Defining an Inventory policy has become a strategic exercise in today’s competitive landscape. Organizations have plethora of product mixes these days which tend to make the process of defining inventory policies make complex. However, at a very high level, there are four types of Inventory policies that are widely used. While I intend to write a separate post on what are the Key steps you need to take to define an Inventory Strategy for your organization, the purpose of this post is to summarize the four widely used Inventory Policies.
What is an Inventory Policy?
To simplify it, Inventory policy helps you answer the following questions:
- How frequently should I review my Inventory position for an item?
- How much should I order?
- When should I order?
These questions essentially mean that there are two key aspects in your Inventory management process:
- Review period
- Inventory Position
- Order Point
Review Period: You can chose to implement a continuous review policy or a periodic review policy. If you are using ABC Classification, you will generally chose Continuous Review for your A and B items and periodic review policy for your C items.
Inventory Position: For a detailed explanation of Inventory position, please refer to my post “Challenges in implementing an Inventory Policy”. The simplified formula for Inventory position is:
Inventory Position = Inventory On Hand + Inventory on Order – Backorders
Order Point: Order point essentially is the Inventory position value at which you place your order.
Four Key Policies
The four key Inventory policies that we are going to summarize here can be categorized in two buckets:
Continuous Review Policies:
- (s, S)- Small s denotes re-order point and Large S is the Order up to Level
- (s,Q)- Small s denotes re-order point and Q is the Economic Order Quantity
Periodic Review Policies:
- (R, S)-R denotes review period and Large S is the Order up to Level
- (R, s, S)-R denotes review period, Small s denotes re-order point and Large S is the Order up to Level
We will now highlight the key points of each of these polices:
The (s, Q) Policy
The Policy in (s,Q) policy is:
Order your Economic Order Quantity Q, every time your inventory position drops below s (Reorder Point). It is called a two bin system as you have two Inventory Bins: One is your Cycle Inventory and another bin consists of Demand during lead time and Safety Stock.
The (s, S) Policy
The Policy in (s,S) policy is:
Order up to a level S (so your order quantity is S-Inventory Position), every time your inventory position drops below s (Reorder Point). It is also called a Min-max system as the policy says that you can order a Max of S when you reach the min of s.
The (R,S) Policy
The Policy in (R,S) policy is:
Order up to a level S (so your order quantity is S-Inventory Position), every R time periods (R is the Review Period)
The (R,s,S) Policy
The Policy in (R,s,S) policy is:
Order up to a level S (so your order quantity is S-Inventory Position), every R time periods (R is the Review Period) if Inventory Position is less than or equal to s (Reorder Point).
This overview is pretty high level. In real world, there are multiple challenges to implementing these policies as determining Order Point and Inventory Position is not that straight forward. These challenges have been discussed in the article “Challenges in implementing an Inventory Policy”.