Itl lecture-12 & 13 (inventory management)

07/06/10 1
By :
Prof. Amit Kumar

07/06/10 2
“Logistics has advanced from warehousing and
transportation to boardrooms of the successful leading
companies across the world. Due to increasing
importance of business logistics, it becomes necessary
for the student pursuing management education from
IILM- Graduate School of Management, to understand
logistics, its basic framework and practical utility.”
IILM-GSM
Importance of this course
International Trade Logistics

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Course: International Trade Logistics
1. Logistics - At the Centre of World Trade
2. Supply Chain Management
3. Warehousing: A Role Beyond Storage
4. Material Handling & Storage System
5. Inventory Management
6. Transportation: Backbone of Logistics
7. Logistics Packaging
8. Logistics Information System
9. Global Logistics & Outsourcing
IILM-GSM
International Trade Logistics

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IILM-GSM
International Trade Logistics Inventory Management

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Contents
• Inventory Flow-Bullwhip Effect
• Inventory- Assets or Liability?
• Inventory Decisions & Costs
• Inventory Expectations
• Inventory Functionality
• Inventory Controls
 ABC Analysis, VED Analysis
 SAP Analysis, FSN Analysis
 Inventory Decision Matrix
 Case: Inventory Reduction by Supply Chain
Reengineering at Asian Paint
• Inventory Management System
IILM-GSM

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• Inventory is technically an asset, but it is indirectly taxing
on the profitability of the firm.
• Corporations across the world always finding different
methods ad techniques to reduce the investments in
inventory.
• It is probably common sense that inventory should be
hold only when the benefits of holding inventory exceed
the cost of holding it.
Introduction: Inventory Management
IILM-GSM

Bullwhip Effect
• While customer demand for specific products does not vary much
• Inventory and back-order levels fluctuate considerably across
their supply chain
• P&G’s disposable diapers case
 Sales quite flat
 Distributor orders fluctuate more than retail sales
 Supplier orders fluctuate even more
IILM-GSM

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• Inventory constitutes the second largest item after fixed
asset in the financial balance sheet of a company.
• From a financial perspective, inventory is one of the
major current assets that can contribute to maximizing
the value of the firm and no significant disadvantages are
seen in carrying more inventory.
• But investments in inventory carry cost.
Today, inventory management is viewed as a supply chain
cost driver rather than as a material asset. Hence, the
lean supply chain operating on material requirement
planning (MRP) or JIT system is preferred.
Inventory- Assets or Liability?
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Inventories may be held for a variety of purposes, but in
general, there are five types of inventories that an
organization can use for serving these purposes. These
are:
1. Movement Inventories
2. Buffer Inventories
3. Anticipation Inventories
4. Decoupling Inventories
5. Cycle Inventories
Types of Inventory
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Movement inventories are also called transit or pipeline
inventories. Their existence owes to fact that transportation
time is involved in transferring substantial amounts of
resources.
For example, when coal is transported from the coalfields
to an industrial town by trains, then the coal, while in
transit, cannot provide any service to the customers for
power generation or for burning in furnaces.
Types of Inventory: Movement
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Buffer inventories are held to protect against the
uncertainties of demand and supply. An organization
generally knows the average demand for various items it
needs. However, the actual demand may not exactly match
the average and could well exceed it.
To meet this kind of situation, inventories may be held in
excess of the average or expected demand.
Types of Inventory: Buffer
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Similarly, the average delivery time( that is, the time
elapsing between placing an order and having the goods in
stock ready to use, and technically called as the lead time)
may be known. But unpredictability events could cause the
actual delivery time to be more than the average.
Thus, excess stocks might be kept in order to meet the
demand during the time for which the delivery is delayed.
This stock is also known as safety stocks.
IILM-GSM

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The idea of keeping buffer stocks is to render a higher level
of customer service and consequently reduce the number
of stock outs and back-orders. A stock out occurs when a
customer is denied fulfillment of an order because the
inventory of the item(s) has run out. In some situations
back-ordering is possible(i.e. the order for goods
demanded may be fulfilled as soon as the next shipment of
the item(s) is received while in others it is not and the
demand might be lost forever leading to
temporary/permanent loss of the customer goodwill.
The optimum level of the buffer stocks to be held can be
determined.
IILM-GSM

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Anticipation inventories are held for the reason that a future
demand for the product is anticipated. Production of
specialized items like crackers well before Diwali, umbrellas
and raincoats before rains set in, fans while summers are
approaching, are all examples.
The idea is to smoothen the production process producing
for a longer duration on a continuous scale rather than
operating with excessive overtime in one period and then
let the system to be idle or close down for the reason of
inadequate/ no demand for another period.
Types of Inventory: Anticipation
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The idea of the decoupling inventories is to dis-couple or
disengage, different parts of the production system. As we
can observe easily, different machines/equipment and
people normally work at different rates: some slower and
some faster. A machine, for example, might be producing
half of the output of the machine on which the item being
handled to be processed the next. Inventories in between
the various machines are held in order to disengage the
processing on those machines. In the absence of such
inventory, different machines and people cannot work
simultaneously on a continuous basis. When such
inventories are held, then, even if a machine breaks down,
the work on others would not stop.
Types of Inventory: Decoupling
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Cycle inventories are held for the reason that purchases
are usually made in lots rather than for the exact amounts
which may be needed at a point of time. If purchases are
made frequently and in small numbers, then the cost
involved in obtaining the items would be very large.
As the cycle inventories are related to the purchases in lots,
they are also called lot-size inventories.
Types of Inventory: Cycle
IILM-GSM

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In an inventory control situation, there are three basic
questions to be answered. They are:
1.How much to order? That is to say, what is the optimal
quantity of an item that should be ordered whenever an
order is placed?
2.When should the order to be placed?
3.How much safety stock should be kept? (buffer stock)
Inventory Decisions
IILM-GSM

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Inventory as Percentage of Sales
IILM-GSM
Company
Sales
turnover
(Rs
millions)
Raw
material &
components
(% of
sales)
Work in
progress
(% of
sales)
Finished
goods (%
of sales)
Total
inventories
(% of
sales)
L & T 179006 2.24 13.14 1.37 16.75
M & M 102450 6.81 0.37 4.37 11.55
Raymond 13749 4.36 6.30 9.86 20.52
Godrej 7581 5.02 2.82 7.62 15.46
Ranbaxy 40713 10.17 5.38 8.42 23.97
Sterlite Ltd 124576 7.84 6.60 0.40 14.84

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Inventory Expectations
IILM-GSM
Inventory
Expectations
Finance Department
• Lower inventory levels
• Low cost of operations
• Higher inventory turnover
• Lower cost of delivery
Sales & Marketing
• Quick Delivery
• No stocks outs
• Varieties and volumes
• Frequent & small deliveries
Manufacturing
Department
• Less varieties
• Economic batch quantity
• Quick off takes
• No rejection and cancellations
Top Management
• Higher inventory turnover
• Lower operating cost
• Excellent customer service
Not only external customers make demands on the
inventories but internal customers such as top management,
finance, manufacturing also have different expectation.

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Irrespective of its location in the supply chain, product
inventory essentially serves the following functions:
• Balancing Supply and Demand
• Periodic variation
• Scale Economics
Inventory Functionality
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Reasons for Carrying Inventories
IILM-GSM
• Meeting Production Requirements
• Supporting Operational Requirements
• Customer Service Considerations
• Hedge Against Future Expectation

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Inventory-Related Costs
IILM-GSM
Inventory
Related Costs
Inventory Costs
Exchange Rate
Costs
Ordering Costs
Warehousing
Costs
Carrying Costs
Damages, Loss,
Pilferage Cost

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The classical inventory analysis identifies four major cost
components:
1.Purchase Cost
2.Ordering Cost / Set-up Cost
• Ordering cost is incurred whenever the inventory is replenished.
It includes cost associated with the processing and chasing of
the purchase order, transportation, inspection for quality,
expediting overdue orders and so on.
• It is also known as procurement cost.
• Parallel to the ordering cost when units are produced within the
organization is the set-up cost. It refers to the cost incurred in
relation to developing the production schedules, the resource
employed in making the production system ready and so on.
Inventory Costs
IILM-GSM

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3. Carrying Cost / Holding Cost
• Also known as holding cost or storage cost. Carrying cost
represents the cost that is associated with storing an item in
inventory. It is proportional to the amount of inventory and
the time over which it is held.
• The element of carrying cost include the opportunity cost of
capital invested in the stock, the cost directly associated with
storing goods (like, store men's salary, rates, heating and
lighting, racking and pelletisation, protective clothing, store’s
transport etc), the obsolescence cost (including scrapping
and possible rework), deterioration costs and costs incurred
in preventing deteriorations; and fire and general insurance.
• The carrying cost is usually expressed as a rate per unit or
as a percentage of inventory value.
4. Stock-out Cost
Inventory Costs
IILM-GSM

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Inventory Controls
IILM-GSM
• The variability in customer demand if not conveyed
properly with distortion as it travels upstream in supply
chain- the phenomenon called bullwhip effect- cause
either stock-outs or inventory pile-ups.
• Bullwhip effect is a deformation in information when it
goes upstream in the supply chain. The ripple effect of
demand volatility results in inventory problems impacting
on profitability and customer service of the firm.

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Inventory Controls
IILM-GSM
The after-effects of bullwhip phenomenon can be
minimized by using the latest inventory control
techniques supported by an efficient and effective
information flow for the supply chain.
The ultimate objective of the inventory control
program is to provide maximum customer service
at minimum cost.

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Inventory Controls
Inventory Reduction by Supply Chain
Reengineering at Asian Paints
IILM-GSM
With the industry business becoming complex, most
companies have restructured. At Asian Paints this
was essential in order to tighten inventory controls
and simultaneously achieve customer satisfaction.

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Inventory Controls
IILM-GSM
Color dispensing machines, both computerized and
manual, have transformed the business, particularly
on the manufacturing and distribution sides.
Earlier, paint companies were required to
manufacture all the shades (30-50 depending on
the product line) in all the packs (5-8 packs). The
result was a drastic reduction in plant-level
finished goods inventory.

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Inventory Controls
IILM-GSM
The demand pattern was difficult to predict even with the
support of historical data/trends, as consumer
preferences were changing fast.
Machines altered the production pattern from shades
to producing bases thus providing economies of
scale, reduced inventory level and eliminate
redundancy of stocks.
This has helped expand the range of shades for each
product category, offering a choice of shades to
consumers in the hundreds

07/05/10 30
Inventory Controls
IILM-GSM
There are approximately 11,000 color- tinting machines
installed at the dealers’ end, including multiple
machines at some counter.
With the strategy of ‘postponement’ of finished goods
making at the demand point rather than at the
manufacturing plant, Asian Paints reduced its finished
goods variety and volumes at plant level.

07/05/10 31
Inventory Controls
Selective Control Techniques
IILM-GSM
In these methods the degree of control varies with the
importance of the item in the supply chain.
Following are the methods in practice:
1. ABC Analysis
2. VED Analysis
3. SAP Analysis
4. FSN Analysis

07/05/10 32
Inventory Controls
Selective Control Techniques: ABC Analysis
IILM-GSM
• ABC inventory classification method is used to recognize
inventory into groups based upon certain activity
characteristics.
• It is a process of classification of products per the level of
importance in terms of their relative criteria such as
purchase or sales volume.
• Examples of ABC classification include:
 ABC by velocity (times sold)
 ABC by sales in rupees
 ABC by quantity sold or consumed
 ABC by average inventory investment
 ABC by margin

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Inventory Controls
Selective Control Techniques: VED Analysis
IILM-GSM
• These relates to Vital, Essential and Desirable status of
inventory items.
• As the term implies, certain parts and items are
considered to be vital for meeting operational
requirements and this aspect is taken into consideration
while making the forecast.

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Inventory Controls
Selective Control Techniques: SAP Analysis
IILM-GSM
• Scarce, Availability and Plenty status of inventory item is
used for planning and forecasting of inventory
requirement.
• The ordered quantity is governed by the scarcity factor.

07/05/10 35
Inventory Controls
Selective Control Techniques: FSN Analysis
IILM-GSM
• Fast, Slow or Normal determines the consumption
pattern of an item.
• However, a consumption pattern where the production
run is slowed down for various reasons may not give a
realistic picture for procurement action. these

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Inventory Controls
Inventory Decision Matrix
IILM-GSM
Continuous review
Procure as needed
High safety stock
Low order quantity
Continuous review
Procure as needed
Low safety stock
Low order quantity
Periodic review
High safety stock
High order quantity
Periodic review
Low safety stock
High order quantity
High
V E D
A
C
B
High Low
Low
Critically of Item
Consumption
Value

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Inventory Controls
Inventory Decision Matrix
IILM-GSM
• For all these control techniques, the degree of control
varies with the importance of the items.
• For the A class vital, scarce and fast moving items
perpetual reviews are recommended.
• While for B class essential, medium moving items,
periodic review will be OK.
• In the case of Class C desirable, slow moving items, the
periodicity of review will be longer.

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Basically, there are two inventory management systems.
They are:
1.Fixed order quantity system, in which a level called the re-
order level is determined. As soon as the stock level reaches this
point, an order for a predetermined number of units is placed.
2.Periodic review system, where inventories are replenished at
fixed intervals of time. Whereas the size of the order is fixed in
the previous system and the time is not, in this system the time
after which the supplies are ordered is fixed but not the quantity
to be ordered.
3.There is another system, called Ss system, which combines
the features of both of these.
Inventory Management System
IILM-GSM

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The fixed-order quantity system of inventory management
is also called the Q-system.
Under this system a re-order point is established and as
soon as the stock level reaches this point, a fresh order for
supplies is triggered. We shall consider this system under
conditions of certainty (i.e. when the demand and the lead
time are known with certainty) and then extend it to
probabilistic conditions when demand and lead time are
uncertain.
Fixed Order Quantity System
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According to this, our cost model would, assuming a period
of one year, be
T(Q) = O(Q) + H(Q)
Where, Q = the ordering quantity
T(Q) = total(variable ) annual inventory cost
O(Q) = total annual ordering cost
H(Q) = total annual holding cost
IILM-GSM

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Let us develop this model with the following examples,
LG Electronics Ltd produces 2000 TV sets in a year for
which it needs an equal number of tubes of certain type.
Each tube costs Rs 10 and the cost to hold a tube in stock
for a year is Rs 2.40. besides, the cost of placing an order
is Rs. 150, which is not related to its size.
Now, if an order for 2000 tubes is placed, only one order per
annum is required. When 1000 units are ordered for, 2 orders
in a year are required, while if 500 units are ordered to be
supplied, then total of 4 orders per annum are required.
IILM-GSM

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Naturally, as the numbers of orders places increases the
ordering cost goes up.
More order, however, would also imply smaller order
quantity and, therefore decreasing holding costs. Thus we
have a trade-off between the ordering and the holding cost.
What we attempt in our EOQ model is, the, to find the order
size that minimizes that cost function T(Q).
TOTAL ANNUAL ORDERING COST
O(Q) = N * A
The value
IILM-GSM

Itl lecture-12 & 13 (inventory management)

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