Inventory Management

Rajamahender(PGPB6), in his in-depth research on Inventory Management has found some startling revelations on IM. He is destined to contribute a series of columns to our GenOps Club. The 1^st outing deals with the fundamental concepts of Inventory management and its value added to the operations management.  

Release – 1

Inventory Management

In any business or organization, all functions are interlinked and connected to each other and are often overlapping. Some key aspects like supply chain management, logistics and inventory form the backbone of the business delivery function. Therefore, these functions are extremely important to marketing managers as well as finance controllers.

• All organizations engaged in production or sale of products hold inventory in one form or other.

• Inventory can be in complete state or incomplete state.

• Inventory is held to facilitate future consumption, sale or further processing/value addition.

• All inventoried resources have economic value and can be considered as assets of the organization.

Types of Inventory by Function

INPUT	PROCESS	OUTPUT
Raw Materials	Work in Process	Finished Goods
Consumables required for processing. E.g.: Fuel, Stationary, Bolts & Nuts etc. required in manufacturing	Semi-Finished Production in various stages, lying with various departments like Production, WIP Stores, QC, Final Assembly, Paint Shop, Packing, Outbound Store etc.	Finished Goods at Distribution Centers throughout Supply Chain
Maintenance Items/Consumables	Production Waste and Scrap	Finished Goods in transit
Packing Materials	Rejections and Defectives	Finished Goods with Stockiest and Dealers
Local purchased Items required for production		Spare Parts Stocks & Bought Out items
		Defectives, Rejects and Sales Returns
		Repaired Stock and Parts
		Sales Promotion & Sample Stocks

1. With VMI model, Dell has reduced its inbound supply chain and thereby gets to reduce its logistics and inventory management costs considerably.

1. DELL gets to postpone owning inventory until at the time of actual consumption. Thereby with no inventories DELL has no need for working capital to be invested into holding inventories.

1. DELL does not have to set up inventory operations and employ teams for operations as well as management of inventory functions.

1. Supplier gets to establish better relationship and collaboration with DELL with long-term business prospect.

1. By agreeing to hold inventories and effect JIT supplies at the door to DELL, supplier will be in a better position to bargain and get more business from DELL.

1. With VMI model, supplier gets an opportunity to engage in better value proposition with his customer DELL.

1. Supplier gets confirmed forecast for the entire year with commitments from DELL for the quantity off take.

1. VMI managed is managed by 3PL and supplier does not have to engage himself in having to set up and manage inventory operations at DELL’s premise.

1. 3PL Managed VMI holds inventories of all suppliers thereby charges each supplier on per pallet basis or per sq.ft basis. Supplier thereby gets to pay on transaction basis without having to marry fixed costs of inventory operations.

Need for Inventory Management - Why Do Companies hold Inventories?
 
 
why organizations maintain Raw Material Inventory?
1.     Meet variation in Production Demand
2.     Cater to Cyclical and Seasonal Demand
3.     Economies of Scale in Procurement
4.     Take advantage of Price Increase and Quantity Discounts
5.     Reduce Transit Cost and Transit Times
6.     Long Lead and High demand items need to be held in Inventory
 
Finished Goods Inventory
Why and when do Organizations hold Finished Goods Inventories?
1.     Markets and Supply Chain Design
2.     Production Strategy necessitates Inventory holding
3.     Market penetration
4.     Market Size, location and supply design
5.     Transportation and Physical Barriers
6.     Local tax and other Govt. Rules
7.     Production lead times
8.     Speculative gain
9.     Avoid Certain Costs
 

Inventory management is a very important function that determines the health of the supply chain as well as the impacts the financial health of the balance sheet. Every organization constantly strives to maintain optimum inventory to be able to meet its requirements and avoid over or under inventory that can impact the financial figures.

Inventory is always dynamic. Inventory management requires constant and careful evaluation of external and internal factors and control through planning and review. Most of the organizations have a separate department or job function called inventory planners who continuously monitor, control and review inventory and interface with production, procurement and finance departments.

Defining Inventory

Inventory is an idle stock of physical goods that contain economic value, and are held in various forms by an organization in its custody awaiting packing, processing, transformation, use or sale in a future point of time.

Any organization which is into production, trading, sale and service of a product will necessarily hold stock of various physical resources to aid in future consumption and sale. While inventory is a necessary evil of any such business, it may be noted that the organizations hold inventories for various reasons, which include speculative purposes, functional purposes, physical necessities etc.

From the above definition, the following points stand out with reference to inventory:

Types of Inventory

Inventory of materials occurs at various stages and departments of an organization. A manufacturing organization holds inventory of raw materials and consumables required for production. It also holds inventory of semi-finished goods at various stages in the plant with various departments. Finished goods inventory is held at plant, FG Stores, distribution centers etc. Further both raw materials and finished goods those that are in transit at various locations also form a part of inventory depending upon who owns the inventory at the particular juncture. Finished goods inventory is held by the organization at various stocking points or with dealers and stockiest until it reaches the market and end customers.

Besides Raw materials and finished goods, organizations also hold inventories of spare parts to service the products. Defective products, defective parts and scrap also forms a part of inventory as long as these items are inventoried in the books of the company and have economic value.

Core Concepts

Inventory management and supply chain management are the backbone of any business operations. With the development of technology and availability of process driven software applications, inventory management has undergone revolutionary changes. In the last decade or so we have seen adaptation of enhanced customer service concept on the part of the manufacturers agreeing to manage and hold inventories at their customers end and thereby effect Just In Time deliveries. Though this concept is the same in essence different industries have named the models differently. Manufacturing companies like computer manufacturing or mobile phone manufacturers call the model by name VMI - Vendor Managed Industry while Automobile industry uses the term JIT - Just In Time whereas apparel industry calls such a model by name - ECR - Efficient consumer response. The basic underlying model of inventory management remains the same.

Let us take the example of DELL, which has manufacturing facilities all over the world. They follow a concept of Build to Order where in the manufacturing or assembly of laptop is done only when the customer places a firm order on the web and confirms payment. Dell buys parts and accessories from various vendors. DELL has taken the initiative to work with third party service providers to set up warehouses adjacent to their plants and manage the inventories on behalf of DELL’s suppliers. The 3PL - third party service provider receives the consignments and holds inventory of parts on behalf of Dell’s suppliers. The 3PL warehouse houses inventories of all of DELL’s suppliers, which might number to more than two hundred suppliers. When DELL receives a confirmed order for a Laptop, the system generates a Bill of material, which is downloaded at the 3PL, processed and materials are arranged in the cage as per assembly process and delivered to the manufacturing floor directly. At this point of transfer, the recognition of sale happens from the Vendor to Dell. Until then the supplier himself at his expense holds the inventory.

Benefits of this model for both Dell as well as Its Suppliers:

Supplier Benefits

Today most of the Multi-National companies have successfully managed to get their suppliers and 3PL service providers to setup VMI throughout their plants all over the world and this model has become the order of the day.

Inventory is a necessary evil that every organization would have to maintain for various purposes. Optimum inventory management is the goal of every inventory planner. Over inventory or under inventory both cause financial impact and health of the business as well as effect business opportunities.

Inventory holding is resorted to by organizations as hedge against various external and internal factors, as precaution, as opportunity, as a need and for speculative purposes.

Most of the organizations have raw material inventory warehouses attached to the production facilities where raw materials, consumables and packing materials are stored and issue for production on JIT basis. The reasons for holding inventories can vary from case to case basis.

Production plan changes in response to the sales, estimates, orders and stocking patterns. Accordingly, the demand for raw material supply for production varies with the product plan in terms of specific SKU as well as batch quantities.

Holding inventories at a nearby warehouse helps issue the required quantity and item to production just in time.

Market demand and supplies are seasonal depending upon various factors like seasons; festivals etc. and past sales data help companies to anticipate a huge surge of demand in the market well in advance. Accordingly, they stock up raw materials and hold inventories to be able to increase production and rush supplies to the market to meet the increased demand.

Buying raw materials in larger lot and holding inventory is found to be cheaper for the company than buying frequent small lots. In such cases one buys in bulk and holds inventories at the plant warehouse.

If there is a price increase expected few months down the line due to changes in demand and supply in the national or international market, impact of taxes and budgets etc., the company’s tend to buy raw materials in advance and hold stocks as a hedge against increased costs.

Companies resort to buying in bulk and holding raw material inventories to take advantage of the quantity discounts offered by the supplier. In such cases the savings on account of the discount enjoyed would be substantially higher that of inventory carrying cost.

In case of raw materials being imported from a foreign country or from a faraway vendor within the country, one can save a lot in terms of transportation cost buy buying in bulk and transporting as a container load or a full truck load. Part shipments can be costlier.

In terms of transit time too, transit time for full container shipment or a full truck load is direct and faster unlike part shipment load where the freight forwarder waits for other loads to fill the container which can take several weeks.

There could be a lot of factors resulting in shipping delays and transportation too, which can hamper the supply chain forcing companies to hold safety stock of raw material inventories.

Often raw material supplies from vendors have long lead running into several months. Coupled with this if the particular item is in high demand and short supply one can expect disruption of supplies. In such cases it is safer to hold inventories and have control.

Holding inventories help the companies remain independent and free from vendor dependencies.

All Manufacturing and Marketing Companies hold Finished Goods inventories in various locations and all through FG Supply Chain. While finished Goods move through the supply chain from the point of manufacturing until it reaches the end customer, depending upon the sales and delivery model, the inventories may be owned and held by the company or by intermediaries associated with the sales channels such as traders, trading partners, stockiest, distributors and dealers, C & F Agents etc.

Organizations carry out detailed analysis of the markets both at national as well as international / global levels and work out the Supply Chain strategy with the help of SCM strategists as to the ideal location for setting up production facilities, the network of and number of warehouses required to reach products to the markets within and outside the country as well as the mode or transportation, inventory holding plan, transit times and order management lead times etc, keeping in mind the most important parameter being, to achieve Customer Satisfaction and Demand Fulfillment.

The blue print of the entire Production strategy is dependent upon the marketing strategy. Accordingly, organizations produce based on marketing orders. The production is planned based on Build to stock or Build to Order strategies.

While Build to Order strategy is manufactured against specific orders and does not warrant holding of stocks other than in transit stocking, Build to Stock production gets inventoried at various central and forward locations to be able to cater to the market demands.

Marketing departments of companies frequently run branding and sales promotion campaigns to increase brand awareness and demand generation. Aggressive market penetration strategy depends upon ready availability of inventory of all products at nearest warehousing location so that product can be made available at short notice - in terms of number of hours lead time, at all sales locations throughout the state and city.

Any non-availability of stock at the point of sale counter will lead to dip in market demand and sales. Hence holding inventories becomes a necessity.

Supply chain design takes into account the location of market, market size, demand pattern and the transit lead time required to reach stocks to the market and determine optimum inventory holding locations and network to be able to hold inventories at national, regional and local levels and achieve two major objectives. The first objective would be to ensure correct product stock is available to service the market. Secondly stocks are held in places where it is required and avoid unwanted stock build up.

Market location and the physical terrain of the market coupled with the local trucking and transportation network often demand inventory holding at nearest locations. Hilly regions for example may require longer lead-time to service. All kinds of vehicles may not be available and one may have to hire dedicated containerized vehicles of huge capacities. In such cases the will have to have an inventory holding plan for such markets.

Far away market locations mean longer lead times and transportation delays. Inventory holding policy will take into account these factors to work out the plan.

In many countries where GST is not implemented, regional state tax rules apply and vary from state to state. Accordingly, while one state may offer a tax rebate for a particular set of product category, another state may charge higher local taxes and lower interstate taxes. In such cases the demand for product from the neighboring state may increase than from the local state. Accordingly inventory holding would have to be planned to cater to the market fluctuation.

While in case of exports from the country of origin into another market situated in another country, one needs to take into account the rules regarding import and customs duties to decide optimum inventories to be held in route or at destination.

FG inventory holding becomes necessary in cases where the lead-time for production is long. Sudden market demand or opportunities in such cases require FG inventories to be built up and supplies to be effected.

Companies always keep a watch on the economy, annual state budget, financial environment and international environment and are able to foresee and estimate situations, which can have an impact on their business and sales.

In cases where they are able to estimate an increase in industry prices, taxes or other levies which will result in an overall price increase, they tend to buy and hold huge stocks of raw materials at current prices. They also hold up finished stock in warehouses in anticipation of a impending sale price increase. All such moves cause companies to hold inventories at various stages.

Finally, organizations hold FG inventories to satisfy customer demand, to reduce sales management and ordering costs, stock out costs and reduce transportation costs and lead times.