Inventory Management: Strategies for Business Success

Key Steps in the Inventory Management Process

Effective inventory management is crucial for the success of any business. It involves a series of steps that, when executed correctly, can lead to significant improvements in profitability and operational efficiency.

  1. Formulate the Problem:
    • Identify the specific situation(s) that need to be addressed.
    • Define the problem(s) clearly, nesting them if necessary.
    • Prioritize solving the most critical and/or viable issues according to management’s assessment.
    • Note: A well-defined problem statement is crucial, as a flawed approach can have negative consequences. For example, cost-cutting measures should not compromise service quality in the long term.
  2. Build a Model:
    • Represent the problem mathematically, adapting it to your specific case.
    • Remember that the best model is not necessarily the most complex, but rather the one that accurately reflects reality and provides valuable insights for decision-making.
  3. Collect Data:
    • Gather data from all relevant areas of the organization.
    • This may include information on inventory maintenance costs, order costs, demand patterns, and supplier lead times.
    • Note: The quality of the data directly impacts the validity of the model. As the saying goes, “garbage in, garbage out.”
  4. Solve the Model:
    • This is often the easiest part if the previous steps have been carried out correctly.
    • Work with the collected data using the model built in the previous step.
    • Some authors recommend running scenarios by fluctuating the data to analyze potential impacts and prepare for different situations.
    • Others suggest testing the model against past situations to evaluate its effectiveness.
  5. Interpret Results:
    • Management’s input is essential in this stage.
    • The model should support, not replace, the decision-maker’s judgment.
    • Decision-makers should approach the results objectively, avoiding biases and preconceived notions.
    • Note: True professionalism involves analyzing data and adapting to changing circumstances.
  6. Implement the Model:
    • If the previous steps were handled correctly, implementation should be relatively straightforward.
    • However, resistance to change within the organization can sometimes pose challenges.
    • It’s common for individuals at all levels to resist new ideas and stick to established routines.
  7. Feedback and Refine the Model:
    • Continuously monitor and adjust the model based on changing circumstances and feedback.
    • This demonstrates a commitment to accuracy and objectivity in decision-making.
    • Remember that even the most sophisticated models cannot replace the judgment of a skilled manager.

The Importance of Procurement

A well-defined procurement policy is essential for efficient company management and cost reduction. Inventory management should be integrated into the company’s overall planning and control processes, starting from the moment a purchase is planned.

Understanding Inventory

In the broadest sense, inventories are usable resources stored for later use. Some define them as idle assets in storage, while others consider them a vital current asset for the company’s operations. There are many justifications for holding inventory, including:

  • Meeting customer demand
  • Buffering against supply chain disruptions
  • Taking advantage of bulk discounts

Fixed Quantity System (Q)

In a continuous review system, also known as a Q system, the inventory level is evaluated after each transaction or continuously. When the inventory level drops to a predetermined reorder point, a fixed quantity order is placed. Because the order quantity is fixed, the time between orders varies depending on the random nature of demand.

Service Level

The service level can be defined in several ways:

  1. The probability that all orders are filled with material stored during the lead time for replenishment reorder cycle.
  2. The percentage of demand that is satisfied by the stock during a specified period (e.g., one year).
  3. The percentage of time the system has available stock.

Reorder Point

The reorder point is based on the probability distribution of demand during the lead time. Once an order is placed, the inventory system is vulnerable to stockouts until the order arrives. The reorder point is typically set above zero to minimize the risk of stockouts during the replenishment lead time. The figure below illustrates a typical probability distribution of independent demand during lead time. The reorder point can be adjusted to achieve the desired service level. For pedagogical purposes, we often assume a normal distribution for demand, which is often a reasonable approximation of reality.

Stock and Warehouse Management

Stock management is responsible for determining what, how, when, and at what price to stock. This involves collaboration between the overall business direction and the marketing, commercial, manufacturing, and purchasing departments. Warehouse management implements the principles established by stock management, optimizing the corresponding physical flows within the warehouse.

Store Design

To define the appropriate design of a store, consider the following:

  • Items to be stored
  • Available financial resources
  • Logical design of operations
  • Projected requirements

Types of Inventory

Depending on the characteristics of the firm, there are typically five types of inventory:

  • Inventory of Goods
  • Inventory of Semi-Processed or Finished Products
  • Inventory of Goods in Process Manufacturing
  • Inventory of Raw Materials
  • Inventory of Factory Supplies