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INTRODUCTION
Inventory management is a core operations management
activity. Effective inventory management is important for
the successful operation of most businesses and their
supply chains. Inventory management impacts operations,
marketing, and finance. Poor inventory management
hampers operations, diminishes customer satisfaction, and
increases operating costs.

An inventory is a stock or store of goods.

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INTRODUCTION
The different kinds of inventories include the
following:

Raw materials and purchased parts

Partially completed goods, called work-in-process
(WIP)
Finished-goods inventories (manufacturing firms) or
merchandise (retail stores)
Tools and supplies
Maintenance and repairs (MRO) inventory
Goods-in-transit to warehouses, distributors, or
customers (pipeline inventory)

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Functions of Inventory
1. To meet anticipated customer demand.
2. To smooth production requirements.
3. To decouple operations.
4. To reduce the risk of stockouts.
5. To take advantage of order cycles.
6. To hedge against price increases.
7. To permit operations.
8. To take advantage of quantity discounts.

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Objective of Inventory
Management
Inadequate control of inventories can result in both under- and
overstocking of items. Understocking results in missed deliveries,
lost sales, dissatisfied customers, and production bottlenecks.
Overstocking unnecessarily takes up space and ties up funds that
might be more productive elsewhere.

The overall objective of inventory management is to achieve

satisfactory levels of customer service while keeping inventory
costs within reasonable bounds. The two basic issues (decisions) for
inventory management are when to order and how much to order.

Inventory turnover - is the ratio of annual cost of goods sold to

average inventory investment 6
REQUIREMENTS FOR
EFFECTIVE INVENTORY
MANAGEMENT
1. A system to keep track of the inventory on hand and on
order.
2. A reliable forecast of demand that includes an
indication of possible forecast error.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding costs,
ordering costs, and shortage costs.
5. A classification system for inventory items.
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Inventory Counting
Systems
Inventory counting systems can be periodic or perpetual. Under a
periodic system, a physical count of items in inventory is
made at periodic, fixed intervals (e.g., weekly, monthly) in
order to decide how much to order of each item. On the other
hand, a perpetual inventory system (also known as a
continuous review system) keeps track of removals from
inventory on a continuous basis, so the system can provide
information on the current level of inventory for each item.
Perpetual systems range from very simple to very sophisticated. A
twobin system, a very elementary system, uses two
containers for inventory.
Point-of-sale (POS) systems electronically record actual sales.
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Inventory Costs
Four basic costs are associated with inventories:

1. Purchase cost is the amount paid to a vendor or

supplier to buy the inventory.
2. Holding, or carrying, costs relate to physically having
items in storage.
3. Ordering costs are the costs of ordering and receiving
inventory.
4. Shortage costs result when demand exceeds the
supply of inventory on hand.
Setup costs, the costs involved in preparing equipment
for a job.
Classification System
The A-B-C approach classifies inventory items according to
some measure of importance, usually annual dollar
value (i.e., dollar value per unit multiplied by annual
usage rate), and then allocates control efforts
accordingly. Typically, three classes of items are used: A
(very important), B (moderately important), and C (least
important).

Another application of the A-B-C concept is as a guide to

cycle counting, which is a physical count of items in
inventory. The purpose of cycle counting is to reduce
discrepancies between the amounts indicated by
inventory records and the actual quantities of inventory
on hand.
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HOW MUCH TO ORDER
Inventory that is intended to meet expected demand is known as
cycle stock, while inventory that is held to reduce the probability
of experiencing a stockout (i.e., running out of stock) due to
demand and/or lead time variability is known as safety stock.

The question of how much to order can be determined by using an

economic order quantity (EOQ) model. Three order size models
are described here:

1. The basic economic order quantity model

2. The economic production quantity model
3. The quantity discount model

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REORDER POINT ORDERING
EOQ models answer the question of how much to order, but
not the question of when to order. The latter is the
function of models that identify the reorder point (ROP)
in terms of a quantity: The reorder point occurs when the
quantity on hand drops to a predetermined amount.
The goal in ordering is to place an order when the amount of
inventory on hand is sufficient to satisfy demand during
the time it takes to receive that order (i.e., lead time).
There are four determinants of the reorder point
quantity:
1. The rate of demand (usually based on a forecast)
2. The lead time
3. The extent of demand and/or lead time variability
4. The degree of stockout risk acceptable to management
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HOW MUCH TO ORDER
The fixed-order-interval (FOI) model is used when orders
must be placed at fixed time intervals (weekly, twice a
month, etc.): The timing of orders is set. The fixed-interval
system results in tight control. In addition, when multiple
items come from the same supplier, grouping orders can
yield savings in ordering, packing, and shipping costs. On
the negative side, the fixed-interval system necessitates a
larger amount of safety stock for a given risk of stockout
because of the need to protect against shortages during an
entire order interval plus lead time (instead of lead time
only), and this increases the carrying cost.

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THE SINGLE-PERIOD MODEL
The single-period model (sometimes referred to as the
newsboy problem ) is used to handle ordering of
perishables (fresh fruits, vegetables, seafood, cut
flowers) and items that have a limited useful life
(newspapers, magazines, spare parts for specialized
equipment). The period for spare parts is the life of the
equipment, assuming that the parts cannot be used for
other equipment. What sets unsold or unused goods
apart is that they are not typically carried over from
one period to the next, at least not without penalty.
Analysis of single-period situations generally focuses
on two costs: shortage and excess.
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OPERATIONS STRATEGY
Improving inventory processes can offer significant benefits in terms
of cost reduction and customer satisfaction. Among the areas
that have potential are the following:
Record keeping. It is important to have inventory records that are
accurate and up-to-date, so that inventory decisions are based
on correct information.
Variation reduction. Lead time variations and forecast errors are
two key factors that impact inventory management, and variation
reduction in these areas can yield significant improvement in
inventory management.
Lean operation. Lean systems are demand driven, which means
that goods are pulled through the system to match demand
instead of being pushed through without a direct link to demand.
Supply chain management. Working more closely with suppliers to
coordinate shipments, reduce lead times, and reduce supply
chain inventories can reduce the size and frequency of stockouts
while lowering inventory carrying costs.
Thank you!
For listening!
Reference:
Stevenson, W. (2016). Operations
Management 13th edition. NY:
McGraw-Hill Education.

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