Types of Inventory

Prof. Mandar Shirsavakar

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 Supply Chain ….

Supplier Plant RDC DCs Customers

No Stock
Cross dock / break bulk

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 Independent Demand Items

• Continuous Demand items

• Finished goods, spare parts typically belong to independent demand items
• Independent demand items are in continuous demand
• Where there is a continuous demand for an item, constant availability of items and
periodic replenishment of stock are important from planning point of view
• Non-availability of items translates into lost sales, poor consumer goodwill, and
additional costs in serving the promised deliveries

• Uncertainty of demand
• There is considerable uncertainty of independent demand items
• Two major questions-
• How much?
• When?

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 Inventory: Stock of the Goods
Types of Inventories in Manufacturing
• Raw materials & purchased parts
• Partially completed goods: work in progress
• Finished-goods inventories
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers

Types of Inventories in Retail/Distribution

• Finished-goods inventories (Merchandise)
• In-transit inventories

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 Who Cares About Inventory?

Apparently no one…. That’s why there is $1.16 trillion of it in the US

economy alone.

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 Why So Much Inventory?
Motivations for Holding Inventory?
• Exploit economies of scale Cycle/Batch
• Fixed costs associated purchasing or starting stock
a production run
• Quantity discounts
• Hedge against uncertainty in supply and Safety
demand stock
• Avoid Stockouts

• Manage seasonal variability

Seasonal
• Smooth production requirements
stock
• Decouple operations
• Allow independence b/w opn’s WIP
• Price Speculations Speculative
stock
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 Economical Setting

• Newsvendor Model
• Short life cycle product (perishable)
• Single selling season with uncertain demand
• Typically one replenishment prior to season
• Most retail/manufacturing settings
• Shelf life of the product is longer
• There are multiple replenishment opportunities
• Demand still uncertain

▪ Perpetual Inventory Systems

– Order-up-to (Base Stock) model

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 Demand-Supply Mismatch
“Too Much” and “Too Little” Costs
• Too much
• Capital tied in inventory (Inventory Holding Cost)
• H: Inventory Holding Cost ($/unit/time)
• Too little
• Lost sales or backorder costs
• Poor customer service
• Hard to quantify usually
• Fundamental Trade-off
• Efficiency versus Responsiveness
• More inventory – more cost – less stock outs
• How should we hedge against stockouts while
maintaining control over costs?
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 Sequence of events in the order up-to
model
• Time is divided into periods, e.g., one hour, one month.
• During a period the following sequence of events occurs:
• A replenishment order can be submitted.
• Inventory is received.
• Random demand occurs.
• Lead times:
• An order is received after a fixed number of periods (lead time).
• Let l represent the length of the lead time.

An example
with l = 1

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 Basic Pull Inventory Control Model

ROP= Reorder Point Q= Order Quantity

LT= Lead Time T= Time between orders
SS= Safety Stock

Maximum Stock Level

Place
Order

ROP

SS Receive
Order

LT LT LT LT

T T T
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 Key Inventory Terms

• Lead time: time interval between ordering and receiving

the order
• Holding (carrying) costs: cost to carry an item in inventory
for a length of time, usually a year
• Ordering costs: costs of ordering and receiving inventory
• Shortage costs: costs when demand exceeds supply

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 Economic Order Quantity Model

• The order size that minimizes total annual cost

• Only one product is involved
• Annual demand requirements known
• Demand is even throughout the year
• Lead time does not vary
• Each order is received in a single delivery
• Inventory level= 0 when new order just arrived
• There are no quantity discounts

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 Total Cost Optimization Goal

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

𝑄 𝐷
= H+ 𝑆
2 𝑄

Total Cost is minimum when Carrying Cost is

equal to Ordering Cost

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 Selective Control of Inventory

• ABC Classification
• ABC classification of inventory is based on the cost (or value) of items consumed
• Very high-value items are A class items and may require tight control
• Medium value items are B class items while low value items are C class items

• Other classifications
• On the basis of unit cost of the item (XYZ classification)
• This is based only on unit cost while ABC considers consumption pattern as well
• On the basis of inventory movement (FSN)
• Fast moving, slow moving, non-moving
• Depends on frequency of pull
• On the basis of source of supply:
• Imported, indigenous (national players), indigenous (local players)

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Managerial Insights

140 • More inventory is

needed as fill rate/
120 customer service
target increases (at
100
an increasing rate)
Expected inventory

80 • More inventory is
needed as demand
60 uncertainty increases
for any fixed fill rate.
40
Inc re a s ing
s ta nda rd de via tion
• The required
20
inventory is more
sensitive to the fill
0 rate level as demand
90% 91% 92% 93% 94% 95% 96% 97% 98% 99% 100% uncertainty increases
Fill rate

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Managerial Insights

• Lower your lead time and

600 lower your inventory
500 Fill rate
increases
• Reducing the lead time
Expected inventory

400
reduces inventory,
300
especially as the target fill
rate increases
200

100 • Do not forget: Reducing

the leadtime also reduces
0 pipeline (in-transit)
0 5 10 15 20 inventory
Lead time

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 Thank You!

Mandar Shirsavakar
[email protected]
+91 95279 66700

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