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TOPIC 5: INVENTORY AND WAREHOUSING

Topic Outcomes:

You should be able:

1. Define the concept of inventory management in supply chain and logistics activities
2. Explain types of inventory
3. Define the purpose in inventory
4. Describe the objectives of inventory management
5. Describe the importance of warehouse storage
6. Relate warehousing to logistics and supply chain activities

5.1 IMPORTANCE OF INVENTORY MANAGEMENT

Transportation strategy, as we have discussed in the previous chapter is concern

with the inbound flow of goods. The inbound flow refers to the inflow of raw materials
and semi finished products, while the outbound flow refers to the distribution of finished
products to business and end consumers.

Transport Warehouse Production Warehouse Transport

Inbound Storage and Work in Storage and Outbound

Inventory Process Inventory
Management Management

Figure 5.1: Inventories and the flow of materials

Inventory Management is responsible for planning and controlling inventory from

the raw material stage to the customer. Inventory management is not only concern with
aggregate or overall inventory management but also individual item levels too.

5.1.1 Reasons for Inventory

As firms product could not be supplied instantaneously to meet the demand,

therefore the need for inventory storage arises. Firms use inventory to improve supply-
demand coordination and to lower overall costs. As it is impractical and impossible to
know future demand with certainty and because the availability of supplies cannot be

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guaranteed at any given moment, inventories are accumulated to assure an availability of

goods and to minimize the overall costs of producing and distribution the goods.

The purpose of using inventory

Improve customer service

Encourage production economies
Permit purchase and transportation economies
Act as a hedge against prices changes
Protect against uncertainties in demand and lead time
Act as hedge against contingencies

5.1.2 Inventory Demand Types

In order to deal with the challenges of controlling inventory levels, breaking inventories
into various classification due to the nature of demand for the inventories. The various
types of inventory demands are shown in Table 5.2

Table 5.2: Types of Inventory Demand

Types of Inventory Demand Explanation

Perpetual Demand Require continual or period replenishment.
Deals with products that have a significant
demand for a very long period of time.
Inventory management is directed as
forecasting the level of demand that will occur
for each item when and quantity of stocks to be
replenished.
Seasonal Demand May involve products that are demanded at
certain period of the year or require accurate
forecasting the level of demand that will occur.
Lumpy Demand This type of demand will occur due to drastic
environment or lifestyle change. It is quite
difficult to predict quite accurately of the
coming demand trend. Close monitoring of the
erratic or lumpy demand with slow response in
product replenishment.
Terminating Demand This is more of a planned preparation. Demand
will decline and excessive inventories can be
worked out slowly. The focus of the planning
is when and how much should be stocked
during each period (week, month or year) with
preparation towards the termination period
specified.

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Derived Demand The demand for this category of products is

derived from the final consumer market. How
much and when to order or produce can be
accurately determined from monitoring the
demand for finished products.

5.1.3 The six purposes of using inventory

Purpose of using Explanation

inventories
Improve Customer Service Having inventories will ensure that customer who desire or must
have immediate stock availability or short delivery times are
satisfied in their dealing with the firm. This measure assists the
marketing department and specifically the level of customer service
to the customers.
Encourage Production Items purchased or manufactured in quantities greater than what is
Economies needed immediately will create lot-size inventories. This is to take
advantage of quantity discounts, to reduce shipping, clerical, setup
costs and in some cases, where it is impossible to make or purchase
items at the same rate it will be used or sold.
Permit Purchase and Inventory acts as buffer between demand and supply so that
Transportation Economies production can be geared to a more constant output than fluctuating
demand. Therefore, lowest per-unit cost is possible due to the fact
that production runs at a constant quantity.
Inventory will also allow the seizure of lower per-unit rates of full-
vehicle-load quantities. Likewise, lower prices can also be realized
from price-quantity discount offer as more can be purchased and
inventoried.
Act as Hedge against Price Goods that are purchased on the open market are subject to the
Changes price level s dictated by changing supply-demand pattern.
Purchases may be made in advance of need because of anticipated
price increases.
Protect against In most cases, the level of demand on a logistics system and the
Uncertainties in Demand time required for re-supply cannot be known for sure. To assure
and Lead Time product availability, additional amounts of stock are maintained.
These stocks are in addition to the regular stock to meet production
and marketplace needs.
Act as a Hedge against Labour strikes, fire and floods are just a few of the contingencies
Contingencies that can happen. Therefore, maintaining backup inventories is one
way in which normal supplies can be maintained for a period of
time.

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5.1.4 INVENTORY CONTROL FEATURES

These features are basic to inventory management whether these inventories are
raw materials, work-in-progress goods or finished products. These features are the
relevant costs associated to inventory, inventory objectives and forecasting the
uncertainties. Understanding these features will assist in implementing control over
inventories.

5.1.4.1 Relevant Costs

Inventory costs are important for three major reasons.

a. First, inventory costs represent a significant component of total logistics cost in many
companies.
b. Second, the inventory levels that a firm maintains at points in its logistics system will
affect the level of service the firm can provide to its customers.
c. Third, cost trade-off decisions in logistics frequently depend upon and ultimately affect
inventory carrying costs.

Different cost categories will be involved when managing inventories. Understanding

these costs is important especially when making inventory policy decisions. The major types
are inventory carrying cost, order/setup cost, carrying cost versus order cost, expected
stockout cost and in-transit inventory carrying costs as shown in Table 5.3.

Table 5.3: Types of Inventory Costs

Types of Inventory Costs Explanation

Inventory Carrying Costs Capital cost, storage space cost, inventory service cost and inventory
risk costs are components of inventory carrying costs.
Order/ Setup Costs Order costs refer to the activities associated with placing and
receiving orders that could affect cost. While setup costs refer to the
expenses each time a company modifies a production line to produce
a different item for inventory. It is essential to separate the fixed and
variable costs of both order and setup costs with the emphasis on the
variable costs.
Expected Stockout Costs This cost refer to the cost of not having product available when a
customer demands or needs it. If customer turns to competitor
product, the possibility of losing a customer on long-term basis
might occur.
In-transit Inventory The title F.O.B products is transferred only when the product
carrying Costs reaches the customer. To consider the trade-off between higher cost

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of fast delivery versus the cost of the product in transit.

5.1.4.2 Inventory Objectives

A firm wishing to maximize profits will have at least the following objectives,
which are maximum customer service, low-cost plant operation or minimum inventory
investment. Customer service is the ability of a company to satisfy the needs of
customers through the availability of items when needed and is a measure of inventory
management effectiveness. Inventories help to maximize customer service by protecting
against uncertainties. If the exact forecast on what customers want and when, their
demand can be fulfilled without any uncertainty.

Inventory help to make a manufacturing operation more productive in allowing

operations with different rates of production to operate separately and more
economically. Inventories also allow manufacturing to run longer production. This will
certainly result in lower setup costs per item, increase in production capacity, larger
quantity purchases and provide stocks for peak periods.

Inventory investment should also be balanced with customer service, cost

associated with changing production levels, cost of placing orders and transportation
costs. The benefit of carrying inventories should exceed the costs of carrying the
inventories or else the purpose of carrying inventories is useless.

5.2.1 Importance of Warehouse Storage

Economically, the importance of warehouse storage is because it creates time utility for raw
materials, industrial goods and finished products. The proximity of market-oriented warehouse to
the customer allows a firm to serve the customer within a shorter lead-time period. Basically, the
products are available according to when and where the customers demand is.

By warehousing some inventories, a firm can lower its production costs by avoiding wide
fluctuations in outputs levels due to the uncertainties and variations in supply and demand
patterns. It can also lower transportation costs through larger and economical quantities
shipments. Table 5.4 shows basic reasons for warehouse storage requirements.

Table 5.4: Basic Reasons for Warehouse Storage Requirements

Basic Reasons for Warehouse Storage Explanation

Requirements
Transportation-Production-Cost Reduction Products originate from many sources. By
stocking inventories, the supplying and

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distributing transportation and production costs

will be lowered.
Coordination of Supply and Demand For highly seasonal production coupled with
constant demand for products. Warehousing is
highly needed to coordinate supply and
demand and to avoid excessive costs incurred
due to production and transportation.
Production Needs For products that needs to be stored for a
certain period before consumption period
begins for example, cheese.
Marketing Considerations Fast delivery that can satisfy customers
requires stock availability through stocking in
warehouse.

5.2.2 Warehouse Activities

Operating a warehouse involves several processing activities and the efficient

operation of the warehouse depends upon how well there are performed. The activities
performed are:

Warehouse Activities

a. Receive goods the warehouse accepts goods from outside transportation or an attached
factory and accepts responsibility for them. This means that the warehouse must check
goods against an order and the bill of lading, check the quantities, check for damage and
fill out damage report if necessary and inspect goods if required.
b. Identify the goods- items are identified with the appropriate stock-keeping unit (SKU)
number and the quantity received recorded.
c. Dispatch goods to storage where goods are sorted and stored away.
d. Hold goods where goods are kept in storage and under proper protection until needed.
e. Pick goods items required from stock must be selected from storage and brought to a
marshalling area.
f. Marshal the shipment where goods making up a single order are bought together and
checked for omissions or errors. Order records are updated.
g. Dispatch the shipment where the orders are packaged, shipping documents prepared
and goods loaded on the right vehicle.
h. Operate an information system a record must be maintained for each item in stock
showing the quantity on hand, quantity received, quantity issued and location in the
warehouse.

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The complexity of managing a warehouse very much depends on the number of

SKUs handled, the quantities of each SKU, the number of orders received and filled. In order
to maximize the use of space available in floor space and above the floor and the effective
use of labour and equipment through good location system and layout moving goods
efficiently.

5.3 WAREHOUSE DECISIONS

A number of choices such as ownership, number, size, location and stocking are
important in warehouse decision. Regarding to the ownership, there are two basic
alternatives which are private versus public warehouse or even a combination of both.
Among the reason for private warehouse is that it is regarded as fixed cost that can
contribute to property taxes and depreciation in cost structure, stability of demand, dense
market area relatively close to the warehouse or numerous vendors relatively close to a
physical supply warehouse, higher degree of control and multiple uses.

Public warehouse suits company that has no large inventory accumulation or a

seasonal need for warehouse or that deals with small shipment. The main advantage is
financial need for warehouse or that deals with small shipment. The main advantage is
financial as it requires no or limited capital investment. Second is its flexibility whereby
firm could rent space for a short period, lets say thirty days, therefore this enables
company to immediately launch in, expand in or pull out of new untried markets without
prolong distribution costs.

In centralized versus decentralized warehouse decision, the decision is concern

with the number of warehouse a firm should provide. It is quite common that the size of
the company indicates the number or warehouses. Small and medium size firms with a
regional market area often need only in warehouse. While a manufacturing firm or
distribution a highly competitive and substitutable product on national basis may need to
use decentralized warehouse to give rapid service in the market area.

In decision regarding warehouse size and location for public warehouse the
question on size and location are less important as the company can expand or contract
space according to its needs at different times. Although the location of a public
warehouse is fixed, it can change necessary.

Firms have to make decisions on how to layout the warehouses interior.

Specifically, the firm has to make decisions about aisle space, shelving, equipment and
all the other physical dimensions of the interior warehouse including how to arrange
stock most efficiently in the warehouse.

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Regarding to the items stocked, a firm having a number of locations must decide
whether all warehouse will carry the entire product line, or whether each warehouse will
specialize to some extend or the warehouse will combine specialization and general
stocking

Another aspect that concerns the warehouse decision is employee safety. Risk is
involved when monotonous and dangerous work situations exist in most warehouse.

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