What is Inventory Control and Inventory Management?

What is Inventory Control and Inventory Management? In this article, you will find more information about common inventory control terms and best practices.

1. What is Inventory Control and Inventory Management?
Inventory Control can be defined as below:
Inventory Control is the function responsible for all decisions about all goods and materials in an organization. It makes decisions for policies, activities and procedures to make sure the right amount of each item is held in stock at any time. Inventory Management or Stock Control is sometimes used interchangeably with Inventory Control” - from Inventory Control and Management by Donald Waters

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According to the same author, inventory control is the function and it's also known as Inventory Management or Stock Control.

Inventory control often starts with how to know the demand of particular product. So next 2-3 sections we will discuss about forecasting related issues.

2. What is the Best Forecasting Model?
Most inventory control and operations management books tell people to choose a forecasting model that produces the lowest forecast errors. Then, many people think sophisticated forecasting models will do a better job. Believe it or not, many fancy forecasting methods have not been tested extensively in the real-world situations. For example, Box-Jenkins model was recently outperformed by a simple forecasting method.

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Another thing to consider is that, sophisticated forecasting model only provides the excuse for a forecaster when the forecast goes wrong. So sticking to simple methods always yield better results.

3. How to Reduce Forecast Error?
Forecast error is the real headache for every demand planner and inventory controller because it is always wrong. However, we can provide some guidelines as below,

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- Forecast at the right level: Standard inventory control textbooks suggested that forecast be done at a product family level. The reason is that the aggregation of items help to improve the forecast accuracy (it's referred to as "Law of Large Number or Risk Pooling).

- Combine multiple methods: Sometime you have multiple sources of forecast data (your own forecast from historical data, forecast adjusted by sales team, forecast from customer) what you should do in this case? Some scientific paper suggested you average the forecast from multiple methods/experts because it can lead to improved forecasting accuracy.

- Handle unstable time series: In case a time series is very unstable, reducing weight of smoothing constant of the most recent period (damp trend forecast) will help to reduce the errors because data from the most recent period may not be very reliable.

4. What is Sales and Operations Planning (S&OP)?
Sales and Operations Planning (S&OP) is becoming an integral part of inventory control and it's being accepted by academia. It can be defined as below,
Sales and Operations Planning (S&OP) is an aggregate planning process that determines the resource capacity a firm will need to meet its demand over an intermediate time horizon—6 to 12 months in the future. Within this time frame, it is usually not feasible to increase capacity by building new facilities or purchasing new equipment; however, it is feasible to hire or lay off workers, increase or reduce the workweek, add an extra shift, subcontract out work, use overtime, or build up and deplete inventory levels.” - from Operations Management by Russell and Taylor

Inside nutshell, S&OP focuses on the synergy of cross functional team instead of the separate meetings by each department. It follows 4-step process as described below,

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- Forecaster develops a baseline forecast using statistical methods

- Forecast is then adjusted by the sales team to reflect a promotion plan, new product introduction, special events, current market and economic conditions and so on

- Adjusted forecast is passed to the manufacturing and supply planning team to resolve potential issues

- A meeting among the cross-functional team is arranged to resolve the demand/supply imbalance and everyone agrees upon the plan

As you can see, S&OP enables an inventory planner to incorporate various factors that enhance the efficiency of "classic" inventory control theories.

5. What is Inventory Cost?
Inventory cost is used to determine the right lot size each time the order is placed and can be summarized as below,

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- Inventory Ordering Cost: cost associated with the acquisition of stock items such as cost to prepare and transmit purchase order, cost of inspection, cost to put inventory into storage area. It's sometimes called Setup Cost

- Inventory Carrying Cost: cost associated with holding stock items such as cost of capital, interest rate, warehouse cost, insurance cost, damage cost and obsolescence cost. It's sometimes called Holding Cost

When we assemble all cost data, we can know proceed to the next step.

6. What is Economic Order Quantity (EOQ Model)?
Economic Order Quantity or EOQ is one of the most earliest mathematical model for inventory control. EOQ Model was introduced by Ford W. Harris in 1913. The formula can be expressed as below,

"Order Quantity= Square Root of (2DS/H)"

In this case D = Annual Demand, S = Setup Cost or Ordering Cost, H = Carrying Cost or Holding Cost. However, notation can be different from one book to the other but they follow the same logic.

7. What is Service Level?
Service Level is the way to measure the effectiveness of inventory control policy. The term is often used interchangeably with “Fill Rate” which can be classified as below,

- Unit Fill Rate: percent of units or quantity delivered from stock

- Line File Rate: percent of lines within Purchase Orders delivered from stock

- Order Fill Rate: percent of orders delivered from stock (complete order)

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As you can see, Unit Fill Rate is the easiest metric because you can ship whatever you have in stock. Order Fill Rate is the hardest metric because you have to ship every item in the same order at the same time. Then you have to be more specific which service level or fill rate metric you are talking about.

8. What are Scheduling Rules?
In manufacturing environment, production scheduling has a very strong impact on overall service level and level of work-in-process inventory. For many decades, researchers try to improve the efficiency in this area. Many scientific papers confirms that scheduling jobs with shortest processing time (SPT) first help to reduce overall lead-time.

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In literal meaning, when the sales team enter the orders consisting of multiple items, producing items that can be finished quickly will increase overall level of on-time delivery to customers.

9. What is Storage Policy?
Since the variability of order cycle time is high in some situations, reducing cycle time inside the warehouse is strategically important. Improvement in this area can be done through a proper use of storage policy.

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- Random Storage: the first policy is to store items anywhere. Under this policy, space can be fully utilized but inventory accuracy will be poor because it's difficult to maintain the record of storage locations. Imagine an inventory controller reserves the items but warehouse workers can't find where they are.

- Dedicated Storage: second storage policy is more common where items must be stored in designated shelf/bin. This kind of storage policy helps a lot with cycle counting and inventory accuracy. However, order picking time is usually poor because order picker must travel through the aisles which results in longer traveling distance and traveling time.

- Class Based Storage: tn the last type of storage policy, high turnover items are stored near the front part of storage area. The good point is that workers don't have to walk very far to pick the orders. It also helps with inventory accuracy and cycle counting because important items are stored in fixed locations at front.

The most important point is to use the policy appropriate for your business.

Related Article: What is Logistics and Supply Chain Management?