Inventory Management

• Inventory management refers to the process of overseeing and controlling the

flow of goods and materials in and out of a business.
• It involves tracking inventory levels, managing stock to meet customer demand,
and ensuring that products are available when needed without overstocking,
which can incur additional costs.
• Efficient inventory management ensures a balance between having enough
products to fulfill orders and avoiding excess stock that could lead to storage
costs or obsolescence.
Types of Inventory
• Cycle Inventory: refers to the inventory created when goods are
produced or purchased in batches due to economies of scale in
production and transportation.
• Companies face a choice between ordering frequently, which incurs
high ordering costs, or ordering less often, which leads to higher
inventory holding costs. Recent trends, especially in just-in-time (JIT)
systems, aim to reduce cycle inventory.
• Additionally, quality requirements may sometimes necessitate larger
batch production. Analytical models are available to help determine
the optimal cycle stock level.
• Safety Stock: is inventory kept as a buffer to protect against
uncertainties in demand and supply. When supply is reliable and
customer demand is predictable, safety stock isn't necessary.
• However, to avoid the high costs of losing customers due to stockouts,
companies often maintain large quantities of safety stock. While
demand is hard to control, firms can work on reducing supply
uncertainties over time.
• In regions with high transportation and supply challenges, such as
India, safety stock forms a significant portion of inventory. Analytical
models exist to help determine the optimal level of safety stock.
• Decoupling Stocks: are inventories held at various organizational or
departmental boundaries within a supply chain to provide flexibility
for each decision-making unit (e.g., materials, manufacturing, and
distribution).
• Since it’s not possible for a single entity to control the entire supply
chain, these units manage their operations independently, allowing
them to optimize performance in their respective areas (buy, make,
deliver).
• While decoupling inventory allows for this flexibility, better
coordination across the supply chain can help reduce its need.
• Anticipation inventory: Anticipation inventory consists of stock
accumulated in advance of expected peak in sales or that which takes
care of some special event that does not occur on a regular basis.
Anticipation stock may further fall into two categories, seasonal stock
and speculation stock.
• Seasonal Stock: refers to inventory built up during low-demand
seasons to meet peak-season demand for products with seasonal
variability, such as paints, refrigerators, and air conditioners.
• While a company could increase production capacity for peak
demand, it may prefer not to due to the costs associated with surplus
capacity during the off-season or issues with labor and supplier
relationships.
• Instead, businesses typically plan ahead to manage predictable
seasonal demand fluctuations by building inventory in advance.
• Speculation Stock: refers to inventory that is accumulated in anticipation
of potential disruptions or events, such as labor strikes, transport issues, or
price increases.
• For example, a company may stockpile diesel oil in anticipation of a price
hike due to geopolitical tensions or hold extra finished goods if a
competitor is expected to face supply problems.
• This type of inventory acts as a preventive measure against events that may
or may not occur. While some firms prefer holding speculation stock to
protect against price increases, others may choose financial strategies like
hedging or forward contracts instead.
• However, holding speculation stock carries risks, and once the anticipated
event passes, the firm should avoid retaining excess inventory related to
that speculation.
• Pipeline Inventory: refers to inventory that is in transit or actively
being worked on during the production or transportation process. It
includes both work-in-process inventory (materials currently being
worked on) and in-transit inventory (materials being moved between
locations).
• The amount of pipeline inventory is determined by the process time
or transport time and the usage rate of the item. For example, faster
transportation methods (like air vs. sea) or shorter manufacturing
lead times can help reduce pipeline inventory. Efficient management
of pipeline inventory can improve supply chain flow and reduce
unnecessary stock.
• Dead Stock: refers to inventory that is no longer moving and is unlikely to be of
any further use due to obsolescence, changes in customer preferences, or
production processes.
• This includes items that have lost market value and become obsolete. Many firms
allow dead stock to accumulate, often avoiding disposal to prevent showing a
financial loss on their books.
• Ideally, companies should periodically dispose of dead stock, even at a loss, but
the process can be delayed due to approval requirements at higher levels, such as
the board. The accumulation of dead stock becomes more difficult to manage
over time.
• Some firms monitor inventory for slow-moving items and try to find new uses for
them within the company or offer discounts to move them quickly. In industries
like fashion, offering steep discounts to clear out old stock at the end of a season
is a common strategy. The key is to have a process in place to regularly identify
and dispose of dead stock before it becomes a significant issue.
INVENTORY-RELATED COSTS

• The major portion of the working capital of a firm is blocked in

inventory. If the inventory is in excess of the optimum level, more
funds will be blocked that cannot be used for other productive
purposes, resulting in opportunity loss.

• Hence these funds are tied up unnecessarily. There are other costs
related to inventory. The incidence of those costs will also be higher if
inventories are in excess of the optimum level.
Logistic Management – V V Sople
• Carrying Cost: The second major cost contributor is carrying cost. Funds invested
in inventory attract interest charges on working capital borrowed from the bank.
The current bank rate of interest on working capital borrowring is 12–15 per cent.
Thus, the interest charges investment on excess inventory will erode the bottom
line.

• Ordering Cost: This refers to the cost involved in the ordering process. The
paperwork, faxes, phone calls, and so on will add to the inventory-related cost.
• Warehousing Cost: This is the cost for product holding in the
warehouse. Depending on the kind of warehouse (private, public or
contract), there will be a cost related to space occupancy based on
the duration of storage. This cost varies from 1.5 to 4 per cent and
may be taken into consideration while computing inventory-related
costs.
• Damage, Pilferage and Obsolesce Cost: Material stored carries the risk of
damage, shrinkage and loss of weight. A product also carries the risk of
pilferage or obsolescence due to technology change or availability of
substitutes. The percentage varies from 0.5 to 2 per cent depending on the
product.
• Exchange Rate Differentials: In case of imported inventories, the valuation
is done based on the current currency exchange rates in the market. Any
fluctuation may increase or decrease the value of the inventory. Due to
exchange rate fluctuations, there is the risk of selling the material at prices
lower than the landed cost.
Other elements of Inventory Cost
1. Administrative Costs:
o These are the costs related to managing and overseeing inventory.
They are more indirect but still important.
o Examples include:
▪ Salaries of inventory management staff
▪ Software and technology used for inventory tracking
▪ Recordkeeping and accounting costs
2. Purchase Costs:
o These are the costs associated with acquiring inventory items. This
can include the actual cost of purchasing goods, as well as any
associated costs for transportation, customs, and import duties.
o Examples include:
▪ Purchase price of goods
▪ Taxes and duties on purchased goods
▪ Freight and handling charges
3. Stockout Costs:
o These occur when inventory runs out, and a business cannot meet
customer demand. Stockout costs can be direct, like lost sales, or
indirect, such as damage to customer relationships or loss of future
sales.
o Examples include:
▪ Lost sales revenue
▪ Customer dissatisfaction
▪ Increased expedited shipping or ordering costs
Inventory Management Techniques

• Inventory management is crucial for optimizing stock

levels, reducing costs, and meeting customer demand.
There are several inventory management techniques
that businesses use, each suited to different types of
operations and goals.
Logistic Management by V V Sople
Just In Time (JIT)
• JIT is a strategy where inventory is ordered and delivered just in time for production or
customer demand. The aim is to minimize stock levels and reduce holding costs.

• Benefits:
o Reduces storage costs
o Decreases risk of excess inventory and stock obsolescence

• Challenges:
o Highly dependent on reliable suppliers
o Vulnerable to supply chain disruptions
Economic Order Quantity (EOQ)
• What it is: EOQ is a formula used to determine the optimal order quantity that minimizes total inventory costs, including
ordering and holding costs.

2𝐷𝑆
• Formula: 𝐸𝑂𝑄 = Where:
𝐻
o D = demand rate (units per period)
o S = ordering cost per order
o H = holding cost per unit per period

• Benefits:
o Balances the costs of ordering and holding inventory

• Challenges:
o Assumes constant demand and ordering costs, which may not be realistic in every situation.
ABC Analysis
• ABC analysis categorizes inventory into three categories (A, B, and C) based on their value and
importance.
o A items: High-value, low-quantity items (often 70-80% of value, but only 10-20% of items).
o B items: Moderate-value, moderate-quantity items.
o C items: Low-value, high-quantity items (often 50-60% of items, but only 5-10% of value).

• Benefits:
o Focuses management attention on the most valuable items.

• Challenges:
o Requires constant monitoring of stock value and usage.
Reorder Point (ROP)
• ROP is the inventory level at which a new order should be placed to replenish
stock before it runs out. It's based on demand rate and lead time.
• Formula: ROP=Demand Rate × Lead Time
• Benefits:
o Ensures you don’t run out of stock.
o Simple and easy to implement.
• Challenges:
o Does not account for demand variability or unexpected supply chain delays.
Consignment Inventory
• In consignment inventory, the supplier retains ownership of the goods until
they are sold. The retailer or business only pays for the items as they are
used or sold.
• Benefits:
o Reduces inventory costs for the business.
o Minimizes the financial risk associated with overstocking.
• Challenges:
o Suppliers may charge higher prices to cover the risk.
o Requires strong relationships with suppliers.
Vendor-Managed Inventory (VMI)
• What it is: With VMI, the supplier manages the inventory of products at
the retailer’s location, ensuring that the stock is replenished as needed.
• Benefits:
o Reduces stockouts and excess inventory.
o Less time spent on inventory management by the retailer.
• Challenges:
o Requires trust between the supplier and retailer.
o Less control over inventory for the retailer.
First-In, First-Out (FIFO)
• FIFO assumes that the first items added to inventory are the first
ones to be sold or used.
• Benefits:
o Suitable for perishable goods (e.g., food, pharmaceuticals).
o Helps prevent obsolescence and wastage.
• Challenges:
o Can be challenging for products with a long shelf life or those
not subject to expiration.
Last-In, First-Out (LIFO)
• What it is: LIFO assumes that the most recently acquired items are
the first to be sold or used.
• Benefits:
o Useful when prices are rising (i.e., minimizes tax liability in some
countries).
• Challenges:
o Not ideal for perishable goods.
o Not allowed under certain accounting standards (e.g., IFRS).
Choosing the Right Technique
The best inventory management method depends on the type of
business, product types, and market conditions. For example:
• Retailers might benefit from techniques like ABC Analysis or JIT.
• Manufacturers may use techniques like EOQ, JIT, and Kanban.
• E-commerce businesses might lean toward drop shipping or VMI.
JIT (Just in Time)
• Just-in-time (JIT) is a concept based on the fact that an activity should
not take place until there is need for it.
• Hence an inventory item should not be brought into the system until
it is required for making the final product.
• JIT is characterized by maintaining zero inventories of raw materials
and assemblies at the assembly plant.
• Therefore, the JIT system involves the close coordination of the buyer
and the suppliers on a real-time basis. This means frequent receipts
of materials from suppliers.
The following are prerequisites to a successful JIT system:
• Buyer–seller partnership
• Online communication and information sharing
• Commitment to zero defects from both the sides
• Frequent and small lot size shipments
The main barriers to the successful operation of
the JIT system are:
• Organization Structure
• Organization Culture
• Technology differentials at buyer and supplier ends
• Reluctance to Information Sharing
• Dispersed Suppliers
Quick Response System
• The Quick Response System in inventory management is a strategy
primarily used in the retail industry to ensure that inventory is
replenished quickly and efficiently in response to demand
fluctuations.
• It involves close coordination between manufacturers, suppliers, and
retailers to streamline the flow of products and reduce lead times.
Key Features of the Quick Response System
1. Real-Time Data Sharing:
o The system relies on real-time data exchange between all partners (retailers,
suppliers, manufacturers) about inventory levels, sales data, and demand forecasts.
o This allows all parties to make timely replenishment decisions based on actual
demand and not just predictions or historical trends.

2. Demand Forecasting and Inventory Replenishment:

o QR systems use advanced forecasting tools to predict demand with high accuracy,
ensuring that stock levels are maintained without overstocking or stockouts.
o Replenishment orders are made more frequently and in smaller quantities to keep
inventory moving efficiently.
3. Integrated Supply Chain:
o The QR system promotes a highly integrated supply chain, where suppliers are
involved in the process of inventory management, receiving up-to-date data about
sales and stock levels.
o This leads to faster order fulfillment and quicker restocking from suppliers.
4. Lead Time Reduction:
o A key objective of QR is to reduce lead times. This is achieved by streamlining order
processing, delivery schedules, and communication between the supply chain
partners.
o Shorter lead times mean less inventory is needed at any point in the supply chain,
improving efficiency and reducing costs.
5. Use of Technology:
o QR systems rely heavily on technology such as barcode scanning, RFID
tags, Electronic Data Interchange (EDI), and enterprise resource
planning (ERP) systems to facilitate real-time communication and
inventory tracking.
6. Just-in-Time (JIT) Principles:
o QR incorporates Just-in-Time (JIT) principles, ensuring that products
arrive exactly when they are needed in the correct quantity, thereby
reducing the need for large inventory buffers.
7. Collaborative Relationships
o QR encourages strong partnerships and collaboration between
retailers and suppliers, with both parties sharing responsibility for
inventory management.
o This collaboration helps reduce the bullwhip effect, where small
fluctuations in customer demand lead to large swings in inventory
levels throughout the supply chain.
Benefits of the Quick Response System
1.Improved Stock Availability:
o QR systems ensure that products are available when customers
want them, reducing the risk of stockouts and lost sales.

2.Reduced Inventory Costs:

o By reducing the need for excess stock and improving
replenishment efficiency, QR minimizes inventory holding costs
and improves cash flow.
3. Faster Inventory Turnover:
o Inventory moves faster through the supply chain, leading to higher turnover
rates and better responsiveness to market changes.

4. Reduced Obsolescence:
o Since QR systems focus on replenishing inventory based on real-time
demand, there’s less likelihood of unsold stock becoming obsolete (especially
important for fashion and technology sectors)
5. Enhanced Customer Satisfaction:
o With products available in the right quantities and at the right time, customer
satisfaction improves as orders are fulfilled promptly.

6. Stronger Supplier-Retailer Relationships:

o The QR system fosters better communication and trust between suppliers
and retailers, leading to a more resilient and responsive supply chain.
Challenges of Implementing a QR System
1. High Initial Investment:
o Setting up a QR system can require significant investment in technology,
training, and infrastructure (such as ERP systems or RFID tracking), especially
for smaller businesses.

2. Dependence on Accurate Data:

o A QR system relies heavily on accurate, up-to-date data. If data is incorrect or
delayed, it can lead to inventory imbalances, stockouts, or overstocking.
3. Supply Chain Coordination:
o The success of a QR system depends on the collaboration and coordination of
all parties in the supply chain. Without strong relationships, it can be difficult
to maintain the system’s efficiency.

4. Risk of Over-Reliance on Suppliers:

o Since QR systems require tight integration with suppliers, there’s a risk that a
disruption on the supplier’s side (e.g., delays or errors) could significantly
impact the retailer’s operations.
Example

• Consider a fashion retailer that sells seasonal clothing. Using a Quick

Response system, the retailer closely monitors sales data in real time.
As certain sizes or colours of items start selling out, the system
automatically places orders with manufacturers and suppliers for
additional stock, ensuring that the retailer’s shelves remain stocked
with high-demand products while avoiding overstocking slower-
moving items.
QR System vs. Traditional Inventory Systems
• Traditional Inventory System: Involves ordering stock based
on forecasted demand, which often leads to overstocking or
stockouts. The replenishment process is less frequent and
not as responsive.
• Quick Response System: Involves continuous, real-time
inventory monitoring and faster replenishment, ensuring
that products are ordered only when necessary and in
smaller, more frequent batches.