Course: Logistics and Supply Chain Management – Strategy, Planning & Operation
Module 10: Inventory Management
Inventory management is one of the most critical components in logistics and supply chain
management. It directly impacts customer service levels, working capital, production
schedules, and profitability. Organizations must balance the need to maintain sufficient
inventory to meet demand with the cost of holding and managing that inventory. This module
explores the core concepts, strategies, and tools involved in inventory management and how
these can be effectively applied in various business environments.
Reasons for Holding Stock
Despite the modern emphasis on lean and just-in-time (JIT) systems, inventory remains a
necessary part of the supply chain. The reasons organizations hold inventory include:
1. To buffer against uncertainties – Demand forecasts are never perfect. Holding stock
ensures that customers are served even when demand spikes unexpectedly.
2. Lead time coverage – There’s often a delay between placing an order and receiving goods.
Inventory ensures continuous production or sales during this lead time.
3. Economies of scale – Bulk purchasing and production often reduce per-unit costs, but result
in excess inventory that must be stored until used or sold.
4. Seasonal demand – Products with seasonal peaks (e.g., winter apparel, Diwali lights) are
produced or purchased in advance and stocked.
5. Speculative purposes – Inventory may be held in anticipation of price increases or supply
shortages.
6. Decoupling operations – Inventory serves as a buffer between stages of production, allowing
each process to operate independently and efficiently.
Case Study: A leading FMCG brand like Hindustan Unilever maintains higher inventory levels in
rural distribution hubs to compensate for transportation delays and unpredictable rural
demand. This improves customer service despite infrastructure challenges.
Costs of Carrying Stock
While holding inventory has its benefits, it also incurs significant costs. These costs must be
carefully analyzed to avoid overstocking or understocking.
1. Capital costs – Money invested in inventory cannot be used elsewhere. These are the
opportunity costs of capital.
2. Storage costs – Warehousing, shelving, refrigeration (for perishables), and security all add
up.
3. Risk costs – Inventory risks include obsolescence, depreciation, theft, and damage.
4. Service costs – Inventory needs to be managed, counted, insured, and audited—this
consumes manpower and systems.
Example: In the electronics industry, obsolete inventory due to rapid product evolution leads to
significant write-offs. According to a report by McKinsey, consumer electronics companies can
lose 3–5% of revenues annually to inventory obsolescence.
Economic Order Quantity (EOQ)
EOQ is a fundamental concept that helps determine the optimal order quantity that minimizes
the total cost of ordering and holding inventory.
Formula:
EOQ = √(2DS/H)
Where:
D = Annual demand
S = Ordering cost per order
H = Holding cost per unit per year
The EOQ model assumes constant demand and lead time. It helps companies avoid frequent
orders (which increase ordering costs) or large orders (which increase holding costs). Though
simplified, EOQ provides a baseline for inventory planning, especially for predictable items.
Example: A company selling 10,000 units annually, with an ordering cost of ₹500 per order and a
holding cost of ₹10/unit/year would have an EOQ of:
EOQ = √(2 × 10,000 × 500 / 10) = √1,000,000 = 1,000 units per order.
Timing of Orders
Deciding when to order is as important as how much to order. This decision depends on lead
times, demand variability, and safety stock levels.
Reorder Point (ROP): The inventory level at which a new order should be placed.
Formula: ROP = (Average daily demand × Lead time in days) + Safety stock
If average demand is 50 units/day, lead time is 10 days, and safety stock is 100 units, then ROP =
(50×10)+100 = 600 units.
The reorder point ensures continuous availability of inventory and prevents stockouts.
Sensitivity Analysis
Sensitivity analysis is the process of studying how changes in variables affect the EOQ, safety
stock, or total cost.
• If holding cost increases, EOQ decreases.
• If ordering cost increases, EOQ increases.
• If demand becomes more variable, safety stock needs to increase.
Businesses use sensitivity analysis to understand which factors have the greatest impact on
inventory decisions. This helps in making robust plans that are adaptable to real-world volatility.
Uncertain Demand and Safety Stock
No forecast is 100% accurate, and unexpected events (strikes, floods, supplier delays) can
cause demand-supply mismatches. To protect against this, companies maintain safety stock.
Safety stock levels depend on the following:
• Variability in demand
• Variability in lead time
• Desired service level (e.g., 95%, 99%)
Higher service levels require higher safety stock.
Example: Amazon’s fulfilment centers use real-time data analytics to adjust safety stock
dynamically across thousands of SKUs, helping ensure high service levels during promotions
and peak seasons.
Periodic Review Systems
Unlike continuous review systems (which track inventory after every transaction), periodic
review systems check inventory levels at fixed intervals (e.g., weekly, monthly).
In this system, the order quantity varies, but the review period is fixed. The order size = Target
stock level – Inventory on hand.
This approach suits organizations with many items, where constant monitoring is not feasible.
However, it requires accurate demand forecasts and sufficient safety stock to cover the period
between reviews.
Example: A supermarket may review its dry goods inventory weekly and place orders based on
current stock and expected sales in the coming week.
ABC Analysis
ABC analysis categorizes inventory into three classes based on importance:
A items: High value, low quantity (e.g., microchips in electronics)
B items: Moderate value and quantity (e.g., packaging materials)
C items: Low value, high quantity (e.g., stationery, fasteners)
The Pareto Principle (80/20 rule) often applies: 20% of items (A category) account for 80% of
inventory value.
Managing A items closely with frequent reviews, JIT practices, and tight controls can reduce
capital lock-up. B and C items can be managed more loosely or in bulk.
ABC analysis helps focus resources on the most impactful inventory. For example, pharma
companies closely monitor A items like high-value drugs with expiry risks, while C items like
syringes are stocked in bulk.
Inventory management is both an art and a science. It involves balancing costs with service,
planning with responsiveness, and data with judgment. An efficient inventory system can lower
operating costs, improve customer satisfaction, and increase agility. Mastering EOQ, safety
stock, ABC analysis, and review systems gives supply chain professionals the tools to manage
stock effectively in a dynamic global market. With advancements in AI and data analytics,
inventory decisions are becoming more predictive and responsive—but foundational principles
remain essential.
Quiz: Inventory Management
These questions are for your practice only, no need to send the answer to us. A final
assessment test will be conducted at the end of this course, the link will be shared once all
modules are delivered.
1. What is the main purpose of safety stock in inventory management?
A) Increase profit margins
B) Reduce lead time
C) Buffer against demand and supply variability
D) Reduce holding costs
2. Which of the following is NOT a component of carrying cost?
A) Storage cost
B) Ordering cost
C) Insurance
D) Risk of obsolescence
3. What is the main assumption of the EOQ model?
A) Demand is variable
B) Lead time is uncertain
C) Holding cost is not considered
D) Demand is constant
4. In ABC analysis, what percentage of inventory items typically represents 80% of inventory
value?
A) 10%
B) 20%
C) 50%
D) 70%
5. Periodic review systems are best suited for:
A) Products with very low demand variability
B) Environments with real-time tracking
C) Items that are inexpensive and numerous
D) Items that are perishable
