Five keys to effective inventory management

Maintaining an efficient inventory management strategy can help industrial plant mangers improve and ensure the success of their operations. When addressing inventory management, there are several major factors to consider. Perhaps the most important is recognizing that inventory costs extend well beyond the initial purchase price of materials.
By Dave Janiga, ExxonMobil Lubricants & Specialties June 1, 2005

Maintaining an efficient inventory management strategy can help industrial plant mangers improve and ensure the success of their operations.

When addressing inventory management, there are several major factors to consider. Perhaps the most important is recognizing that inventory costs extend well beyond the initial purchase price of materials. Other factors to consider

are additional costs for handling and storage, different types of stock, accurately estimating the replenishment quantity and predicting the appropriate timing to reorder.

Furthermore, the effort and sophistication needed for a successful inventory strategy should be balanced with the size, complexity and, most importantly, the cost of the inventory to be handled. Here are five of the most important factors that need to be considered.

Carrying costs

Let’s say a company typically has 100 containers of oil in inventory at $500 per container. One would think that the inventory cost would be $50,000. But it’s not. Additional carrying costs will actually drive the total cost of purchasing and maintaining the oil, or any other product, closer to $60,000 or $70,000.

Carrying costs are associated with holding or “carrying” inventories over time. In other words, the company has to pay more money on top of the purchase price of the oil for things such as storage, insurance, extra equipment and personnel.

Also included are costs for such items as forms, clerical support, processing, borrowing and taxes. While the carrying costs will vary with specific situations, they are often estimated at 18 to 25 percent above the value of the inventory.

Understanding your stock

Another factor impacting the efficiency of one’s inventory management strategy is the role of the inventory. Inventory is composed of two separate stocks — working stock and safety stock.

Working stock supports day-to-day operations and will continuously cycle up and down as the material is consumed and replenished.

Safety stock is basically an insurance policy against uncertainty. Material shortages caused by unexpected events such as delayed replenishment or an unusually high consumption rate can be covered with the safety stock. Under ideal operating conditions, safety stock is not used. However, since operating conditions for any business are not always ideal, one should regard safety stock like the insurance policy on one’s car — you hope you’ll never have to use it, but it would be very risky to be without it.

Replenishment quantity

How much should you buy when replenishing inventory?

The most economic replenishment quantity, commonly called the EOQ (Economic Order Quantity), represents the lowest total sum cost of total inventory and inventory acquisition costs (order placement costs, invoice processing costs, payables costs, freight, etc.). Large replenishment quantities translate into fewer replenishment orders but larger inventories. Small replenishment quantities will reduce inventories but will increase the number of replenishment orders needed.

The EOQ is a function of the consumption rate, carrying cost, inventory value and inventory acquisition costs.

Reorder point

The appropriate time to reorder inventory can be determined by how quickly the inventory is being consumed and the order lead time designated by the supplier.

For example, if a business consumes 10 gallons of oil per day and it takes five days to receive material from the supplier, reordering should take place when the working stock gets down to 50 gallons. If one’s inventory management system is working to maximum efficiency, one’s working stock will get to zero gallons as the replenishment arrives.

Inventory cost reduction opportunities

Reducing inventory and related total inventory costs do not always go hand-in-hand. So, how can one further trim inventory costs, beyond the tips provided above, without running the risk of running out of necessary materials? First, and perhaps the most basic element in reducing costs, is to work with suppliers to shorten cycle order fulfillment times to minimize the need for excess safety stock.

Another area in which one can achieve cost savings is through product consolidations. Multiple individual safety stocks can be combined into one typically smaller safety stock. Consumption rates for consolidated products are higher, making smaller order quantities more economical. The higher consumption rates are also typically more ratable, which can translate into further safety stock reductions with no increased risk of runouts.

In every operation, it is important

to develop an efficient inventory management strategy so as to achieve a competitive edge in the marketplace. By paying close attention to the key factors mentioned above, plant managers can build and sustain an efficient inventory management system that saves time and money.

Author Information
Dave Janiga is an industrial lubrication specialist with ExxonMobil Lubricants & Specialties