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 cases of essential and critical raw materials, usually good demand and shorter lead teams, as well as a low purchase cost due to the volume normally acquired (usually already tied to some contract). Continuous review is ideal when the purchase cost is higher, or the behavior of item demand is not so linear and/or the cost of this material is high and a periodic review could lead to excess.

We can also define a different strategy for an item, which is the replacement against request. This is used for items where it is not interesting to maintain constant stock, but replace it only when an order is placed. It is not traditionally cited as a type of replacement when you see Make-To-Stock (MTS) as it represents a Make-To-Rader (MTO) orientation. However, as the decision on producing or buying to stock or against order is up to the company, it is important to know that one can always 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 resurrect their inventory instantly, it would not be necessary to plan, as it would only be to respond to the immediate demand. But reality is not even close to it. Therefore, we need to think about how much we want to have in stock and when we will replenish. Understanding your future demand and inventory replacement time, it is possible to do so. What are these levels or volumes 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 does the opposite as it “rounds up” purchase lots to meet future demands and thus save on the unit value of the purchase.

In addition to these, inventory policies infers a series of analyzes that seek to improve health, such as inventory turnover, sales frequency, stockouts, medium replacement teams and their standers, maintenance and storage costs, obsolescence index and even demand planning and purchasing information, such as Supplier Scorecard. That is, information that can be critically useful for decision making about how much we keep in stock and how much we ask to buy or produce are relevant to such policies.

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

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