Chapter 24 Inventory management

Question 1

Reasons for holding inventory

Answer 1

• Raw materials and components: These will have been purchased from outside suppliers. They will be held in storage until they are used in the production process. These inventories can be sent to the
  production line quickly. The business can meet increases in demand by increasing the rate of
  production quickly.
• Work in progress: At any one time, the production process will be converting raw materials and components into finished goods. During this process there will be work in progress and for some businesses, such as building and construction businesses, this will be the main form of inventories held. The value of work in progress depends on the length of time needed to complete production and
  on the method of production. Batch production tends to have high work-in-progress levels.
• Finished goods: Having been through the complete production process, goods may then be held in
  storage until sold and dispatched to the customer. These inventories can be displayed to potential customers and increase the chances of sales. They are also held to cope with sudden unpredicted increases in demand, so that customers can be satisfied without delay. Firms will also stockpile completed goods to meet anticipated increases in demand, for example seasonal goods or products such as toys or fireworks at festival times

Question 2

Consequences of poor inventory management

Answer 2

• There might be insufficient inventories to meet unforeseen changes in demand.
• Out-of-date or obsolete inventories might be held if an effective rotation system is not used, for example, for fresh foods or for fast-changing technological products.
• Inventory wastage might occur due to mishandling or incorrect storage conditions.
• High inventory levels have high storage costs and a high opportunity cost.
• Poor management of the supply purchasing function can result in late deliveries, low discounts from suppliers or a delivery too large for the warehouse to cope with.

Question 3

Costs of holding inventory

Answer 3

• Opportunity cost
• Storage costs
• Risk of wastage/obsolescence

Question 4

Benefits of holding inventory

Answer 4

• Reduces risk of lost sales
• Allows for continuous production
• Avoids the need for special orders from suppliers
• Large orders of new supplies reduce costs

Question 5

Optimum order size

Answer 5

The optimum order size is supplies of the right qualities, are delivered at the right time in sufficient quantities to allow smooth and unbroken production.

Question 6

Importance of supply chain management- Ways it helps reduce time it takes to convert raw materials into completed products available for sale.

Answer 6

• establishing excellent communications with supplier companies, which helps to ensure the right number of goods of the right quality are received exactly when needed
• cutting the time taken to deliver all materials required for production by improving transport systems
• speeding up the new product development process to improve the competitiveness of the business
• speeding up the production process with technology and flexible workforces
• minimising waste at all production stages to cut costs

Question 7

Benefits of effective supply chain management

Answer 7

• Improves customer service: Customers expect products to be delivered quickly and on time. Good
  supply chain management ensures that customers receive products more quickly and of the appropriate quality. This increases customer satisfaction.
• Reduces operating costs: Effective supply chain management allows a business to reduce costs. In
  particular, purchasing costs and inventory costs should fall. Also, production costs are cut as time is
  saved in converting raw materials into finished products.
• Improves profitability: By reducing wasted time, improving inventory management and creating a low-cost but efficient supply chain, business profits should increase.

Question 8

Just-in-time (JIT) inventory management

Answer 8

Just-in-time (JIT) inventory management aims to achieve zero buffer inventories. Components and other supplies arrive just as they are needed on the production line. Finished goods are delivered to customers as soon as they are completed.

Question 9

Just-in-case (JIC) inventory management

Answer 9

JIC aims to reduce risk of running out of inventory to the minimum by holding high buffer inventory levels

Question 10

Advantages of JIT

Answer 10

• Capital invested in inventory is reduced and the opportunity cost of inventory holding is
  reduced.
• Costs of storage and inventory holding are reduced. Space released from holding inventories can be used for a more productive
  purpose.
• There is much less chance of inventories becoming outdated or obsolete. Fewer goods
  held in storage also reduces the risk of damage or wastage.
• The greater flexibility needed for JIT leads to quicker response times to changes in consumer demand or tastes.
• The multi-skilled and adaptable staff required for JIT to work may gain improved motivation.

Question 11

Disadvantages of JIT

Answer 11

• Any failure to receive supplies of materials or components in time, caused by, for example, a strike at the supplier’s factory, transport
  problems or IT failure, will lead to expensive production delays.
• Delivery costs will increase as frequent small deliveries are an essential feature of JIT.
• Order administration costs may rise because so many small orders need to be processed.
• There could be a reduction in the bulk discounts offered by suppliers because each order is likely to be very small.
• The reputation of the business depends significantly on outside factors such as the reliability of suppliers and traffic delays.

Question 12

Advantages of JIC

Answer 12

• There is much less need for accurate sales forecasting than with JIT.
• Economies of scale from very large orders of supplies/components are possible.
• There is very little chance of running out of inventory. Production levels can be maintained even if there are major delays in the supply of materials/components.

Question 13

Disadvantages of JIC

Answer 13

• High capital cost of finance invested in inventories.
• High storage, insurance and other costs are associated with inventory holdings.
• Inventories could lose value if fashion or technology changes while they are being held.

Question 14

CONDITIONS FOR JIT TO OPERATE SUCCESSFULLY

Answer 14

1. Relationship with suppliers
2. Production staff must be multi skilled and prepared to change jobs
   at short notice
3. Equipment and machinery must be flexible
4. Accurate demand forecasts will make JIT a much more successful
   policy
5. The latest IT equipment will allow JIT to be more successful.
6. Excellent employee-employer relationships are essential for JIT to
   operate smoothly
7. Quality must be every ones priority

• Excellent supplier relationships: Suppliers must be prepared and able to deliver additional supplies at very short notice (i.e. on a short lead time). Suppliers have to see that being reliable and consistent
  is of great long-term benefit to them as well as to the business adopting JIT. This often means that a business might have only one supplier for each component, so that a relationship of mutual benefit can be built up.
• Production employees must be multi-skilled and flexible: It is wasteful for a worker to produce the same item all the time if this leads to inventories building up. Workers must be able to switch to making different items at very short notice so that no excess supplies of any one product are made.
  For example, if a worker in a clothing factory usually makes men’s denim jeans, but demand is
  falling, then the worker should be able to switch to making other garments that are still in demand.
• Equipment and machinery must be flexible: Old-fashioned manufacturing equipment was designed to produce products which were very similar. It often took days to adapt the equipment to making other types of products. The machinery would have to produce large batches of one type of product before being converted to making another. Large inventories of each product would be needed to meet demand while equipment was producing other products. This equipment would be most unsuitable for JIT. Modern, computer-controlled equipment is more flexible. It is able to quickly switch to making another type of product with no more than a different software program.
  Very small batches of each item can be produced, which keeps inventory levels to an absolute minimum. However, such equipment is expensive, so JIT may not be appropriate for small or underfinanced firms.
• Accurate demand forecasts: If it is difficult for a firm to predict likely future sales levels, then keeping zero inventories of materials, parts and finished goods could be a risky strategy. Demand
  forecasts can be converted into production schedules that allow calculation of the number of
  components of each type needed over a certain time period.
• IT equipment is needed for JIT: Accurate data-based records of sales, sales trends, re-order levels and lead times will allow very low or zero inventories to be held. Communication with suppliers should use the latest electronic data exchanges. Automatic and immediate ordering can take place
  when it is recorded that more components will shortly be required.
• Excellent employee–employer relationships: Any industrial relations problem could lead to a break in supplies and the entire production system could grind to a halt. It is no coincidence that many of the businesses that have adopted JIT in Japan and in Europe have a no-strike deal with the major
  trade unions.
• Quality must be everyone’s priority: As there are no spare inventories to fall back on, it is essential that each component and product must be right first time. Any poor-quality goods that cannot be used will mean that a customer will not receive goods on time.

Question 15

JIT Evaluation

Answer 15

This change can be of great benefit to a business staff must be more accountable for their performance and suppliers should be reliable as any failure to meet targets will lead to production stopping.

There is no surplus or buffer in the JIT system to cover up for inefficient workers, inflexible people and equipment, unreliable suppliers or poor production planning
JIT may not be suitable for all firms at all times:-

• If the costs of production resulting from production being halted exceeding the costs of holding buffer stock
• Small firms can argue that the costs cannot be justified by the potential cost savings.
• Rising global inflation makes holding stocks more beneficial as it may be cheaper to buy a large quantity now that smaller quantities in the future.