Inventory Management and Its Role in Supply Chain

Abstract

Inventory management can be considered as the backbone of supply chain management because the way inventory is managed the flow of goods along the supply chain. In addition, successful inventory management ensures that the company keeps just enough stock or raw materials to maintain profitable production and supply of finished products in the market. A company that has an efficient supply chain remains competitive in its industry. Information technology (IT) has influenced inventory management positively, as there are IT systems that can monitor inventory to ensure no excess or insufficient inventory is held. This increases the efficiency of the firm while saving on the operations costs. Some of the models employed in the management of inventory include the economic order quantity framework and the just-in-time system. Inventory management is popular in manufacturing organisations, as they need to monitor the raw materials they have and then produce goods that are enough for the market to avoid the costs of producing and storing excess products.

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Introduction

Inventory management is one of the crucial elements of the organisation. In fact, it is considered as the backbone of supply chain management. Inventory, which can also be referred to as stock, are the goods that are produced by a business organisation at any given time for the purpose of selling or manufacturing. Therefore, inventory management is simply managing these goods (Jacoby, 9). The managers need to ensure that the goods are at a level that is economical, and there is constant availability of stock at all times. If the organisation has too much stock held at a given time, then it will be uneconomical to the organisation, because the cost of holding will be too high and will reduce profitability. The value of money forgone to buy the stock will be too high, the space occupied by the stock will be big, and the management of that stock will be costly. On the other hand, holding too little stock at any given time will lead to insufficient stock, as it might lead to stock-outs, which might lead to loss of sales. This essay will discuss the inventory management as the backbone of supply chain management (Chandrasekar 245).

Inventory Management as the Backbone of Supply Chain Management

Inventory management, as mentioned earlier, is one of the most significant elements of supply chain management. It has a big effect on the profitability of the organisation. One of the major aims of the organisation is to make profits, thus, inventory management is very crucial in supply chain management because it leads to increased profitability. In fact, the aim of supply chain management is to maximise customer value and give the organisation a competitive advantage (Tompkins and Dale 43). Inventory management is all about the following areas: carrying cost or holding cost of inventory, replenishment lead time, inventory valuation, asset management, quality management of inventory, price forecasting, inventory forecasting, the physical state of inventory, ordering cost of inventory, and the physical state of inventory, among other areas of concern. One of the objectives of inventory management is to ensure that the retailer has the necessary information that will help him or her in managing and maintaining proper merchandise when making orders, shipping goods, handling them in the warehouse, as well as maintaining other costs. The retailer needs to identify the inventory requirements and then set the targets for the organisation. He should then be able to provide the correct replenishment techniques and give a report on the status of the inventory at the end of a financial period. The report should compare the actual and predicted inventory. In addition, the manager should be able to track the movement of inventory to ensure no losses are incurred. In so doing, the manager should be able to reconcile the inventory balances at regular intervals using the various reports.

Why Keep an Inventory?

It is important for an organisation to keep inventory. Among the reasons why inventory should be maintained are time, economies of scale, seasonal uncertainty, and seasonal demand. There is a time period that exists between when an order is made and when the goods are delivered. An organisation needs to supply goods continuously to avoid losses through stock-outs. It should be noted that stock out may even affect the goodwill of a company (Tompkins and Dale 43). It is not easy for an organisation to bring back a customer who moves on to another organisation. Therefore, stock out is an issue that can lead to the organisation losing its competitive advantage. When an order is placed, it takes time to process the order and deliver the ordered goods. The span of time that this process takes is referred to as the lead time. A firm can shorten the lead time by placing orders in time. On the other hand, this may not be reliable because there could be unforeseen factors that may cause a delay.

Economies of scale

“Economies of scale” is another reason why an organisation should maintain stock. It is costly for an organisation to buy one unit at a time when it is required. The logistics in such a case will be too expensive. The organisation should, therefore, buy in bulk, as the cost per unit, in this case, will be cheaper (Tompkins and Dale 44). It will also be able to enjoy the discount. This becomes one of the reasons why an organisation should maintain an inventory. Buying in bulk will mean that the organisation will have some stock kept in store.

Uncertainty

Uncertainty is also a reason why organisations maintain stocks. At times, the management is not able to predict what demand and supply will be in the future. There could also be changes in the movement of goods in the future that cannot be predicted. For instance, the demand can increase, leading to an organisation experiencing stock out. This could be the same issue if the movement of goods increases (Tompkins and Dale 44). The supply of goods may also decrease in the future. The above situations may result from changes in the economic, political, or technological environments in the business world. The fact that these factors are external to the organisation and the management is not in a position to control these environments means that it is not easy to predict the future in regard to such. Therefore, an organisation should maintain stock in order to ensure constant supply at such times.

Seasonal demand

Finally, seasonal demand also leads to an organisation keeping stock. The demand for goods is not always consistent. However, not all goods have a demand that is seasonal in nature. Some of the goods that have a seasonal demand are those consumed during holiday seasons (Tompkins and Dale 43). The production capacity is fixed, despite the variation in demand. The resultant effect is that stock is accumulated in the business.

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Any of these factors have a direct influence on the profitability of a company. The fact that the organisation aims to make profits means that these factors are very important. A lack of maintaining stock can lead to less stock, which will lead to lower profitability due to the loss of sales. If the company is not able to make profits, then it means that it will not be in a position to support the rest of the supply chain management activities. It will not be able to sufficiently fund transportation, production, value addition and storage of goods, among other activities. The overall effect will be that the organisation will not be in a position to satisfy its customers and maintain its competitive grounds in the market.

Inventory Management in Manufacturing Organisations

A company thrives if the products or services it provides have a touch of quality. On the same note, one of the determinants of the quality of products is the quality of the raw materials. When a company offers quality goods, it is able to satisfy the customers and gain a competitive advantage, as customers will mainly go for goods that are of high quality. However, the customers are always willing to pay the least price possible for the best quality available. The supply chain management has the major objective of ensuring customer satisfaction and the competitive advantage of the organisation (Chandrasekar 260).

It is through inventory management that an organisation is able to maintain quality goods. The handling of goods, as well as the accountability of stock will contribute greatly towards the maintenance of quality goods. For instance, the organisation will be able to determine any goods that have become obsolete or those that have gone bad in the warehouse. Bad stock can affect the whole production line and lead to the organisation losing a competitive edge. When an organisation has effective inventory management, it is able to detect such faults early enough before production takes place, or before the goods are released to the final consumer. This contributes to the success of the supply chain management and that of the organisation in general.

The supply chain managers are always trying to keep the inventory at a low level. This forms the basis of inventory management. Inventory management also helps in the management of risk. Most of the firms keep inventory at a low level, probably due to the fact that they want to reduce the costs involved in holding stock. However, supply chain managers have increasingly viewed inventory management as a strategy of managing risk (Chandrasekar 260). This has been implemented through the provision of safety stock. The managers need to maintain a safety stock to avoid unforeseen events that may occur within the organisation. An organisation needs to venture in opportunities that are as less risky as possible, as well as those ventures that have a high return on investment. Supply chain management has been viewed as an important way through which risk can be managed. It is the inventory management element of the supply chain management that is highly essential in reducing risks. Consequently, one can consider inventory management as the pillar of supply chain management, without which supply chain becomes a failure.

Information Technology and Inventory Management

Economic order quantity

This is a method of inventory management that aims to minimize the cost spent on holding stock, as well as the costs incurred in making orders. Most organisations normally hold stock so that they can avail goods to customers whenever an order is received (Chandrasekar 259). Production firms may also hold raw materials to ensure continuous production. Inventory is normally stored in a warehouse. There are a number of costs that are incurred when inventory is stored. The first cost is the opportunity cost that is foregone or the cost of investment that the organisation has overlooked in order to buy stocks. Second, there is the cost incurred when an organisation places an order for the goods. These are costs like carriage-in, the costs of processing invoices, as well as any other cost that will facilitate the transaction. There is also the cost incurred in a warehouse, which is commonly known as the “holding cost”. EOQ, therefore, helps the organisation in reducing costs.

The EOQ is an inventory management practice that is normally very effective in reducing the amount of costs that are incurred in holding and ordering goods. It is useful in determining whether a certain order should be made or not, depending on how reasonable it is. The EOQ model can be classified as one of the first frameworks to be coined to help in scheduling production. The model was developed under a framework referred to as Wilson EOQ Model (Tompkins and Dale 47). The organisation must hold as fewer raw materials as possible at a particular time in order to reduce the holding cost. However, it will need to compare the costs incurred in terms of idle machines and workers when the orders are made after the materials are completely exhausted with the holding costs, which would have been incurred if the raw materials were stored in large quantities in the company’s warehouse. If the raw materials are completely exhausted, then the organisation will have to make a quick order, which may be more expensive compared to the normal order. The company will need to compare the two costs to determine whether to hold more stock and incur a high cost of holding materials or to hold lesser stock and incur lesser costs of holding stock.

The EOQ is essential for the success of the supply chain management. As mentioned earlier, it helps in reducing the costs of operations of the organisation. In turn, it helps in increasing the profitability of the business organisation. When a company makes good profits, it is able to finance its other operations in the supply chain management (Tompkins and Dale 47). For instance, the company is able to pay the employees well and motivate them to increase their productivity. The company is also able to pay for the transportation of goods from one area to another. In addition, it is able to meet the storage costs and improve on the storage facilities. It is possible for the company to compute the amount of goods that should be purchased at any given time in order to maximise quantity discounts, reduce the holding and ordering costs, as well as reduce other costs. All this contributes to the success of the supply chain management (Tompkins and Dale 47).

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The Economic Order Quantity (EOQ) can be calculated using this formula:

(Tompkins and Dale 48)
(Tompkins and Dale 48)

This graph demonstrates how the Economic Order Quantity can help in reducing costs.

Tompkins and Dale (48)
Source: Tompkins and Dale (48)

Just-in-time

Another method of inventory management that can be used to reduce costs is the just-in-time method of inventory management. The just-in-time inventory management system is a more contemporary one when compared to most of other methods, like the EOQ. It is a method whereby an organisation makes arrangements with its suppliers so that the raw materials will be delivered exactly at the time when they are needed and where they are required (Chandrasekar 258). The method has been used by most organisations over the recent years because it is seen as a mode of inventory management that helps organisations save a lot of money. However, the organisation should first identify a supplier who is highly reliable before adopting such a system. The major aim of the JIT inventory management system is to reduce the costs of in-process inventory, as well as the costs incurred when transporting the raw materials. It aims to increase the returns of a business organisation by reducing those costs. The JIT has to operate based on certain signals that are also known as Kanban for it to be effective. The signals come from the various points in the production process.

For instance, one point will signal the other one within the production line when to make a certain part or when to order a certain part. The JIT ensures that the production activities are continuous, but there is little or no inventory in the company’s warehouse at the same time (Jacoby 24). Therefore, it ensures that the raw materials are always delivered at the time when they are required. This calls for a very efficient and effective communication system so that the various points within the production line can communicate to each other and the suppliers of the different parts or raw materials. The suppliers must also be highly efficient, so that when an order is made, it has to be delivered at the time when it is needed (Jacoby 24). Therefore, the organisation will have to ensure that the key areas of focus are functional and effective in order to make the JIT efficient. For instance, employee commitment must be guaranteed. Moreover, the raw materials should be flowing smoothly within the organisation, as well as from the suppliers to the firm. The production activities should also maintain high quality. In addition, the system might rely on the inventory chain.

Although it is possible for an organisation to rely on the JIT inventory management system and still end up getting completely different results from what it had hoped to get from it, the just-in-time system has a lot of advantages that it gives to the firm. The first, and the most important, benefit, is that it reduces holding cost. In fact, the space required for storing raw materials in the organisation using the JIT method is very small. The rest of the space that could otherwise be used for storage can be utilised for production activities. The system also enables the organisation to utilise the various skills of employees (Jacoby 24).

For instance, employees who have multiple proficiencies can be highly effective because an employee can be moved to different points of production, based on the Kanban signals. In addition, the employees who do not have multiple skills can improve and specialise in their area fully. This has the benefit of increasing the quality of production. Ensuring quality, the JIT system also facilitates in the reduction of inventory breakage and the expiration of materials. Moreover, it leads to a smoother movement of goods within and out of the warehouse to the point of sale. Further, the suppliers are able to deliver raw materials continuously and at different intervals throughout the production process. This is essential in ensuring that the production process does not stop. However, the one major factor that may be critical for this system is that the organisation does not buy in large quantities.

Case Study: Apple’s Inventory Management

Apple Inc. has one of the best inventory management systems in the retail business. The success of Apple is not based only on the innovative products it sells, but also on the success of handling inventory (Lu par. 1-2). Although inventory for technology products like iPhones depreciates very quickly, the company has not fallen into the problem of poor inventory handling. Apple uses a formula known as the Inventory Turnover, which indicates the number of times the inventory can be disposed, through sale or replacement, in a given time period. This formula saw Apple lead as the best technology company in managing inventory in 2011. In fact, Apple sold all the iPads it had made in 2011 (Lu par. 3).

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The secret of the success is also hidden in reducing inventory to levels that are needed only. The company does not have excess warehouses. Apple also has a limited number of components suppliers to avoid overstocking and incurring costs associated with holding stock. Those suppliers further compete against each other to provide Apple with the components. Such measures saw Apple manage to get new inventory after every five days, down from almost six months back in the late 1990s (Lu par. 6). The company is never caught with excess products in stock, even when a competitor announces a new product that has the potential of devaluing the available inventory. Apple is also able to synchronise data from various warehouses to enhance supplier relationships. Moreover, it foresees and forecasts demand and sales with accuracy, thereby avoiding holding excess stock.

Inventory Management for E-commerce

Inventory management is becoming increasingly important in e-commerce. Performing manual inventory management for e-commerce can, however, be tedious and inaccurate. Therefore, there are inventory management softwares to help vendors access the business system all the time, thus they can monitor and update inventory online at any time. The software improves the relationship between the vendors and the business in the e-commerce platform (Rell and Basel 1).

In addition to simplifying the process of inventory management and SCM, the application of software in e-commerce inventory management gives a log of events, which can be used in creating reports about the best performing products and the most valuable clients. Moreover, inventory management in e-commerce using special software helps in connecting the business with multiple channels, thereby increasing sales and profitability. The system links the order management with inventory in a synchronic way, thus adjusting the levels of inventory in individual channels automatically. It enhances the overall online shop by making automatic removal of out-of-stock products in the online shop (Rell and Basel 2). Stock levels are more accurate and optimised when an inventory management software is used in e-commerce.

An e-commerce inventory management system helps in integrating warehouses for retailers who have more than one warehouse. Consequently, it is possible to track inventory at all of them easily. Some inventory management systems used in e-commerce are compatible with bar scanners that are used to count stock in warehouses. The systems therefore reduce stock counting time considerably (Rell and Basel 4).

Conclusion

Supply chain management is a very crucial component of business operations. It plays a vital role in helping an organisation gain a competitive advantage and maximise customer satisfaction. The role of supply chain management in business has become more important in the current business world owing to the increasing level of competition. Consequently, there is an increased need for organisations to ensure that customers are satisfied. Inventory management plays an essential role in achieving customer satisfaction, as it forms the backbone of supply chain management. Through the EOQ and JIT, inventory management helps in reducing the costs incurred in the supply chain management as well as in forecasting the inventory levels. In addition, inventory management is an effective tool in managing risk in an organisation through the maintenance of safety stock. Through inventory management, supply chain management is able to achieve its very basic objectives. It can therefore be argued that inventory management forms the core of supply chain management and needs to be embraced by organisations to realise the success of supply chain management. In other words, organisations cannot easily succeed in a supply chain without inventory management. In fact, it forms the basis of all the other supply chain activities, such as transportation, manufacturing and distribution among others.

Works Cited

Chandrasekar, Sreedevi Kumar. Marketing Management: Text and Cases. New Delhi: Tata McGraw-Hill, 2010. Print.

Jacoby, David. Guide to Supply Chain Management. London: Profile, 2010. Print.

Lu, Clara. Apple Had the Best Supply Chain in the World for the Last Four Years – Here is What You can Learn From it. 2014. Web.

Rell, Snyder, and Hamdan Basel. “E-Commerce and Inventory Management.” Proceedings of ASBBS 16.1 (2009): 1-5. Print.

Tompkins, James A, and Dale A. Harmelink. The Supply Chain Handbook. Raleigh: Tompkins Press, 2004. Print.

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