EXPRESSING INVENTORY CONTROL POLICY IN THE TURNOVER CURVE

Journal of Business Logistics, 2005 by Ballou, Ronald H

INTRODUCTION

A simple function relating the volume passing through a facility (e.g., warehouse throughput) to the inventory level is used as an integral part of facility location analysis to estimate inventory levels at various stocking points. It allows inventory levels at the facilities to be approximated as customer demand is allocated to them. Once inventory levels are known, inventory carrying costs can be computed. Trade-offs can then be considered involving production/purchase; transportation; and facility fixed, handling, and storage costs. The sum can then be minimized. The function, called the inventory turnover curve, has the form AIL = kV^sup a^, where Vis the volume passing through a facility, k and a are constants to be determined from a company's inventory turnover ratios at their stocking points, and AIL is the average inventory level at a stocking point.

The function has additional utility as an evaluative tool for inventory policy. It is an expression of a company's inventory policy application and provides a means for comparing performance. That is, various inventory policies can be represented by the turnover curve from which the resulting inventory levels can be compared to existing levels. The magnitude of the differences are determined that can serve as the basis for improvement.

Incomplete data and misapplication of policy can require that the function be established from the nature of the inventory policy itself. This requires that the relationship of inventory policy to the inventory turnover curve be understood. It is the intent of this article to develop the turnover curves resulting from various inventory policies applied under a variety of item characteristics, uncertainty conditions, and fill rates. Thus, by knowing basic information about item cost, demand, lead time, and inventory control methodology, a normative inventory turnover curve can be expressed.

BACKGROUND

Inventory Policy

Inevitably, product flows in a supply channel must be moved to meet demand simply because product is not available at the time and place desired. Depending on the strategy that a firm adopts to manage the flows, some inventories will accumulate at various facilities in the channel or in the transportation system. A supply-to-demand, or just-in-time, strategy attempts to avoid inventories by matching supply to demand as demand occurs. On the other hand, a supply-to-stock strategy includes inventories with the objective of balancing them with product availability requirements. It is the control of these planned inventories that is considered in this research.

Planned inventories are controlled in numerous ways. Ford Harris attempted to optimize inventory levels as early as 1913 with the development of the Economic Order Quantity (EOQ) model for determining replenishment order size in perpetual demand inventories (Harris 1913). Subsequently, the EOQ became an integral part of reorder point and periodic review inventory control methodologies for controlling the combination of regular and safety stocks when demand and lead time are uncertain. Although demand is assumed constant and perpetual, practical application usually involves forecasting demand with one of the popular forecasting methods, such as exponential smoothing or moving average. The reorder point and periodic review methodologies are well described in most operations, logistics, and supply chain management textbooks; however, for reference, they are repeated in the Appendix.

Less discussed, but very popular with companies, is the stock-to-demand approach to inventory management. With this method, inventory levels are directly related to the demand forecast. The objective is to maintain inventory items at the level of, for example, 6-weeks demand or of a specific inventory turnover ratio. It is a form of the periodic review method, since inventory levels are examined at specified time intervals, perhaps monthly in conjunction with a forecast, except that replenishment quantities are not based on the EOQ and the review period is not economically determined and optimized. The method's popularity probably comes from its simplicity of understanding and application. It also is described in the Appendix.

These previous methods are "pull" methods, meaning that stocking decisions are made locally to the inventory. In contrast, many companies prefer a "push" methodology. Under the latter, inventory decisions are made at the source point level in the channel based on the demand at more than one downstream stocking location. Stocking quantities shipped to the inventory locations are determined from the combined forecasted demands, the period for replenishment of all stocking points, and product lot sizes or vendor order minimums. Except for demand being forecasted from multiple stocking locations, the "push" method is similar to the stock-to-demand methodology.

As a practical matter, variations of these basic control methods are used. For example, orders from the same source may be composed of multiple product items, order quantities may be determined by vendor deals and quantity discounts, and there may be different policies applied to different stocking locations. Although there may be many possible inventory policies applied to specific situations, the analysis here will be limited to these popular methods for perpetual demand inventories. Just-in-time, or supply-to-demand, methods are not considered since their intent is to eliminate inventories rather than manage them. The "pull" methods are more likely to be applied by those members of the supply channel that experience perpetual item demand and regular demand patterns, namely retailers and distributors, but are not limited strictly to these.