Inventory consists of the goods and materials that a retail business holds for sale or a manufacturer keeps in raw materials for production. Inventory control is a means for maintaining the right level of supply and reducing loss to goods or materials before they become a finished product or are sold to the consumer.
Inventory control is one of the greatest factors in a company’s success or failure. This part of the supply chain has a great impact on the company’s ability to manufacture goods for sale or to deliver customer satisfaction on orders of finished products. Proper inventory control will balance the customer’s need to secure products quickly with the business need to control warehousing costs. To manage inventory effectively, a business must have a firm understanding of demand, and cost of inventory.
Uncertainty in Demand
Methods to control inventory can depend on the kinds of demand a business experiences. Derived demand, or the demand of raw materials for production and manufacture, can be met through calculations in manufacturing output, balanced with demand forecasts for a given product. Independent demand comes from consumer demand, making it more susceptible to market fluctuations and seasonal changes. By coordinating the supply chain businesses can reduce uncertainty in this area.
Inventory costs are controlled through different models that will apply to varying products. Items that are in continuous supply benefit from the Economic Order Quantity model (EOQ). Products available for a limited period are best suited to News Vendor models.
Safety stock is comprised of the goods needed to be kept on hand to satisfy consumer demand. Because demand is constantly in flux, optimizing the Safety Stock levels is a challenge. However, demand fluctuations do not wholly dictate a company’s ability to keep the right supply on hand most of the time. Companies can use statistical calculations to determine probabilities in demand.
Ordering costs have to do with placing orders, receiving and stowage. Transportation and invoice processing are also included. Information technology has proven itself useful in reducing these costs in many industries. If the business is in manufacturing, then to production setup costs are considered instead.
The Cost of Shortfalls
Stockout or shortfall costs represent lost sales due to lack of supply for consumers. How these costs are calculated can be a matter of contention between sales and logistics managers. Sales departments prefer these numbers be kept low so that an ample stock will always be kept. Logistics managers prefer to err on the side of caution to reduce warehousing costs.
Shortfall costs are avoided by keeping an ample safety stock on hand. This practice also increases customer satisfaction. However, this must be balanced with the cost to carry goods. The best way to manage stockout is to determine the acceptable level of customer service for the business. One can then balance the need for high satisfaction with the need to reduce inventory costs. Customer satisfaction must always be considered ahead of storage costs.
Retail businesses rely heavily on counting to manage inventory. Counts are compared with records to identify shortages, errors or shrinkage. In many cases, counts must be retaken to ensure the discrepancy is accurate before the source of the problem can be tracked.
When low stock is identified, ordering levels can be increased to adjust for changes in demand. Paperwork errors will be more difficult to find, requiring checking and rechecking of receiving slips with inventories taken when the goods were received. Shrinkage problems are often the result of employee theft, requiring a thorough investigation.
Cyclical counting is preferred because it allows for operations to continue while inventory is taken. If not for this practice, a business would have to shut down while counts were taken, often requiring the hire of a third party or use of overtime employees. Cyclical counting usually utilizes the ABC rule, but there are other variations of this method that can be used.
The ABC rule specifies that tracking 20 percent of inventory will control 80 percent of the cost to store the goods. Therefore, businesses concentrate more on the top 20 percent and counter other goods less frequently. Items are categorized based on three levels:
- A Category: Top valued 20 percent of goods, whether by economic or demand value
- B Category: Midrange value items
- C Category: Cheaper items, rarely in demand
Warehouse staff can now schedule counting of inventories based on these categories. The “A” category is counted on a regular basis while “B” and “C” categories are counted only once a month or once a quarter.
Cyclical counting can also take place by physical location within the warehouse during slow hours, as long as transactions can be tracked during the inventory taking.
Manufacturers are less likely to use cyclical counting and often rely on flow management, by analyzing cycle times in the manufacturing process. This involves calculating lead times for raw materials and the manufacture time in which the materials are used to create the product. By analyzing the time cycle, manufacturers learn when the optimal ordering times are for raw materials.
Businesses that process raw materials for other industries are not likely to employ inventory management techniques, other than ensuring there is sufficient space to store processed materials until they are shipped or picked up by the manufacturer that will use them.
Special Concerns for Retail
Retail businesses have a greater risk of loss to goods than other businesses. They suffer from shrinkage due to employee and third party theft on a regular basis. Because of this, hiring practices play an important role in inventory control for these businesses. By screening potential employees for criminal records and drug use, retailers are able to reduce shrinkage.