Chapter 12: Inventory planning and...

Study guide
This chapter is relatively unusual in so much as it takes more of a quantitative approach to its topic. While not avoiding quantitative models where they are appropriate, the general approach of this book is to deal with operations management from a general management point of view. Here we include some quantitative models of how inventory is managed mainly to demonstrate that some parts of the inventory decision can be quantified. In practice, most of these decision models will be embedded within an operations routine stock control computer system. However, whilst working through them remember that it is the underlying principles behind the models which are more important than the mathematics on which the models are based.

Your learning objectives

This is what you should be able to do after reading Chapter 12 and working through this study guide. Understand what is meant by an inventory and why they exist. Identify some of the advantages and disadvantages of keeping inventory in an operation. Understand the basic principles behind the quantitative approaches to deciding how much inventory to keep. Be able to describe the limitations of traditional quantitative models of inventory decision making. Identify the two main approaches to managing inventory on an on-going basis.

What do we mean by inventory?

The chapter discusses inventory (we use the word interchangeably with the word stock) predominantly as accumulations of transformed input resource. In fact, usually as accumulations of material, parts or products. It does however mention the broader use of the word inventory or stock to denote the organisations stock of people, machines, and other assets. You often hear economists talking of a stock of resources in this way. From here on however we use the word exclusively to mean an accumulation of materials.

Stock is both good and bad

The problem with inventory management is that keeping stock has both advantages and disadvantages. The advantages include, Inventory allows customers to be served quickly and conveniently (otherwise you would have to make everything as the customer requested it). Inventory can be used so a company can buy in bulk, which is usually cheaper. Inventory allows operations to meet unexpected surges in demand. Inventory is an insurance if there is an unexpected interruption in supply from outside the operation or within the operation. Inventory allows different parts of the operation to be decoupled. This means that they can operate independently to suit their own constraints and convenience while the stock of items between them absorbs short-term differences between supply and demand. In many ways this is the most significant advantage of inventory.

The disadvantages of inventory include, It is expensive. Keeping inventory means the company has to fund the gap between paying for the stock to be produced and getting revenue in by selling it. This is known as working capital. There is also the cost of keeping the stock in warehouses or containers. Items can deteriorate while they are being kept. Clearly this is significant for the food industry whose products have a limited life. However, it is also an issue for any other company because stock could be accidentally damaged while it is being stored. Products can become obsolescent while they are being stored. Fashion may change or commercial rivals may introduce better products. Stock is confusing. Large piles of inventory around the place need to be managed. They need to be counted, looked after and so on.

The objectives of inventory planning and control

Generally the operations objectives of managing the companys inventories include the following. Quality products need to be maintained in as good a condition as possible while they are being stored. For perishable products this means not storing them for very long. Speed inventories must be in the right place to ensure fast response to customer requests. Dependability the right stock must be in the right place at the right time to satisfy customer demand. There is no point having the wrong products in stock. Flexibility stock should be managed to allow the operation to be flexible. For example, that may mean keeping sufficient stock to allow the operations processes to switch to producing something else and yet being able to satisfy customers during that period from existing stock levels. Cost if possible the total cost of managing stock levels should be minimised. This is the objective of the various quantitative models covered in the chapter.

Stock sometimes has unexpected advantages

In some organisations stock may increase in value while it is being kept. For example the two photographs on page 378 give examples of the value-adding characteristic of stock. In the first one wine is being matured. When it is first harvested the wine is of relatively low value. Keeping it in special casks under the right conditions enhances its value considerably. Similarly the computer monitors illustrated are increasing in value in so much as the ones which are likely to fail early in their life are being identified. They will therefore not be shipped to customers and fail in use, which could damage the companys reputation. Another example is where a company deliberately purchases more stock than it needs because it feels the availability of the material or the price of the material is likely to change. Of course this is risky. Many companies have suffered severely by speculative purchasing of this type to avoid price increases only to see the prices drop.

Inventory Planning Metrics

Chainalytics Inventory Planning Metrics can help you create a program to monitor, manage, and reduce the impact of business variability on your inventory operations. By defining and interpreting key metrics, you will be able to uncover sub-optimal or underperforming activities and effectively evaluate your inventory planning performance. Chainalytics approach will help you compare actual results to plans and measure critical elements such as forecast to actual demand, inventory performance to plan, and replenishment performance to plan. The scope of this service can range from a one-time implementation of a performance tracking program to a recurring service. Chainalytics Inventory Planning Metrics can help you improve your inventory performance by answering the following questions:

How should we measure our inventory planning performance? What activities should we evaluate more thoroughly? Where does variance occur in my network? Why does it occur? Where should we focus improvement efforts? What is the cost penalty of particular decisions, such as changing product flow paths or adding new stocking locations? How can I modify operational processes to keep variance to a minimum? How much of our planning variance is due to controllable factors? How much is due to uncontrollable factors like service requirements or fuel costs? Are we interpreting performance measurement results correctly? How can I identify and capture opportunities to reduce inventory costs? Which system is best suited for my organization?