# Classification of Inventory Systems

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Lot Size Reorder Point Policy

Under this operating policy the inventory status is continuously reviewed and as soon as the inventory level falls to a prescribed value called `Reorder Point’. A fresh replenishment order of fixed quantity called Economic Order Quantity (EOQ) is initiated. Thus, the order size is constant and is economically determined. This is one of the very classical types of inventory policies and a lot of mathematical analysis has appeared on this type of policy. Figure I show the typical stock balance under this type of inventory policy. The solid line in this figure represents the actual inventory held in practical situation with a finite lead time, the lead time being defined as the time delay between the placing of a replenishment order and its subsequent receipt. The broken line indicates the inventory that would be held in the ideal situation if no lead time existed. Lot size and reorder point are the two decision variables involved in the design of the policy.

Figure 1: Typical Inventory Balances for EOQ- Reorder Point Policy

Fixed Order Interval Scheduling Policy

Under this policy the time between the consecutive replenishment orders is constant. There is a maximum stock level(s) prescribed and the inventory status is reviewed periodically with a fixed interval (T). At each review an order of size Q is placed which takes the stock on hand plus an order equal to the maximum stock level. Thus, order quantity could vary from period to period. This policy ensures that when the level of stock on hand is high at review, a smaller size replenishment order is placed. Figure II shows the typical stock balances under this fixed reorder cycle policy. S, the maximum stock level and T the review period are the decision variables under this policy.

Optional Replenishment Policy

This is very popularly known as the (s, S) policy. Figure III shows the typical stock balance under this policy. The status of stock is periodically reviewed and maximum stock level (S) and minimum stock level (s) are prescribed.

If at the time of review, the stock on hand, is less than or equal to s, an order of size Q is placed so that stock on hand plus on order equals the maximum stock level S. If stock on hand at review is higher than s, no order is placed and the situation is reviewed at the time of next review period. S, s and T (review period) are the decision variables in the design of such inventory policy

Other Types of Inventory Systems

There may be other policies which may be special cases of the policies mentioned above or may be a combination of these policies. As a special case of (s, S) policy we may have (S-1, S) policy or one-for-one order policy when the maximum stock level may be up to S and whenever there is demand for one unit, a replenishment of one unit is ordered. Such a policy may be quite useful for slow moving expensive items. We may use a combination of lot size reorder point policy and fixed interval order scheduling policy. Yet another variation of inventory policy could be multiple reorder point policy where more than one reorder point may be established.

Other types of inventory systems may be static inventory systems when a single purchase decision is to be made which should be adequate during the entire project duration. Such decisions are not repetitive in nature. Other initial provisioning decisions may be with respect to repairable assemblies such as engines, gearboxes etc. in a bus which may have to be overhauled and for which we have to find adequate number of spare engines to be provided initially.

The right choice of an inventory policy depends upon the nature of the problem usage value of an item and other situational parameters. We must first select an operating policy before determining optimal values of its parameters.

Inventory Management Models

Inventory management is aimed at deciding the quantity of inputs or resources that need to be arranged, and the time when they need to be ordered, in order to reduce the production costs, in sync to the key requirements. On account of various abnormalities in the production inventory, no particular inventory model is important to the whole variant inventory situations. Therefore, different inventory models have been established to address these specific inventory issues.

An inventory system provides the organizational structure and the operating policies for maintaining and controlling goods to be stocked. The system is responsible for ordering and receipt of goods: timing the order placement and keeping track of what has been ordered, how much and from whom. The system also needs to follow up to answer such questions as: Has the supplier received the order? Has it been shipped? Are the dates correct? Are the procedures established or reordering or returning undesirable merchandise?

The classic inventory model is usually used by organizations to make forecasts on optimum inventory level or for evaluating two or more inventory systems. Nevertheless, inventory models are adopted on the basis of level of uncertainty with lead time or demand situations.

 Situation Demand Lead time Type of Model to be adopted 1 Constant Constant Deterministic Model 2 Constant Variable Probabilistic Model 3 Variable Constant Probabilistic Model 4 Variable Variable Probabilistic Model

There are two fundamental techniques being employed mostly, to develop inventory reserve estimates, viz. deterministic and probabilistic methods. While deterministic methods involve making a single best estimation of existing inventory reserves on identified engineering, economic and geological information, probabilistic methods utilize the identified engineering, economic and geological information to create a collection of rough stock reserves and their related probabilities. Each categorized inventory reserve indicates the prospect of revival.

The best part about a probability approach is that one can create a model in a better way when provided with values within a bandwidth modeled by an organized distribution density, in comparison to using deterministic figures.

Deterministic models are generally used to depict the optimal inventory of a single item, in the presence of an obscure demand, whereby the inventory builds up at a constant rate to meet an accepted or determined demand. For example, if a contract is received in February with a delivery deadline of December (in a period of 10 months), the product can be manufactured at a rate of 10 per month.

Further, stochastic one-time models can also be used for inventory control, when the demand is unknown. These are more realistic models and hence, fetch more relevance, since they take into account factors such as cost of shortfalls, stacking away, arranging for reserves, and accordingly create an optimal inventory plan.

Let us now take hypothetical Deterministic and Probabilistic inventory control conditions:

A deterministic circumstance is basically one whereby the system parameters can be ensured accurately, also referred to as a situation of definiteness as it is known, things will occur as ensured. Further, the information system under consideration should be complete for clear demarcation of parameters. However, such kind of system rarely exists, and if it does, there lies uncertainty most of the times. In a deterministic model, the state of affairs is assumed to be deterministic and hence, a numerical model is produced to optimize on system arguments. As it conjures the system to be deterministic, it indicates that one has complete details about the system.

On the other hand, a probabilistic model depicts an uncertainty situation, which is as a matter of fact more pervasive, yet less comforted. Therefore, people tend to reduce uncertainty. The prototypes of probabilistic inventory comprising probabilistic demand and supply are more applicable in real life situations, though can be troublesome and uncontrollable during analysis.

So, we conclude that in general cases, the suitable inventory plan should be to reduce the costs associated with holding stock of both raw materials as well as finished goods. As for the model to be chosen, it should largely depend on the type of the industry, and you can select to adopt a deterministic or probabilistic model.

Inventory Control and Replenishment Techniques

Obtaining actual order, setup, carrying and shortage costs are difficult – sometimes impossible. Even the assumptions are sometimes unrealistic. All inventory systems are plagued by two major problems:

• Maintaining adequate control over each inventory item
• Ensuring that accurate records o stock on hand are kept

Three simple inventory systems are often used in practice:

• Optional Replenishment System
• One-Bin System
• Two-Bin system

Apart from the above three systems, ABC Analysis is a popular method used for analysing inventory based on value. Cycle counting is another technique used for improving inventory record accuracy.

Optional Replenishment System

This system forces reviewing the inventory level at a fixed frequency (such as weekly) and ordering replenishment supply if the level has dropped below some amount. For instance, the maximum inventory level can be computed based on demand, ordering costs and shortage costs. Because it takes time and costs money to place an order, a minimum order of size Q can be established. Then, whenever this item is reviewed, the inventory position (I) is subtracted from the replenishment level (M). If that number (say, q) is equal to or greater than Q, order q. Otherwise, forget it until the next review period. Stated formally,

q = M – 1

If q ≥ Q, order q. Otherwise, do not order any.

Two-Bin System

In a two-bin system, items are used from one bin, and the second bin provides an amount large

enough to ensure that the stock can be replenished. Ideally, the second bin would contain an amount equal to the reorder point (R) calculated earlier. As soon as the second bin supply is brought to the first bin, an order is placed to replenish the second bin. Actually, these bins can be located together. In fact, there could be just one bin with a divider between. The key to a two-bin operation is to separate the inventory so that part of it is held in reserve until the rest is used first.

One-Bin System

A one-bin inventory system involves periodic replenishment no matter how few are needed. At fixed periods (such as weekly), the inventory is brought up to its predetermined maximum level. The one bin is always replenished, and it therefore differs from the optional replenishment system, which reorders only when the inventory used is greater than some minimum amount.

Inventory Rreplenishment Ssystems

The aim of an effective inventory replenishment system is to maintain a suitable balance between the cost of holding stock and the particular service requirement for customers. The need for this balance can be illustrated by considering the disadvantages of low stock levels (which should provide very low costs) and high stock levels (which should provide a very high service).

• The disadvantages of low stock levels are that customers’ orders cannot be immediately fulfilled, which may lead to the loss of both existing and future business, and that goods have to be ordered very frequently, which may lead to heavy ordering costs and heavy handling and delivery costs.
• High stock levels have a major disadvantage because capital is tied up that might be better invested elsewhere. Also, there is the risk of product deterioration (egg food and drink) and of products becoming outdated, superseded or obsolete if they are stored for long periods of time.

Inventory replenishment systems are designed to minimize the effects of these high/low stock level disadvantages by identifying the most appropriate amount of inventory that should be held for the different products stocked. There is a variety of systems, but the two major ones are the periodic review (or fixed interval) system and the fixed point (or continuous) reorder system.

For the fixed-point reorder system, a specific stock level is determined, at which point a replenishment order will be placed. The same quantity of the product is reordered when that stock level is reached. Thus, for this system it is the time when the order is placed that varies.

These systems, and variations of them, have been used for many years.

Inventory Accuracy and Cycle Counting

Inventory records usually differ from the actual physical count; inventory accuracy refers to how well the two agree. Companies such as Wal-Mart understand the importance of inventory accuracy and expend considerable effort ensuring it. The question is how much error is acceptable? If the record shows a balance of 683 of part X and an actual count shows 652, is this within reason? Supposedly, the actual count shows 750, an excess of 67 over the record; is this any better?

Every production system must have agreement, within some specified range, between what the records says is in inventory and what actually is in inventory. There are many reasons why records and inventory may not agree. For example, an open stockroom area allows items to be removed or both legitimate and unauthorized purposes. The legitimate removal may have been done in a hurry and simply not recorded. Sometimes parts are misplaced, turning up months later. Parts are often stored in several locations, but records may be lost or the location recorded incorrectly. Sometimes stock replenishment orders are recorded as received, when in fact they never were. Occasionally, a group of parts is replaced in inventory without cancelling the record. To keep the production systems flowing smoothly without parts shortages and efficiently without excess balances, records must be accurate.

How can a firm keep accurate, up-to-date records?

1. The first general rule is to keep the storeroom locked. If only storeroom personnel have access, and one of their measures of performance for personnel evaluation and merit increases is record accuracy, there is a strong motivation to comply.
2. A second way is to convey the importance of accurate records to all personnel and depend on them to assist in this effort

Cycle Counting: Another way to ensure accuracy is to count inventory frequently and match this against records. A widely used method is called Cycle Counting. It is a physical inventory-taking technique in which inventory is counted frequently rather than once or twice a year. The key to effective cycle counting and, therefore, to accurate records lies in deciding which items are to be counted, when, and by whom.

Virtually all inventory systems these days are computerized. The computer can be programmed to produce a cycle count notice in the following cases:

• When the record shows a low or zero balance on hand; it is easier to count fewer items.
• When the record shows a positive balance but a backorder was written (indicating a discrepancy).
• After some specified level of activity.
• To signal a review based on the importance of the item, as in the ABC system.

The easiest time for stock to be counted is when there is no activity in the stockroom or on the production floor. This means on the weekends or during the second or third shift, when the facility is less busy. If this is not possible, more careful logging and separation of items are required to count inventory while production is going on and transactions are occurring.

Regardless of the specific accuracy decided on, the important point is that the level be dependable so that safety stocks may be provided as a cushion. Accuracy is important for a smooth production process so that customer orders can be processed as scheduled and not held up because of unavailable parts.

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