INVENTORY MANAGEMENT:

FOR LEAN SUPPLY CHAIN

B.K School Of Business Management.

BULLWHLP EFFECT

Deformation of demand volatility information across the supply

chain, resulting in inventory problems.
1.1 INVENTORY—ASSET OR LIABILITY?
 From a financial perspective, inventory is one of the major
current assets that can contribute to maximizing the value of
the firm
 Funds invested in inventory cost the firm by way of interest
on working capital borrowings from the bank at the current
interest rates.
 The benefits of inventory reduction will be reflected in
terms of increase in profit margins, return on investment
(ROI) and economic value addition (EVA).
 Today, inventory investment is viewed as a supply chain
cost driver rather than as a material asset.
1.2 INVENTORY FUNCTIONS
 Raw material and components inventory
 Work-in-progress inventory
 Finished goods inventory
 Maintenance, repairs and operating supplies
inventory
 Pipeline or in-transit inventory
 Inventory management is both an art and
a science
• Right level of inventory
• Trade-off between inventory cost and customer service
• Treating inventory as a liability or asset
 The industry will have to manage basically three types of
inventories that are held at stages of the supply chain of a
company
1. Raw materials and components on the procurement side
2. In-process or work-in-progress inventory
3. Finished goods inventories (at source and distribution
centers)
 In outbound logistics we are mainly concerned with the
finished goods inventories.
 • Non-excise paid goods at plant warehouse
 • Inventory in transit
 • Channel inventory
 Manufacturer
 Manufacturer keep inventories of raw materials, work
in progress and finished goods.
 Inventory commitments of the manufacturer are of a
longer period, even though his product lines are
narrower as compared to wholesalers or retailers.
 Inventory commitments are closely related to the
investments made in anticipation of
I. The Returns Budgeted
II. Lead Time Of The Raw Materials And Components
III. Complexity And Width Of The Distribution Network
IV. Unit Value Of The Product
V. The Nature Of Demand
 Wholesaler
 The wholesaler’s risk is spread over the different

products.
 For seasonal products, the wholesaler purchases

the inventory in advance in anticipation

of future sales, thus widening the risk element
 Retailer.
 The retailer’s risk duration is much shorter

than for the wholesaler and manufacturer,

 The retailer basically buys and sells and does

not stock the material for a longer duration.

 Retailer faces the risk of marketing rather

than of inventory.
1.3 INVENTORY FUNCTIONALITY
 Balancing Supply and Demand- the products are
manufactured in advance in anticipation of demand
and kept in stock for supply during the peak period
 Periodic Variation-products are manufactured and
stocked as inventory to meet the demand of the
finished product throughout the year
 Scale Economics - inventories provide demand
utility for products at the time and places they are
required for consumption.
1.4 REASONS FOR CARRYING INVENTORIES
 Meeting Production Requirements
 Supporting Operational Requirements

 Customer Service Considerations

 Hedge Against Future Expectations

1.5 INVENTORY-RELATED COSTS
 Inventory Cost- Inventory blocks funds, Funds
once blocked cannot be invested in any other
productive activities
 Carrying Cost- Funds invested in inventory attract
interest charges on working capital borrowed from
the bank
 Ordering Cost.- The cost involved in the ordering
process, The paperwork, faxes, phone calls, and so
on.
 Warehousing Cost- This is the cost for product
holding in the warehouse. Depending on the kind of
warehouse (private, public or contract).
 Damage, Pilferage and Obsolesce Cost.- Material
stored carries the risk of damage, shrinkage and loss
of weight A product carries the risk of pilferage or
obsolescence due to technology change or availability
of substitutes.
 Exchange Rate Differentials- fluctuation may
increase or decrease the value of the inventory
1.6 INVENTORY CONTROLS
 Selective Control Techniques
 In these methods the degree of control varies with
the importance of the item in the supply chain.
 ABC Analysis
• ABC by velocity (times sold),
• ABC by sales in rupees,
• ABC by quantity sold or consumed,
• ABC by average inventory investment,
• ABC by margin.
 ABC ANALYSIS

 ABC analysis is an inventory management technique that

determines the value of inventory items based on their
importance to the business. ABC ranks items on demand, cost
and risk data, and inventory mangers group items into
classes based on those criteria. This helps business leaders
understand which products or services are most critical to the
financial success of their organization.
 The most important stock keeping units (SKUs), based on
either sales volume or profitability, are “Class A” items, the
next-most important are Class B and the least important are
Class C. Some companies may choose a classification system
that breaks products into more than just those three groups
(A-F, for example).
 How ABC Analysis Simplifies Work for Inventory
Managers
 Inventory managers are always looking for ways to
improve pricing and quality or to achieve greater
efficiencies. In light of that goal, they may use the ABC
technique, sometimes called the “always better
control” method. They can use the analysis to focus
their time and effort primarily on Class A inventory and
less on B and C class products. For example, inventory
managers will use ABC analysis to check the purchase
orders of the highest value (Class A items) products
first, since these generate the most revenue.
 VED Analysis
 This relates to Vital, Essential and Desirable

status of the inventory items.

 The modified version of this is ABC-VED analysis

that takes into consideration both value and the

criticality of the item.
 High-value and critical items are under

continuous review and ordered in low quantities

 Low-value, least critical items are periodically

reviewed and ordered in large quantities with

lower safety stock requirements
 VED analysis is a method of inventory management that
classifies inventory items into three categories based on
their criticality to the business:
1. Vital (V) items are required to the business’s operations and would
cause a major disruption if they were to run out. Examples of vital
items include raw materials, critical components, and finished
goods that are in high demand.
2. Essential (E) items are important to the business’s operations, but
they are not as critical as vital items. Examples of essential items
include maintenance supplies, spare parts, and office supplies.
3. Desirable (D) items are not essential to the business’s operations,
but they are still important to have in stock. Examples of desirable
items include promotional items, seasonal items, and low-volume
items.
 Here are some examples of how to develop inventory management strategies for
each VED category:
1. Vital items:
1. Keep a high safety stock level of vital items.
2. Use multiple suppliers to reduce the risk of supply chain disruptions.
3. Implement expedited shipping procedures for vital items.
2. Essential items:
1. Keep a moderate safety stock level of essential items.
2. Use a single supplier for essential items, but have a backup supplier in place.
3. Use standard shipping procedures for essential items.
3. Desirable items:
1. Keep a low safety stock level of desirable items.
2. Use a single supplier for desirable items, but have a backup supplier in place.
3. Use standard shipping procedures for desirable items.
 VED analysis can be a complex process, but it is a valuable tool for improving
inventory management. By following these steps, businesses can develop a VED
analysis system that is tailored to their specific needs.
 Here are some specific examples of how VED analysis is used in different
industries:
1. A manufacturing company uses VED analysis to prioritize its inventory of raw
materials for its most popular products. This helps to ensure that the company has
enough raw materials on hand to meet customer demand.
2. A retail chain uses VED analysis to prioritize its inventory of seasonal items. This
helps to ensure that the chain has enough of the right products in stock at the right
time to meet customer demand.
3. A hospital uses VED analysis to prioritize its inventory of critical medical supplies,
such as bandages, surgical gowns, and anesthesia drugs. This helps to ensure that
the hospital has enough of these supplies on hand to provide care to patients in
need.
4. A transportation company uses VED analysis to prioritize its inventory of spare parts
for its buses. This helps to ensure that the company can quickly repair any buses
that break down, minimizing disruptions to service.
5. A food and beverage company uses VED analysis to prioritize its inventory of fresh
produce. This helps to ensure that the company can deliver fresh produce to its
customers on time.
 SAP Analysis
 Scarce, Available and Plenty status of
inventory item is used for planning &
forecasting of inventory requirement
  FSN analysis
 Fast, Slow or Non-moving determines consumption pattern of
item

 For example,
• A class vital, scarce and fast-moving items perpetual reviews are
recommended,
• B class essential, medium-moving items periodic reviews will be OK.
• C class desirable, slow-moving items the periodicity of review will be
longer.
Inventory decision matrix
 Inventory Planning Models

Inventory model selection variables

 Economic Order Quantity (EOQ)
The assumptions under this model are:
• Demand is known. It is constant and uniformly spread over
a period of time.
• There is no lead time for re-supply of material (i.e.
material is supplied instantaneously.)
• The cost of ordering per unit is the same irrespective of
the lot size
 Where,
 Q economic order quantity in units
 S cost of placing an order in Rs.

 D average annual consumption in units

 H percentage of inventory cost vis-à-vis unit cost

 C cost per unit

 To go per the formula will be rarely possible because of the following reasons:

•The ordered quantity figure may be modified to take into account the
standard pack size available in the market.
• To avail of the quantity discount offered by the suppliers, the order quantity
figure may be modified.
• The availability of funds will force the buyer to go for the less than
minimum ordered quantity.
• To take care of the anticipated shortage of material in the market, the
higher quantities may be ordered.
• The EOQ formula is normally used as a guideline rather than to decide on
the exact material requirements
 The EOQ formula is normally used as a guideline rather than to decide on the

exact material requirements

 The economic order quantity (EOQ) refers to the ideal order quantity a
company should purchase in order to minimize its inventory costs, such as
holding costs, shortage costs, and order costs. EOQ is necessarily used in
inventory management, which is the oversight of the ordering, storing, and
use of a company's inventory. Inventory management is tasked with
calculating the number of units a company should add to its inventory with
each batch order to reduce the total costs of its inventory.1
 The EOQ model seeks to ensure that the right amount of inventory is
ordered per batch so a company does not have to make orders too
frequently and there is not an excess of inventory sitting on hand. It
assumes that there is a trade-off between inventory holding costs and
inventory setup costs, and total inventory costs are minimized when both
setup costs and holding costs are minimize
• The economic order quantity (EOQ) refers to the ideal order quantity
a company should purchase in order to minimize its inventory costs.
• A company's inventory costs may include holding costs, shortage
costs, and order costs.
• The economic order quantity model seeks to ensure that the right
amount of inventory is ordered per batch.
• This is so a company does not have to make orders too frequently
and there is not an excess of inventory sitting on hand.
• EOQ is necessarily used in inventory management, which is the
oversight of the ordering, storing, and use of a company's inventory.
EOQ model
 Example of Economic Order Quantity
 EOQ considers the timing of reordering, the cost incurred to place an
order, and the costs to store merchandise. If a company is constantly
placing small orders to maintain a specific inventory level, the ordering
costs are higher, along with the need for additional storage space.
 For example, consider a retail clothing shop that carries a line of men’s
shirts. The shop sells 1,000 shirts each year. It costs the company $5 per
year to hold a single shirt in inventory, and the fixed cost to place an
order is $2.
 The EOQ formula is the square root of (2 x 1,000 shirts x $2 order cost) /
($5 holding cost), or 28.3 with rounding. The ideal order size to minimize
costs and meet customer demand is slightly more than 28 shirts.
 Modern Inventory Control Systems
• The modern approach to control inventories is
focused on the following factors:
 Flow.
 Flexibility.

 Balancing.

 Integration.
 Material Requirements Planning (MRP).
 MRP system does the work of materials manager to
control inventory of items to lean the supply chain
 MRP is typically applied to manage inbound material
movement in the enterprise and is based on production
requirements and scheduling.
 MRP system is suitable for both push- and pull-type
supply chain systems.
 Material requirements planning (MRP) is a software-based integrated
inventory and supply management system designed for businesses.
 Companies use MRP to estimate quantities of raw materials,
maintain inventory levels, and schedule production and deliveries.
• Material requirements planning (MRP) is the earliest
computer-based inventory management system.
• MRP helps develop a production plan for finished goods by
defining inventory requirements for components and raw
materials.
• MRP assures that materials and components will be
available when needed, minimizes inventory levels, reduces
customer lead times, and improves customer satisfaction.
• MRP relies on data accuracy, has a high cost to implement,
and maintains a strict production schedule.
Framework of MRP system
 How Material Requirements Planning (MRP) Works
 MRP helps businesses and manufacturers define what is needed, how
much is needed, and when materials are needed and works backward
from a production plan for finished goods.
 MRP converts a plan into a list of requirements for the subassemblies,
parts, and raw materials needed to produce a final product within the
established schedule. MRP helps manufacturers get a grasp of
inventory requirements while balancing both supply and demand.
 Using MRP, managers can determine their need for labor and supplies
and improve their production efficiency by inputting data into the
MRP scheme such as:
• Item Name or Nomenclature: The finished good title,
sometimes called Level "0" on BOM.
• Master Production Schedule (MPS): How much is required
to meet demand? When is it needed?
• Shelf life of stored materials.
• Inventory Status File (ISF): Materials available that are in
stock and materials on order from suppliers.
• Bills of materials (BOM): Details of materials and components
required to make each product.
• Planning data: Restraints and directions like routing, labor and
machine standards, quality and testing standards, and lot sizing
techniques.
 MRP and Manufacturing
 Manufacturers manage the types and quantities of materials they purchase strategically
and cost-effectively to ensure that they can meet current and future customer demand.
MRP helps companies maintain appropriate levels of inventory so that manufacturers can
better align their production with rising and falling demand.
 The MRP process:
 • Estimates demand and required materials. After determining customer
demand and utilizing the bill of materials, MRP breaks down demand into specific raw
materials and components.
 • Allocates Inventory of materials. MRP allocates inventory into the exact
areas as needed.
 • Schedules Production. Time and labor requirements are calculated to complete
manufacturing and a timeline is created.
 • Monitors the process. MRP automatically alerts managers of any delays and
even suggests contingency plans to meet build deadlines.
 Manufacturing Resource Planning—MRP II
 MRP II is a long-term planning tool for complex products. It
can give an accurate completion date at the time of order,
The system fits in with conventional accounting and the
progress of manufactures and inventory sizes which are
available at all times.
 It tightly controls work orders and changes therein.
 In, MRP II it is necessary to maintain an accurate database.
 Inventory accuracy requirement is vital to the extent of 99
per cent.
 MRP II is a computer-based system, inflexible and relies on
forecast.
 MRP II is a computer-based system that can create detailed
production schedules using real-time data to coordinate the
arrival of component materials with machine and labor
availability. MRP II is used widely by itself, but it's also used as a
module of more extensive enterprise resource planning (ERP)
systems.
• Manufacturing Resource Planning (MRP II) is an integrated
information system used by businesses.
• MRP II is an extension of materials requirement planning (MRP).
• Both MRP and MRP II are seen as predecessors to Enterprise
resource planning (ERP).
 MRP I VS. MRP II

 For all intents and purposes, MRP II has effectively replaced MRP I software. Most MRP II systems deliver all of the
functionality of an MRP system. But in addition to offering master production scheduling, bill of materials (BOM), and
inventory tracking, MRP II provides functionality within logistics, marketing, and general finance.
 For example, MRP II is able to account for variables that MRP is not—including machine and personnel capacity—
providing a more realistic and holistic representation of a company’s operating capabilities. Many MRP II solutions
also offer simulation features that allow operators to enter variables and see the downstream effect. Because of its
ability to provide feedback on a given operation, MRP II is sometimes referred to as a closed-loop system.
 MRP I included the following three major functionalities:
• master production scheduling
• bill of materials
• inventory tracking
 MRP II includes those three, plus the following:
• machine capacity scheduling
• demand forecasting
• quality assurance
• general accounting
 MRP II systems are still in wide use by manufacturing companies today and can either be found as stand-alone
solutions or as part of an enterprise resource planning (ERP) system. Enterprise Resources Planning (ERP) software
systems are regarded as the successors of MRP II software.
  Distribution Requirement Planning
• It is a logical extension of MRP.
• DRP allocates inventory from the warehouse to the various distribution
based on the following ;
• Demand pattern • Reorder point
• Safety stock provision • Average performance
• Order quantity cycle length

• DRP system success is dependent on the accuracy of the

forecast
• DRP is used enterprise resource planning (ERP), rather than as a
stand-alone system, so as to get the full benefits of ERP on both the
procurement and distribution sides.
 The major benefits of using DRP are:
• Improvements in customer service level
• Effective marketing efforts for high value stock items
• Decrease in inventory level resulting in a reducing inventory-carrying
and transportation costs and warehouse space requirements.

Framework of DRP system

 Just-in-Time System (JIT).
 Just-in-time (JIT) is a concept based on the fact that an
activity should not take place until there is need for it and
until it is required for making the fi nal product
• JIT is characterized by maintaining zero inventories of raw
materials and assemblies at the assembly plant.
• JIT system involves the close coordination of the buyer and
the suppliers on a real-time basis.
o Prerequisites to a successful JIT system:

• Buyer–seller partnership • Commitment to zero defects from

• Online communication and both the sides
information sharing • Frequent and small lot size
shipments
 JIT is the philosophy of “Help, to get helped.”
 The success pf JIT is depends on the mutual trust and
commitments of both seller and purchaser.
 The main barriers to the successful operation of the JIT
system are:
• Organization structure • Reluctance to information sharing
• Organization culture • Dispersed suppliers
• Technology differentials at buyer and supplier ends
 Vendor-Managed Inventory (VMI)
 In VMI the supplier takes charge of inventory management
of products and manages the replenishment process based
on the consumption pattern of the customer
 For VMI to be successful, three things are essential,
• The right partners- Consistency in quality, low cost
transactions, reliability and on-time delivery
• The right set of products
• Mutual trust
• The benefits of VMI
 Reduction in inventory-related costs risk of stock outs and
for the vendor speedy payment realization, reduction in
transaction cost, and the assured business
 Automated Inventory Tracking System
(AITS)
 The system involves usage of the electronic data interchange
(EDI) system to track the flow of inventory through the supply
chain
 The system connects suppliers, manufacturers, distribution
hubs and retail stores and institutional buyers.
 The system is based on integrating EDI and the bar coding
system to track inventory for controlling inventory investment
through the supply chain.
1.7 KANBAN
 It is basically an information system to support JIT
inventory for manufacturing operations.
 Kanban coordinates the inflow of parts and components
to the assembly line, minimizing replenishment
processing.
 Kanban is used in process logistics for movement of parts
and components on the shop floor of a manufacturing
plant

The kanban system

 The kanban system can be thought of as a signal and response system. When an item is
running low at an operational station, there will be a visual cue specifying how much to order
from the supply. The person using the parts makes the order for the quantity indicated by the
kanban and the supplier provides the exact amount requested.
 For example, if a worker is bagging product on a conveyor belt, a kanban may be placed in
the stack above the last 10 bags. When the worker gets to the card, he gives the floor runner
the card to bring more bags. A station further from the supply room might have the kanban
placed at 15 bags and a closer one at five. The flow of bags and the placement of cards are
adjusted to make sure no station is left bag-less while the belt is running.
 The kanban system can be used easily within a factory, but it can also be applied to
purchasing inventory from external suppliers. The kanban system creates extraordinary
visibility to both suppliers and buyers. One of its main goals is to limit the buildup of excess
inventory at any point on the production line. Limits on the number of items waiting at
supply points are established and then reduced as inefficiencies are identified and removed.
Whenever a limit of inventory is exceeded, it points to an inefficiency that needs to be
addressed.
1.8 INVENTORY POLICY GUIDELINES
 Centralized System.
 In the centralized system inventories are stocked at one
central location for distribution to customers or depots.
 Benefits- Maintain tight controls on inventory movement
both for replenishment and dispatches
 Disadvantage- as the volume of transaction grows, is
a longer order performance cycle and delayed
response time for the smaller but nevertheless larger
number of customers
 Decentralized System.
 The decentralized systems are closer to the customer
and make decisions independently
 Benefits - better customer service with quick response
and a shorter performance cycle time.
 Drawback- the controls are lax and the operating cost is
higher
 The management has to make a policy decision to strike
a balance between customer service, controls and the
cost.
 Service Level
• Order cycle time
• Case fill rate
• Order fill rate
 Stock Levels
 To meet the desired level of customer

service, the average level of inventory stocks

to be maintained at any point of time is
determined in terms of the number of days of
sales value

Inventory performance cycle

1.9 SQUARE ROOT LAW (SRL) OF
INVENTORY
 “Total safety stock inventories in a future number of
facilities can be approximated by multiplying the total
amount of inventory at existing facilities by the square
root of the number of future facilities divided by the
number of existing facilities.”
 The increase in number of warehouses of a company will
cause a specific increase in certain costs. Thus, with
lesser number of warehouses, the company will enhance
its savings of certain costs.
 This increase, either in a positive or negative direction,
 SRL be mathematically computed using the square root
law :
 For example, if a business firm has a network of 15 field
warehouses for stocking their inventory, their costs would
likely be almost 75 per cent greater than if they used a
single warehouse. Also, if Company B originally had five
warehouses and decided to centralize their inventory,
they would see a saving of just over 50 per cent.
 Average versus stocking points

 The assumptions to square root law are as follows:

 Inter-location inventory transfer is not at the same common
level
 Lead times do not vary
 No change in customer service level
 Normal distribution of demand at each location
 SRL will be most effective when markets have demands that
are negatively correlated, and there is little or no benefit from
consolidation when demands faced by the various stocking points
are positively correlated with the multiplicity of warehouses the
fixed costs increase in the same proportions.
 In addition, multiple warehouses are more difficult to manage
because keeping rack of the inventory at several locations,
watching stock amounts, handling orders, and planning
distribution are all the more complicated when a company has to
deal with more than one or two warehouses.
 The decision on the number of warehouses considering SRL
should be weighed in light of other factors like
 Transportation costs, lead time, inventory availability and
warehouse proximity.
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