PROCUREMENT AND INVENTORY DECISION Basic Inventory Planning and Management Introduction Inventory Planning and Management is the systematic process of planning, purchasing, storing, controlling, and monitoring the materials and products required by an organization. Inventory includes raw materials, components, work-in-progress, finished goods, spare parts, and other supplies. Every organization needs inventory to maintain smooth operations. However, holding too much inventory increases storage and financial costs, while holding too little can cause stockouts, production interruptions, and loss of customers. Therefore, the fundamental objective of inventory management is to maintain the right quantity of the right item at the right time and at the right cost. Definition Inventory management can be defined as the process of controlling the ordering, storage, movement, and utilization of inventory so that the required materials are available when needed while minimizing the total cost of inventory. Inventory planning focuses mainly on determining: What items are required? How much is required? When will they be required? When should they be ordered? How much should be ordered? What level of safety stock should be maintained? Meaning of Inventory Inventory refers to the stock of goods and materials maintained by an organization for use in production, operations, or sale. For example, a manufacturing company may maintain: Raw Materials → Work-in-Progress → Finished Goods → Spare Parts A retail business may mainly hold: Purchased Goods → Stored Goods → Goods Available for Sale Inventory represents a significant investment for many organizations. Hence, proper planning and control are essential. Meaning of Inventory Planning Inventory planning is the process of determining the quantity and timing of inventory required to meet anticipated demand. It connects demand, purchasing, production, warehousing, and sales. Main Questions in Inventory Planning An inventory planner needs to determine: 1. What materials are required? 2. What quantity is required? 3. When are materials required? 4. How much inventory is currently available? 5. How much stock is already on order? 6. What is the expected demand? 7. How long will suppliers take to deliver? 8. What safety stock is necessary? 9. When should the next order be placed? 10. What is the appropriate order quantity?
Meaning of Inventory Management Inventory management is concerned with day-to-day control and monitoring of inventory. It involves: Receiving materials Inspecting materials Storing materials Recording inventory Issuing materials Monitoring stock levels Identifying slow-moving items Reordering materials Preventing losses and wastage Maintaining accurate inventory records Thus: Inventory Planning = Deciding future inventory requirements Inventory Management = Controlling inventory on an ongoing basis Both activities are closely related. Objectives of Inventory Planning and Management The major objectives are as follows. 1. Ensure Continuous Supply The organization should have sufficient materials available for production and operations. 2. Meet Customer Demand Finished goods should be available when customers require them. 3. Avoid Stock-Outs Stock-outs occur when the organization does not have sufficient inventory to meet demand. Effective inventory planning reduces this risk. 4. Avoid Excess Inventory Too much inventory leads to: Higher storage costs Capital being tied up Obsolescence Damage Insurance costs Handling expenses 5. Minimize Inventory Costs The organization attempts to minimize the total cost of: Purchasing Ordering Holding Transportation Stock-outs 6. Improve Production Efficiency Manufacturers need continuous availability of raw materials and components. Proper inventory planning prevents unnecessary production interruptions. 7. Improve Customer Service Adequate finished-goods inventory helps organizations deliver products on time. 8. Optimize Working Capital
Inventory consumes working capital. Effective management ensures that unnecessary funds are not locked into excessive inventory. 9. Reduce Wastage Proper storage and monitoring reduce: Damage Theft Expiry Deterioration Obsolescence 10. Improve Supply Chain Performance Inventory management connects suppliers, manufacturers, warehouses, distributors, and customers. Importance of Inventory Planning and Management Inventory planning and management is important for almost every business. A. Ensures Availability Materials and products are available when required. B. Reduces Costs Proper inventory levels help reduce unnecessary carrying and ordering costs. C. Supports Production Manufacturing can continue without interruptions caused by material shortages. D. Improves Customer Satisfaction Customers receive products on time. E. Improves Cash Flow Excessive inventory ties up money. Better inventory planning frees working capital. F. Helps in Demand Fluctuations Inventory planning provides protection against unexpected increases or decreases in demand. G. Supports Purchasing Purchasing departments can determine when and how much to purchase. H. Improves Warehouse Utilization Proper inventory planning helps organizations use warehouse space efficiently. I. Reduces Business Risk Safety stock and proper supplier planning can protect organizations against supply disruptions. Types of Inventory Inventory can be classified into different categories. 1. Raw Materials Materials used to manufacture finished products. Example: Steel used in automobile production. 2. Work-in-Progress Partially completed products that are still undergoing production. 3. Finished Goods Completed products ready for sale or delivery. 4. Spare Parts Items maintained for replacement of damaged or worn-out components. 5. Maintenance, Repair and Operating Supplies Materials required for supporting business operations. Examples: Lubricants
Cleaning materials Tools Safety equipment 6. Safety Stock Additional inventory maintained to protect against unexpected demand or supply problems. 7. Cycle Stock Inventory normally consumed between two replenishment orders. 8. Seasonal Inventory Inventory accumulated in preparation for seasonal demand. 9. Pipeline Inventory Inventory that has been ordered and is currently in transit.
Inventory Planning Process A systematic inventory planning process generally involves the following steps: Step 1 – Forecast Demand Estimate future customer requirements. Step 2 – Determine Inventory Requirements Calculate how much stock will be required to meet expected demand. Step 3 – Check Existing Inventory Determine the quantity currently available. Step 4 – Check Outstanding Orders Identify materials that have already been ordered but have not yet arrived. Step 5 – Determine Safety Stock Establish an appropriate level of stock to protect against uncertainty. Step 6 – Determine Reorder Point Identify the inventory level at which a new order should be placed. Step 7 – Determine Order Quantity Decide how much should be ordered. Step 8 – Place Purchase Orders Orders are placed with appropriate suppliers. Step 9 – Receive and Store Inventory Materials are received, inspected, recorded, and stored. Step 10 – Monitor and Review Inventory levels and demand patterns are continuously monitored and adjusted. Challenges in Inventory Planning and Management Organizations face several challenges. 1. Demand Uncertainty Actual demand may differ from forecasts. 2. Supplier Delays Late deliveries can cause stock shortages. 3. Excess Inventory Poor planning can result in unnecessary stock accumulation. 4. Obsolescence Products can become outdated. 5. Price Fluctuations Changes in material prices can affect inventory decisions. 6. Inaccurate Inventory Records Incorrect stock information can lead to poor purchasing decisions. 7. Storage Problems
Limited warehouse capacity can make inventory management difficult. 8. Supply Chain Disruptions Transportation problems, supplier failures, natural disasters, and other disruptions may affect inventory availability. The Need to Hold Stocks Introduction Stock or inventory refers to the goods and materials that an organization keeps for future use, production, or sale. Holding stocks is an important activity in inventory and supply-chain management. Organizations cannot always purchase or produce goods exactly at the moment they are required. There may be time gaps between ordering, receiving, producing, and using or selling goods. Demand may also be uncertain, and suppliers may not always deliver on time. Therefore, businesses maintain an appropriate level of stock to ensure continuity of operations and customer satisfaction. The basic objective is: To maintain sufficient stock to meet requirements without holding unnecessary excess inventory. Meaning of Holding Stocks Holding stocks means keeping a certain quantity of goods, materials, components, or finished products in storage for future use or sale. For example, a manufacturing company may keep: Raw materials → Components → Work-in-progress → Finished goods → Spare parts A retailer may hold products in a warehouse or store so that they are immediately available when customers purchase them. Factors Determining the Need to Hold Stocks The appropriate stock level depends on several factors. 1. Nature of the Product Perishable products generally require careful inventory control. 2. Demand Pattern Stable demand requires less safety stock than highly uncertain demand. 3. Lead Time Longer lead times generally require more inventory protection. 4. Supplier Reliability Unreliable suppliers may require higher safety stock. 5. Storage Capacity Limited warehouse space restricts inventory levels. 6. Product Value High-value products require tighter inventory control. 7. Product Life Cycle Products with short life cycles have higher obsolescence risks. 8. Seasonal Demand Seasonal businesses may need to accumulate inventory before peak periods. 9. Price Changes Expected price increases may influence inventory decisions. 10. Cost of Stock-Out If stock-outs are extremely costly, organizations may maintain higher safety stock. THE NEED TO HOLD STOCKS
There are a number of reasons why a company might choose or need to hold stocks of different products. In planning any distribution system, it is essential to be aware of these reasons. The aim is to ensure that stock levels are adequate and not excessively high. The most important reason for holding stock is to provide a buffer between supply and demand. This is because it is almost impossible to synchronize or balance the varying requirements of demand with the vagaries of supply. These and other important reasons are summarized, as follows: ● To keep down production costs. Often it is costly to set up machines, so production runs need to be as long as possible to achieve low unit costs. It is essential, however, to balance these costs with the costs of holding stock. ● To accommodate variations in demand. The demand for a product is never wholly regular so it will vary in the short term, by season, etc. To avoid stock-outs, therefore, some level of safety stock must be held. ● To take account of variable supply (lead) times. Additional safety stock is held to cover any delivery delays from suppliers. ● Buying costs. There is an administrative cost associated with raising every order. To minimize this cost, it is necessary to hold additional inventory so that orders do not have to be repeated too frequently. It is essential to balance these elements of administration and stockholding, and for this the economic order quantity (EOQ) is used. ● To take advantage of quantity discounts. Some products are offered at a cheaper unit cost if they are bought in bulk. ● To account for seasonal fluctuations. These may be for demand reasons whereby products are popular at peak times only. To cater for this while maintaining an even level of production, stocks need to be built up through the rest of the year. Supply variations may also occur because goods are produced only at a certain time of the year. This often applies to primary food production where, for example, large stocks result at harvest time. ● To allow for price fluctuations/speculation. The price of primary products can fluctuate for a variety of reasons, so some companies buy in large quantities to cater for this. ● To help the production and distribution operations run more smoothly. Here, stock is held to ‘decouple’ the two different activities. ● To provide customers with immediate service. It is essential in some highly competitive markets for companies to provide goods as soon as they are required (ex-stock). ● To minimize production delays caused by lack of spare parts. This is important not just for regular maintenance, but especially for breakdowns of expensive plant and machinery. Thus, spares are held to minimize plant shutdowns. ● Work-in-progress. This facilitates the production process by providing semi-finished stocks between different processes. Types of Stocks / Inventory Introduction Stock or inventory refers to the goods, materials, components, and supplies held by an organization for production, sale, distribution, or future use. Different types of stocks are maintained for different purposes. A manufacturing company, for example, may hold raw materials for production, work-in-progress during production, finished goods for customers, and spare parts for machinery. Proper classification of inventory helps an organization determine how much stock to hold, where to hold it, and how it should be controlled. Importance of Classifying Stocks Proper classification helps management to:
1. Identify which items require strict control. 2. Determine appropriate stock levels. 3. Reduce inventory costs. 4. Improve purchasing decisions. 5. Prevent stock-outs. 6. Identify obsolete and slow-moving items. 7. Improve warehouse utilization. 8. Improve inventory turnover. 9. Reduce wastage. 10. Improve customer service. TYPES OF STOCKHOLDING/INVENTORY There are a number of different stock types that can be found in company supply chains. These are generally held at strategic positions throughout the company logistics network and in particular at the interfaces with suppliers or customers. The main categories are: ● Raw material, component and packaging stocks: generally used to feed into a production or manufacturing process. ● In-process stocks: sometimes known as work-in-progress (WIP), these consist of partfinished stock that is built up between different manufacturing processes. ● Finished products: stocks that are held at the end of the production line normally in a finished goods warehouse and sometimes known as finished goods inventory (FGI). ● Pipeline stocks: probably the most common type of stockholding, these are held in the distribution chain for eventual transfer to the final customer. ● General stores: containing a mixture of products used to support a given operation, such as a large manufacturing plant. ● Spare parts: a special category because of the nature of the stock, which provides a crucial back-up to a manufacturer’s machinery or plant where any breakdown might be critical, and also held by service and maintenance companies for supply to their customers to support service contracts. Service industries, such as utilities, hospitals, and maintenance, repair and overhaul (MRO) providers, invest in spare parts inventory to support their service offer. They have two main stock categories: 1) consumables (nuts, bolts, etc); 2) rotables and repairables (parts that require periodic maintenance or are repairable). Within the above categories, stock can again be broken down into other major classifications: ● Cycle stock or working stock: this refers to the amount of inventory available for normal or average expected demand in a given period, excluding safety stock. It is the stock created by products arriving in large quantities to meet frequent but small-quantity demands. A typical example is the major production stock within a production warehouse, where it reflects the batch sizes or production run lengths of the manufacturing process. This flow of inward supply and outward demand for a product in a warehouse is not balanced and is often depicted as a classic ‘saw-tooth’ as shown in Figure 15.1. The sharp rise in stock level represents the delivery of an order, and the steady decline in stock level represents the regular demand for the product over time (although this would in reality be more irregular than that depicted in Figure 15.1)
Safety stock: this is the stock that is used to cover the unpredictable daily or weekly fluctuations in demand. It is sometimes known as ‘buffer’ stock, as it creates a buffer to take account of this unpredictability. This is depicted in Figure 15.2.
Speculative stock: this can be raw materials that are ‘bought forward’ for financial or supply reasons, or finished stock that is pre-planned to prepare for expected future increases in demand. Seasonal stock: this is product that is stockpiled to allow for expected large increases in demand. Typically, in Western Europe, this would include inventory built up prior to the Christmas demand peak. Purchasing and Supply – Introduction and Setting the Procurement Objectives
Introduction to Purchasing and Supply Meaning of Purchasing Purchasing is the process of obtaining the goods, materials, equipment, and services required by an organization from suitable suppliers at the right quality, quantity, price, time, and place. Purchasing is not simply the act of buying. It involves a series of activities such as identifying requirements, finding suppliers, obtaining quotations, evaluating suppliers, negotiating prices and terms, placing orders, receiving goods, and evaluating supplier performance. Meaning of Supply Supply refers to the process of ensuring that the required materials, products, and services are available to the organization when and where they are needed. Supply management covers activities from sourcing and purchasing through delivery, storage, and coordination with suppliers. Purchasing and Supply Relationship Purchasing is mainly concerned with acquiring what the organization needs, while supply management has a broader focus on ensuring a reliable and continuous flow of materials and services. The basic flow can be represented as: Need Identification → Supplier Search → Supplier Evaluation → Negotiation → Purchase Order → Delivery → Inspection → Storage → Payment → Supplier Evaluation Importance of Purchasing and Supply Purchasing and supply play an important role in organizational performance because materials and services are required for almost every business activity. 1. Ensures Availability of Materials Purchasing ensures that raw materials, components, and supplies are available when required. 2. Supports Production Manufacturing organizations depend on regular supplies of raw materials to maintain uninterrupted production. 3. Controls Costs An effective purchasing department can reduce costs through: Competitive quotations Negotiation Bulk purchasing Supplier comparison Long-term contracts Efficient transportation 4. Maintains Quality Purchasing must ensure that materials meet the organization's required specifications. 5. Supports Customer Service Timely supply of materials helps organizations produce and deliver products to customers on time. 6. Improves Working Capital Management Purchasing the correct quantity at the correct time prevents excessive money from being tied up in inventory. 7. Builds Supplier Relationships Effective purchasing creates long-term relationships with reliable suppliers. 8. Reduces Supply Risk
A well-planned purchasing system can reduce risks associated with supplier failure, shortages, delays, and price fluctuations. Objectives of Purchasing and Supply The major objectives include: 1. Obtaining the right quality. 2. Obtaining the right quantity. 3. Obtaining the right material or service. 4. Obtaining it from the right supplier. 5. Obtaining it at the right price. 6. Receiving it at the right time. 7. Receiving it at the right place. 8. Maintaining continuity of supply. 9. Minimizing total procurement costs. 10. Developing reliable supplier relationships. 11. Supporting organizational goals. 12. Ensuring ethical and sustainable purchasing. These are commonly summarized as the Seven Rights of Purchasing: Right Quality + Right Quantity + Right Price + Right Time + Right Source + Right Place + Right Product/Service THE PROCUREMENT CYCLE A typical procurement cycle progresses sequentially through the list below: 1 The identification of the need to procure a good or service. 2 Production of a requisition document that needs to be approved and passed to the procurement department. 3 A request for quotation (RFQ) is sent to a selection of suppliers. 4 Suppliers respond with prices and a period of negotiation may be entered into. 5 A supplier is selected and a purchase order (PO) is raised, which records the details of agreed price, delivery terms and place, and items or services to be provided. 6 The PO is signed and authorized by a manager. It is then sent to the supplier. 7 The goods or services are delivered and inspected. 8 The supplier sends an invoice. 9 The invoice is approved and paid or held pending resolution of any discrepancies found. 10 The procurement department assesses the performance of the supplier based on quality, timeliness, price and the completeness of the order. This is known as post-contract review. Different organizations may structure the cycle slightly differently or call the stages by different names. The scope and scale of the purchase will dictate how much attention it receives. Most of the steps listed above could be completed online, especially for routine and repeat orders. Large capital purchases would require some of the stages to be quite complex. It is important to understand that the technical specifications need to be approved by technical specialists. This is not a job for the procurement people. Authorization of purchase orders and therefore expenditure should not be in the hands of the purchasers. To ensure integrity of the process these roles and responsibilities need to be separated. The purchasers will do the job of selection and negotiation but the final authority to spend company money should not be theirs. This separation of roles acts as a protection for all parties involved in the transaction.