Inventory policies are a way to determine what is the best way a product can flow through a supply chain. They are a set of rules establishing how much and when a product should be bought or produced.
What’s concerns inventory policies?
First, inventory policies are important to manage time, demand and uncertainties in a supply chain. With a well-adjusted policy, companies can be more agile, efficient and profitable.
It’s hard to predict every little detail that can go wrong in the process, therefore, these set of rules established by an inventory policy will, at the very least, help deal with those problems. Ideally, it will not only do that but also minimize those mistakes.
Those policies must take care of three main levels of inventory decisions. Primarily, they must deal with strategic decisions in the supply chain, like:
- What are the potential alternatives to inventory?
- How the product is designed?
For instance, it may make sense for a company investing in a faster transportation and therefore not have a lot of inventory. In other cases, with products that take more time to transport, it’s possible that the best solution is to have a bigger stock.
Kinds of items for inventory policies
It’s necessary to keep in mind how the product is designed to decide what kind of policy, the supply chain and inventory will follow. Two important aspects are the shipping and storing . Besides the strategic decisions in the supply chain level, there is the deployment questions, which we can consider more tactical in nature. They must deal with key aspects such as:
- What items should be carried as inventory?
- In what form should they be maintained?
- How much should be held?
- Where they should be held?
Chris Caplice, supply chain management professor on MIT, says that the place where you are going to store your product is especially important when you are launching a new product.
This happens because you should try to anticipate where the demand is going to materialize for the specific product. The result of doing that anticipation is a more efficient process that usually delivers items to customers in a faster way.
What Inventory Policy should I use?
Finally, the chosen inventory policy should take care of the operational decisions related to replenishment. Those are the decisions a company take everyday.
Operational decisions try to determine a safe quantity of stock and better moments to replenish. They deal with questions like:
- How often inventory status must be determined?
- When a replenishment decision be made?
- How large should replenishment be?
All these questions define what we call inventory policy, and they are the key points of a supply chain. A great way to start optimizing your supply chain is answering the questions.
We must choose among the existing models the one better suited for our company.
Types of Inventory Policies
There are two types of inventory policy divided by the moment you must order. In a continuous review policy you can order at any time. On the other hand, in a periodic review policy, orders can only be made at specific times.
Continuous review policy
In the continuous review, as soon as the net inventory reaches the threshold, the policy dictates that the company should order a pre-determined numbers of units from the supplier.
However, when talking about stock, we need to consider units on different stages of the supply chain. For example:
- On-hand inventory: those units available for clients to buy; products that are already in the warehouse.
- Back-orders: when you don’t have enough on-hand inventory but don’t lose the order.
- Net inventory: considers both on-hand inventory and those that are in-transit; therefore, units that are already on the warehouse and units on transportation.
- In-transit: units that are on the way of the warehouse; goods ordered from the supplier but not yet available to clients.
These definitions give us a deeper understanding of how we should think about units in an inventory.
That said, with a continuous review policy, the elapsed time between two consecutives orders will vary, it will depend on how long it took the warehouse to be empty, among other things.
However, even with the elapsed time being different, the quantity will always stay the same. This option is safe when you assume you can make an order whenever you need.
This is a good policy when you deal with expensive items and need to monitor them closely. In the other hand, this model won’t allow you to group into a single order different items with a single supplier.
Periodic review policy
The periodic review policy dictate that products mustbe ordered periodically, based on a fixed schedule, and always taking the stock back to it’s full potential, in other words, it operates in an up-to level method.
Every cycle on the periodic review starts with an order that will bring enough products to the net inventory. But every cycle a different quantity will be necessary because it depends on how much inventory the company have at the time.
On the other hand, the moment to order is always the same, on a fixed schedule. That means that the elapsed time between two consecutive orders will always be the same.
The major advantage of this model is that it allows business to group their orders with each of their suppliers. Probably because of that it is the most common inventory policy.
The problem is, even though it gives the possibility to group the orders, this policy is usually riskier because it creates a blind spot on the impossibility of ordering in-between two cycles.
Why we need inventory policy after all?
We’ve seen the two most common inventory policies out there. Of course there are others like reorder point, fixed order, R,s,S policy or multi-sourcing. But getting to know these two is a good first step to start thinking of an inventory policy.
As the supply chain specialist Nicolas Vandeput affirms, inventory management is at the core of the supply chain dynamics. So, we have a lot of reasons to hold inventory, minimize costs of operations and deal uncertainties in demand.
One of the major problems supply chain professionals must deal when talking about inventory is excess inventory. It can lead to spoilage, obsolescence, and damage. Having a good inventory policy is the best way to deal with that problem.
The Delorean, Supply Brain’s demand prediction and inventory optimization solution applies an automated inventory review methodology that prevents overages and stocking by helping to direct products to the correct locations. This maximizes the return on inventory investment.
With greater assertiveness we build more efficient simulations of the chain behavior, allowing the visualization of different scenarios for optimization and planning.
Do you want to define your stock policy and economic order? Let’s talk!