MODULE 4
Introduction to Inventory Concepts
Introduction to Inventory Concepts: various costs associated
with inventory, EOQ, buffer stock, lead time reduction, reorder
point / re-order level fixation, ABC analysis, SDE/VED Analysis.
Goals, need, impact of inventory management on business
performance. Types of Inventory, Alternative approach for
classification of inventories, components of inventory decisions,
inventory cost management, business response to stock out,
replenishment of inventory, material requirements planning.
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Engineering
Inventory
•The term inventory denotes any stock of materials or idle
resources that could be put to some future use
•The performance of firm indicates its ability to cut down the
inventory level
•The purpose of inventory is to meet customer demand, to avoid
stock –out of materials which may cause stoppage of production or
even to hedge against strikes and lockouts and to meet
uncertainties in supply from vendors
•For many firms inventory is the largest current asset
•Automobile assembly plants and component manufactures are
known to carry very little inventory and provide good quality
products at right time
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Engineering
Role of Inventory Management
• The role of inventory management is to strike a
balance between inventory investment and
customer service.
• Inventory is one of the most expensive assets of
many companies, representing as much as 50%
of total invested capital.
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Engineering
Functions of Inventory
1. To meet anticipated demand
2. To smooth production requirements
3. To decouple operations
4. To protect against stock-outs
5. To take advantage of quantity discounts
6. To hedge against price increases
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Objective of Inventory Control
• To achieve satisfactory levels of customer service while
keeping inventory costs within reasonable bounds
– Level of customer service
– Costs of ordering and carrying inventory
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Engineering
Types of inventory
• Seasonal inventory
– Organizations carry inventory to meet fluctuations in demand
arising out of seasonality
– Inventory build up happens during non peak period to manage
the demand during peak periods
• Decoupling inventory
– Manufacturing systems typically involves a series of production
and assembly workstations
– Raw material passes through these stages before it is converted
into finished goods
– Planning the multistage production process becomes complex
– Solving this by decoupling at successive stages using inventory
at some intermediate
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Engineering
• Cyclic inventory
– It is customary for organizations to order inventory in repeated
cycles and consume them over time
– E.g.: repeatedly placing order after a fixed interval of time
Quantity
Time
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Engineering
• Pipeline inventory
– Pertains to the level of inventory that organizations carry in the long run
due to non-zero lead time for order, transport and receipt of material from
the suppliers
– Due to geographical distances between the buyers and the suppliers and a
host of business processes involved in ordering and receipt of material,
there is a time delay between order placement and order receipt, Hence to
manage these situation.
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Engineering
• Safety stock
• Additional investment in inventory to buffer
against uncertainties in demand and supply of
raw materials and components
Cyclic stock
Quantity
Pipeline inventory
L Time
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Engineering
Inventory related costs
• Inventory costs
• Inventory carrying costs
• Inventory ordering costs
• Warehousing costs
• Damage, pilferage and Obsolescence cost
• Cost of shortages ( stock out costs)
• Exchange rate differentials
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Engineering
Inventory Costs
• Ordering (Setup) Costs
– The costs, usually fixed, of placing an order or setting up
machines for a production run.
• Acquisition Costs
– The total costs of all units bought to fill an order, usually
varying with the size of the order.
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• Inventory-Holding (Carrying) Costs
– All the costs associated with carrying parts or materials in
inventory.
• Stock out Costs
– The costs associated with running out of raw materials, parts,
or finished-goods inventory.
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Engineering
Inventory Management and Supply Chain
• Inventory is technically an asset, but it is indirectly
taxing on the profitability of the firm.
• With a lean supply chain, corporations across the world
are always finding different methods and techniques to
reduce their investments in inventory.
• With the latest IT tools and communication
technologies, it has become comparatively easier than
before to size and control this single largest cost spinner
in the supply chain.
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Engineering
Economic Order Quantity (EOQ)
• Economic Order Quantity (EOQ)
– An inventory management system based on a simple formula
that is used to determine the most economical quantity to order
so that the total of inventory and setup costs is minimized.
– Assumptions:
• Constant per unit holding and ordering costs
• Constant withdrawals from inventory
• No discounts for large quantity orders
• Constant lead time for receipt of orders
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Engineering
The Economic Order Quantity Model
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Formula to Calculate EOQ
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Assumptions of EOQ Model
• Only one product is involved
• Annual demand requirements known
• Demand is even throughout the year
• Lead time does not vary
• Each order is received in a single delivery
• There are no quantity discounts
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Engineering
Selective inventory management
• There are some selective Inventory control methods to have an
effective control on the inventory.
• The important methods are:-
1. ABC Analysis (Always Better Control)
2. VED “ (Vital, Essential, Desirable)
3. FSN “ (Fast, Slow moving and Non-moving)
4. SDE “ (Scarce, Difficult, Easy)
5. HML “ (High, Medium, Low)
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Engineering
ABC classification
• Is based on the cost (or value) of items consumed
• Very high value items are “A” class items and may require
tighter control
• Medium value items are categorized as “B” class and the low
value items as “C” class
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Engineering
VED classification
• Is done to determine the criticality of an item and its effect on
production and other services
• It is specially used for classification of spare parts
• If a part is vital it is given ‘V’ classification
• If it is essential it is given ’E’ classification
• and if it is desirable the part is given ‘D’ classification
• For ‘V’ items a large stock of inventory is generally
maintained, while for ‘D’ items minimum stock is enough
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Engineering
FSN analysis
• FSN stands for fast moving, slow moving and non-moving
• Classification is based on the pattern of issues from stores and is
useful in controlling obsolescence
• To carry out FSN analysis, the date of receipt or the last date of
issue, whichever is later , is taken to determine the number of
months , which have lapsed since the last transaction
• The items are usually grouped in periods of 121 months
• FSN analysis is useful in identifying active items which need to
be reviewed regularly and surplus items which have to be
examined further
• Non moving items may be examined further and their disposal
can be considered
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Engineering
SDE (Scarce, Difficult, Easy)
• SDE i.e. Scarce, Difficult and Easy analysis estimates the
significance of inventory items on the basis of their availability.
According to SDE analysis the inventory items are combination
in the subsequent categories:
▪ Scarce (S) items are those items that are in short supply.
Mainly of the time these items are significant and essential for
continuous production.
▪ Difficult (D) items are those items that can't be produced
simply.
▪ Easy (E) items are those items that are readily available in the
market.
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Engineering
HML Analysis “ (High, Medium, Low)
H-M-L analysis is similar to ABC analysis except the difference
that instead of “Annual Inventory Turnover”, cost per unit criterion
is used .
The items under this analysis are classified based on their unit
prices . They are categorized in three groups , which are as follows
H-High Price Items
M-Medium Price Items
L-Low Price Items
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Engineering
SAP Analysis
• Scarce, Available and Plenty status of inventory item is used
for planning & forecasting of inventory requirement.
• The ordered quantity is governed by the scarcity factor.
•
• The limitations in supply or obsolescence of an item in the
near future will be guideline for procurement policy decision.
•
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Engineering
Just In Time (JIT) Method
• In the Just in Time method of inventory control, the
company keeps only as much inventory as it needs
during the production process.
• With no excess inventory in hand, the company saves
the cost of storage and insurance.
• This is a little risky method of inventory management
because a little delay in ordering new inventory can lead
to a stock-out situation.
Dr.V Vikram,Dept. of MBA, JNN College of
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Engineering
Material Requirements Planning (MRP) Method
• Material Requirements Planning is an inventory control
method in which the manufacturers order the inventory
after considering the sales forecast.
• MRP system integrates data from various areas of the
business where inventory exists. Based on the data and
demand in the market, the manager would carefully
place the order for new inventory with the material
suppliers.
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Engineering
Stockouts
• Stockout or out-of-stock (OOS) is a condition in which
the inventory of a particular product is depleted.
• For a retail store, stockout is a term for a product that is
not available on this store shelf but may be available in
another location in the supply chain.
• Therefore, ensuring the right product hits the shelf at the
right time for optimal order fulfillment is crucial as it
increases the chances of sales and delivers the best
customer experience.
Dr.V Vikram,Dept. of MBA, JNN College of
12/28/2023 27
Engineering
Stockouts
1. Four possible outcomes from a stockout
1. Customers wait
2. Back orders
3. Lost sales
4. Lost customers
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Engineering
Business response to stock out
• Regular stocktake
– It’s the process of manually verifying the actual quantity and quality of
products in retail inventory.
• Timely replenishment on shelves
– Retailers should arm themselves with physical inventory management
software to avoid stockouts from all of their retail locations. In addition to
maintaining inventory levels, one can also monitor on-shelf availability.
• Supply chain optimization
– One might consider using a radio frequency identification (RFID) system
for supply chain transparency for more sophisticated retail businesses and
to reduce stockout costs.
– This type of technology uses a chip in the item’s packaging to track the
item’s movement at the individual product level throughout the supply
chain, including retailers, distributors, and manufacturers.
Dr.V Vikram,Dept. of MBA, JNN College of
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Engineering
Expected Costs of Stockouts
Expected
Event Probability Costs Costs
Back Order 70% $ 6.00 $ 4.20
Lost Sale 20% $20.00 $ 4.00
Lost
10% $200.00 $ 20.00
Customer
Estimated
cost per 100% --- $ 28.20
stockout
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THANK YOU
Dr.V Vikram,Dept. of MBA, JNN College of
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Engineering