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Effective Inventory Management: Balancing Costs and Demand Variability

Inventory management is critical in a low-profit margin, low-cost strategy. It involves determining the appropriate inventory levels while balancing holding costs, such as interest, storage, and shrinkage, against pressures for high inventory due to customer service and operational needs. Various inventory types include cycle, safety stock, anticipation, and pipeline inventory. Understanding economic order quantity, continuous review systems, and periodic review systems helps firms maintain optimal inventory levels while managing costs. This guide also examines the advantages of periodic versus continuous review systems.

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Effective Inventory Management: Balancing Costs and Demand Variability

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  1. CHAPTER 13 INVENTORY MANAGEMENT

  2. THE CONCEPTS • Crucial for low profit margin, low cost strategy • Determining appropriate inventory level by conflicting the related costs and pressures • Inventory represents a temporary monetary investment in goods on which the firm must pay interest

  3. THE COSTS • Inventory holding/carrying costs : variable costs of keeping items on hand, including interest/opportunity cost, storage & handling cost, taxes, insurance and shrinkage which create pressure for maintaining low inventory • Pressures for high inventory despite the expenses : customer service, ordering cost, setup cost, labor & equipment utilization, transportation cost, payment to suppliers

  4. TYPES OF INVENTORY • Cycle inventory : the portion of total inventory that varies directly with lost size • Safety stock inventory : surplus inventory that company holds to protect against uncertainty in demand, lead time and supply • Anticipation inventory : to absorb uneven rates of demand or supply • Pipeline inventory : inventory moving from point to point in the materials flow system

  5. ECONOMIC ORDER QUANTITY • The lot size that minimizes total annual inventory holding and ordering costs • Assumptions : constant demand rate, no handling constraint, constant lead time

  6. INVENTORY CONTROL SYSTEM • Dependent and Independent demand items Continuous Review (Q) System • Reorder Point System : the predetermined minimum level that an inventory position must reach before a fixed quantity Q of the item is ordered • Inventory Position : the measurement of an item’s ability to satisfy future demand = OH + SR - BO • The need of safety stock when demand and lead time are uncertain

  7. Periodic Review (P) System • fixed interval or periodic reorder system which an item’s inventory position is reviewed periodically rather than continuously • the length of time between review (P) can be based on convenient interval or average TBO of EOQ • the target inventory level (T) must be large enough to make the IP last beyond the next review - the expected demand during protection interval (P + L) plus safety stock

  8. COMPARATIVE ADVANTAGES OF P & Q SYSTEM Advantages of P System : • convenience, standardized operations • simplify multiple orders from the same supplier into a single purchasing order which reduces ordering and transportation cost -- price deduction • IP is known at the time of review Advantages of Q System : • tailoring the review frequency will reduce total cost • fixed lot size may result in quantity discount • lower safety stock results in savings

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