Importance of Inventory Management in Supply Chain

Efficient management of Inventory has played a vital role in deciding a firm’s ability to operate with good profit margins. High Inventory Turnover ratio indicates that a company is efficient in managing its inventories and is having high sales. Having no prior knowledge of financial concepts or relevant industry experience, I was forced to think that if the Sales factor in the equation was not in our control, having less inventory would be the way to achieve high Inventory Turnover ratio. The reality however is different. Having low inventory might often result in company not being able to meet the committed service levels, which obviously means that more often than not, customers will be sent back home without the product they wanted or would be directed to other stores. This situation stresses the importance of efficient inventory management and its significance in efficiently managing your supply chain.

While Inventory was regarded as an asset, the Japanese changed the way inventory was perceived by the introduction of concepts like “Just in Time” and considered inventory as a necessary “evil”. The key to the just in time methodology are factors like inventory being closely managed, understanding the customers buying behaviors, having reliable suppliers and removing unnecessary inspection steps. Concepts such as these have changed the way companies perceive the idea of inventory management. Firms now believe that excessive cash tied up in unwanted inventory can be utilized in other avenues that would generate profits. Many companies have been successful in achieving this through improvement of flow of materials in their supply chain. These companies in addition to focusing on the efficient ways to do things, also focused on the strict “don’ts” such as purchasing huge stock and treating them as an asset, excessive changes to schedules, treating all types of stock in the same way without any regard to the value of the good.

“With the new reengineering in management and companies not just adopting just-in-time inventory practices but engaging in more integrated supply chain management, attention has recently been more focused on creating processes that reduce or eliminate inventories, mainly by reducing or eliminating uncertainties that make them necessary. These efforts have been motivated in part by the recognition that metrics describing the performance of a company's inventory management practices can be important signals to shareholders regarding the efficiency of the company's operations and hence its profitability”²

The idea of an integrated inventory management has helped companies through Optimization and Coordination. The integrated system allows companies to optimize the linkage between supply chain and inventory and coordinate the inventory management to reduce costs and enhance differentiation. The maintenance of lower transaction costs and optimum inventory control management is not without some costs and tradeoff. “Past experiences have shown that managing inventory effectively in our economy and the business environment is often difficult. For example, in 1993, Dell Computer's stock plunged after the company predicted a loss. Dell acknowledged that the company was sharply off in its forecast of demand, resulting in inventory write-downs. Also, in 1993, Liz Claiborne experiences an unexpected earnings decline as a consequence of higher-than-anticipated excess inventories. And in 1994, IBM struggled with shortages in the ThinkPad line due to ineffective inventory management (Simchi-Levi et al., 2000). In recognition of these difficulties and the urgency to pursue effective integrated supply chain management, Barsky and Ellinger (2001) pointed out that to generate lower levels of inventory and fewer stock-outs for customers, suppliers and manufacturers may have to hold significantly more inventory and expend considerably more staff time to administer the program effectively”².

Some thoughts and questions that come across with respect to inventory management are how do companies decide the inventory levels, relevance to the current demand, how forecasting is done efficiently to avoid loss due to improper inventory management, and how much reliance can be on transport and how transit times impact the inventory planning and management.

Credits

1. Logistics and Resource Efficiency – MX Start

2. Role of supply chain management decisions in effective inventory control. - Julius A. Alade, Dinesh K. Sharma, Hari P. Sharma

3. INVENTORY-Critical Issue in Supply Chain Management – by THOMAS CRAIG