the importance of supply chain management

4.2 Inventory Management – Managing Inventory

1. Purpose of Inventory (4.2.1)

Inventory is held at three distinct stages of the production‑distribution process. Each stage smooths the transformation from input to output, protects against uncertainty and creates economies of scale (see 4.1.1 of the syllabus).

• Raw‑material inventory – materials waiting to be processed; provides a buffer before the first transformation.
• Work‑in‑progress (WIP) inventory – partially finished goods at various production stages; bridges the gap between operations that have different cycle times.
• Finished‑goods inventory – completed products ready for sale; ensures product availability for customers.

2. Costs & Benefits of Holding Inventory (4.2.1)

Cost	What it Represents (syllabus wording)	Benefit (why the cost may be acceptable)
Holding (carrying) cost	Warehouse space, insurance, depreciation, opportunity cost of capital	Allows higher service levels and protects against stock‑outs.
Ordering (set‑up) cost	Administrative work, transport, purchase‑order processing	Economies of scale – larger, less frequent orders reduce total ordering cost.
Stock‑out (shortage) cost	Lost sales, back‑order handling, damage to reputation	Motivates maintaining safety stock to meet customer demand.
Obsolescence & wastage cost	Write‑offs for perishable, out‑of‑date or technologically obsolete items	Encourages accurate forecasting and timely replenishment.

3. Inventory Control – Re‑order Point, Safety Stock & Lead Time (4.2.1)

• Lead time (L) – total time between placing an order and the goods being ready for use.
• Safety stock (SS) – extra inventory kept to protect against variability in demand or lead time.
• Re‑order point (ROP) – the inventory level that triggers a new order.

Formulae

$$\text{ROP}= (\text{Average demand per period} \times L) + \text{Safety stock}$$ $$\text{Safety Stock}= Z \times \sigma_{L}$$

• $Z$ = service factor (standard normal deviate) that corresponds to the desired service level (e.g., 95 % → $Z \approx 1.65$). Students should know how to obtain $Z$ from a standard normal table.
• $\sigma_{L}$ = standard deviation of demand during lead time.

Impact of lead‑time variability: Reducing lead time (through better SCM, reliable suppliers, or improved logistics) lowers the product $L$ in the ROP formula and often reduces $\sigma_{L}$, meaning both the ROP and the required safety stock fall.

4. Example: Interpreting a Simple Inventory Control Chart (4.2.1)

From the chart:

1. Identify the point where the inventory line first meets the ROP line (e.g., at 2 500 units).
2. Read the average daily demand from the slope (e.g., 200 units/day).
3. Given a lead time of 10 days, calculate the ROP: $200 \times 10 = 2 000$ units. Add the safety stock shown (e.g., 300 units) → ROP = 2 300 units. Compare with the chart to see whether the order was placed at the correct moment.

5. Economic Order Quantity (EOQ) (4.2.1 / 4.2.4)

The EOQ model gives the order size that minimises the total of holding and ordering costs.

$$\text{EOQ}= \sqrt{\frac{2DS}{H}}$$

• $D$ = annual demand (units)
• $S$ = ordering (set‑up) cost per order
• $H$ = holding cost per unit per year

Worked example

• Annual demand $D = 12\,000$ units
• Ordering cost $S = £30$ per order
• Holding cost $H = £1.50$ per unit per year

$$\text{EOQ}= \sqrt{\frac{2 \times 12\,000 \times 30}{1.5}} = \sqrt{480\,000}= 692 \text{ units (≈ 700)}$$

Students can compare the EOQ with the company’s actual order size to discuss whether the firm is over‑ordering (high holding cost) or under‑ordering (high ordering cost).

6. Just‑In‑Time (JIT) vs. Just‑In‑Case (JIC) (4.2.2)

Aspect	JIT (Just‑In‑Time)	JIC (Just‑In‑Case)
Philosophy	Minimise inventory; receive goods only when needed.	Hold extra stock as a contingency against uncertainty.
Typical safety stock	Very low or zero.	Significant buffer.
Reliance on suppliers	Requires highly reliable, responsive suppliers (link to SCM).	Less dependent on supplier reliability.
Risk exposure	High – any disruption can halt production.	Low – disruptions absorbed by buffers.
Cost focus	Reduces holding cost; may increase ordering cost.	Higher holding cost; lower risk of stock‑out cost.
Best suited for	Stable demand, reliable suppliers, high‑volume, low‑variety items.	Unstable demand, long/uncertain lead times, high‑value or perishable items.

7. Importance of Supply Chain Management (SCM) (4.2.1 & 4.2.2)

• Cost reduction – Better forecasting (a core SCM activity) lowers safety stock → reduces holding cost.
• Improved customer service – Reliable deliveries keep stock‑out cost low and maintain high service levels.
• Enhanced flexibility – Shorter, more predictable lead times (through efficient SCM) lower the ROP.
• Forecast accuracy – Integrated data across the chain cuts the bull‑whip effect → reduces both safety stock and ordering cost.
• Risk management – Diversified sourcing and contingency planning reduce the chance of stock‑outs, allowing lower buffer inventory.

8. How SCM Improves Inventory Management (Practical Steps)

1. Synchronise demand forecasts with production schedules to avoid over‑stocking or stock‑outs.
2. Adopt JIT where supplier reliability and lead‑time stability permit; use JIC where risk is high.
3. Implement Vendor‑Managed Inventory (VMI) so suppliers monitor and replenish stock on your behalf.
4. Use technology (ERP, RFID, IoT) for real‑time inventory visibility and automatic ROP triggers.
5. Continuously review lead times; recalculate safety stock and ROP whenever lead‑time or demand variability changes.

9. Modern Inventory‑Control Techniques (Extension – 4.2.7)

• Vendor‑Managed Inventory (VMI) – Supplier takes responsibility for maintaining agreed stock levels.
• Enterprise Resource Planning (ERP) systems – Integrate order, production and inventory data across the whole chain.
• Radio‑Frequency Identification (RFID) & Internet of Things (IoT) – Provide real‑time location and quantity data, reducing manual counts and improving accuracy.

10. Safety Stock Calculation Example (4.2.5)

Desired service level: 95 % → $Z \approx 1.65$ (from standard normal tables).
Standard deviation of demand during a 10‑day lead time: $\sigma_{L}=30$ units.

$$\text{Safety Stock}= 1.65 \times 30 = 49.5 \;\text{units} \approx 50 \text{ units}$$

Average daily demand = 200 units.

$$\text{ROP}= (200 \times 10) + 50 = 2\,050 \;\text{units}$$

11. Comparison: Traditional vs. Integrated SCM (4.2.1)

Aspect	Traditional SCM	Integrated SCM
Information flow	Fragmented, paper‑based or siloed systems	Real‑time, shared digital platforms
Inventory levels	Higher safety stocks to buffer uncertainty	Reduced safety stocks through better forecasting
Lead times	Longer, less predictable	Shorter, more reliable
Cost control	Higher holding and ordering costs	Lower total inventory cost
Customer service	Variable service levels	Consistently high service levels

12. Practical Activities for A‑Level Students

• Analyse a real‑world case study; identify SCM strengths/weaknesses and their impact on inventory levels.
• Calculate the EOQ for the company and compare it with the actual order size; discuss reasons for any discrepancy.
• Interpret a simple inventory control chart (as in section 4) and calculate the ROP from the data shown.
• Discuss how ERP, RFID or IoT improve inventory visibility and reduce costs.
• Evaluate the effect of a supply‑chain disruption (e.g., natural disaster, strike) on safety stock, ROP and overall service level.

13. Suggested Diagram

Flowchart of an integrated supply chain: Supplier → Manufacturer → Distributor → Retailer → Customer, with inventory control points (raw‑material, WIP, finished‑goods) highlighted at each stage. Arrows should indicate the flow of goods, information and finances.

Summary

Supply Chain Management is the backbone of effective inventory management. By coordinating activities across the whole chain, businesses can lower holding, ordering and stock‑out costs, improve service levels, and react swiftly to market changes. Mastery of these concepts – from the purpose of inventory to EOQ, safety‑stock calculations and the choice between JIT and JIC – is essential for success in the Cambridge 9609 (AS Level) examination and for real‑world business practice.