Inventory Management

IOANNIS Dermitzakis
 Inventory

• Inventory refers to stocks of goods and

materials that are maintained for many
purposes, the most common being to satisfy
normal demand patterns. (internal and external)

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 Inventory Management

• Inventory management
– Related to Materials Management and Physical
Distribution Management
– Inventory decisions drive other logistics activities
– Different functional areas have different inventory
objectives
– Inventory costs are important to consider

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 Inventory Management
Rate of supply from
input process

Rate of demand
from output
Inventory process

Input Output
process process
Inventory
 Aims of Inventory Management

• Provide internal and external customers with required

service levels at optimum cost
• Establish present and future requirements for all types
of inventory to avoid overstocking
• Keep stocks to a minimum by variety reduction
• Provide upstream and downstream inventory visibility
in the supply chain

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 Performance Objectives of
Inventory Management
• Quality
– Materials/products need to be maintained in as good a condition
as possible
• Speed
– Inventories must be in the right place to ensure fast response to
customer requests.
• Dependability
– The right stock must be in the right place at the right time to satisfy
customer demand.
• Flexibility
– Stock should be managed to allow the operation to be flexible.
• Cost
– Minimize the total cost of managing stock levels
 Inventory in ROCE

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 Inventory types
Wholesaler or retailer: Manufacturer:

Manufacturer Supplier
Firm Includes other
manufacturing
Firm Raw materials costs ( Direct
Merchandise labor costs,
Work-in-process direct
inventory materials,
Finished goods manufacturing
overhead,
etc.)
Customer Customer
Gross Profit: Sales – Cost of Goods Sold

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Inventory Resource

Other inventories:
Rooms in a hotel
Cars in a vehicle-hire firm
 Discussion

• Reasons for holding inventory

• Advantages and disadvantages of holding
inventory
Reasons for Inventory
 Importance of Inventory
Management

• Inventory is an asset.
• Inefficient inventory management will increase costs and
reduce profitability.
• Inventory can enhance flexibility and provide competitive
advantages.
• It needs the co-operation of efficient and effective
suppliers.
• The armed forces need inventory to maintain operational
readiness and performance.

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 Stock May Increase Value

• For example:
– Wine - when it is first harvested the wine is of
relatively low value. Keeping it in special casks under
the right conditions enhances its value considerably.
– A company may deliberately purchase more stock
than it needs because it feels the availability of the
material or the price of the material is likely to change
(it may be risky!)
 Disadvantages of
Holding Inventory
• It is expensive
• to fund the gap between paying for the stock and getting
revenue in by selling the product.
• keep the stock in warehouses or containers.
• Items can deteriorate
• significant for the food industry
• stock could be accidentally damaged
• Products can become obsolescent
• fashion may change
• commercial rivals may introduce better products.
 Disadvantages of
Holding Inventory
• Items could be totally lost, or expensive to retrieve
• Might be hazardous to store
• May require special facilities and systems for safe-
handling
• May take excessive storage space compared to its value
• May involve high insurance costs
• Stock is confusing.
• large piles of inventory around the place need to be managed.
• They need to be counted, looked after and so on.
Inventory Costs
 Inventory-Related Costs

• Ordering or Setup Costs

– Ordering costs: costs associated with outside procurement of
materials
– Setup costs: costs associated with internal procurement of
parts of materials
• Inventory Carrying or Holding Costs, including:
– Capital costs, storage costs and risk costs
• Stockout Costs
– Inventory is unavailable when customers request it, or when
it is needed for production
 Ordering Costs

• Ordering costs refer to those costs associated with

ordering inventory, such as order costs and setup costs.
• Examples of order costs include:
– Costs of receiving an order (wages)
– Conducting a credit check
– Verifying inventory availability
– Entering orders into the system
– Preparing invoices
– Receiving payment

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Inventory Carrying Cost
 Stockout Costs

• Stockout cost is an estimated cost or penalty

that is realized when a company is out of stock
when a customer wants to buy an item.

• Stockout costs involve an understanding of a

customer’s reaction to a company being out of
stock.

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 Inventory Costs
• Inventory costs are important to consider
– Inventory turnover: cost of goods sold divided by
average inventory at cost

cost of goods sold = inventory turnover

average inventory

$200,000 = inventory is sold 4 times per year

$ 50,000
• Compare with competitors or benchmarked companies

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 Inventory costs

• Low inventory turnover = high inventory carrying

costs, little (or no) stockout costs
• High inventory turnover = low inventory carrying
costs, high stockout costs
• Managing the tradeoff is important to maintain
service levels

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 Inventory Costs
• Trade-Off between Carrying and Ordering Costs

Ordering cost = number of orders per year x ordering cost per

order

Carrying cost = average inventory x carrying cost per unit

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 How much to order?

• The amount of inventory to hold depends on:

– The needs for a production run
– How often the material is used
– The cost of placing an order
– The lead time for delivery of the materials
– Deterioration or obsolescence
– Discounts for bulk purchases
– Price fluctuations.
 Economic Order Quantity:
Optimising Trade-offs

Ordering More Frequently Ordering Less Frequently

 Higher Ordering Costs  Lower Ordering Costs

 Smaller Average Inventory  Larger Average Inventory

Need to Calculate:
CO = fixed cost of placing an order
CH = holding cost per item per unit of time (e.g. a year)

Aim is to minimise ordering and holding costs

 EOQ

The economic order quantity

Total costs

Inventory carrying costs

Costs ($)

Inventory Ordering Costs

EOQ Order quantity (Q)

 EOQ (Q*)

Where: D = Total Annual usage

CO = fixed cost of placing an order
CH = unit cost of the item x Carrying cost rate per year
 Reorder Point System

• In reorder point system an inventory level is

specified at which a replenishment order for
a fixed quantity of the inventory item is to be
placed.
A Reorder Point System
 Priorities for Inventory
Management

• ABC Analysis of Inventory recognizes that inventories are

not of equal value to a firm and as such all inventory should
not be managed in the same way.

– A. High-value items
– B. Medium-value items
– C. Low-value items
 ABC Analysis or Pareto
Analysis

• Inventories are not of equal value to firms

• About 20% of items account for 80% of a firm’s
expenditure

Item Class Percentage Percentage value Control

of items of annual usage
Class A items About 20% About 80% Close day-to-day control
Class B items About 30% About 15% Regular review
Class C items About 50% About 5% Infrequent review

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 Discussion Questions

• Which inventory management system would

be useful for
a) A computer manufacturer
b) A pub or bar
c) Computer printer paper supplies at a University

• What characteristics of each operation would

influence this choice?
 Conclusions
• Inventory is major asset in many businesses.
• It is used to balance uncertainty of supply and demand,
and to permit immediate availability when replenishment
times are too lengthy.
• But inventory is often regarded as a hindrance rather
than a help.
• Primary goal for SCM:
– to replace inventory with information by increasing the
use of real demand rather than the use of forecasts.