Inventory Management: A Comprehensive Guide
Inventory Management
Introduction
Inventories are collections of raw materials, supplies, components, work-in-progress, and finished products found throughout a company’s production and logistics channels. Maintaining these inventories can cost between 2% and 4% of their value annually.
Inventory Systems
An inventory system consists of policies and controls designed to:
- Monitor inventory levels
- Determine optimal stock levels
- Establish replenishment schedules
- Determine order sizes
Inventory Analysis
Inventory analysis focuses on determining:
- When to order items
- Appropriate order size
Reasons for Maintaining Inventory
Companies maintain inventory to:
- Adapt to changing demand
- Account for variations in raw material delivery times
- Leverage economies of scale in purchasing
- Enable flexible production scheduling
Inventory and Customer Service Objectives
Inventory management balances product availability (customer service) with the costs of ensuring that availability. The Total Period Service Performance (TPSP) is calculated by multiplying the frequency of each item combination in an order by the probability of fulfilling the entire order, given the number of items ordered.
Relevant Costs
Three cost categories are crucial for determining inventory policy:
- Acquisition costs
- Holding costs
- Shortage costs
Acquisition Costs
These costs may include the product’s price (or manufacturing cost), order processing costs, transmission costs, shipping costs, and receiving/handling costs.
Holding Costs
These costs are associated with storing items and are proportional to the average inventory level. They can be categorized as:
- Space costs: Charges for storage space.
- Capital costs: The cost of money tied up in inventory, often representing over 80% of total inventory cost.
- Service costs: Insurance and taxes, which depend on inventory levels.
- Risk costs: Costs associated with damage, loss, deterioration, or obsolescence.
Shortage Costs
These costs arise when an order cannot be fulfilled from existing inventory. There are two types:
- Lost sales costs: Incurred when a customer cancels an order due to unavailability.
- Backorder costs: Incurred when a customer waits for an order, delaying the sale but not losing it.
Inventory Control Methods
Pull Method (Demand-Driven)
Each stock point (e.g., a warehouse) operates independently.
Push Method (Increment-Driven)
Planning and replenishment decisions are made independently for each stock point, potentially leading to uncoordinated batch sizes.
Push Inventory Control
Suitable when production quantities exceed short-term inventory requirements.
Pull Inventory Control
Each stock point is treated independently.
Single Order (One-Time Demand)
When demand occurs only once, a single order is placed to meet that demand. The challenge lies in determining the optimal order size.
Repeat Orders (Recurring Demand)
With continuous demand, replenishment orders are repeated over time. Orders can be filled instantly or delivered over time.
Instant Replenishment
When demand is continuous and constant, inventory control involves specifying:
Instant No Replenishment
The original Economic Order Quantity (EOQ) formula assumes instant replenishment in a single batch.
In-Transit Inventory
This refers to inventory in transit between storage locations.