Operations Management / Supply Chain Management

Module 10: Inventory Management

In this Module, we will consider the basic purpose of inventory and explore some financial implications for carrying stocks in general.  In subsequent sections we will explore detailed inventory management at the individual item level.

Also, inventory indicates all the money currently tied up in the system.

The objective of inventory management is to strike a balance between inventory investment and customer service.  After all, inventory represents one of the most expensive assets of many companies – comprising as much as 50% of total invested capital.  That is why we noted that operations managers must balance inventory investment and customer service.
•Inventory provides a selection of goods for anticipated demand and to separate the firm from fluctuations in demand.  It also serves to decouple or separate various parts of the production process, to take advantage of quantity discounts, to hedge against inflation, and many other purposes.

There are many different types of inventory that exist in organizations.

  • Raw Materials represent materials that are used in manufacturing but have not yet entered the production process
  • Work-in-Process Inventory (WIP) represents material that is in some intermediate phase of manufacturing.
  • Finished Goods represent materials that have been completed, tested, and are ready for shipment to customers (internal or external)
  • Distribution Inventories represent finished goods that are located somewhere in the distribution system
  • Maintenance, Repair and Operation Inventories represent items that do not actually become part of the product.

In this module, we will be considering some fairly high level reasons for maintaining these different types of inventory and also bring in the concept of ABC Analysis as it relates to overall inventory control.

Inventory is money.  Well, maybe not actual money but it does have financial value.  Regardless, if we are considering a personal or a business example, it takes funds to purchase, modify (add value), and store inventory.  Funds invested in inventory are not available for investment elsewhere.  Inventory is subject to such things as spoilage, obsolescence, pilferage, damage, etc.

In general, the only reason for carrying inventory is because it is less costly to have inventory than not to have it.  We will see this relationship when we get into item level inventory management in a subsequent Module.  The cost of having inventory includes the purchase cost, storage cost, lost opportunity cost and such.  The cost of not having inventory might be a lost order, expedited handling costs for a late order, lost customer, and such.  In general, the higher the level of finished goods, the higher the level of Customer delivery service (%).  This relationship was present in the Module on Demand Management / Forecasting.

The objectives of inventory management are simple to write but often difficult to do.   Inventory planning and execution processes are designed to: maximize customer service (adequate stocks to meet customer demand); facilitate low-cost plant operation (economical production, storage and movement); and minimize total inventory investment of the firm.