Operations Management

Note-20
Prof. Satyanath Mohapatra (Asst. Professor)
Quantitative Finance
Inventory Management in Operations Management
Inventory management is a critical aspect of operations management that involves overseeing the acquisition, storage, and
utilization of materials and goods required for a company's production or service delivery processes. Effective inventory
management ensures that the right amount of inventory is available at the right time to meet customer demand while
minimizing carrying costs and stockouts. In this lecture, we will explore the key concepts, strategies, and techniques related
to inventory management.
Importance of Inventory Management:
Balancing Supply and Demand: Inventory management helps strike a balance between supply and demand fluctuations,
ensuring products or services are available when customers need them.
• Cost Optimization: By efficiently managing inventory levels, companies can reduce holding costs, warehousing
expenses, and obsolescence costs.
• Customer Service: Maintaining optimal inventory levels leads to improved customer service, as products are readily
available for timely delivery.
• Risk Mitigation: Adequate safety stock and buffer inventory protect against uncertainties like supply chain
disruptions or unexpected demand surges.
Types of Inventory:
• Raw Materials: Inventory of basic inputs required for production or service delivery.
• Work-in-Progress (WIP): Partially processed materials in the production cycle.
• Finished Goods: End products ready for sale or distribution.
• Maintenance, Repair, and Operations (MRO): Inventory of materials used for maintenance and support functions.
• Safety Stock: Extra inventory kept to mitigate uncertainties in demand or supply.

Inventory Management Techniques:

Economic Order Quantity (EOQ):
The economic order quantity (EOQ) refers to the ideal order quantity a company should purchase in order to minimize its
inventory costs, such as holding costs, shortage costs, and order costs. EOQ is necessarily used in inventory management,
which is the oversight of the ordering, storing, and use of a company's inventory. Inventory management is tasked with
calculating the number of units a company should add to its inventory with each batch order to reduce the total costs of its
inventory.

The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a company does not have to
make orders too frequently and there is not an excess of inventory sitting on hand. It assumes that there is a trade-off
between inventory holding costs and inventory setup costs, and total inventory costs are minimized when both setup costs
and holding costs are minimized.
 The EOQ is a company's optimal order quantity that
minimizes its total costs related to ordering, receiving,
and holding inventory.
The Economic Order Quantity (EOQ) is the number of
units that a company should add to inventory with each
order to minimize the total costs of inventory, such as
holding costs, order costs, and shortage costs.

Just-In-Time (JIT):
Just-in-time also known as JIT is an inventory management method whereby labour, material and goods (to be used in
manufacturing) are re-filled or scheduled to arrive exactly when needed in the manufacturing process.
JIT approach has the capacity, when adequately applied to the organisation, to improve the competitiveness of the
organisation in the market significantly by minimizing wastes and improving production efficiency and product quality.

Importance of Just in Time

The aim is to reduce non profitable activities and make the manufacturing system more flexible, eliminating the associated
costs of carrying and maintaining the inventory. There is no scope for extra inventory what so ever. This was pioneered by
Toyota at their facility.
1. Reduced setup time and low wastage.
2. The flow of goods from warehouse to shelves improves.
3. Employees with multiple skills are used more efficiently.
4. Increased emphasis on supplier relationships.
5. Minimizes storage space needed thereby saving warehousing costs.
6. Smaller chance of inventory breaking/expiring.
Dell computers is a prime example of using just in time technique. For its customized laptops & personal computers, Dell
only placed order of spare parts once a customer confirmed the orders. Hence there was minimum inventory storage,
thereby reducing inventory costs & lead times.

Drawbacks of Adopting JIT Systems

• JIT approach states ZERO tolerance for mistakes, making re-work difficult in practice, as inventory is kept to a
minimum level.
• A successful application of JIT requires a high reliance on suppliers, whose performance is outside the purview of
the manufacturer.
• Due to no buffers in JIT, production line idling and downtime can occur which would have an unfavorable effect on
the production process and also on the finances.
• Chances are quite high of not meeting an unexpected increase in orders as there will be no excess inventory of
 finished goods.
• Transaction costs would be comparatively high depending upon the frequency of transactions.
• JIT may have certain negative effects on the environment due to the frequent deliveries as the same would result in
higher use and cost of transportation, which in turn would consume more fossil fuels.
ABC Analysis:
ABC Analysis, also known as Pareto Analysis or the 80/20 rule, is a valuable inventory management technique used to
categorize items based on their significance. It helps organizations prioritize resources, optimize inventory control, and
focus efforts on the most critical aspects of their business. This lecture will delve into the concepts, benefits, and
implementation of ABC Analysis to enhance operational efficiency and profitability.

ABC Analysis is named after the three

categories it creates: A, B, and C.
Category A includes items that have the
highest value or impact, typically
constituting a small portion of the
inventory but contributing significantly to
revenue or costs.
Category B comprises items of moderate
value or importance, constituting a larger
portion of the inventory than Category A
but still contributing substantially to the
business.
Category C contains items with the lowest
value or significance, representing a large part of the inventory but contributing relatively little to revenue or costs.

Pareto Principle:
ABC Analysis is based on the Pareto Principle, also known as the 80/20 rule, which states that approximately 80% of the
effects come from 20% of the causes.
In the context of inventory management, this means that around 80% of the value comes from 20% of the items.

Benefits of ABC Analysis:

• Efficient Resource Allocation: By categorizing items, organizations can allocate resources and efforts according
to their significance. This prevents wasting valuable resources on less critical items.
• Inventory Optimization: Prioritizing inventory control for Category A items ensures that the most valuable and
high-impact products are always available.
• Cost Reduction: ABC Analysis helps identify opportunities to streamline processes and reduce expenses related to
less critical items.
• Risk Management: Category A items often carry higher risks, such as stockouts. By managing them effectively,
companies can mitigate potential risks and uncertainties.
Inventory Control Policies:
• First-In-First-Out (FIFO): The earliest items purchased are the first to be sold or used in production, reducing the
risk of obsolescence.
• Last-In-First-Out (LIFO): The most recent items purchased are the first to be sold or used, which can be useful
for tax purposes but may lead to obsolescence risks.
• Perpetual Inventory System: A continuous tracking system that updates inventory levels in real-time as items are
bought or sold.
• Periodic Inventory System: Inventory is counted periodically, and stock levels are adjusted accordingly, which
may be less accurate but is simpler and less costly.
Inventory Performance Metrics:
o Inventory Turnover Ratio: Measures how quickly inventory is sold and replaced during a specific period.
o Days Inventory Outstanding (DIO): Indicates the average number of days inventory is held before being sold.
o Stockout Rate: Measures the frequency of stockouts and assesses the effectiveness of inventory management.

Material Requirements Planning (MRP):

Material Requirements Planning (MRP) is a vital technique used by manufacturing and production companies to manage
their inventory and production processes efficiently. MRP helps organizations ensure that they have the right amount of
materials at the right time to meet customer demand while minimizing excess inventory and associated carrying costs. This
lecture will delve into the concepts, benefits, and implementation of MRP to enhance production efficiency and customer
satisfaction.
MRP is a computer-based inventory management system that calculates the precise quantity and timing of raw materials,
components, and sub-assemblies required for the production process.
It helps manufacturers maintain optimal inventory levels, prevent stockouts, and minimize carrying costs by synchronizing
production with demand.

Key Components of MRP:

• Bill of Materials (BOM): A BOM is a comprehensive list of all components, sub-assemblies, and raw materials
required to manufacture a finished product. It acts as the foundation of the MRP system.
• Master Production Schedule (MPS): The MPS outlines the production plan, specifying the quantities and delivery
dates of finished products. It serves as the primary input to the MRP process.
• Inventory Status Records: These records track the current inventory levels for each component and finished
product, including on-hand quantities, scheduled receipts, and lead times.

Benefits of Material Requirements Planning:

• Optimized Inventory Management: MRP ensures that inventory levels are precisely aligned with production needs,
reducing excess stock and the associated holding costs.
• Enhanced Production Scheduling: Manufacturers can plan and schedule production more effectively, avoiding
production bottlenecks and unnecessary overtime.
• Improved Customer Service: Accurate MRP helps meet customer demand on time, leading to improved customer
satisfaction and retention.
• Reduced Lead Times: By having the right materials available at the right time, lead times for production can be
minimized, resulting in faster order fulfillment.
• Cost Savings: MRP reduces wastage, inventory carrying costs, and stockouts, leading to significant cost savings for
the company.

Material Requirements Planning is a valuable tool for manufacturing companies to optimize inventory, streamline
production, and deliver products on time to meet customer demand effectively. By accurately calculating material
requirements and synchronizing production schedules, MRP helps businesses achieve higher efficiency, cost savings, and
improved customer satisfaction. Regularly updating the MRP system ensures it remains relevant and effective in the
dynamic manufacturing environment.