What is inventory policy?

Inventory policies

Understanding the fundamentals:

Do you think inventory policies is just safety stock? You can be sure not, even taking good care of your stock in times of high interest rates, where they are more expensive than ever, should be a priority for any industry. But then, what are the infamous inventory policies?

Inventory policies play a crucial role in the efficient management of an industrial company. They involve the definition of guidelines and procedures for the acquisition, storage and management of materials and products, from raw material to semi-finished and finished. The main purpose of these policies is to ensure that the company has the right amount of inventory at the right time, minimizing costs and avoiding excesses or lack of products. There are some possible fronts to work with such policies:

1. Resupply Strategy - Review Types

First it is necessary to decide how the important items will be replaced for the company. And there are the following ways:

1. Replacement or Continuous Review: The inventory is continuously monitored and a request is triggered as soon as the inventory level reaches a predefined replacement point. The order size is usually fixed (as an economic lot ) or multiple of this batch.

2. Periodic replacement or review: Stock is revised at fixed time intervals (for example, weekly or monthly). The order size is made based on the amount required to bring inventory to a predetermined level.

Periodic review is useful for essential and critical raw materials, typically with high demand and shorter leadmes , as well as low purchasing costs due to the volume typically purchased (usually already tied to a contract). Continuous review is ideal when the purchasing cost is higher, or the demand behavior of the item is not as linear, and/or the cost of the material itself is high, and a periodic review could lead to excess supply.

We can also define a different strategy for an item, which is replenishment against order. This is used for items where it is not desirable to maintain constant stock, but rather to replenish mes only when an order is placed. It is not traditionally cited as a type of replenishment when considering make-to-stock (MTS) scenarios, as it represents a make-to-order (MTO) approach. However, since the decision to produce or purchase for stock or against order is up to the company, it is important to know that it is always possible to redefine whether an item should be MTO or MTS, especially if demand is dynamic in the medium/long term.

2. Management of inventory levels

If all companies could replenish their inventory instantly, there would be no need to plan, as it would simply be responding to immediate demand. But the reality is nowhere near that. Therefore, we need to think about how much inventory we want to have and when we will replenish it. By understanding your future demand and the inventory replenishment lead time, this is possible. What are these levels ormes to be defined?

Safety Stock: Safety stock is its protection against demand and supply fluctuations. In theory it is not to be consumed ever. It is stored for extreme events.

Minimum stock: The minimum stock may be the safety stock itself, or it may be just above, being the lowest point it will arrive when its replacement finally arrives. It is the lower end of the “saw tooth chart”.  

Refusion or order point: This is the point where the order is made (whether purchasing or production) within the continuous review strategy.

Cycle Stock: It is basically the stock between the position at the time of order and the minimum stock. It is that volume that is always spinning.

Maximum Inventory: This is the volume when the stock is reached with a new planned lot. It is the highest peak of the “mountain tooth chart”.

3. Lots

Lots are usually empirical rules in industries, but can also be calculated for use in more mature productive chains. They are:

1. Economic Purchase Lot (LEC or EOQ - Economic Order Quantity): It is the lowest cost batch for the company. It takes into account annual demand parameters, cost per order and annual carrying cost maintenance cost. Since these 3 parameters can vary greatly in some cases, or be defined based on very subjective assumptions of apportionment in the costs, it is always good to carefully evaluate the use of LEC.

2. Minimum production lot or purchases: It is the minimum lot where it makes sense to produce or buy an item. For production, it is usually defined by the industrial area, and it is a parameter to take care, as it was often defined many years ago and has never been reevaluated or criticized. In purchases, it is usually imposed by the supplier;

3. Multiple production or purchase lot: multiple to produce or buy, often equivalent to the minimum (but not always) batch. When it is not equal to a unit, it is usually defined from some process of occurs in beads or by transport unit (a box, pallet, coil), which makes this break by lot evident.

4. Maximum production lot: Limit for a production lot. Usually defined by management to improve material traceability (very large lots are more difficult to track) or regulatory reasons (such as pharmaceutical industry, for example).

4. Segmentation (curves)

Here we see the famous curves. The most famous is certainly ABC. But there are others, such as Xyz, 123, PQR, among others. If you want to know more about each of them, check out the exclusive post on the subject here .
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5. Specific methods and analysis

There are still more specific methodologies for managing inventories, such as Just-in-Time (JIT), which seeks to minimize inventories as much as necessary for short-term production, with agile replacement, and just-in-Case, which makes the opposite as “rounding” purchase lots to meet future demands and thus save the unit value of the purchase.

In addition, inventory policies include a series of analyses aimed at improving health, such as inventory turnover, sales frequency, stockouts, average replenishment leadmes and their standard deviations, maintenance and storage costs, obsolescence rates, and even demand planning and purchasing information, such as the Supplier Scorecard. In other words, information that can be critically useful for decision-making regarding how much to keep in inventory and how much to order or produce is relevant to such policies.

In short, inventory policies are essential to the effective operation of an industrial company. They help ensure that necessary materials are available when needed, mesalso controlling costs and optimizing processes. Well-planned inventory management can lead to improved customer satisfaction, reduced waste, and increased profitability.

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