operations management

1. PRESTIGE INSTITUTE OF MANAGEMENT
AND RESARCH , INDORE

2. Inventory
• It is a necessary part of doing business and provided
by most organizations in any sector of economy.
• Inventory exists because supply and demand are
difficult to synchronize perfectly and it takes time to
perform material-related operations .
• Inventory serves following purposes within the firm:
1. It enables the firm to achieve economics of scale.
2. It balances supply and demand and it enables specialization in
manufacturing.
3. It provides protection from uncertainties in demand and order
cycle.
4. It acts as a buffer between critical interfaces within the supply
chain.

3. • Inventory can be a source of conflict among different managers
in organization because different managers have different roles
to play which involve the use of inventory.
• The conflicting roles of managers must not be allowed to
impair the organization as a whole.
• To overcome this conflict, inventory management should be
everybody’s concern.
• The objective of inventory management is to have the
appropriate amounts of materials in the right place, at the right
time, and at low cost.
• Therefore, inventory decision problem can be solved by using
economic criteria. One of the most important prerequisites is
an understanding of the more relevant costs to inventory
system.

4. • There are four types of inventory costs:
Item cost
• Item cost is the cost of buying or producing the individual
inventory items.
• The item cost is usually expressed as a cost per unit multiplied
by the quantity procured or produced.
Ordering/ setup cost
• Ordering cost is associated with ordering a batch or a lot of
items. It does not depend on the number of items ordered,
but assigned to the entire batch, including transportation
costs, receiving costs, and so on.
• When the item is produced within the firm, there are also
costs associated with placing an order, called setup costs,
including paperwork costs and the costs required to set up
the production equipment for a run.

5. Carrying/ holding costs
• This cost is associated with keeping items in
inventory for a period of time. It is typically charged
as a percentage of rupees value per unit time.
• In practice, this cost typically range from 15% - 30%
per year. The carrying/ holding cost consists of three
components: Cost of capital, Cost of storage and
Costs of obsolescence/deterioration/loss
Obsolescence costs
Stock out cost
• Stock out cost reflects the economic consequences
of running out of stock, including back ordered cost
and loss sales.

6. VED Analysis
• V stands for vital, E stands for essential and D
stands for desirable items.
• In addition to the conventional ABC analysis,
VED analysis also plays an important role in
materials management.
• VED ranking may be done on the basis of the
shortage costs of materials, which can be
either quantified or qualitatively expressed.

7. • Organizations should ensure that they take
specific actions to optimize the inventory level
with the minimum total annual inventory cost
and they implement the actions consistently.
• To determine which actions are the right ones
for the organizations, they first carry out the
detailed analysis of the inventory. The results
of the analysis can be used as a basis for
defining the appropriate inventory
optimization measures.

8. Inventory system can be used to
• Fixed order size system and Fixed order interval system
• In fixed order size system, the same number of units
(how many) is always ordered, and the time between
orders (when) is not expected to vary. This system is
also termed as Q-system, since the size of order (Q) is
fixed for each replenishment.
• The stock level is reviewed with each transaction, and
whenever the inventory position reaches a
predetermined point, an order for a fixed number of
units is placed.
• Thus, the defining parameters of the system are reorder
point (B) and the size of the order (Q).

9. • The fixed order interval system or periodic inventory system,
is based on a periodic rather than a continuous review of the
inventory stock position. It is a time based inventory system in
which orders are placed at equally interval, predetermined
points in time, and the order quantity is dependent upon the
usage between order review periods. This system is also
termed as T-system, since the order interval is constant.
• A maximum inventory level for each item is developed, based
on usage during lead time and order interval. After a fixed
period of time has passed, the stock position of the item is
determined. An order is placed to replenish the stock with the
sufficient size to bring the present stock level up to the
maximum inventory level.
• Therefore, the defining parameters of the system are fixed
review period (T) and the maximum inventory level (E).

10. COMBINATION OF ABC &VED
ANALYSIS
• We can combine both and classify the
materials depending on both the consumption
value and the criticality; it will give us a fruitful
result. This can be done in nine ways

11. V E D
A AV AE AD
B BV BE BD
C CV CE CD

12. • This type of classification helps the
management to decide the materials policy
and what the service levels are expected to
see that no difficulty is faced.
• An item belongs to both A and V class is
costlier, at the same time higher criticality, the
management should see that it is available at
any time the need arises and the stock levels
to be controlled properly to see that inventory
carrying cost are kept under control.

13. Example
• The ABC and VED (vital, essential, desirable) analysis of the
pharmacy store of Post Graduate Institute of Medical Education and
Research (PGIMER), Chandigarh, India, was conducted to identify
the categories of items needing stringent management control.
• The annual consumption and expenditure incurred on each item of
pharmacy for the year 2007-08 was analyzed and inventory control
techniques, i.e. ABC, VED and ABC-VED matrix analysis, were
applied. The drug formulary of the pharmacy consisted of 421
items.
• The total annual drug expenditure (ADE) on items issued in 2007-08
was Rs. 40,012,612.

14. Continued…
• ABC analysis revealed 13.78%, 21.85% and 64.37% items as
A, B and C category items, respectively, accounting for
69.97%, 19.95% and 10.08% of ADE of the pharmacy. VED
analysis showed 12.11%, 59.38% and 28.51% items as V, E,
and D category items, respectively, accounting for 17.14%,
72.38% and 10.48% of ADE of the pharmacy.
• On ABC-VED matrix analysis, 22.09%, 54.63% and 23.28%
items were found to be category I, II and III items,
respectively, accounting for 74.21%, 22.23% and 3.56% of
ADE of the pharmacy. The ABC and VED techniques need to
be adopted as a routine practice for optimal use of
resources and elimination of out-of-stock situations in the
hospital pharmacy.