How To Manage Production

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1 DESIGNING INVENTORY MANAGEMENT SYSTEM: A CASE OF RETAIL STORE IN CIANJUR, INDONESIA Rianti Indah Lestari School of Business and Management, Bandung Institute of Technology Bandung, West Java, Indonesia ABSTRACT Inventory Management plays a critical role in any business sector. With effective inventory management firm may gain lower cost and higher profit. As a new player, Hemat Toserba, a retail store in Cianjur, Indonesia, is facing issue on how to optimize inventory management system. This study aims to identify the cause and effect of inventory management issue and design new inventory management system in Hemat Toserba. The study is conducted by using qualitative and quantitative analysis. No inventory control system, lack of experience, lack of knowledge in inventory management system, no appropriate forecasting system, dependent on supplier, and recording system error are the main causes of the issue. In this study, the inventory management system proposed is Economic Order Quantity (EOQ) model, including reorder point (ROP) by using probabilistic model and minimum stock. KEYWORDS-- Inventory Management, Retail, ROP, Stock I. INTRODUCTION Retail business is one of potential business in Indonesia. In recent years, the number of retail store grows rapidly. Retail store is available in almost every place in Indonesia. Modern retail grows faster than traditional retail. Moreover, according to Federasi Organisasi Pedagang Pasar Indonesia (Foppi), there is an 8% shrinkage per year in the number of traditional market in Indonesia [7]. The condition of economy in Indonesia becomes the reason for the growth of retail industry [6]. The good condition of economy gives direct impact to people purchasing power. This condition becomes the opportunity for Retail Company, especially modern retail to expand their business. Minimarket, convenience store, and hypermarket are modern retail which have the highest level of growth. There was 23,000 units of modern market in Indonesia which consists of more than 14,000 units of minimarket and the rest are supermarket [5]. The large number of modern retail store brings out the competition among modern retail companies. On the other hand, retail sector others than competition also 275 facing an issue on how to improving its operation management. Out of stock is a common issue in retailing industry. The worldwide out of stock level still average 8% or when a shopper has a plan to purchase 13 items, one item will be out of stock [2]. Cianjur is one of regencies in West Java which is also experiencing growth in modern retail industry. Hemat Toserba is one of modern retail stores in Cianjur that capture the potential opportunity in retail industry. As a new player, Hemat Toserba is facing issue on their management system. Currently, Hemat Toserba focuses on its inventory management problem. Some products in the store cannot satisfy customers demand because the quantity of those products is less than the customer demand, on the other word out of stock is the problem. Moreover, Hemat Toserba is also experiencing overstock. This condition causes the store holding many inventories in warehouse. The out of stock will affects the company s revenue, lost sales will occur because company cannot fulfill the customer demand. Otherwise, when the company has many inventories, it would satisfy the customer demand. However, overstock will increase the cost of inventory, the cost of carrying the inventory would be high. In addition, the manager of Hemat Toserba also cannot predict the cost that should be incurred for inventory. Because of these problems, Hemat Toserba could not reach their target profit in March and April Stock-out, overstock, and unpredictable cost happened because Hemat Toserba does not have effective inventory management system. Managing inventory becomes critical for Hemat Toserba in order to meet customer demand, minimizing cost, and increasing profit. Hemat Toserba should have effective inventory management by determining the appropriate and optimal amount of orders that should be placed which can reduce the opportunity of out of stock, overstock, and generate low cost. The objectives of this research would be: A. To identify the cause and effect of inventory management issue in Hemat Toserba B. To design appropriate inventory management system for Hemat Toserba

2 II. LITERATURE REVIEW A. Inventory Management Inventory has been defined in many ways. Chase, Jacobs, and Aquilano [1] defined inventory as the stock of any item or resource used in organization. Inventory includes a company s raw materials, work in process, supplies used in operations, and finished goods [4]. Inventory management is a set of the policies and controls that monitor levels of inventory and determine what levels should be maintained, when stock should be replenished, and how large orders should be [1]. The objective of inventory management is to strike a balance between inventory investment and customer service [3]. Meanwhile, Chase, Jacobs, and Aquilano [1] stated that the basic purpose of inventory analysis in manufacturing and stock keeping services is to specify when item should be ordered and how large the order should be. There are some important reasons for obtaining and holding inventory which are predictability, fluctuations in demand, unreliability of supply, price protection, quantity discounts, and lower ordering cost [4]. The four major functions of inventory management are to decouple or separate various parts of the production process, to decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers, to take advantage of quantity discounts, to hedge against inflation and upward price changes [3]. B. ABC Analysis ABC analysis is a method of managing inventory which divides on-hand inventory into three classifications based on annual dollar volume. The categories determine the importance of items and the control level. The three classes of ABC analysis are Class A, Class B, and Class C. Class A is products that has high annual dollar volume. The total products of Class A is only about 15% of the total inventory items, however the Class A represents 70% to 80% of the total dollar usage. Class B has medium annual dollar volume, the items of Class B represents about 30% of inventory items and 15% to 25% of the total value. And Class C is the class that has the lowest annual dollar volume. The items of this class represents only 5% of the annual dollar volume but the total items in Class C is about 55% of the total inventory. The policies based on ABC Analysis are Class A should have tighter inventory controls rather than 276 Class B and Class C, forecasting Class A items may warrant more care than forecasting other items, and purchasing resources expended on supplier development should be much higher for individual A items than for C items. C. Inventory Cost 1) Holding Cost: Holding cost refers to the cost to keep or hold the inventory. Holding costs include the costs for storage facilities, handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes, and the opportunity cost of capital. 2) Ordering Cost: Ordering cost is the cost of ordering process. The ordering cost includes cost of supplies, forms, order processing, purchasing, and clerical support. 3) Setup Cost: Setup cost is the cost to prepare a machine or process for manufacturing an order. D. Inventory Models Inventory management is divided into two types, the first one is inventory management when demand is independent and the second one is when demand is dependent. EOQ, Production Order Quantity Model, and Quantity Discount model are inventory models for independent demand. 1) EOQ EOQ is inventory control technique to minimize the inventory cost. There are several assumptions to implement EOQ model which are the demand used is known, independent, and reasonably constant; lead time is known and constant between place an order and receipt the order; the inventory from an order is received in one batch at one time; quantity discounts are impossible; there are only two variable costs which are ordering or setup cost and holding cost; shortage will not occur if the order arrives punctually. Q*= optimal number of pieces per order (EOQ) D= Annual demand in units for the inventory item S= Setup or ordering cost for each order H= Holding or carrying cost per unit per year Inventory model is concerned with cost. The

3 following equation is the formula of total annual cost: Total annual cost = annual purchase cost + annual ordering cost + annual holding cost 2) Probabilistic Models and Safety Stock Probabilistic Model is a statistical model applied when demand is not known but can be specified by means of a probability distribution. When demand is variable and lead time is constant, the formula to determine ROP is as follows: uses historical data of Hemat Toserba started from August 2014 to April B. Data Analysis The primary data that gathered through in-depth interview and direct observation are analyzed by using qualitative technique. The secondary data which are about order, sales, and operational cost data will be analyzed by using quantitative technique. In this research, Microsoft Excel will be used to determine the reorder point (ROP) and minimum stock. C. Research Design ROP = (Average daily demand x Lead Time in days) + ZσdLT σdlt = Standard deviation of demand during lead time = σd Leadtime σd = Standard deviation of demand per day When lead time is variable and demand is constant, the formula to determine ROP is as follows: ROP = (Daily demand x Average lead time in days) + Z (Daily demand) x σlt σlt = Standard deviation of lead time in days When both demand and lead time are variable, the formula to determine ROP is as follows: ROP = (Average daily demand x Average lead time) + ZσdLT σd = Standard deviation of demand per day σlt = Standard deviation of lead time in days IV. DATA ANALYSIS A. Company Profile Figure 2. Research Design Hemat Toserba is a retail store located on Ariawiratanudatar Street, Cianjur, Indonesia. The company was established in 2014 by Mande s Group. Hemat Toserba provides basic daily needs for customer. B. Competition Map III. METHODOLOGY A. Data Collection Method Primary data are collected by the researcher through direct observation to Hemat Toserba and in-depth interview with the owner and manager of Hemat Toserba. Secondary data is obtained by using literature survey which is the study that use article, journal, and document that related to the theory and the basic concept of the research. The research also 277 Figure 3. Competition Map Hemat Toserba is located near two other modern retail and two traditional retail. Those two modern retail

4 stores are Toserba Pasar Muka and Ramayana, while the traditional retail stores are Pasar Muka and Toko Abang. Toserba Pasar Muka and Ramayana are the main competitors of Hemat Toserba because both of them have similar concept with Hemat Toserba. C. Cause and Effect Analysis The following diagram describes the root causes of overstock and out of stock issue in Hemat Toserba: Figure 1. Cause and Effect Diagram The root causes of overstock and out of stock issue in Hemat Toserba are Hemat Toserba does not have system in reviewing or controlling the stock, lack of experience and inability to read market demand since Hemat is a new player in retail sector and just operated in a few months, Hemat does not have appropriate forecasting system, lack of knowledge in inventory management system, inaccurate inventory data that caused by computer system error, and some products in the store depend on one supplier and depend on supplier lead time. D. ABC Analysis ABC analysis is conducted to classify the products in Hemat Toserba into three categories which are A- Class, B-Class, and C-Class. These categories determines the importance of items and the control level. In this analysis, the categories are based on unit cost. Since Hemat Toserba has thousands products, the ABC Analysis is conducted by using only several items from product categories that has been classified by Hemat Toserba. Fifteen items from the first category (price: >Rp 75,000), twenty items from the second category (price: Rp 15,000-Rp 75,000), and forty items from the third category (price: <Rp 15,000) are selected to conduct ABC Analysis. The selected items are the fast mover from each categories. Class Percentage of total items Percentage of total unit cost A 20% 70% B 27% 24% C 53% 6% The table shows that the 15 items of A-Class or 20% of total inventory represents 70% of total unit cost, 20 items of B-Class or 27% of total inventory represents 24% of total unit cost, and 40 items of C-Class or 53% of total inventory represents 6% of total unit cost. The result means that A-Class has the smallest number of items but represents the highest value of Rupiah, while the C-Class has many items of product but represents the smallest value of Rupiah, and B- Class has medium number of items and total value. Based on ABC analysis, two items from A-Class, four items from B-Class, and six items from C-Class are selected as a sample for inventory models analysis. Table 2.Products No Product Class Code 1 Indomie Goreng (carton) A A1 2 Indomie Kocok Bandung (carton) A A2 3 Djarum Super 16 B B1 4 Teh Gelas (carton) B B2 5 Ale-Ale (carton) B B3 6 Gg Surya 16 B B4 7 Good Day Mochaccino C C1 8 Aqua 600ml C C2 9 Roma Kelapa 300gr C C3 10 Teh Pucuk Harum 350ml C C4 11 Ultra Mini Coklat 125ml C C5 12 Teh Kotak Ultra 200ml C C6 Table 1. ABC Analysis 278

5 E. Inventory Cost 1) Ordering cost: Ordering cost is the cost of ordering process. Ordering cost includes cost of transportation, parking, and telephone. The total of ordering cost depends on the order frequency. When the order is in small quantity, the order frequency would be more frequent, and the ordering cost would be high. Conversely, when the order is in large quantity, the order frequency would be less frequent, and the ordering cost would be low. 2) Holding cost: Holding cost depends on the total inventory. The holding cost would increase when the store is holding large inventory. In Hemat Toserba, holding cost refers to electricity and labor cost. The holding cost in Hemat is based on the assumption that all of products in the store has the same size and there are around 50,000 units of product per month in the store. Therefore, all of products in Hemat Toserba has the same holding cost which is Rp 194 / unit / month. Table 3. Ordering Cost and Holding Cost No Product Holding cost / Average Ordering carton / Cost month 1 A1 Rp 46,536 Rp 54,320 2 A2 Rp 16,940 Rp 19,400 3 B1 Rp 63,666 Rp 2,910 4 B2 Rp 232,484 Rp 374,808 5 B3 Rp 102,514 Rp 111,744 6 B4 Rp 148,554 Rp 6,790 7 C1 Rp 59,417 Rp 26,675 8 C2 Rp 55,354 Rp 46,560 9 C3 Rp 12,041 Rp 6, C4 Rp 33,339 Rp 18, C5 Rp 37,610 Rp 41, C6 Rp 16,004 Rp 16,296 F. Order Frequency, Order Quantity, and Lead Time Hemat Toserba uses historical data to determine the order quantity. Generally, when demand of product is high, the manager of Hemat would increase the order quantity. However, Hemat Toserba does not have system to determine the appropriate number of order that would minimize their operational cost. Lead time is the time between places an order and receive the order from supplier. Most of products in Hemat Toserba has one or two days of lead time. The following table shows the existing order frequency, order quantity, and lead time in Hemat Toserba. Table 4. Order Frequency and Order Quantity Current Order Frequency/ No. Product Current Average quantity (carton)/order month 1 A Lead Time 2 A B B B B C C C C C C G. Reorder Point (ROP) and Safety Stock Hemat Toserba s current inventory management system does not have ROP and safety stock or minimum stock system. On the other hand, the uncertain demand increase the probability of out of stock. In order to reduce the probability out of stock, 279

6 Hemat Toserba should have extra units in inventory. Therefore, probabilistic models and safety stock analysis is conducted. Probabilistic model is chosen since Hemat Toserba has variable demand and constant lead time. The manager of Hemat Toserba sets 90% service level (meeting 90% of demand or having out of stock only 5% of the time). Table 5. ROP and Safety Stock No Product Lead Time ROP Safety stock 1 A A B B B B C C C C C C H. Economic Order Quantity (EOQ) Economic Order Quantity (EOQ) is a common technique to control inventory. This technique is used to minimize the total of ordering and holding cost. EOQ analysis is conducted by assuming the monthly demand is constant. Table 6. EOQ and Expected Number of Order No Product EOQ (carton) Expected Number of Order / month 1 A A No Product EOQ (carton) Expected Number of Order / month 3 B B B B C C C C C C6 6 2 The table above shows the result of EOQ calculation and expected number of order for the twelve product. Based on the result, the EOQ of Indomie Goreng, Indomie Kocok Bandung, Teh Gelas, Ale-Ale, Ultra Mini Coklat 125ml, and Teh Kotak Ultra 200ml is lower than the existing order quantity, the EOQ of Djarum Super 16, Gg Surya 16, Good Day Mochaccino, Roma Kelapa 300gr, and Teh Pucuk Harum 350ml is higher than the existing order quantity, while the EOQ of Aqua 600ml remains the same as existing order quantity. The expected number of order for Indomie Goreng, Indomie Kocok Bandung, Ale-Ale, Aqua 600ml, Ultra Mini Coklat 125ml, and Teh Kotak Ultra 200ml remains the same as existing order frequency, the expected number of order for Teh Gelas is higher than the existing order frequency, and the expected number of order for Djarum Super 16, Gg Surya 16, Good Day Mochaccino, Roma Kelapa 300gr, and Teh Pucuk Harum 350 ml is lower than the existing order frequency. These results affect the ordering cost and holding cost. As the order quantity increases, the order frequency will decrease and the ordering cost will decrease. However, when the order quantity increases, the holding cost will increase because there are more inventories that should be carried. The following table shows the

7 comparison between the current inventory cost and proposed inventory cost by using EOQ model. Table 7. Ordering Cost Current Proposed No Product Ordering Difference Ordering Cost Cost 1 A1 Rp 46,536 Rp 46,536 Rp - 2 A2 Rp 16,940 Rp 16,940 Rp - 3 B1 Rp 63,666 Rp 10,611 Rp 53,055 4 B2 Rp 232,484 Rp 348,726 Rp (116,242) 5 B3 Rp 102,514 Rp 102,514 Rp - 6 B4 Rp 148,554 Rp 24,759 Rp 123,795 7 C1 Rp 59,417 Rp 29,708 Rp 29,708 8 C2 Rp 55,354 Rp 55,354 Rp - 9 C3 Rp 12,041 Rp 6,021 Rp 6, C4 Rp 33,339 Rp 25,004 Rp 8, C5 Rp 37,610 Rp 37,610 Rp - 12 C6 Rp 16,004 Rp 16,004 Rp - No Product Table 8. Holding Cost Current Holding cost Proposed Difference Holding cost 1 A1 Rp 54,320 Rp 48,449 Rp 5,871 2 A2 Rp 19,400 Rp 17,198 Rp 2,202 3 B1 Rp 2,910 Rp 11,788 Rp (8,878) 4 B2 Rp 374,808 Rp 325,699 Rp 49,109 5 B3 Rp 111,744 Rp 93,969 Rp 17,775 6 B4 Rp 6,790 Rp 30,010 Rp (23,220) 7 C1 Rp 26,675 Rp 39,811 Rp (13,136) 8 C2 Rp 46,560 Rp 46,343 Rp C3 Rp 6,984 Rp 8,371 Rp (1,387) 10 C4 Rp 18,624 Rp 22,889 Rp (4,265) 11 C5 Rp 41,904 Rp 37,429 Rp 4, C6 Rp 16,296 Rp 14,315 Rp 1,981 Total cost is the sum of ordering cost and holding cost. The result shows that the proposed total cost is lower than the current total cost except for B2 or Teh Gelas. For Teh Gelas product, the EOQ model increase the cost by Rp 44,105. It means that the EOQ model is not appropriate for Teh Gelas product. By using EOQ model, Hemat Toserba could decrease their inventory cost by Rp 158,933 per month from the twelve products. Hemat Toserba could save more money if this EOQ model is applied to all products in the store. Table 9. Total Cost Current Total Proposed No Product Difference Cost Total Cost 1 A1 Rp 100,856 Rp 96,897 Rp 3,959 2 A2 Rp 36,340 Rp 34,396 Rp 1,944 3 B1 Rp 66,576 Rp 23,575 Rp 43,001 4 B2 Rp 607,292 Rp 651,397 Rp (44,105) 5 B3 Rp 214,258 Rp 187,937 Rp 26,320 6 B4 Rp 155,344 Rp 60,020 Rp 95,324 7 C1 Rp 86,092 Rp 79,622 Rp 6,469 8 C2 Rp 101,914 Rp 92,687 Rp 9,227 9 C3 Rp 19,025 Rp 16,743 Rp 2, C4 Rp 51,963 Rp 45,777 Rp 6,

8 11 C5 Rp 79,514 Rp 74,857 Rp 4, C6 Rp 32,300 Rp 28,629 Rp 3,670 Total Rp 158,933 V. CONCLUSION AND RECOMMENDATION Out of stock, overstock, and unpredictable issue in Hemat Toserba occurred because Hemat Toserba does not have effective inventory management. There are several main causes of stock-out and overstock issue. From the controlling aspect, Hemat Toserba does not have system to review or control the inventory. Since Hemat Toserba is a new player in retail sector and just operated in a few months, the manager of Hemat Toserba could not read the market demand and need more times to expand his experience in managing retail store. On the other hand, the manager also does not have knowledge in inventory management system. From the recording system, computer error often occurs and causes inaccurate data of inventory. Hemat Toserba also does not have appropriate forecasting system, the current system is based on manager s estimation. And from the sourcing aspect, some products in the store depend on one supplier and depend on supplier lead time. According to ABC analysis, Hemat Toserba should have tighter control to A items rather than B and C items since A items has the highest consumption of Rupiah. Probabilistic model and safety stock could be used by Hemat Toserba to reduce the probability of out of stock due to the uncertain demand and by implementing EOQ model, Hemat Toserba could have appropriate system to lower the overstock and minimize their total inventory cost. The recommendation offered for Hemat Toserba: (i) Hemat Toserba should implement the inventory control system. The control policy based on ABC analysis is recommended for Hemat Toserba in determining the control level or determining product that should have highest priority, (ii) Hemat Toserba should control the recording system frequently and update the computer system to avoid the occurrence of error in recording data of inventory, (iii) In order to reduce the probability of out of stock, Hemat Toserba should have safety stock or minimum stock system that consistent to the market demand and determine the reorder point (ROP) by using probabilistic model, (iv) Economic Order Quantity (EOQ) is preferable for Hemat Toserba to have better inventory system, decrease the overstock and out of stock rate, and minimize their ordering cost and holding cost, so that Hemat Toserba could have higher profit and reach their profit target, (v) Hemat Toserba should improve their forecasting system to capture the market demand accurately. REFERENCES [1] Chase, Richard B., F. Robert Jacobs, and Nicholas J. Aquilano, Operations and supply management, New York: The McGraw-Hill Companies, Inc., [2] Gruen, Thomas W., Daniel S. Corsten, and Sundar Bharadwaj. Retail out-of-stocks: A worldwide examination of extent, causes and consumer responses. Washington, DC: Grocery Manufacturers of America, [3] Heizer, Jay and Barry Render, Operation Management, 10th ed., United States of America: Pearson Prentice Hall, [4] Muller, Max. Essentials of inventory management. AMACOM Div American Mgmt Assn, [5] Sukmana, Y. Agustus Jumlah Pasar Modern di Indonesia Capai Unit. [online]. Available from: /08/ /jumlah. pasar.modern.di.indonesia.capai unit [Accessed 17 March 2015] [6] SWAOnline. December Inilah Kunci Sukses Berbisnis Ritel. [online]. Available from: management/inilah-kunci-sukses-berbisnis-ritel [Accessed 17 March 2015] [7] Utomo, Tri Joko. "Persaingan Bisnis Ritel: Tradisional VS Modern." Fokus Ekonomi 6.1 (2011):