Inventory Management. NEELU TIWARI Jaipuria Institute of Management, Vasundhara Gzb.

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1 INTERNATIONAL JOURNAL OF BUSINESS MANAGEMENT, ECONOMICS AND INFORMATION TECHNOLOGY Vol. 3, No. 2, July-December 2011: Inventory Management NEELU TIWARI Jaipuria Institute of Management, Vasundhara Gzb. The Paper provides an in sight into the various facet of inventory management. The different concepts are lucidly explained with an overview of contribution of Indians in the inventory management. The paper identifies the gap in theory and practice more relevant to Indian context. 1. AN OVERVIEW An overview of inventory management including the various objectives of and constraints and relevant cost categories faced by inventory managers. Many organizations associated with management of inventories are faced with making decisions for large number 1000 s, 10,000 s or 100,000 s of individual items in the face of diverse collection of factors e.g. demand patterns, modes of shipment from suppliers, and methods of delivery to costumers and constraints (e.g., budget limitations vendor restrictions and desired customer service levels) the three key questions that inventory management attempts to answer on item by item basis are. 1. When should a replenishment order be placed? 2. How large should be the replenishment order is? 3. What is the review interval? What should be the inventory status is to be determined? Inventory management is very useful in supply chain management for examples 1. Inventories needed for service activities. 2. Requirement of raw materials for production scheduling. 3. Production of inventories of finished items constrained by aggregate output rates determined. By medium range production planning. 4. Selection of the locations and capacities of warehouses. 5. Modes of transportation. 6. The effect of pricing, promotion and other marketing decisions and 7. The choice of suppliers. 2. OBJECTIVES AND CONSTRAINTS 1. Maximization of rate of return on stock investment. 2. Cost maximization. 3. Profit maximization. 4. Determination of feasible solution. 5. Ensuring flexibility to cope with an uncertain future. 6. Minimizing political conflicts (interims of the competing interest) within the organization. 7. Maximizing the chance of survival of the individual manager s position. 2.1 Supplier Constraints Minimum order sizes, restrictions to certain pack sizes, maximum order quantities restrictions on replenishment times. 2.2 Marketing Constraints Minimum tolerable customer service levels. Where service can be measured in a number of ways. 2.3 Internal Constraints Storage space limitations, maximum budget to be used for purchasing during a particular period. 3. COSTS ASSOCIATED WITH INVENTORIES Various costs associated with inventory control are often classified as follows. 3.1 Set Up Cost This is the cost associated with the setting up of machinery before starting production. Set up cost is generally assumed to be independent of the quantity.

2 304 / International Journal of Business Management, Economics and Information Technology 3.2 Ordering Cost This is a cost associated with ordering of raw material for production purposes. Advertisements, Consumption of stationery and postage, telephone charges, telegrams, rent for space used by the purchasing department, traveling expenditures incurred etc, constitute and ordering cost. 3.3 Purchase (Production Cost) The cost of purchasing (or producing) a unit of an item is known as purchase cost. The purchase price will become important when quantity discounts are allowed for purchases above a certain quantity or when economics of scale suggest that are allowed for purchases above a certain quantity or when economics of scale suggest that the per unit production cost can be reduced by a larger production run. 3.4 Holding Cost The carrying cost is associated with carrying (holding) inventory. This cost generally includes the cost such as rent for space used for storage, interest on the money locked up, insurance of stored equipment production, taxes, depreciation of equipment and furniture used, etc. 3.5 Shortage Cost The penalty cost of running out of stock (i.e. when an item cannot be supplied on the customer s demand) is known as shortage cost. This cost includes the loss of potential profit through sales of items and loss of goodwill, in terms of permanent loss of customers and its associated lost profit in future sales. Many companies in the short run will take almost any possible action to avoid shortages. 3.6 Salvage Cost (Or Selling Price) When the demand for certain commodity is affected by the quantity stocked, decision problem is based on a profit maximization criterion that includes the revenue from selling. Salvage value may be combined with the cost of storage and hence is generally neglected. 3.7 Revenue Cost When it is assumed that both the price and the demand of the product are not under control of the organization, the revenue from the sales is independent of the company s inventory policy and may be neglected expect for the situation when the organization cannot meet the demand and the sale is lost. Therefore the revenue cost may or may not be included in the study of inventory policy. 4. DIMENSIONS OF INVENTORY MANAGEMENT The model should be both effective and efficient. Can each item be considered in isolation for decision making purposes? 4.1 Time Duration In some situations (e.g. style goods newspapers) there is a relatively short selling season and remaining stock cannot be used to satisfy demand in the next season. This decoupling effect simplifies the analysis compared with the multi-period case. When the time horizon extent well out into the future and there is considerable uncertainty, a pragmatic approach is to use a rolling horizon implementation. At the start of each time period the current decisions are made only considering (the most recent) information for a relatively small number of periods in the future. These current decisions are implemented and the problem is resolved at the beginning of the next period. 4.2 Information and Control It is appropriate to treat a single stocking point in isolation. However in many organizations inventories of the same item are kept at more than one location. In multi-location problems (including a single stocking point, but incorporating the supplier s and/ or customers) occurs across and up/down the supply chain. 5. NATURE OF THE PRODUCT AND THE TYPE OF DEMAND PROCESS It is the product consumable, perishable and/ or recoverable/repairable > what generates the demand? Are there primarily external customers or is there internal usage? Is the item used as a spare part for regular maintenance and/or repair? Are life cycle considerations important? Is it a new item, or is it in its growth phases in its mature phase, or is it facing declining demand? In addition, what are important influences on the demand in a specific period? These can include marketing decisions (promotions, special pricing) competitor actions, general economic conditions, seasonal effect and so on. Is the demand primarily from a captive market or is there a significant chance of losing sales/consumption when demands take place during an out of stock situation? Are there different classes of customers that have to be distinguished. There are a number of possible choices in modeling the demand process. For simplicity in exposition will ignore most of the aforementioned issues and assume that demand is to be modeled as just a function of calendar time. The possibility include: Deterministic, level demand

3 Inventory Managements / 305 Deterministic, but varying in a known way with time. Known stationary distribution with known parameters. Unknown stationary distribution Known stationary distribution but with parameters not assumed known Bayesian Methods can be used in this context. Non stationary, Probabilistic demand most practical demand pattern area in this category, but associated mathematical models become very complicated in terms of data requirements, computational needs and user understanding. 6. NUMBER OF STOCKING POINT AND SUPPLY PROCESS In many organizations inventories of same item are kept at more than one location. Obsolescence or deterioration of stock may be important considerations. Obsolescence represents the situation where the stock is still in appropriate physical condition but can no longer be sold at any where near its original price (usually due to the appearance of a new competing product such as in electronics) Deterioration or perish ability signifies that for legal and/ or physical reasons the stock cannot be used for its original purpose after the passage of a certain length of time. 7. INVENTORY CONTROL STEPS Here is series of steps which define a process for achieving higher levels of inventory will be determined by your implementation of these steps. 7.1 Attitude Maintaining inventory accuracy must be an integral part of the attitude of the organization. Like quality, customer service, and plant safety, accuracy must be promoted throughout the organization as everyone s responsibility. This attitude must start at the top levels. All you managers and executives out there want an accurate inventory but are you ding your part through your decisions and business practices to promote in? Processes are often shortcut in the name of Customer Service (this also applies to processes for quality, inventory Management and Production Plans) that reduce or eliminate the effectiveness of the plan, which in the long run will reduce your ability to service your customers. Remember that these plans are designed to meet the needs of the customer, don t compromise them. 7.2 Process Definition You ll struggle to make any progress if you have not clearly defined the processes throughout the organization that affect inventory. While defining the process, you should be looking for opportunities for errors and implementing changes to eliminate or reduce them. Even the most accurate employee will make errors; it is suggested to place formal checks in place of critical operations. Get as many people involved in this step to ensure you have a complete and accurate understanding of the processes. Anything missed in this step will require new procedures and additional employee training later, so once again, take the time and do it right. 7.3 Procedure Documentation This is part where you use the previously defined processes to document the procedures that the employees will follow to maintain inventory integrity. The procedures documented here should not be limited to inventory issues; they should be the complete procedure including quality, physical aspects and safety. This documentation should be as clear and comprehensive as possible. It should be written for a specific task within a specific job responsibility. It should include everything the employee needs to know to complete the task and nothing else. For example: if a stock clerk s responsibility is to notify the supervisor for any discrepancies, that is all it should state in the procedure for the stock clerk even though there will be additional procedures for dealing with the discrepancy. Procedures should also include the correct Method for filling out and processing paperwork, the sequence and timing of entering data, and any checks that are required to be performed. If there are any exceptions to a procedure they should be specified in the document, allowing undocumented exceptions to a procedure will decrease its effectiveness. Be realistic, procedures are not a wish list, they are the documentation of the requirements of a specific task. You must be prepared to enforce compliance to all procedures. Once you are completed with the documentation, it is suggested you first distribute the procedures to a few key employee, then take a couple of weeks for you and the key employees to monitor existing operations to see if anything was missed or if anything is incorrect. Once this is done, the procedures should be officially put into effect and distributed to all employees. 7.4 Employee Training Handling out a written procedure does not constitute employee training. It is important to set a training schedule to go through all the procedures with groups

4 306 / International Journal of Business Management, Economics and Information Technology of employees. Take whatever time is necessary to ensure they have a thorough understanding of the procedures. Make it clear that the procedure document is the only way to perform the task. if you did your job correctly in defining the processes and documenting the procedures you shouldn t run into many surprises during the training. Try to refrain from making changes or exceptions to the documentation at this time (unless there is a critical error). Last minute changes or exceptions will cause confusion and diminish the value of the documents. Make motes for possible future revisions of the procedures instead. Set a timetable for publishing and putting into effect revisions (every quarter or six months). Frequent revisions of procedures tens to cause confusion and make it difficult to enforce adherence. 7.5 Employee Testing One should be a big advocate of formal testing of employees on procedures. This is the only way to know if they understand them (or have even read them). Be prepared, this will scare the hell out of your staff. Do not make the tests too difficult, multiple choice questions are appropriate and maybe some true/false. You may also need testing which requires the employee to perform the task in presence of the tester. Make a point to include items in the test that are known to have been issues in the past. There should not be any penalties for incorrect answers on the test. Any incorrectly answered questions should be discussed with the employee to ensure that he/she now understands the correct answer. You may need to make arrangements to conduct the test verbally for employees with inadequate reading skills or other arrangements if language is an issue. 8. MONITORING PROCESSES FOR COMPLIANCE You must begin to monitor the processes for compliance to the procedures immediately. Any actions observed which do not comply with the written procedures must be addressed immediately with the employees involved. As stated earlier, the written procedures are the only way to perform the task. Allowing employees to do it their own way (even if their way is a better way) will make it impossible to enforce compliance on other issues and will create problems when changes are made to processes. If they have a better way, consider it for the next revision at which point it would then become the only way. 9. SETTING STANDARDS One should be a big advocate of setting maximum accuracy and production standards wherever feasible. Do your research to ensure the standards those set are high enough yet still achievable. You will have to enforce these standards so it is critical to set them correctly. If in doubt, set them lower, you can always increase them later when more data is available. If you set them too high you have put yourself in a difficult position when it comes time to enforce them. Standards should be set specific task being performed. For example, the accuracy standard for a stock clerk stocking in random storage area would be lower than for one stocking in fixed locations. Setting standards requires tracking of the accuracy and productivity of the tasks being performed which makes it more viable when you have several people performing the same tasks. 10. TRACKING ACCURACY Whether you have set standards or not it is suggested to track accuracy organizationally and individually. Accuracy tracking should always be measured as a percentage of total transactions. Tracking accuracy as flat numbers (number of errors) puts your more productive employees at a disadvantage, and at an organizational level will be skewed by variances in business activity. Accuracy tracking should be communicated to staff in a positive manner; it is a tool to facilitate improvement in processes and people. By simply tracking and communicating accuracy to employees you will see immediate reductions in errors even if standards are not set. The fact is we all want to be accurate; the problem is we all think that we are accurate and it s always the other guy who is making all the mistake. 11. ACCOUNTABILITY People must be held accountable for following documented procedures. You have spent the time to document the procedures, provide the training, and the testing. If someone is not following the procedures they must be dealt with applying appropriate disciplinary action. It s that simple. You may be amazed as to how much just one individual not following procedure can screw up your inventory. If you don t hold the employees accountable you may as well throw out everything you have done to this point. Mistakes are mistakes and everyone makes them, however, not following a specified procedure is a conscious decision made by the employee to not do what he/she was instructed to do. 12. COUNT, COUNT, COUNT We would like to believe that since we have taken the above steps we should now assume our inventory is

5 Inventory Managements / 307 accurate. Not necessarily. You will have evaluation. Year-end physical inventories are tools used by accountants and do very little for inventory accuracy. You should count your inventory on a continuous basis (cycle counting) to maintain high levels of accuracy. This is one of the best ways of identifying problem areas on a timely basis and providing an environment conducive to be designed for your specific type of operation. 13. REEVALUATE You should be regularly reevaluating your processes and procedures. Results of your cycle count program should point you in the direction of areas where enhancements are needed. Business conditions often change and new processes are added which will require evaluation. 14. SUGGESTIONS 1. More attention should be developed to the aggregate consequences of inventory decisions rules. Top and middle management, who are usually responsible for the go no go decision on a new system, are much more interested in the aggregate consequences than in the performance on an individual item basis. 2. There is a need for easily understood procedures, particularly in smaller organizations, Spreadsheets and other implementation aids, Such as graphical and tabular displays should be more widely used. 3. More attention should be given to the behavioral aspects of inventory management. A crucial phase of any effective OR study is convincing the decision maker and those providing the data that the decision system is aiding, not replacing, them and that it is in their interest to corporate. 15. SUMMARY We have provided an overview of inventory management, including Indian contributions of fundamental and applied theory. Following a review of the continuing gap between theory and supporting factors. References [1] Sharma J. K., Operations Research - Theory and Applications, Third Edition, Macmillan India Ltd., ISBN [2] Ravi M. Kishore, Financial Management, 6 th Edition Reprint 2008, ISBN: X [3] M. Y. Khan and P. K. Jain, Financial Management, Fifth Edition, ISBN: [4] P. K. Gupta, and Kantiswaru Manmohan, Operations Research, Eleventh Edition, Sultan Chand & Sons, ISBN: [5] Goyal S. K., (1995), A Simple Procedure for Price Break Models Production Planning and Control, 6(6),