PRODUCTION OPERATIONS MANAGEMENT

PRODUCTION/INVENTORY PLANNING AND CONTROL

The Nature and Importance of Inventories

Requirements for Effective Inventory Management
Inventory Costs
Classification System

Inventory Management

Inventory management is a core operations management activity. Good

inventory management is important for the successful operation of most
businesses and their supply chains. Operations, marketing and finance have
interests in good inventory management. Poor inventory management
hampers operations, diminishes customer satisfaction, and increases
operating costs.
Inventory management is directly linked to the operating goal of giving the
best service to customers! When a customer calls for a sales order, delivery
must be done at the fastest possible time and the lowest possible cost.
First, let me present a foundation to facilitate our understanding of inventory
and its functions as well as the requirements for effective inventory
management, the objectives of inventory control.
WHAT IS INVENTORY?
Inventory is a stock or store of goods.
Firms typically stock hundreds or even thousands of items in inventory,
ranging from small things such as pencils, paper clips, screws, nuts and bolts
to large item such as machines, trucks, and airplanes. Naturally, many of
the items a firm carries in inventory relate to the kind of business it engages
in. Thus, manufacturing firms carry supplies of raw materials and purchased
parts, partially completed goods also called the work in process, finished
goods. In retail stores the term is merchandise inventory.
A firm carries inventories related to the kind of business it engages in.
Manufacturing firms carry supplies of raw materials, purchased parts,
partially finished items, and finished goods, as well as spare parts for
machines, tools and other supplies.
The different kinds of inventories include the following:

Raw materials and purchased parts

Partially completed goods, (WIP)
Finished-goods inventories (manufacturing firms) or merchandise
(retail stores)
Tools and supplies
Maintenance and repairs (MRO) inventory
Goods-in-transit to warehouses, distributors, or customers (pipeline
inventory)

Since inventories represent a sizable investment in a logistic system, we

must be aware of the functions they perform
FUNCTIONS OF INVENTORY
1) To meet anticipated demands.
Meeting demand in a timely manner enhances customer satisfaction
2) To smooth production requirements.
Build up inventories during preseason periods to meet high
requirements during seasonal periods
3) To decouple successive operations and
production
Protection against machine breakdown

maintain

continuity

of

4) To protect against stock-outs

Risk of shortage can be reduced by safety stock
5) To take advantage of order cycles
To minimize purchasing and inventory cost a firm often buys in
quantities that exceed immediate requirements
6) To hedge against price increases
Purchase at larger-than-normal amounts to beat possible price increase
that might occur
7) To permit operations
Operations require a certain amount of WIP inventory
8) To take advantage of quantity discounts
Suppliers My give discounts on large order quantities
OBJECTIVES OF INVENTORY CONTROL

To achieve satisfactory levels of customer service while keeping

inventory costs (costs of ordering and carrying inventory) within
reasonable bounds

Measures to determine Effectiveness of Inventory Management

Customer satisfaction (Number and quantity of backorders, &/or
customer complaints
Inventory Turn-Over Ratio (Ratio of Ave COGS to Ave Inventory)
Days in inventory on hand (Ave. Inventory/COGS/Days)

REQUIREMENTS FOR EFFECTIVE INVENTORY MANAGEMENT

A system to keep track of inventory on hand and on order

A reliable forecast of demand that includes an indication of possible
forecast error
Knowledge of lead times and lead time variability
Reasonable estimates of
Holding costs
Ordering costs
Shortage costs
A classification system for inventory items

PERIODIC AND PERPETUAL INVENTORY

Periodic System
Physical count of items is made at periodic intervals in order to
decide how much to order of each item
Perpetual Inventory System
System that keeps track of removals from inventory
continuously, thus monitoring current levels of each item
Two-Bin system
grocery store scanners (bar codes)
RFID-based systems
Two-Bin System - Two containers of inventory; reorder when the first
bin is empty
Universal Product Code (UPC) Bar code printed on a label that has
information about the item to which it is attached
Radio Frequency Identification (RFID) Computer chip embedded in a
label on side of package, cases, or pallets

DEMAND FORECAST AND LEAD TIME INFORMATION

Lead time: time interval between ordering and receiving the order
If we expect that demand will occur on a certain day in the future, we
will need to place an order several days earlier, and account for:
Lead time
Lead time variability
INVENTORY COSTS

Holding (carrying) costs: cost to carry an item in inventory for a length

of time, usually a year

Stated as % of a unit price or Peso amount per unit

Annual cost ranges from 20%-40% of value (unit price) of an
item
Ordering costs: costs of ordering and receiving inventory
fixed amount per order, regardless of order size
Shortage costs: costs when demand exceeds supply
difficult to calculate often assumed

A-B-C Approach
Classifying inventory according to some measure of importance and
allocating control efforts accordingly. These percentages vary from firm to firm,
but in most instances a relatively small number of items will account for a large
share of the value cost associated with an inventory, and these should receive a
relatively greater share of control efforts.

A items should receive close attention through frequent reviews of amounts

on hand and control over withdrawal.
5-10% items account for about 75% value
15-20% items account for about 15% value
Balance items account for about 10value
OBJECTIVE OF ABC ANALYSIS
Rationalization of Ordering Policies

EQUAL TREATMENT TO ALL

Cycle Counting
A physical count of items in inventory. Counts are conducted
periodically.
A items counted frequently
B items counted less frequently
C items counted least frequently

Cycle counting management trades off inventory accuracy against

costs of counting
How much accuracy is needed?
When should cycle counting be performed?
Who should do it?