Topics

Supply Chain Management (SCM)/ Logistic / Distribution Management

Inventory Performance Measurement & Organisational Issues

1. Out of various theories of inventory performance measurement suggested in literature and research papers whether the one chosen by an organization is producing desired result or not can only be ascertained if certain performance parameters are fixed and the same are evaluated on periodic basis.

Inventory Performance measurement is a necessity as it would indicate as to how good or bad is the inventory management being carried out by an organization. It would also give opportunity to compare various performance indicators with same of the benchmark company in similar industry.

Key indicators may be classified as under:

1.1 Financial indicators

• Inventory Investment

nventory investment is basically the expenses met for acquisition of inventory. Whereas higher investment in inventory may improve Fill Rate ie fraction or percentage of demand that is actually met, the downside is that it may block more funds which is not available for alternate application. To check if there is right amount of stock inventory one way is to compare the value of current inventory to an “ideal inventory investment.”
To calculate the value of “right” amount of inventory. requires first to separate the inventory items with (i) recurring demand items and (ii) sporadic usage items.

• Recurring Usage Items

Recurring usage products are used on a regular basis. Typically these items:

• Have had usage in at least eight of the last twelve months.
• Have had usage in at least four continuous months in the last twelve months (This condition identifies seasonal items that are only used during certain times of the year).

Replenishment of these items is normally based on safety stock quantities, order points, line points, and standard order quantities:

• Safety Stock Quantity: The “insurance” inventory maintained in stock to protect from stock outs resulting from unexpected customer demand or vendor shipment delays.
• Order Point: The Safety Stock Quantity plus predicted demand during the anticipated lead time.
• Line Point: The Order Point plus predicted demand during the supplier review or order cycle; the normal length of time between typical replenishment orders with the supplier.
• Standard Order Quantity: Is the minimum quantity that can be ordered once .

Replenishment orders are typically placed with a supplier when the Replenishment Position (On Hand - Committed on Current Outgoing Orders + On Current Incoming Replenishment Orders) of an item is between its Order Point and Line Point:

Figure 1(a) Estimation of ideal inventory investment

Stock receipts for these replenishment orders will normally be received when the replenishment position is somewhere between a point equal to the Line Point -

                                      Figure 1(b) Estimation of ideal inventory investment

Line point     Quantity Demand during order cycle Stock Received Order point Demand during anticipated lead time   Safety Stock Safety Stock

Anticipated Lead Time Demand and the Safety Stock quantity:

For example, if a product is ordered when its replenishment position is just below the line point, shipment would be received when the available stock quantity equals the Line Point minus Anticipated Lead Time Demand. But if the product is not ordered until the replenishment position equals the Order Point, the receipt would probably arrive when the available inventory equals the Safety Stock. Therefore it can be estimated that the “average” quantity on hand at the time of stock receipt will be the average of the Line Point - Anticipated Lead Time Usage and the Safety Stock quantity.

The stock receipt of products with recurring usage will normally be equal to the specified Standard Order Quantity (SOQ) of the product. The average quantity of this SOQ on hand during the time it takes to consume the entire SOQ will be equal to half the SOQ:

Therefore the ideal average on hand quantity of an item with recurring usage should be equal to the average quantity on hand at the time of stock receipt plus half the SOQ:

[(Line Point - Anticipated Lead Time Usage) + Safety Stock]/2 + SOQ/2

Ideal average on hand quantity of each item with recurring usage can be multiplied with its average cost and compare it with the current inventory value of the product to determine whether there is currently over stocking or under stocking.

Sporadic Usage Items

In many organizations more than 50% of stocked products have sporadic usage ie, they are not required on a regular, predictable basis.

Like recurring items, the average or ideal value of sporadic inventory items should be some average of the normal quantity on hand, perhaps the target stock level divided by two. But because sporadic usage items are not consumed on a predictable basis, it is very difficult to calculate an “average” investment for these items. Therefore the “ideal” value of sporadic inventory items is equal to the target stock level quantity times the average cost. It’s true that because we will occasionally use some of the stock of some sporadic items, the value of the target inventory will overstate the average value of some items. But this is considered the most accurate method to determine the ideal value of sporadic inventory items.

Unfortunately the value of the inventory of a sporadic inventory item will often exceed the value of the target stock level. This is because a vendor package quantity of a product may have to be ordered when replenishing stock. And the vendor package quantity may not have any relationship to the normal customer order quantity.

Because sporadic inventory is not used on a recurring basis, careful monitoring of the value of any amount of sporadic inventory in excess of the target stock level, particularly for those items with a high unit cost is needed. Planned excess of sporadic inventory items equals

(Target Stock Level - Normal Order Quantity) + Vendor Package Quantity

Here one of the goals should be to minimize the value of this planned excess. If a sporadic inventory item has a high planned excess value the following may be considered.

• Ordering an amount of the product close to the normal order quantity, even if a higher price per unit is to be paid.

• Discontinuing the product from stock inventory and ordering it only as necessary to fill specific requirements.

• Sharing one vendor package quantity among several stocking locations.

• Saving the carrying cost of excess inventory of one sporadic inventory item may more than compensate from the reduced profit on the resulting use.

One of the best inventory metrics involves comparing the value of current inventory to the sum of the values of the ideal stock level for each product. If the values are not close to one another, inventory planning is not proper and the replenishment recommendations are not being followed. Comparing actual inventory with the “ideal” will lead to actions that can bring improved profitability.

• Inventory Carrying Cost (IC)
Inventory carrying cost are those costs associated with the amount of inventory stored. Lower inventory cost is desirable and reflects better inventory management. This includes all the costs tabulated below: