978-1292016016 Chapter 6

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CHAPTER 6

Inventory management

Objectives of this chapter

• To consider provisioning systems for stock and production purposes

• To examine positive and negative reasons for holding stock and approaches to reducing

inventories

• To identify methods of stock control and their application

• To explain the economic order quantity (EOQ) concept

• To discuss the usefulness and limitations of forecasting in the supply context

• To develop an appreciation of MRP, MRP2, DRP and ERP systems

• To discuss ‘just-in-time’ and related philosophies such as Lean and Agile supply

List of Cases, Research Boxes and Figures in this chapter

Mini Case Studies

• Reckitt & Coleman

• Benetton

Best Practice Boxes

Nil

Figures

• Figure 6.1 Requirement profiles:

(a) constant rate;

(b) increasing rate;

(d) periodic rate

• Figure 6.2 Developing the master production schedule

• Figure 6.3 Flows of information (—>) and materials (—>) in a material requirements

planning system

Baily et al., Procurement, Principles and Management, 11e © Pearson Education Limited 2015,

Instructor’s Manual

• Figure 6.4 A simple kanban system (Source: Hahn et al., 1983)

• Figure 6.5 The ‘milk round’ routing of collection transport

• Figure 6.6 The power of late customisation

Teaching Notes

Holding inventory costs money, and therefore reduces profitability. That inventory is designed

to support production and service operations. Some level of inventory is essential in order to

provide continuity of service and to avoid costly downtime and service disruption and non-

availability. Inventory reduction and, therefore, the release of cash and reduced operating costs

remain essential concerns of inventory management. Although inventory ties up money which

could be used elsewhere, there are, however, reasons for companies holding some inventory:

The reasons include:

• the convenience of having things available as and when required without making

special arrangements;

• cost reduction through purchase or production of optimum quantities; protection against

the effects of forecast error, inaccurate records; or

• mistakes in planning;

• provision for fluctuations in sales or production.

Accordingly, there are many concepts which have been developed to manage inventory

effectively and this chapter attempts to provide an overview of some of the key concepts with

which students of procurement and supply chain should be made familiar.

Key inventory management concepts included are as follows:

• Inventory as waste

• Economic order quantity (EOQ)

EOQ formulae

The basis EOQ formula is:

2 annual usage quantity ordering cost

EOQ = unit cost stockholding

××

Writing u for annual demand or usage quantity;

p for the paperwork and administrative cost associated with an order;

c for unit cost or price each;

s for the cost of holding stock as a decimal fraction of average stock value, the formula

becomes:

EOQ = 2 /u

Stock-turn rate

Instructor’s Manual

DRP is a ‘pull’ approach to replenishment in that it depends on awareness of customers’ (end

users’) requirements, which pulls the rest of the system through the echelons of the distribution

system.

Enterprise resource planning (ERP)

It is, as its name suggests, an approach whereby the resource requirements of the entire

organisation, with reference to those of its neighbours in the supply chain, can be taken into

account in planning. ERP is a multi-mode suite of software, operating on a company-wide basis,

which might be concerned with all aspects of the business including, for example, procurement,

inventories, production, sales, human resource management, marketing, engineering and cash

flows. All departments operate with the same data.

Just-in-time (JIT)

The basic idea is simple. If made-in parts are produced in just the quantity required for the next

stage in the process, just in time for the next operation to be carried out, then work-in-progress

stocks are almost eliminated. If bought-out parts are delivered direct to the production line

without delays in stores or inspection, just in time for the needs of production and in just the

quantity needed, then material stocks are largely eliminated too. Stock-turn rates of better than

30 have been achieved (although after years of effort and not overnight), compared with the

rates of 5 to 8 which comparable businesses were getting with traditional methods.

Vendor managed inventory (VMI)

Researchers at Cardiff Business School have defined VMI as follows:

VMI is a collaborative strategy between a customer and supplier to optimise the availability of

products at a minimal cost to the two companies. The supplier takes the responsibility for the

operational management of the inventory within a mutually agreed framework of performance

targets which are constantly monitored and updated to create an environment of continuous

improvement.

The key concepts underpinning the VMI approach are:

• Collaboration. Readers will be aware of the implications of this word, and the associated

concepts of trust and transparency. VMI, if adopted, is a decision taken jointly with a full

appreciation of the relevant factors.

• Minimal cost to the two companies. VMI is not about cost allocation, in other words the

‘Who pays?’ question, it is about cost removal.

• Framework. The parties involved understand their responsibilities, and have agreed targets

in view. Questions such as ‘Where will the inventory be located? When does payment take

place? Is there a management charge, and if so how much?’ will be answered and those

answers embodied in the framework agreement.

• Continuous improvement. This pervasive concept is very important here. Supplier and

customer can share in the pursuit and avoidance of waste.