Justification for Inventory

By Sammy Ngum May 17, 2018 by Sammy Ngum

Inventory management continues to be a contentious issue in organizations due to the costs (storage and holding) often tied to excess or shortages in inventory. Excess inventory is often symptomatic of inherent problems in the manufacturing and/or procurement processes. Shortages, on the other hand, result in missed sales, reduced customer loyalty and the inability to meet agreed service levels.

In the world of operations management, pundits, scholars, practitioners have grappled with the age-old question of how much inventory is enough? How much should an organization keep? How much should they buy and when should it be done?

This blog revisits the adage of why inventory exists in organizations, highlighting in the process, some of the causative factors, pros and cons often associated with inventory and associated practices.

Justification for Inventory

Inventory or materials management is the hub of a communication network between other businesses, business functions, and customers. It demands the controlled management of all the elements involved in the flow and use of materials within and outside an organization – a material being any item that is bought, sold, kept, consumed or produced in the course of doing business. The management process includes the planning and control of work in process (WIP), purchasing, shipping, receiving, warehousing and distribution of goods.

The purpose and management of inventory are to maintain the right balance between inventory levels and costs. Its major elements can be broken down into the traditional categories of raw, semi-finished or work-in-process and end-product/finished goods. These categories of inventory/stocks exist for several reasons:

Raw Materials Inventory:

• To meet manufacturing schedules
• Questionable supplier delivery or vendor unreliability indicative of poor supplier management
• Questionable supplier quality and rejects
• Lot-size or ‘quantity discount’ requirements due to pricing or transportation decisions and contracts
• ‘Hedging’ due to anticipated price increases with inflation
• Variability in the manufacturing process, need to decouple suppliers from the manufacturing process

Semi-finished/WIP Materials Inventory:

• Required for further assembly into finished goods
• Long setup times requiring economical lots of sizes and long manufacturing runs
• Long Lead times due to complexities in the manufacturing process
• Capacity constraints and in-plant bottlenecks
• Unreliable planning, scheduling, and execution of manufacturing steps leading to poor schedule attainment
• Labor variability/absenteeism to guarantee meeting production schedules

Finished Goods/End-product Inventory

• To satisfy customer requirements
• Manage variability in customer demand patterns
• Competitive pressures to satisfy negotiated and agreed service levels
• Too much variability in the demand pattern requiring the excess stock to satisfy ‘ad hoc‘ or ‘impromptu’ demand.
• Unreliable planning and scheduling of manufacturing steps or operations leading to poor schedule attainment.
• Labor variability and inability to guarantee meeting production schedules
• Requirements for sales and marketing programs.
• Competitive Pressures

Can we honestly find a formula that resolves the dilemmas inherent in some of the challenges highlighted in the three categories above? To me, the age-old question remains. Companies can always try, but market variability will make it almost impossible to say, yes. We are yet to find a formula that can definitively say how much of a given material a company should stock. We however, have seen a shift in behavior from a period where manufacturers, vendors, etc. ruled, to one in which big business or companies that can ‘will’ the big stick now dominate to the point where if they say jump, manufacturers’ responses simply have to conform to ‘how high’? To be able to respond, companies build up excess inventory and tie up significant amounts of capital, a lot of which sit in anticipation of the behavior of these giants.

In my next blog, I examine the concept of Demand Driven MRP (DDMRP), tracing MRP from its early days as simply a calculator that determined requirements and dates for materials and its progression into a tool that provided closed-loop feedback (MRP II). And attempt to decipher the essence of DDMRP in the context of advanced Enterprise Resource Planning (ERP) systems today.

Tags: Inventory Management, Procurement, Sales and Operations Planning