Page 182 - DMGT206_PRODUCTION_AND_OPERATIONS_MANAGEMENT

Unit 9: Inventory Model and Safety Stocks

Only when considered in the light of all quality, customer service and economic factors – from Notes
the viewpoints of purchasing, manufacturing, sales and finance – does the whole picture of
inventory become clear. No matter what the viewpoint, effective inventory management is
essential to organizational competitiveness.

Self Assessment

Fill in the blanks:
1. The cost of increasing production and employment level involves employment and
training, additional staff and service activities, added shifts, and ……………… costs.
2. If the demand for the product is known ………………, it may be possible to produce the
product to exactly meet the demand.
3. Inventories permit production planning for smoother flow and lower cost operation
through ……………… production.
9.2 Inventory Costs

As inventory is a necessary but idle resource, inventory costs in manufacturing need to be
minimized. The heart of inventory decisions lies in the identification of inventory costs and
optimizing the costs relative to the operations of the organization. Therefore, an analysis of
inventory is useful to determine the level of stocks. The resultant stock keeping decision specifies:

1. When items should be ordered, and
2. How large the order should be.
3. “When” and “how many to deliver”.
Inventory can have a significant impact on both a company’s productivity and its delivery time.
Large holdings of inventory also cause long cycle times which may not be desirable as well.
What are the costs identified with inventory? The following costs are generally associated with
inventories:
Holding (or carrying) Costs: It costs money to hold inventory. Such costs are called inventory
holding costs or carrying costs. This broad category includes the costs for storage facilities,
handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes, and the opportunity
cost of capital. Obviously, high holding costs tend to favour low inventory levels and frequent
replenishment.
There is a differentiation between fixed and variable costs of holding inventory. Some of the
costs will not change by increase or decrease in inventory levels, while some costs are dependent
on the levels of inventory held. The general break down for inventory holding costs has been
shown in table.

Table 9.1: Fixed and Variable Holding Costs

Fixed costs Variable costs
Capital costs of warehouse or store Cost of capital in inventory
Cost of operating the warehouse or store Insurance on inventory value
Personnel costs Losses due to obsolescence, theft, spoilage
Cost of renting warehouse or storage space

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