What is inventory?

- Inventory, or stock, is the stored accumulation of the transformed resources in an

operation. Sometimes the words ‘stock’ and ‘inventory’ are also used to describe
transforming resources, but the terms stock control and inventory control are nearly
always used in connection with transformed resources.
- Almost all operations keep some kind of inventory, most usually of materials but also
of information and customers (customer inventories are normally called ‘queues’).
Why is inventory necessary?
- Inventory occurs in operations because the timing of supply and the timing of demand
do not always match. Inventories are needed, therefore, to smooth the differences
between supply and demand.
- There are five main reasons for keeping inventory:
- to cope with random or unexpected interruptions in supply or demand (buffer
inventory);
- to cope with an operation’s inability to make all products simultaneously (cycle
inventory);
- to allow different stages of processing to operate at different speeds and with different
- schedules (de-coupling inventory);
- to cope with planned fluctuations in supply or demand (anticipation inventory);
- to cope with transportation delays in the supply network (pipeline inventory).

Purposes of inventory
1. To maintain independence of operations. A supply of materials at a work center allows that
center flexibility in operations. For example, because there are costs for making each new
production setup, this inventory allows management to reduce the number of setups.
Independence of workstations is desirable on assembly lines as well. The time it takes to do
identical operations will naturally vary from one unit to the next. Therefore, it is desirable to
have a cushion of several parts within the workstation so that shorter performance times can
compensate for longer performance times. This way, the average output can be fairly stable.
2. To meet variation in product demand. If the demand for the product is known precisely, it
may be possible (though not necessarily economical) to produce the product to exactly meet
the demand. Usually, however, demand is not completely known, and a safety or buffer stock
must be maintained to absorb variation.
3. To allow flexibility in production scheduling. A stock of inventory relieves the pressure on
the production system to get the goods out. This causes longer lead times, which permit
production planning for smoother flow and lower-cost operation through larger lot-size
production. High setup costs, for example, favor producing a larger number of units once the
setup has been made.
4. To provide a safeguard for variation in raw material delivery time. When material is
ordered from a vendor, delays can occur for a variety of reasons: a normal variation in
shipping time, a shortage of material at the vendor’s plant causing backlogs, an unexpected
strike at the vendor’s plant or at one of the shipping companies, a lost order, or a shipment of
incorrect or defective material.
5. To take advantage of economic purchase order size. There are costs to place an order: labor,
phone calls, typing, postage, and so on. Therefore, the larger each order is, the fewer the
orders that need be written. Also, shipping costs favor larger orders—the larger the shipment,
the lower the per-unit cost.
6. Many other domain-specific reasons. Depending on the situation, inventory may need to be
carried. For example, in-transit inventory is material being moved from the suppliers to
customers and depends on the order quantity and the transit lead time. Another example is
inventory that is bought in anticipation of price changes such as fuel for jet planes or
semiconductors for computers.
Types of inventory
1. Buffer inventory
Buffer inventory is also called safety inventory. Its purpose is to compensate for the
unexpected fluctuations in supply and demand. It can also compensate for the uncertainties in
the process of the supply of goods into the store, perhaps because of the unreliability of
certain suppliers or transport firms.
2. Cycle inventory
Cycle inventory occurs because one or more stages in the process cannot supply all the
items it produces simultaneously. It is the portion of average inventory that results from
replenishment.
3. Average inventory
Consists of the materials, components, work-in-process, and finished product typically
stocked in the logistical system
Some disadvantages of holding inventory
Although inventory plays an important role in many operations performance, there are a
number of negative aspects of inventory.
● Inventory ties up money, in the form of working capital, which is therefore unavailable for
other uses, such as reducing borrowings or making investment in productive fixed assets
(we shall expand on the idea of working capital later).
● Inventory incurs storage costs (leasing space, maintaining appropriate conditions, etc.).
● Inventory may become obsolete as alternatives become available.
● Inventory can be damaged, or deteriorate.
● Inventory could be lost, or be expensive to retrieve, as it gets hidden amongst other
inventory.
● Inventory might be hazardous to store (for example flammable solvents, explosives,
chemicals and drugs), requiring special facilities and systems for safe handling.
● Inventory uses space that could be used to add value.
● Inventory involves administrative and insurance costs.
Inventory costs
1. Holding (carrying) cost: This broad category includes the costs for storage facilities,
handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes, and the
opportunity cost of capital. Obviously, high holding costs tend to favor low inventory
levels and frequent replenishment.
2. Setup (production change) cost: To make each different product involves obtaining the
necessary materials, arranging specific equipment setups, filling out the required
papers, appropriately charging time and materials, and moving out the previous stock
of material.
3. Ordering cost: These costs refer to the managerial and clerical costs to prepare the
purchase or production order. Ordering costs include all the details, such as counting
items and calculating order quantities. The costs associated with maintaining the
system needed to track orders are also included in ordering costs.
4. Shortage cost: When the stock of an item is depleted, an order for that item must either
wait until the stock is replenished or be canceled. When the demand is not met and the
order is canceled, this is referred to as a stock out. A backorder is when the order is
held and filled at a later date when the inventory for the item is replenished. There is a
trade-off between carrying stock to satisfy demand and the costs resulting from stock
outs and backorders. This balance is sometimes difficult to obtain because it may not
be possible to estimate lost profits, the effects of lost customers, or lateness penalties.
Frequently, the assumed shortage cost is little more than a guess, although it is usually
possible to specify a range of such costs.
ABC analysis
- In any inventory which contains more than one stocked item, some items will be more
important to the organization than others.
- One common way of discriminating between different stock items is to rank them by
the usage value (their usage rate multiplied by their individual value). Items with a
particularly high usage value are deemed to warrant the most careful control, whereas
those with low usage values need not be controlled quite so rigorously.
- Generally, a relatively small proportion of the total range of items contained in an
inventory will account for a large proportion of the total usage value. This
phenomenon is known as the Pareto law (after the person who described it),
sometimes referred to as the 80/20 rule.
- It is called this because, typically, 80 per cent of an operation’s sales are accounted for
by only 20 per cent of all stocked item types. The relationship can be used to classify
the different types of items kept in an inventory by their usage value. ABC inventory
control allows inventory managers to concentrate their efforts on controlling the more
significant items of stock.
● Class A items are those 20 per cent or so of high-usage-value items which account
for around 80 per cent of the total usage value.
● Class B items are those of medium usage value, usually the next 30 per cent of items
which often account for around 10 per cent of the total usage value.
 ● Class C items are those low-usage-value items which, although comprising around
50 per cent of the total types of items stocked, probably only account for around 10
per cent of the total usage value of the operation.

- Although annual usage and value are the two criteria most commonly used to
determine a stock classification system, other criteria might also contribute towards
the (higher) classification of an item:
● Consequence of stock-out. High priority might be given to those items which would
seriously delay or disrupt other operations, or the customers, if they were not in stock.
● Uncertainty of supply. Some items, although of low value, might warrant more attention if
their supply is erratic or uncertain.
● High obsolescence or deterioration risk. Items which could lose their value through
obsolescence or deterioration might need extra attention and monitoring.
- Some more complex stock classification systems might include these criteria by classifying
on an A, B, C basis for each. For example, a part might be classed as A/B/A meaning it is an
A category item by value, a class B item by consequence of stock-out and a class A item by
obsolescence risk.