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Part - II
Selective Control of Inventory
For responsive supply chains, since product variety is large, forecasting becomes difficult. Further, high stockout costs imply large safety stocks have to be maintained. For raw materials, the effect becomes more pronounced because of the large bullwhip effects that take place. To minimize that, collaborative forecasting can be used. Moreover, there is no need to store high safety stocks for all materials. Some amount of monitoring, which can be facilitated by Information Systems like ERP together with a proper prioritisation of materials can reduce inventory without sacrificing responsiveness.
ABC or VED?
In prioritising raw materials or finished goods, companies tend to prefer ABC analysis. However, a VED analysis presents a more complete picture of importance of an item with respect to another.
For this an Impact Analysis should be done. It is explained here with an example. Say, a firm produces 20 products with sales of Rs 200 crores. Raw material A is used in 19 of these, so if it is not available, loss of sales is say, Rs 195 crores. But it is a 'C' class item, purchase value being only Rs 10 lakhs. Raw material B on the other hand, is used in 5 products of combined sales Rs 30 crore. But it is and 'A' class item of value Rs 3 crores. Here, obviously A is more vital to the organization than B. Stockout of A is more harmful. Similarly, for finished goods, the high margin products are more vital though they may be in 'B' or 'C' category.
For raw materials, three parameters should be use to decide how much safety stock to keep and how close monitoring must be done: -
Consumption Value (ABC classification)
Criticality (VED classification and also availability of substitutes)
Reliability of Suppliers. This is measured on: -
Quality (Number of rejections)
Variability in lead time of delivery (measured by coefficient of variation)
Responsiveness (ability to despatch material quickly in case of emergency orders)
Distance from plant (low lead times reduce variance)
For finished goods also, three parameters should be used: -
Sales Value (ABC classification)
Criticality (Measured by margins and classified as VED)
Variability in Demand
In Exhibit 6 (Click on Exhibit 6 to view it) and Exhibit 7 (Click on Exhibit 7 to view it), matrices for classifying raw materials and finished goods are given. For simplicity, we take consumption/sales value to be high or low and similarly criticality as high or low. Exhibit 8 (Click on Exhibit 8 to view it), gives the amount of safety stocks (and cycle stocks) and the closeness of monitoring for each of the cells of exhibits 6 and 7. For simplicity, high safety stock can be considered to correspond to 99% service level, medium to 97% and low to 95% but these values would vary depending upon the industry, the willingness of customers to wait and the competitive environment.
Some of the major raw materials used for paints are: pigments (high cost), rutile, extenders, solvents and vegetable oils. Of these pigments would be in the (A, D) or (B, D) category. These have high consumption value but individually they do not contribute to a large amount of sales. So, for these using them late as tinters is a good strategy. Material like rutile and certain solvents would be in the (A, V) category. So, inventory carrying costs and stockout costs would be large. For these high safety stocks should be maintained but depending on the reliability of the supplier, more frequent ordering should be done, reducing cycle stocks. Stocks should be monitored continuously.
In case of finished goods, the two fast moving brands of Asian Paints would be (A, V). For these close monitoring, high safety stocks and low cycle stock (i.e., continuous replenishment should be used). For high margin but not so fast selling brands, which may be in the (B, D) category, high cycle and safety stocks can be maintained.
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* Contributed by -
Rajit Ghosh,
Done MBA from IIM Bangalore,
Currently working with Tata Strategic Management Group as a Consultant.
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