Inventory

Management
Introduction
Sanjay Choudhari

Indian Institute of Management

Indore

Importance of Inventory

Importance of Inventory
Balance the advantages and
disadvantages of small and large
inventories
Pressures for small inventories
Inventory
Cost

holding cost

of capital

Storage
Taxes,

and handling costs

insurance, and shrinkage

Importance of Inventory
Pressures for large inventories
Customer
Ordering

service

cost

Setup

cost

Labor

and equipment utilization

Transportation
Payments

cost

to suppliers

Reasons for Holding Inventory

To meet anticipated customer demand

To protect against stock outs

To take advantage of economic order

cycles

To maintain independence of operations

To allow for smooth and flexible

production operations

To guard against price increases

In Short,
Buffer against uncertainty in..
Supply (Raw material inventories)
Production process ( Work in process inventories)
&
Demand (Finished good inventories)

Type of Inventory

Process
stage

Raw Materials
WIP
Finished Goods

Demand
Type

Independent
Dependent

Purpose

Cycle
Safety
Seasonal
Pipeline

Others

Spares
Consumable

Independent vs. Dependent Demand

Independent Demand
(demand for item is independent
of demand for any other item)

Dependent Demand
(demand for item is dependent
upon the demand for some
other item)

Independent vs. Dependent Demand..

Item

Materials With
Independent Demand

Materials With
Dependent Demand

Demand
Source

Company Customers

Parent Items

Material
Type

Finished Goods

WIP & Raw Materials

Method of
Estimating
Demand
Planning
Method

Forecast & Booked

Customer Orders
EOQ & ROP

Calculated

MRP

Inventory Type : Purpose

Seasonal stocks

These are accumulated to absorb seasonal fluctuations

in supply or demand.

Cycle stocks

Due to fixed transportation and handling charges or set

up requirements, it is economical to order or produce
large quantities at a time.

Safety stocks

These are built as a hedge against uncertainties in

supply or demand.

Pipeline stocks

Inventories in-transit.

ABC Analysis
Stock-keeping units (SKU)
Identify the classes so management can
control inventory levels
A Pareto chart

ABC Analysis
100
90

Percentage of dollar value

Class C

Class B

80 Class A
70
60
50
40
30
20
10
0
10

20

30

40

50

60

70

Percentage of SKUs

80

90 100

ABC Problem
Bookers Book Bindery divides SKUs into three classes, according
to their dollar usage.
Calculate the usage values of the following SKUs and determine
which is most likely to be classified as class A.
SKU Number

Description

Boxes

Quantity Used
per Year

Unit Value
($)

500

3.00

Cardboard
(square feet)

18,000

0.02

Cover stock

10,000

0.75

Glue (gallons)

75

40.00

Inside covers

20,000

0.05

Reinforcing tape
(meters)

3,000

0.15

Signatures

150,000

0.45

ABC Problem
SKU
Number

Description

Boxes

Quantity
Used per
Year

Unit Value
($)

Annual Dollar
Usage ($)

500

3.00

1,500

Cardboard
(square feet)

18,000

0.02

360

Cover stock

10,000

0.75

7,500

Glue (gallons)

75

40.00

3,000

Inside covers

20,000

0.05

1,000

Reinforcing tape
(meters)

3,000

0.15

450

Signatures

150,000

0.45

67,500

Total

81,310

ABC Problem

Percentage of Dollar Value

100

Class B

Class C

90 Class
80

70
60
50
40
30
20
10
0
10

20 30 40 50 60 70 80 90 100
Percentage of SKUs

Inventory Cost
Holding costs - associated with holding or
carrying inventory over time
Ordering costs - associated with costs of
placing order and receiving goods
Setup costs - cost to prepare a machine or
process for manufacturing an order
Shortage cost

Terms used in Inventory

Material cost = Ci

(Average price paid per unit purchased is a key cost in the

lot-sizing decision )

Fixed ordering cost = Co

(Fixed ordering cost includes all costs that do not

vary with the size of the order but are incurred each time an order is placed)

Holding cost = CH = %*Ci

(Holding cost is the cost of carrying one unit in

inventory for a specified period of time i.e. $ CH/Unit/Year)

Quantity in a lot or batch size = Q

(Quantity is either produced or

purchased at a time, EOQ* = Q* )

Demand per unit time = D

(i.e. Demand in one 1 year, d = average

demand per week, So, D = d *52 / year)

Inventory Cost
Holding Costs (CH)

Obsolescence
Insurance
Extra staffing
Interest
Pilferage
Damage
Warehousing
etc.

Ordering Costs (Co)

Supplies
Forms
Order processing
Clerical support
etc.

Setup Costs (Cs)

Clean-up costs
Re-tooling costs
Adjustment costs
etc.

Inventory Cost
Holding cost (CH)

Cost of Capital
Obsolescence cost
Handling cost

Occupancy cost

Vary with quantity of product received , ZERO otherwise

Vary with quantity of product stored, ZERO otherwise

Miscellaneous costs
Theft, security, damage, tax, insurance

Inventory Cost
Ordering cost (Co)

Buyer time

Time of buyer for placing extra order, ZERO otherwise

Internet and communication has reduced this cost significantly

Receiving costs

Administrative work such as purchase order matching with

updating inventory records

Quantity dependent should not be included here

Transportation costs

Fixed cost should be included here

Shortage Costs
When
occurs,
possibilities..

company

faces

two

It can meet the shortage with some type

of rush, special
handling or priority
shipment
It cannot meet the shortage at all
So. It depends on
How company handles the problem ?

Shortage Costs
Permanent
Lost profits due to unsatisfied demand
Lost profits of future sales

Temporary (CB)
Backordered, so not necessarily lost
Special clerical & paperwork costs
Extraordinary transportation cost to customer