Understanding Inventory Planning

From a supply chain perspective, inventory can be defined as materials held for use in the future, either for sales or in the production process. Inventory can be held in direct relationship to the product being sold or produced, such as finished products inventory, raw materials inventory, or work in progress. The relationship with the production or sales process can also be more indirect, such as inventory for maintenance, repair, and operations.

Talking about inventory implies cost management. To achieve a high performance within the supply chain, it is necessary to understand the costs related to inventory. Holding inventory is often required by companies to ensure good customer service or to enable the core supply chain processes that companies perform to deliver products to their customers. There are several important elements that contribute to the cost of inventory:

Costs of Inventory

• Inventory holding cost: Every day that inventory is in the possession of a company, there's capital tied up in the inventory.
• Inventory scrapping risk: Carrying inventory has an inherent risk of the inventory becoming useless.
• Inventory storage cost: Storing inventory in a location incurs a cost of maintaining a facility.
• Inventory order preparation: This is the cost associated with the preparation of the inventory replenishment order.

The different inventory types summed up in the previous section can be found in different categories of inventory, such as the following:

• Raw/purchased materials inventory: Includes materials that need to be purchased that are used in the production process to create other materials.
• Semi-Finished Materials/Components resp. Bulk Material: These materials are created in production using the purchased materials resp. other inputs (e.g. other components) to provide them for finished good production.
• Finished goods: Inventory which is available for customers to buy.
• Maintenance, repair and overhaul (MRO): To produce finished goods, there might be equipment and assets required that have a risk of failure. This might induce an inventory as well, to be kept close to the equipment or assets.
• Service Parts: Some of the elements in the bill of materials could also induce a demand themselves to be sold as service parts.

Inventory can be held at manufacturing and storage facilities, and distribution or point of sale. In some industries, it's common to keep inventory at customer locations so that customers can have access to the inventory when they need it. Similarly, companies can force their suppliers to keep inventory for them. It's less common to have this inventory be the property of the company already, but it's possible, especially in cases of very specialized products.

As an inventory manager, you're responsible for establishing an effective inventory management approach that will let you respond effectively to customer demands. Inventory control systems provide the necessary information about inventories to build an inventory management approach:

• Periodic inventory systems: Updates to the inventory are made on a periodic basis, for example, first in, first out (FIFO), or last in, last out (LIFO).
• Perpetual inventory systems: These systems are substantially more complex to establish via the combination of new technologies, for example, radio-frequency identification (RFID). Companies update the inventory records based on incoming and outgoing operations information.

The need for inventory is always driven by customer demand. This leads to three approaches:

• Push system: In this system, the customer demand is forecasted and companies produced to the forecasted demand.
• Pull system: In this system, production only starts on receipt of a customer order.
• Hybrid systems: In this model, some levels in the production process follow a push model and, thus, are procured or assembled based on anticipated requirements, whereas other follow a pull model.

From these definitions, we can derive the characteristics that are relevant to define a postponement strategy, suggesting which elements in the production process are to run in a push model and which are to run via pull model:

• Customer wait time: How long a customer is willing to wait for a product is critical to define which steps can be performed for a customer order.
• Lead times: How long it takes to produce or make intermediate and finished products.
• Differentiation process: The points in the production process at which the number of output products is substantially higher than the number of input products.
• Breakdown possibilities: If you produce the wrong product, how hard it is to use the components to build the right product.