow-interrupting problems difficult to find and solve.
In lean system inventory serves as a measure of the health of the operation. The
more inventory needed for the system to work, the less healthy the system is.
In a service setting, excess capacity and increased lead times are the buffers that often hide
problems.
Taken from: Swink, M., Melnyk, S. A., Cooper, M., & Hartley, J. (2014). Managing operations. New York: McGraw-Hill/Irwin.
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 Inventory replenishment policies

Periodic review policy

Two-bin system
Vendor managed inventory (VMI)
Continuous review policy
Point-of-sale (POS) system
Universal product code (UPC) or bar code

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Inventory replenishment policies . . .

Periodic review policy

Inventory status is checked at regular periodic interval (T).
Order is placed to raise the inventory to a specified threshold level (OUL).

Taken from: Saravanan.

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 Inventory replenishment policies . . .
Periodic review policy
Examples
Two-bin system? Two containers are placed, order is placed when the first container
gets empty.

VMI? The vendor checks quantity on hand and resupplies.

Practiced by? Small retailers, household kitchens 13 / 16

Inventory replenishment policies . . .

Continuous (perpetual) review policy

Inventory is continuously tracked.
When inventory drops to ROP, order for a lot size Q.

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 Inventory replenishment policies . . .
Continuous review policy
Examples
Point-of-sale (POS)? It electronically record actual sales.

UPC scanners? Give managers continuous information on inventories.

Practiced by? Walmart, Dell, Supermarkets 15 / 16

Inventory replenishment policies . . .

Periodic review policy
Inventory status is checked at regular periodic interval (T).
Order is placed to raise the inventory to a specified threshold level (OUL).
Continuous review policy
Inventory is continuously tracked.
When inventory drops to ROP, order for a lot size Q.
Daily demand = D units, Lead time = L days
Expected demand during lead time = D * L
Safety inventory = ROP - D * L
How does the safety inventory vary as per the replenishment policy?
Safety inventory in continuous review? To cover uncertainty over lead time L
Safety inventory in period review? To cover uncertainty over lead time L+T
Periodic review replenishment requires more safety inventory than continu-
ous review for the same lead time and level of product availability.
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