Obtaining actual order, setup, carrying and shortage costs are difficult – sometimes impossible. Even the assumptions are sometimes unrealistic. All inventory systems are plagued by two major problems:
- Maintaining adequate control over each inventory item
- Ensuring that accurate records o stock on hand are kept
Three simple inventory systems are often used in practice:
- Optional Replenishment System
- One-Bin System
- Two-Bin system
Apart from the above three systems, ABC Analysis is a popular method used for analysing inventory based on value. Cycle counting is another technique used for improving inventory record accuracy.
Optional Replenishment System
This system forces reviewing the inventory level at a fixed frequency (such as weekly) and ordering replenishment supply if the level has dropped below some amount. For instance, the maximum inventory level can be computed based on demand, ordering costs and shortage costs. Because it takes time and costs money to place an order, a minimum order of size Q can be established. Then, whenever this item is reviewed, the inventory position (I) is subtracted from the replenishment level (M). If that number (say, q) is equal to or greater than Q, order q. Otherwise, forget it until the next review period. Stated formally,
q = M – 1
If q ≥ Q, order q. Otherwise, do not order any.
Two-Bin System
In a two-bin system, items are used from one bin, and the second bin provides an amount large
enough to ensure that the stock can be replenished. Ideally, the second bin would contain an amount equal to the reorder point (R) calculated earlier. As soon as the second bin supply is brought to the first bin, an order is placed to replenish the second bin. Actually, these bins can be located together. In fact, there could be just one bin with a divider between. The key to a two-bin operation is to separate the inventory so that part of it is held in reserve until the rest is used first.
One-Bin System
A one-bin inventory system involves periodic replenishment no matter how few are needed. At fixed periods (such as weekly), the inventory is brought up to its predetermined maximum level. The one bin is always replenished, and it therefore differs from the optional replenishment system, which reorders only when the inventory used is greater than some minimum amount.
Inventory Replenishment Systems
The aim of an effective inventory replenishment system is to maintain a suitable balance between the cost of holding stock and the particular service requirement for customers. The need for this balance can be illustrated by considering the disadvantages of low stock levels (which should provide very low costs) and high stock levels (which should provide a very high service).
The disadvantages of low stock levels are that customers’ orders cannot be immediately fulfilled, which may lead to the loss of both existing and future business, and that goods have to be ordered very frequently, which may lead to heavy ordering costs and heavy handling and delivery costs.
High stock levels have a major disadvantage because capital is tied up that might be better invested elsewhere. Also, there is the risk of product deterioration (eg food and drink) and of products becoming outdated, superseded or obsolete if they are stored for long periods of time (eg computers, mobile phones and fashion goods). A final disadvantage, previously discussed, is the expense of providing additional storage space.
Inventory replenishment systems are designed to minimize the effects of these high/low stock level disadvantages by identifying the most appropriate amount of inventory that should be held for the different products stocked. There is a variety of systems, but the two major ones are the periodic review (or fixed interval) system and the fixed point (or continuous) reorder system. The periodic review system works on the premise that the stock level of the product is examined at regular intervals and, depending on the quantity in stock, a replenishment order is placed. The size of the order is selected to bring the stock to a predetermined level. Thus, the order size will vary each time a new order is placed.
For the fixed point reorder system, a specific stock level is determined, at which point a replenishment order will be placed. The same quantity of the product is reordered when that stock level is reached. Thus, for this system it is the time when the order is placed that varies.
These systems, and variations of them, have been used for many years.
