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Risk Based Inventory Management
Author :
Thursday, October 27, 2016

In this month’s issue of Supply Chain Management Professional, we deal with a very old, but vital challenge faced by firms – how much of inventory do I carry. We are familiar with the challenges – too much inventory and face losses due to obsolescence and higher working capital. Too little inventory and firms runout of stocks when a customer walks in. Finding the sweet spot is crucial. The primary purpose of inventory is deliver what the customer wants, when she wants immediately. Even for a product like soap, customers look at the manufacturing date. If it is old, you can be sure; they will not pick it up. Customers expect fresh stock. At a time when customer preferences are changing rapidly, overstocking is a sure road to losses.

Why is it that firms are not able to create the right inventory levels? If firms can answer this question, a number of their problems will be solved. As with any facet of business, managers face a huge uncertainty about the demand for their product. Supply chain managers have to deal with this uncertainty. The firm has to track and understand the sources of these uncertainties. This is vital in formulating inventory policies. Inventory policy in a VUCA world cannot be a static process. Firms need to constantly tweak their policy, based on the changes to the underlying demand and supply situation. A common method used is an ABC classification of SKUs and inventory policy geared to meet the perceived demand for the classification. The ABC classification is simple and intuitive. And it is linked to the historic demand for the product. But it does not capture the uncertainty of demand and supply for that product. One way out would be to link the inventory policy to the uncertainty. In other words, it is time firms moved to risk based inventory management process.

Unfortunately, it is not possible to generalize a risk based inventory management policy. It depends on the firms’ culture, the product, the customer base, the economic scenario, technology and most important, alternate demands for inputs and substitutes for the product. A small first step would be to classify the supply and demand drivers for a product.

In this issue we bring you three articles that deal with inventory – the first article deals with some of the pitfalls firms face when formulating their inventory policy.

The second article is on inventory decisions. Successful inventory management involves developing a sourcing plan that will ensure that goods are available when they are needed and keeping track of existing inventory and its use. While doing this care should be taken that, the firm does not buy either too much or too little. Two common inventory-management strategies are the just-in-time method, where companies plan to receive items, as they are needed rather than maintaining high inventory levels, and materials requirement planning, which schedules material deliveries based on sales forecasts. Piyush Shah explains Inventory decisions in this article.

The third article Optimizing Inventory for Profitable Growth details some of the challenges in optimizing inventory.

We hope you like what you read.

Happy Reading

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