Introduction to Inventory

Inventory is the stock of any item or resource used in an organization. An inventory system is the
set of policies and controls that monitor levels of inventory and determine what levels should be
maintained, when stock should be replenished, and how large orders should be. By convention,
manufacturing inventory generally refers to items that contribute to or become part of a fi rm’s
product output. Manufacturing inventory is typically classified into raw materials, finished
products, component parts, supplies, and work-in-process. (Richards, 2013)
Purpose of Inventory
All firms keep a supply of inventory for the following reasons:
To maintain independence of operations
A supply of materials at a work center allows that center flexibility in operations. For example,
because there are costs for making each new production setup, this inventory allows management
to reduce the number of setups. Independence of workstations is desirable on assembly lines as
well. The time that it takes to do identical operations will naturally vary from one unit to the
next. Therefore, it is desirable to have a cushion of several parts within the workstation so that
shorter performance times can compensate for longer performance times. This way the average
output can be fairly stable. (Permenter, 2013)
To meet variation in product demand
If the demand for the product is known precisely, it may be possible (though not necessarily
economical) to produce the product to exactly meet the demand. Usually, however, demand is
not completely known, and a safety or buffer stock must be maintained to absorb variation.
(Permenter, 2013)
To allow flexibility in production scheduling
A stock of inventory relieves the pressure on the production system to get the goods out. This
causes longer lead times, which permit production planning for smoother fl ow and lower-cost
operation through larger lot-size production. High setup costs, for example, favor producing a
larger number of units once the setup has been made. (Permenter, 2013)
To provide a safeguard for variation in raw material delivery time
When material is ordered from a vendor, delays can occur for a variety of reasons: a normal
variation in shipping time, a shortage of material at the vendor’s plant causing backlogs, an
unexpected strike at the vendor’s plant or at one of the shipping companies, a lost order, or a
shipment of incorrect or defective material. (Mentzer, 2001)
To take advantage of economic purchase order size
There are costs to place an order: labor, phone calls, typing, postage, and so on. Therefore, the
larger each order is, the fewer the orders that need be written. Also, shipping costs favor larger
orders the larger the shipment, the lower the per-unit cost. (Mentzer, 2001)
Many other domain-specific reasons
Depending on the situation, inventory may need to be carried. For example, in-transit inventory
is material being moved from the suppliers to customers and depends on the order quantity and
the transit lead time. Another example is inventory that is bought in anticipation of price changes
such as fuel for jet planes or semiconductors for computers. (Mentzer, 2001)
Inventory Planning
Inventory planning is about determining the optimum levels of inventory both for today and the
future. The purpose of creation of the plan is to identify the optimum inventory levels. This will
involve understanding demand patterns, what value-add is needed for each product (eg
manufacturing requirements, retail volumes and sales locations, military and medical
consumption levels), and deciding what inventory categories each product should be in. The
inventory plan must aim to match the high level business needs with what is possible at the
detailed item level, ie in order to meet the expected demand for the products to be sold by the
business, what products should be held, where and in what volumes, and at what cost?
A key feature of the plan is to identify and manage the parameters that need to be set within the
business systems, which are needed to balance future stock levels (eg order frequencies, safety
stock policies, minimum order quantities and lead times). (Vollmann, Berry, and Whybark,
2008)
Inventory Planning Process
Report Position
The first step in the inventory planning is to ‘report the current position’: Has the previous plan
achieved the required reduction? What is the impact on customer service and product
availability? Are there critical inventory items that were needed, and why? What items am I short
of, what do I have too much of? What do my customers want? (Vollmann, Berry, Whybark, and
Jacobs, 2005)
Instruction from the Board
Senior management often sees good inventory management as a critical part of the effective way
of managing a business. However, there is often a call from the board to reduce inventory
volumes and costs without any real understanding of the impact at a part level, and the impact
this might have on product availability for customers. This is the responsibility of the operations
management people, who have to consider how this could be done and report back on the
consequences of any reductions. (Vollmann, Berry, Whybark, and Jacobs, 2005)
Plan How
The next step in the inventory planning is to plan how to achieve the reduction. To plan this
reduction the operations manager will need to decide which of the many parts (often 10,000 and
frequently more) can have their stock levels reduced. This will involve a detail understanding of
not only the part’s value, but any issues related to its supply and demand, and its relative
importance to the business. (Vollmann, Berry, Whybark, and Jacobs, 2005)
Implement it
Once the ‘plan how’ is decided, the next step can be started. To do this, instructions need to be
given to the planning and control systems within the business system, for example Master
Production Scheduling (MPS) or Manufacturing Resource Planning (MRP or MRPII). The MPS
or MRP use these instructions to perform a series of planning calculations. Systems often give
planners the opportunity to try this out in a what-if scenario: The instructions are given in the
setting of a number of parameters (for example, lead-time, minimum batch size, safety stock)
which result in suggested order quantities. The planning system uses these parameter settings to
calculate orders and thus volume of inventory that will be produced as a consequence.
The ability of the system and the business processes to continue to satisfy customers with the
reduction in inventory levels can be measured with key performance indicators (KPIs) such as
stock availability measured against demand, non-compliance, etc. (Vollmann, Berry, Whybark,
and Jacobs, 2005)
Conclusion
Understanding the inventory planning pyramid allows a company to address the following
questions, and determine ‘how’ to carry it out and what the implications are likely to be: Does
the company have too much money tied up in stock? Does it make sense to reduce your
inventory by certain per cent? Would you like to understand where you’d be at risk?
References
Mentzer, J T (2001) Defining supply chain management, Journal of Business Logistics, 22(2), 1–
25
Permenter, K (2013, March) Supply Chain Collaboration in the Consumer Markets. Retrieved
from CH Robinson White Paper – Aberdeen Group Research:
www.aberdeen.com/research/8391/ai-supply-chain-collaboration/content.aspx
Richards, G (2013) Warehouse Management: A complete guide to improving efficiency and
minimizing costs in the modern warehouse, p7, Kogan Page, London
Vollmann, T E, Berry, W L and Whybark, D C (2008) Manufacturing Planning and Control
Systems (4th edn), Irwin/McGraw-Hill, Bolton
Vollmann, T, Berry, T, Whybark, D C and Jacobs, F R (2005) Manufacturing Planning and
Control for Supply Chain Management (5th edn), McGraw Hill, Singapore