24. Inventory management Flashcards
Managing inventory
Operations efficiency can be improved if a business manages inventory well by balancing the holding cost against the cost of running out of essential supplies.
Reasons for holding inventory
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Raw materials and components:
These will have been purchased from outside suppliers. They will be held in storage until they are used in the production process. These inventories can be sent to the
production line quickly. The business can meet increases in demand by increasing the rate of production quickly. -
Work in progress:
At any one time, the production process will be converting raw materials and components into finished goods. During this process there will be work in progress and for some businesses, such as building and construction businesses, this will be the main form of inventories held. The value of work in progress depends on the length of time needed to complete production and on the method of production. Batch production tends to have high work-in-progress levels. -
Finished goods:
Having been through the complete production process, goods may then be held in storage until sold and dispatched to the customer. These inventories can be displayed to potential customers and increase the chances of sales. They are also held to cope with sudden unpredicted increases in demand, so that customers can be satisfied without delay. Firms will also stockpile completed goods to meet anticipated increases in demand, for example seasonal goods or products such as toys or fireworks at festival times
Problems of poor inventory management
- There might be insufficient inventories to meet unforeseen changes in demand.
- Out-of-date or obsolete inventories might be held if an effective rotation system is not used, for example, for fresh foods or for fast-changing technological products.
- Inventory wastage might occur due to mishandling or incorrect storage conditions.
- High inventory levels have high storage costs and a high opportunity cost.
- Poor management of the supply purchasing function can result in** late deliveries, low discounts from suppliers or a delivery too large for the warehouse to cope with**
Costs of holding inventory
Opportunity cost
* Working capital tied up in goods in storage could be put to other uses. It might be used to pay off loans, buy new equipment or pay suppliers early to gain an early payment discount. During periods of high interest rates, the opportunity cost of inventory holding increases.
Storage costs:
* Inventories have to be held in secure warehouses. They often require special conditions, such as refrigeration. Employees will be needed to guard and transport the goods. Insurance of inventories is recommended in case they are stolen or damaged by fire or flood
Risk of wastage and obsolescence:
* If inventories are not used or sold as rapidly as expected, then there is a danger of goods deteriorating or becoming outdated. This will lower the value of such inventories. Goods often become damaged while held in storage or when moved. They can then only be sold for a much lower price
Benefits of holding inventory
Reduces risk of lost sales:
Holding high inventories not only gives customers more choice but reduces the risk of losing sales because no products are available.
Allows for continuous production:
If inventories of raw materials and components run out, then production will have to stop. This will leave expensive equipment idle and labour with nothing to do. The costs of lost output and wasted resources could be considerable and can be avoided by holding inventories.
Large orders of new supplies reduce costs:
The larger the size of each delivery, the higher will be the average level of inventories held. By ordering in large quantities and keeping inventory levels high, a business may gain from bulk discounts while transport costs could be lower since fewer deliveries have to be made.
Inventory Control Charts
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Buffer inventories:
The greater the degree of uncertainty about delivery times or production levels, then the higher this buffer level will have to be. Also, the greater the cost involved in shutting production down and restarting, the greater the potential cost savings from holding high buffer levels of inventories. -
Maximum inventory level:
This may be limited by space or by the financial costs of holding even higher inventories. One way to calculate this maximum level is to add the economic order quantity of each component to the buffer level for that item. -
Re-order quantity:
This will be influenced by the economic order quantity. -
Lead time:
The longer this period of time, the higher will be the re-order inventory level. If suppliers are unreliable and the lead time is long, the buffer inventory level will have to be relatively high. -
Re-order level:
This depends on how long it takes suppliers to deliver new supplies and the rate of usage of inventories. Most businesses use computers to keep a record of every sale and every delivery of stock. The re-order quantity and re-order stock level can be programmed into the computer. It can then re-order automatically from the supplier when inventories fall to the re-order level. The inventory control chart can also be computerised.
Importance of supply chain management
Businesses of any size will benefit from reducing the time it takes to convert raw materials into completed products available for sale. Supply chain management aims to reduce this time period by:
* establishing excellent communications with supplier companies, which helps to ensure the right number of goods of the right quality are received exactly when needed
* cutting the time taken to deliver all materials required for production by improving transport systems
* speeding up the new product development process to improve the competitiveness of the business
* speeding up the production process with technology and flexible workforces
* minimising waste at all production stages to cut costs.
Benefits of effective supply chain management
Benefits of effective supply chain management
* Improves customer service:
Customers expect products to be delivered quickly and on time. Good supply chain management ensures that customers receive products more quickly and of the appropriate quality. This increases customer satisfaction.
* Reduces operating costs:
Effective supply chain management allows a business to reduce costs. In particular, purchasing costs and inventory costs should fall. Also, production costs are cut as time is saved in converting raw materials into finished products.
* Improves profitability:
By reducing wasted time, improving inventory management and creating a low-cost but efficient supply chain, business profits should increase.
Just in time Inventory management
* Advantages
- Capital invested in inventory is reduced and the opportunity cost of inventory holding is reduced.
- Costs of storage and inventory holding are reduced. Space released from holding inventories can be used for a more productive purpose.
- There is much less chance of inventories becoming outdated or obsolete. Fewer goods held in storage also reduces the risk of damage or wastage.
- The greater flexibility needed for JIT leads to
quicker response times to changes in consumer demand or tastes. - The multi-skilled and adaptable staff required for JIT to work may gain improved
motivation.
Just in time Inventory management
* Disadvantages
- Any failure to receive supplies of materials or components in time, caused by, for example, a strike at the supplier’s factory, transport problems or IT failure, will lead to expensive production delays.
- Delivery costs will increase as frequent small deliveries are an essential feature of JIT.
- Order administration costs may rise because so many small orders need to be processed.
- There could be a reduction in the bulk discounts offered by suppliers because each order is likely to be very small.
- The reputation of the business depends significantly on outside factors such as the reliability of suppliers and traffic delays.
Just in case Inventory management
* Advantages
- There is very little chance of running out of inventory. Production levels can be maintained even if there are major delays in the supply of materials/components.
- There is much less need for accurate sales forecasting than with JIT.
- Economies of scale from very large orders of supplies/components are possible.
Just in case Inventory management
* Disadvantages
- High capital cost of finance invested in inventories.
- High storage, insurance and other costs are associated with inventory holdings.
- Inventories could lose value if fashion or technology changes while they are being held.
Conditions for JIT to operate successfully
- Excellent supplier relationships:
Suppliers must be prepared and able to deliver additional supplies at very short notice (i.e. on a short lead time). Suppliers have to see that being reliable and consistent is of great long-term benefit to them as well as to the business adopting JIT.
- Production employees must be multi-skilled and flexible:
Workers must be able to switch to making different items at very short notice so that no excess supplies of any one product are made.
- Equipment and machinery must be flexible:
Modern, computer-controlled equipment is more flexible. It is able to quickly switch to making another type of product with no more than a different software program. Very small batches of each item can be produced, which keeps inventory levels to an absolute minimum. However, such equipment is expensive, so JIT may not be appropriate for small or underfinanced firms.
- Accurate demand forecasts:
If it is difficult for a firm to predict likely future sales levels, then keeping zero inventories of materials, parts and finished goods could be a risky strategy. Demand forecasts can be converted into production schedules that allow calculation of the number of components of each type needed over a certain time period.
- IT equipment is needed for JIT:
Accurate data-based records of sales, sales trends, re-order levels and lead times will allow very low or zero inventories to be held. Communication with suppliers should use the latest electronic data exchanges.
- Excellent employee–employer relationships:
Any industrial relations problem could lead to a break in supplies and the entire production system could grind to a halt
- Quality must be everyone’s priority:
As there are no spare inventories to fall back on, it is essential that each component and product must be right first time. Any poor-quality goods that cannot be used will mean that a customer will not receive goods on time.
JIT evaluation
JIT requires a very different organisational culture to that of JIC. It means not accepting waste or poorly used resources, which can be of great benefit to a business. It requires employees to be more accountable for their performance and suppliers to be very reliable. Any failure to meet targets will lead to production stopping. There is no surplus or buffer in the JIT system to cover up for inefficient workers, inflexible
people and equipment, unreliable suppliers or poor production planning. JIT is an important aspect of the move towards lean production . It is a principle that has been so widely adopted that most of the world’s manufacturing industry will never return to the old ways of inventory management.
JIT may not, however, be suitable for all businesses at all times:
* There may be limits to the use of JIT, if the costs resulting from production being halted when supplies are delayed, far exceed the costs of holding buffer inventories of key components.
* Small businesses may not be able to finance the expensive IT systems needed to operate JIT.
* Global inflation could make holding inventories of raw materials more beneficial. It may be cheaper to buy a large quantity now, rather than smaller quantities in the future when prices have risen. High oil prices will make the transport of frequent and small deliveries of materials and components more expensive.
* Tertiary-sector businesses, such as hotels and hairdressers, may decide to hold buffer inventories to avoid running out. Zero inventories mean they cannot meet customer service expectations, which will damage their reputation.
