Chapter 4 Inventory

                                                      4.3 Introduction to Inventory

Inventoryorstock refers to the goods and materials that a business holds for theultimate purpose of resale (or repair). Inventory management is a scienceprimarily about specifying the shape and placement of stocked goods. It isrequired at different locations within a facility or within many locations of asupply network to precede the regular and planned course of production andstock of materials. Formulation of an inventory policy requires anunderstanding of the role of inventory in manufacturing and marketing.Inventory serves five purposes within the firm:

(1) Enable economies of scale

Inventoryis required if a firm is to realize economies of scale in purchasing,transportation, and/or manufacturing. For example, raw materials inventory isnecessary if the manufacturer is to take advantage of the per-unit pricereductions associated with volume purchases. Purchased materials have a lowertransportation cost per unit if ordered in larger volumes. This lower per-unitcost results because truckload and full railcar shipments receive lowertransportation rates than smaller shipments of less than truckload (LTL) orless than carload (LCL) quantities.

Theproduction of large quantities, however, may require that some of the items becarried in inventory for a significant period of time before they can be sold.The production of large quantities may also prevent timely and responsiverecovery on items that are stocked out, since large production runs mean thatitems will be produced less frequently. The cost of maintaining this inventorymust be compared to the production savings realized. Although frequentproduction changeovers reduce the quantity of inventory that must be carried,and shorten the lead time that is required in the event of a stockout, theyrequire time that could be used for manufacturing a product.

(2) Balancing supply and demand

Seasonalsupply and/or demand may make it necessary for a firm to hold inventory. Forexample, a producer of a premium line of boxed chocolates experiencessignificant Sales volume increases at Christmas, Valentine’s Day, Easter, andMother’s Day. The cost of establishing production capacity to handle the volumeat these peak periods would be substantial. In addition, substantial idlecapacity and wide fluctuations in the labor force would result if the companywere to produce to demand. The decision to maintain a relatively stable workforce and produce at a somewhat constant level throughout the year createssignificant inventory buildup at various times during the year, but at a lowertotal cost to the firm. The seasonal inventories are stored in a freezerwarehouse that was built adjacent to the plant.

On the other hand, demand for a product maybe relatively stable throughout the year, but raw materials may be availableonly at certain times during the year. Such is the case for producers of cannedfruits and vegetables. This makes it necessary to manufacture finished productsin excess of current demand and hold them in inventory.

(3) Specialization in manufacturing

Inventory makes it possible for each of afirm’s plants to specialize in the products that it manufactures. The finishedproducts can be shipped to large mixing warehouses, from which customer ordersand products for field warehouses can be shipped. The economies that resultfrom the longer production runs, as well as savings in transportation costs,more than offset the costs of additional handling. Companies such as WhirlpoolCorporation have found significant cost savings in the operation ofconsolidation warehouses that allow the firm to specialize manufacturing byplant location. The specialization by facility is known as focused factories.

(4) Protection from uncertainties

Inventory is also held as protection fromuncertainties. Raw materials inventories in excess of those required to supportproduction can result from speculative purchases made because managementexpects a future price increase or future supply is in doubt due to a potentialstrike, for example. Other reasons include seasonal availability of supply,such as in the case of fruits or vegetables for canning, or a desire tomaintain a source of supply. Regardless of the reason for maintaining a rawmaterials inventory, the costs of holding the inventory should be compared tothe savings realized or costs avoided by holding it. Work-in-process inventoryis often maintained between manufacturing operations within a plant to avoid ashutdown if a critical piece of equipment were to break down, and to equalizeflow, since not all manufacturing operations produce at the same rate.

Finally, finished goods inventory can be usedas a means of improving customer service levels by reducing the likelihood of astockout due to unanticipated demand or variability in lead time. If theinventory is balanced, increased inventory investment will enable themanufacturer to offer higher levels of product availability and less chance ofa stockout. A balanced inventory is one that contains items in proportion toexpected demand

(5) Inventory as a buffer

Inventory is held throughout the channel ofdistribution to act as a buffer for the following critical interfaces:supplier-procurement (purchasing); procurement production; productionmarketing; marketing distribution; distribution-intermediary andintermediary-consumer/user. Because channel participants are separatedgeographically, it is necessary for inventory to be held throughout the channelof distribution in order to successfully achieve time and place utility.Because channel participants are separated geographically, it is necessary forinventory to be held throughout the channel of distribution in order tosuccessfully achieve time and place utility. Figure 2.2 shows the typicalinventory positions in a supplier manufacturer-intermediary -consumer channelof distribution. Raw materials must be moved from a source of supply to themanufacturing location, where they will be input into the manufacturingprocess. In many cases this will require holding work-in-process inventory.

Figure 4.1 Logistics flow-Typicalinventory positions in a supplier manufacture-intermediary-consumer channel ofdistribution

4.1.1 Definition of a Warehouse

Awarehouse is a commercial building for storage of goods. Warehouses are used bymanufacturers, importers, exporters, wholesalers, transport businesses,customs, etc. They are usually large plain buildings in industrial areas ofcities, towns and villages. They usually have loading docks to load and unloadgoods from trucks. Sometimes warehouses are designed for the loading‍ and unloadingof goods directly from railways, airports, or seaports. They often have cranesand forklifts for moving goods, which are usually placed on ISO standardpallets loaded into pallet racks. Stored goods can include any raw materials,packing materials, spare parts, components, or finished goods associated withagriculture, manufacturing and production.

Warehouse allow transport optimization alongthe supply chain, and allow companies to work with an optimal inventory(economic order quantity) regarding service quality. For example, at theterminal point of a transport system it is necessary to stockpile produce untila full load can be transported. Warehouses can also be used to store theunloaded goods from the vessel. In industries whose goods require a period ofmaturation between production and retail, such as viniculture and cheesemaking, warehouses can be used to store the goods in large quantities.

4.1.2 Types of Warehouses

When a firm decides to store product in thefield, it faces two warehouse options: (1) rented facilities, called publicwarehouse, or (2) owned or leased facilities, called private warehouse. Anotheroption also exists, termed (3) contract warehouse, which is a variation ofpublic warehouse.

(1) Public warehouses

The warehouses which are run to store goodsof the general public are known as public warehouses. Anyone can store hisgoods in these warehouses on payment of rent. An individual, a partnership firmor a company may own these warehouses. To start such warehouses a license fromthe government is required. The government also regulates the functions andoperations of these warehouses. Mostly these warehouses are used bymanufacturers, wholesalers, exporters, importers, government agencies, etc. Aclassification of public warehouses has been developed. On the basis of a rangeof specialized operations performed, they are classified as general merchandise,refrigerated, special commodity, bonded, and household goods and furniturewarehouses. There are many benefits of using the services of public warehouses.Public warehouses can help a business in many facets including recallinventory, distribution, packaging, labeling, transportation, and marketingresources, among others. It provides financial flexibility and scale economy benefitsas well. Drawback of public warehouses is the lack of space available,especially during the peak time of the year, such as holiday seasons. Thetemperature within the warehouse is another aspect to consider. Very often thetemperature, within the public warehouse, is not sufficiently monitored. Inrelation to many goods, this incorrect temperature can create a problem.

(2) Private warehouse

The private warehouses are owned or occupiedon a long-term lease by the firm using them. This type of warehouse providesmore control since the enterprises has absolute decision-making authority overall activities in the warehouse. The control facilities the ability tointegrate warehouse operations with the rest of the firm’s internal logisticsprocess. But private warehousing is also characterize by some shorts, includinghigh fixed cost of private storage and the necessity of having high and steadydemand volumes. The largest users of private warehouse are retail chain stores.They handle large volumes of products on a regular basis. Manufacturing firmsalso utilize private warehouse.

Firms must examine important customer serviceand financial considerations to choose between public and private warehouse.

(3) Contractwarehouse

Contract warehouse (also referred to asthird-party warehouse) is a partnership arrangement between the user andprovider of the warehousing service. For many years, organizations had only twooptions: public or private warehouse. But more recently, contract warehouse hasemerged as another warehouse alternative. Contract warehouse is a long term,mutually beneficial arrangement which provides unique and specially tailoredwarehouse and logistics services for one customer. This type of warehouse isbecoming a preferred choice for many organizations because it allows a companyto focus on its core competencies, with warehouse provided by experts. Contractwarehouse also tends to be more cons-effective than private warehouse withalmost the same degree of control, because key specifications can be includedin the contracts.

4.1.3 Functions of Warehouses

(1) Displayof goods for sale 

A warehouse can be used for displaying goodsfor domestic sale. This would be finished goods such as the latest cottonblouses or fashion items. Richard Cobden's construction in Manchester's Mosley Street was the first palazzo warehouse. There were already sevenwarehouses on Portland Streetwhen they commenced building the elaborate Watts Warehouse of 1855, but four more were opened before itwas finished. It was this type of warehouse that inspired the Germans in Düsseldorf and Munich to name their prestigious department stores Warenhäuser.

(2) Overseaswarehouses

Overseas warehouses, catered for the overseastrade, became the meeting places for overseas wholesale buyers where printedand plain could be discussed and ordered. Trade in cloth in Manchester was conducted by manynationalities. Behrens Warehouse is on the corner of Oxford Street and Portland Street. It was built for Louis Behrens & Son byP Nunn in 1860. It is a four storey predominantly red brick build with 23 baysalong Portland Streetand 9 along Oxford Street.The Behrens family were prominent in banking and in the social life of theGerman Community in Manchester.

(3) Packing warehouses 

The main purpose of packing warehouses wasthe picking, checking, labelling and packing of goods for export. The packingwarehouses: Asia House, India House and Velvet House along Whitworth Street were some of the tallest buildingsof their time.

(4) Railway warehouses

This type of warehouses were built close tothe major stations in railway hubs. The first railway warehouse to be built wasopposite the passenger platform at the terminus of the Liverpool and ManchesterRailway.There was an important group of warehouses around London Roadstation (nowPiccadilly station).In the 1890s the GreatNorthern Railway Company’s warehouse was completed on Deansgate: this was the last major railway warehouse to be built.

(5) Cool warehouses and cold storage 

Cold storage can effectively preserve agriculturalproducts (e.g., vegetables, fruits), dairy product, frozen food, sea food, etc.Refrigerated storage helps in eliminating sprouting, rotting and insect damage. Edible products are generally not stored for morethan one year. Several perishable products require a storage temperature aslow as −25°C. Cold storage helps stabilize market prices and evenly distribute goods both on demandbasis and time basis. The farmers get the opportunity of producing cash crops to get remunerative prices. The consumersget the supply of perishable commodities with lower fluctuation of prices.