Inventory management or inventory system is created to provide customers with the services or products they need. Although it is the type of customers who dictate the level of services and the timeliness of the need and supply required, generally the level of services expected is high. For instance, a customer may be willing to wait several weeks for a luxury car but will not wait even half an hour for grocery. Supplier on the other hand may have the desire to meet all the demands and expectations of the customers but cannot do so because of the cost they would incur. Therefore, with the nature of customer requirements and products, supply chains have been developed as well as inventory strategies by companies to meet the demands of the customers using inventory policies or physical and management infrastructure inherent in supply chains (Muckstadt & Sarpa 2006).
The inventory strategies are based on inventory models ranging from simple to complex models of supply chain and demand. Regardless of the complexity, the design or model must meet certain goal. The goal usually is to create a supply chain policy that would maximize profit or minimize relevant cost. In some cases, the goal is to minimize cost of achieving performance goal, such as minimizing the cost of achieving maximum expected waiting time to satisfy demands or what is called fill rate target. The fill rate target means satisfying faction of demand from stock on time. On the other hand, too much inventory has its own effect (Muckstadt & Sarpa 2006). Therefore inventory policies must be an efficient management of inventories within the supply chains.
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Although companies are composed of elements of people, production, supply, customers and other elements; and that companies divide these elements into smaller divisions to improve efficiency, according to Goldratt's Theory of Constraints, such divisions have only minimum impact on the performance of the company. What impacts the performance of the company is called constraints. Therefore, according to the Theory of Constraints, for any company to achieve its goal, it must identify first the constraints. After identifying, it must then focus on them and make the necessary modifications to the constraints (CIRAS - TOC Fundamentals 2007).
In order to create an effective policy that meets the goal of the company, it must therefore apply the Theory of Constraints in the inventory and supply chain. According to the Theory of Constraints of the supply chain, what should be achieved is to have the product at the right time, at the right place and at the right price. This is very appropriate since most supply chain have the problem of having the right amount of supply in their inventories. Moreover, this is a process of ongoing improvement. Goldratt gave Five Step Process for Ongoing Improvement: Identifying the system's constraints, deciding how to Exploit the constraint, Subordinate everything to the above decision, Elevate the system constraint (if necessary) and going back to step 1 but do not let inertia cause a system constraint.
This is perfectly demonstrated by The Hourglass Analogy (Youngman 2003):
Step 1: Identify.
Identify - find the neck in our hourglass
Step 2: Exploit.
Exploit - remove any blockages from the neck
Step 2: Exploitation continuedâ€¦
Exploit - improve the value of the output
Step 3: Subordinate.
Subordinate - there is no point in forcing more in. It won't come out any quicker
Step 4: Elevate.
Elevate - make the hole bigger!
Step 5: Don't stop.
Don't let inertia become a constraint to the system.
Most companies are faced with the problem of having more inventoried which then results in having high holding cost and eventually having obsolete and useless supplies. In some cases, the mismanagement of inventories results in low inventory. While in other cases the result is lost sales.
Most companies generally, in order to prevent having lost sales would rather have high inventory. With more supplies than they need or more than what the customers demand, they would end up "pushing" the products to the market. They would have sale, preseason discounts and other types of discounts. This would however result in creating good profit.
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The Theory of Constraints solution to inventory problem is not to "push" but instead to "pull". What this translates to is that instead of pushing the goods to the customers, the company holds on to only relatively small amounts of inventory at the point of purchase and also by developing an inventory system of replenishing the outlets with the supplies (Distribution/Supply Chain 2010). This will improve retailing while allowing for low inventory at supply chain.
In a distribution center, the main use of the Theory of Constraints is in the distribution line but the bottom line is the costs and profit. With the use of the elements, more business can be delivered to the customers with less effort. For Theory of Constraints, the process will involve finding the bottleneck, exploiting this bottleneck and making all the steps of the process compliant with the maximum capacity of the bottleneck. This makes for improving he bottleneck (Elssamadisy & Mufarrige 2007). This is demonstrated by the following sequential process:
Each step (A, B, C, D and E) has speed. Inventory therefore builds up in between the steps if the speeds are mismatched. Thus, in the diagram, since step A is faster than step B, the excess product of step A shall await the process of B (Elssamadisy & Mufarrige 2007).
Aside from applying the Theory of Constraints in creating inventory policy for the distribution, there are also other components that must be taken into considerations since they affect inventory policy decision making. These are system structure, the items, market characteristics, lead times and cost (Muckstadt & Sapra 2006).
System structure is the supply chain's structure. This indicates the way in which both the materials and information flow in the supply chain. This may involve several stages or few stages, depending on the organization. In a distribution center therefore, the system structure would consist of several echelons, starting from the main warehouse which stock the different items. Then these items are distributed to other regional locations or distributing branches or regional warehouse. From there the items are distributed to the branches and then the branches supply the items to the customers (Fig 1) (Muckstadt & Sapra 2006).
The efficiency of management of supply would be dependent on how the supply and information flow among the echelons. Therefore this would be the first thing that must be evaluated.
The items mean the nature of the items to be stocked at particular location. When establishing inventory policies, the number of items being stocked, as well as their interactions are very important for several reasons. One example is the amount of space available in the warehouse which then may limit the amount of the inventory for each type of item. Another is the processing of incoming freight which dictates the number of items that can be delivered or received. Also, items differ in physical attributes, weight and volume. For instance in automotive muffler system, the unusual shape is different than items in boxes. There is also the issue of obsolescence as well as being perishable, depending on the product or item. Moreover, market requirement and costs differ depending on the items. These shall affect the inventory policy (Muckstadt & Sapra 2006).
Market characteristic is also important since they are the reason why specific items must be stock at specific locations. For instance, if the market or buyers in certain location or branch demand certain item over another the inventory policy must address this issue. Delivery of items to customers is also important therefore the policy must make sure that it can deliver the items on time to that market. Moreover since the demand for lower volume items are more often changing, it may result in forecast error (Muckstadt & Sapra 2006). Market characteristics must therefore be considered and evaluated thoroughly to make efficient inventory policy.
Lead times "measure the time lag between the placement of an order and its receipt," (Muckstadt & Sapra 2006). In other words this is the responsiveness of the supplier to the customers. In inventory management this is important since the lead time's length is uncertain, what becomes also uncertain is the demand over lead time. In this case, safety stock requirement therefore increases (Muckstadt & Sapra 2006).
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Lastly cost is another key factor in inventory policy. These may be purchasing cost, carrying or holding costs, stockout cost and obsolescence costs. In manufacturing, for instance, purchasing cost may is acquisition of raw materials while in retail it is acquisition of products that are offered for sale to customers. All these types of costs affect inventory policy making (Muckstadt & Sapra 2006).
As inventory policies must be an efficient management of inventories within the supply chains, this means that inventory policies must be proper management of the relationship between the inventory and the distribution of supplies. This can be first achieved by applying the Theory of Constraints to supply chain. With the application of the Theory of Constraints to the supply chain, efficiency is ensured regardless of the policy or model created for the distribution of supplies down to the last customer. The Theory of Constraints shall continuously check for constraints which may cause problems in the inventory supply chain.
Aside from the Theory of Constraints the other important components of the inventory and distribution shall also be considered and thoroughly evaluated in the formulation of inventory policies. These components, the system structure, the items, market characteristics, lead times and costs, directly affects inventory management so the policy must consider them in terms of how they affect the flow of supplies from the main warehouse to the customers.