Inventory

Inventory Management

Managing Inventory

  • Operations Efficiency: Operations efficiency can be improved through effective inventory management by balancing the holding costs against the costs associated with running out of essential supplies.

Reasons for Holding Inventory

  • All businesses hold inventories of some kind.

  • Types of Businesses:

    • Banks and Insurance Companies: Hold supplies of stationery.

    • Retailers: Have goods on display and in their warehouses.

    • Manufacturing Businesses: Hold inventories in three distinct forms:

    • Raw Materials and Components:

      • Purchased from outside suppliers.

      • Stored until used in production.

      • Facilitates quick production responses to demand increases.

    • Work in Progress (WIP):

      • Goods being converted from raw materials and components into finished goods.

      • Critical for industries such as construction where WIP constitutes a significant inventory form.

      • Value Dependence: Depends on the duration to complete production and the production method. Batch production often reflects high WIP levels.

    • Finished Goods:

      • Completed goods held in storage until sold.

      • Can meet sudden increases in customer demand, maintaining customer satisfaction.

      • Utilized in anticipation of demand surges (e.g., seasonal goods).

Importance of Effective Inventory Management

  • Consequences of Ineffective Management:

    • Insufficient inventories to meet unforeseen demand changes.

    • Out-of-date or obsolete inventories held due to ineffective rotation (e.g., fresh foods, tech products).

    • Inventory wastage from mishandling or improper storage conditions.

    • High storage costs and opportunity costs due to excess inventory levels.

Costs of Holding Inventory

  • Opportunity Cost:

    • Working capital tied up in stored goods could have alternative uses (e.g., paying off loans or investing).

    • Defined as the value of its most favorable alternative use.

    • Increased opportunity cost observed during high-interest rates, leading to higher overall costs.

  • Storage Costs:

    • secured warehouses required for safe inventories, possibly needing special conditions (e.g., refrigeration).

    • Costs include:

    • Employee costs for security and goods transport.

    • Insurance costs against theft or damage (e.g., fires or floods).

    • Interest charges if financing is required to purchase stored goods.

  • Risk of Wastage and Obsolescence:

    • Deterioration or obsolescence risk if inventories are not used/sold quickly.

    • Damaged goods can be sold only at lower prices, reducing their value.

Benefits of Holding Inventory

  • Risks and costs arise from very low inventory levels, leading to financial impacts (inventory-out costs). Conversely, benefits include:

    • Reduced Risk of Lost Sales:

    • Enhanced customer service by ensuring product availability, hence reducing potential loss of sales to competitors.

    • Continuous Production:

    • Prevents production halts due to stockouts, saving on idle equipment and labor costs.

    • Avoidance of Special Orders:

    • Prevents incurring extra costs due to urgent orders for out-of-stock materials/supplies.

    • Cost Reductions from Bulk Orders:

    • Larger orders yield bulk discounts and loading efficiencies through smaller transport costs.

    • Optimum Inventory Level:

    • The minimum point of total costs on the total inventory cost graph.

Optimum Order Size

  • Purchasing Challenges:

    • The need for sufficient supplies of the right quality and quantities complicates inventory level decisions.

    • Increasing order quantities may yield benefits but also lead to increased holding costs and higher opportunity costs.

  • Economic Order Quantity (EOQ):

    • A calculable optimum order size for each product.

Inventory Control Charts

  • Function:

    • Used to monitor and assist in decision-making about inventory position.

    • Record inventory numbers, deliveries, buffer levels, and maximum inventory over time.

  • Key Features:

    • Buffer Inventories:

    • Higher uncertainty in delivery leads to necessary buffer increases.

    • Maximum Inventory Level:

    • Limited by space or financial holding costs; calculated as EOQ plus buffer levels.

    • Re-order Quantity:

    • Influenced by EOQ and the product nature.

    • Lead Time & Re-order Level:

    • Longer lead times necessitate higher re-order levels and are linked to supplier reliability.

Importance of Supply Chain Management

  • Operational efficiency through supply chain management focuses on minimizing costs and improving customer service.

  • Aims to reduce time from raw materials to completed products via:

    • Improving supplier communications for timely deliveries of the right quality and quantity.

    • Enhancing transport systems to minimize delivery times.

    • Accelerating product development processes to remain competitive.

    • Speeding up production processes by leveraging technology and ensuring workforce flexibility.

    • Minimizing waste at all stages of production to enhance cost-effectiveness.

Benefits of Effective Supply Chain Management

  • Improves Customer Service:

    • Customers receive products more timely and of better quality, raising satisfaction.

  • Reduces Operating Costs:

    • Lowered purchasing and inventory costs along with production cost savings due to effective time management.

  • Improves Profitability:

    • Waste reduction, better inventory management, and efficient supply chains enhance profit margins.

Just-in-Time (JIT) Inventory Management

  • Objective: Achieve zero buffer inventories where components and supplies arrive right as needed and finished goods are promptly delivered.

JIT vs. Just-in-Case (JIC)

  • JIT Approach:

    • Prioritizes minimizing inventory levels.

  • JIC Approach:

    • Focuses on safety stock, preparing for delays and demand surges.

  • Trends: The shift towards JIT grew significantly in various sectors due to cost reduction pressures, though it faced challenges during events like the COVID-19 epidemic when supply disruptions occurred.

JIT Advantage and Disadvantages

  • Advantages of JIT:

    • Reduced capital tied in inventory and lower opportunity costs.

    • Decreased storage cost with space maximized for productivity.

    • Less risk of obsolescence.

    • Increased flexibility ensures rapid response to market changes.

    • Potential for motivated employees due to multi-skilled operational requirements.

  • Disadvantages of JIT:

    • Production delays risk from unreliable supply deliveries (e.g., strikes, transport issues, IT failures).

    • Increased delivery costs related to smaller, frequent shipments.

    • Higher order administration costs due to numerous small orders.

    • Reduced bulk discounts from suppliers, impacting overall pricing.

Conditions for Successful JIT Operation

  • Excellent Supplier Relationships:

    • Essential for short lead times and consistency in supply.

  • Employee Flexibility:

    • Multi-skilled employees needed to switch tasks rapidly to manage demand changes without inventory buildup.

  • Flexible Equipment and Machinery:

    • Must quickly adjust production processes to meet varying product demand.

  • Accurate Demand Forecasts:

    • Essential for planning and minimizing risks associated with zero inventories.

  • IT Equipment for JIT Management:

    • A requisite for accurate inventory management, real-time data communication, and automation.

  • Strong Employee-Employer Relationships:

    • Vital for avoiding disruptions in the supply chain due to industrial strikes.

  • Quality Assurance:

    • Ensures every component/product must meet standards first time as no buffer inventories exist.

JIT Evaluation

  • JIT introduces a culture focused on waste reduction and optimal resource use requiring higher accountability from employees and suppliers.

  • However, concerns exist about the viability of JIT considering:

    • Costs resulting from halted production when material supplies falter versus holding inventory costs.

    • Small businesses facing financial constraints for necessary IT investments.

    • Inflation making some inventory holding strategies less costly in the long term.

    • Service industry scenarios where zero inventories could detract from customer service expectations.

Short Questions

  1. Explain one reason why manufacturers hold inventories in the form of WIP. [3]

  2. Analyze one cost to a business associated with holding inventories. [5]

  3. Explain one advantage of supply chain management. [3]

  4. Explain one factor that influences the economic order quantity of inventories. [3]

  5. Analyze one condition that must exist for JIT inventory control to work effectively. [5]

  6. Analyze one risk to a business from operating a JIT system. [5]

  7. Explain one reason why JIT might not be appropriate for all businesses. [3]

Essay Questions

  1. a) Analyze two costs of holding inventories. [8]
    b) Evaluate the importance of supply chain management to a manufacturer of electric vehicles. [12]