Challenges in Implementing an Inventory Policy

Conceptually, implementing an Inventory policy seems straightforward.  All you have to do is to categorize your products (say, using ABC Classification) and then define an Inventory Policy for  each category/class . However, in the real world, there are various challenges that you will encounter when defining Inventory policies. Before we do a deep dive into those policies, let us understand (briefly), what exactly is an Inventory policy.

So what exactly is an Inventory Policy?

To simplify it, Inventory policy helps you answer questions like:

  • How frequently should I review my inventory?
  • How much Inventory should I hold?
  • How much should I order?
  • When should I order ?

Two challenging areas: Inventory Position and Order Point

If you ponder over the questions above a little bit, you can figure out that from an operational aspect, the answer to these questions depends on two key aspects:

  • How much Inventory do I have (Inventory Position)
  • What is my inventory position when I place the order (Order point)

If you need to refresh your knowledge base on what are the commonly used Inventory policies, you can visit my blog post A Summary of commonly used Inventory polices.

Challenges in determining Order Point

Let us assume that we are planning to implement a (s,Q) policy. Our Order Point formula will be:

Order Point = Expected demand over lead time + Safety Factor  x  Std Dev of demand

We will now  go through each term above to see what challenges we can run into.

Expected demand over lead time: Key parameters are lead time and forecasted demand during lead time

  • How do you capture lead time?
  • How frequently you refresh your lead time data?
  • How do you calculate lead time variance?
  • What is your forecast accuracy?
  • What impact promotions, trends, seasonality or other events will have on your forecasted demand?
  • How good is the integration between the forecasting and Inventory management system/modules?

Safety factor: Depends on a defined service level and the probability distribution function of demand.

  • How good is your analytics to classify the demand distribution (normal, Poisson) ?
  • How are service levels defined? How are they updated? How does this data feed into the Inventory planning system/module?

Standard Deviation of demand: Assuming that you will use forecast error to determine this, the challenges are:

  • How good is your forecast error estimation method?
  • What is the level of detail used in determining errors?
  • Are you including lead time variability in your calculations?

Challenges in determining Inventory Position

Inventory position can be determined by:

Inventory position = Inventory on hand + Inventory on order – Backorders & commitments

We will now  go through each term above to see what challenges we can run into.

Inventory on hand: There are two aspects of challenges when we need to determine the Inventory on hand numbers: Data collection and data integrity.

Data collection:

  • If you have thousands of SKUs and multiple locations stocking these SKUs, your possible number of item-location combinations can be mind boggling. You need extensive database processing power.
  • The business process cycle can be different for different SKUs (daily, weekly etc.), which further complicates the collection process.

Data Integrity:

  • Missing or wrong error codes
  • Data entry errors
  • Problems with scanning equipment or barcodes

Inventory on order: Here the key challenges is determining when does an order gets into “on order” status?

Is the order considered on order when

  • It is generated by the system?
  • Transmitted to the supplier?
  • Accepted by the supplier?
  • Shipped by the supplier?

This in not an exhaustive list but gives a good overview of the kind of challenges that you need to plan for when determining the implementation strategy for your inventory policies.

Disclaimer: This is a personal blog site and views and perspectives expressed here are solely my own and do not express the views or opinions of my employer.

One comment

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s