Symptoms of mismanaged inventories

In many medium and smaller firms, the management of inventory of physical goods is based on the intuitive determinations of the purchasing manager, who decides which items to buy, when to buy them, and what quantities to buy. When a company is small and the number of items to be stocked is few such informal procedures may work well. However, as a company grows and begins to require a wide variety of inventory items having different usage rates, informal systems tend to create problems that can result in higher costs and interruptions in production and the supply of end items. Unfortunately, detecting mismanaged inventories is not easy, as the symptoms vary a great deal. Some symptoms that should indicate to managers that a scientific management of inventories is required are (1) the total amount of inventory rises faster than the growth of sales; (2) stock outs of items occur, causing interruptions in production or delayed deliveries to customers; (3) clerical costs for procuring, expediting and maintaining inventories become too high; (4) there is too much quantity in stock for some items and too little for others; and (5) items are missing or misplaced and spoilage and obsolescence rates are too high.

A formal system of inventory management can produce substantial savings for a company. These savings are realized in several different forms depending on the particular situation of the company. Some common sources of such savings are lower purchase cost, lower interest expenses or an increase in the availability of internal funds, lower operating costs (clerical, expediting, transportation, receiving, etc), lower production cost per unit, dependable delivery of production, and better customer service in the supply of goods. In this article we will outline the basic principles and models that are important for designing a formal system of inventory management

The main stock points in a production-distribution system, from the ordering of raw materials and supplies, through the productive process, and culminating in the availability of finished goods for consumption. At the head of the system, stocks of raw materials and supplies are required in order to carry out the productive process at minimum cost and by the required schedule. Inventory policies are developed to determine when to replenish these inventories and how much to order at one time. These issues are compounded by price discounts and by the need to ensure that delays in supply time and temporary increases in requirements will not disrupt operations.

As a part of the conversion process within the productive system, in-process inventories are converted to finished goods inventories. The level of finished goods inventory depends on the policy used for determining production lot sizes and timing and on the usage rates as determined by distributors’ orders. High volume items justify different policies for production and inventory replenishment than those for medium- or low-volume items. Decisions about production lot size and timing are very important regarding the economical use of personnel and equipment. The continuous production of high volume item may be justified. On the other hand, low-volume items should probably be produced only periodically and in economic lots. Again, we will need policy guidelines to determine the size of buffer inventories necessary to absorb the effects of production delays and random variations in demand by distributors.

The function of distributors and retailers is to make products available to consumers from finished goods inventories. Distributors and retailers often carry a wide range of items; therefore, replenishing policies that take this kind of complexity into account are required. Commonly, routine orders for a variety of items are periodically placed with each supplier. Price discounts are often an additional factor to consider.

Although the details of problems at each level in the production distribution system may differ, note that the basic policy issues at each stage pertain to the inventory replenishment process and focus on how much and when to order. There is a general class of problem for which the concepts of economic order quantities (EOQ) provide important insights.