Inventory: Result of mismatch between supply and demand

Inventory results due to mismatch between supply and demand in a manufacturing organization. Demand and supply are external to the manufacturing system and have uncertainty associated with them. Low supplier yields from breakdowns, maintenance or unreliable lead times create uncertainty in getting appropriate supply. Demand has always been uncertain due to several factors that are beyond control of the organization.

Manufacturing organizations have control over capabilities that are within their control such as production capacity, storage capacity, resources and flexibility. Flexibility can be either in form of volume or delivery flexibility. Both these forms of flexibility impact the amount of inventory that exists in the system. Further, due to assembly and production activities within the organization, there are three types of inventory at any given point of time.

1.      Raw material inventory

2.      WIP (Work In Process) inventory

3.      Finished goods inventory

Names of the three categories of inventory are self explaining the forms of inventory that exist during procurement, production and after final assembly. Raw material inventory is amount of raw material that is present in stock to take care of uncertainty from less reliable suppliers and utilization of part in production obtained from BOM (Bill of Material) structure. While, it is more dependent upon supplier uncertainty, the decision of how much stock to store is influenced by the production capacity and forecasted demand. Inventory requirement for a particular period “t” can be stated as:

Inventory[t] = Forecasted demand[t] - Production[t] - Inventory [t - 1]

The above expression is a necessary condition, but does not necessarily would produce optimal result since we do not have an objective that is to be optimized. Initially we have forecasted demand for finished goods, and using BOM utilization and current material on hand, we can calculate the requirement (or forecasted demand for raw material). WIP inventory is outcome from system design and how different work stations are aligned to smooth the production flow.

While these are deterministic in nature, there is another source of uncertainty for delivery lead time and it must take into account demand during lead time by the manner in which demand is replenished. This makes the calculations difficult since uncertainty of demand is cascaded further down into the calculations. Safety stock is the amount of inventory that takes care of such uncertainty originating from unreliable lead times.

Safety Stock = Reorder Point + Lead time consumption

These calculations are rather straightforward, but increases vulnerability of the system due to uncertainties of supply, demand and delivery lead time. The production capacity is internal and can be controlled by the manufacturing system. So, with accurate prediction of systematic demand component inventory stock is determined. Safety stock is determined by taking into account both systematic and random component of demand and lead time uncertainty.