Chapter 5:

Inventory Management

Inventory Management
You might deal with the new advertisements and marketing messages from
your hotel on every given day, the study of your sales statistics and occupancy rates;
the management of guest preferences and online reviews; the monitoring of
maintenance works and renovations; and that's before we even mention the efficient
management of your hot workers.

Inventory management practices help companies place orders accurately as

well as maintain different assortments of products and supplies. Inventory
management systems are used to create reports and track costs on which suppliers
and vendors have the best costs as well as used to reconcile or adjust inventory
after physical counts.

Role of Inventory
Before understanding the role of inventory in supply chain, we need to
understand the cordial relationship between the manufacturer and the client.
Handling clients, coping up with their demands and creating relationships with
manufacturer is a critical section of managing supply chains.

There are many instances where we see the concept of collaborative

relationship being marked as the essence of supply chain management. However, a
deeper analysis of supply chain relationships, especially those including product
flows, exposes that at the heart of these relationships is inventory movement and
storage.
More than half of it relies on the purchase, transfer or management of inventory. As
we know, inventory plays a very important role in supply chains, being a salient
feature.

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 The most fundamental functions that inventory has in supply chains are as
follows:

•To supply and support the balance of demand and supply.

•To effectively cope with the forward and reverse flows in the supply chain.

Companies need to manage the upstream supplier exchanges and

downstream customer demands. In this situation, the company enters a state where
it has to maintain a balance between fulfilling the demands of customers, which is
mostly very difficult to predict with precision or accuracy, and maintaining adequate
supply of materials and goods. This balance can be obtained through inventory.

ASPECTS OF INVENTORY MANAGEMENT

Companies ideally would want to carry just enough finished goods inventory
to satisfy market demands, at the right time and right quantity. Large inventories
have to be evaluated carefully if these would mean incremental sales and profits.
Inventory decisions Involve two major concerns: 1.) when to order and 2.) how much
to order. This requires entrepreneurial decisions in the right stock quantities to
maintain in order not to suffer out-of-stock or over-the-stock situations.

There are four (4) aspects of inventory management and these are:
a. Stock turnover
b. When to order (Re-order point)
c. How much to order (Economic Order Quantity)
d. Warehousing

Stock Turnovers
This is the balance between sales and inventory on hand, expressed by stock
turnover, the number of times during specified period that average inventory on hand
is sold. Stock turnover is calculated in units and pesos:

No. of units sold during the year

Annual Rate of stock Turnover (in units) =
Average Inventory on hand (in units)
Cost of Goods Sold
Average Inventory on hand (Pesos) 2
Annual Rate of stock Turnover (in Pesos) =

The advantages of high inventory turnover are:

1. Inventory investments are productive;
2. Merchandise are fresh;
3. Losses from changes in styles and packaging are reduced; and
4. Cost of maintaining inventory are lessened to the minimum.

Example:
For the year ending December 2019, EAT's Showtime Restaurant reported
from cost of goods sold of Php 525,000 and an average inventory of 5,250 units
which costs Php 52,500. Compute for the Annual Rate of stock Turnover (in
Pesos).

Solution:
Cost of Goods Sold
Annual Rate of stock Turnover (in Pesos) =
Average Inventory on hand (Pesos)
Php 525,000
Annual Rate of stock Turnover (in Pesos) =
Php 52,500

Annual Rate of stock Turnover (in Pesos) = 10x

In other words, within a year, the company tends to turn over its inventory 10 times.

When to Reorder Inventory

The reorder point establishes an inventory level at which new sales orders
must be placed. The reorder point depends on: order lead time, usage rate, and
safety stock. Order lead time is the period form date a sales order is placed until the
date goods are ready for sale or use (received, checked and altered if necessary).
Usage rate means the average sales in units per day or the rate at which a product
is used in a production process. Safety stock is the extra merchandise kept on hand
to protect against out-of-stock conditions resulting from unexpectedly high demand,
greater-than-anticipated production volume and delivery delays.

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The Reorder Point formula is:
Reorder Point= (Order Lead Time x Usage rate) + Safety Stock
Example:
A fast-food restaurant needs to find when it should place orders for specific
food product from its manufacturer. Compute for the Reorder Point using the
following relevant information:
 Average usage: 600 units per day
 Average Lead time: 17 days
 Safety Stock: 253 units
 EOQ: 35,000 units

Solution:
Reorder Point= (Order Lead Timex Usage rate) + Safety Stock
Reorder Point= (17 days×600 units) +253
Reorder Point= 10,453 units

In short, the company should re-order another set of inventories when the
level of inventory is at 10,453 units.

How much to Reorder

There are two types of costs related to the maintenance of inventory in a firm.
The carrying cost refers to the cost of carrying one unit of inventory into stock. It
can be defined as expenses involved in keeping and maintain a stock. It is including
rent of space, equipment, materials, labor, insurance, security, interest, and other
direct expenses. On the other hand, ordering cost refers to the cost of placing an
order for an item. This is the amount of money that you spend on ordering items from
vendors, as well as the labor cost associated with making these orders.

These two inventory related costs go in opposite directions. The carrying cost is
directly proportional to the number of units on stock (or the level of inventory
maintained), that is, as the number of units of stock goes up, so does the carrying
cost. Thus, more units will mean higher carrying cost. Ordering cost and inventory

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level have an inverse relationship. This means that more inventories on stock do not
require frequent orders, resulting in lover ordering costs.

To illustrate, see the figure below:

Figure 7.1. Behavior of Carrying vs Ordering Cost

The level of inventory to be maintained by a firm is that level that will put total
inventory cost at a minimum. Total inventory cost simply refers to the sum of carrying
and ordering cost. The total inventory cost at its lowest level under the inventory
level where carrying amount and ordering costs are equal. This level is known as
Economic order quantity or EOQ. It is the order volume corresponding to the
lowest sum of ordering cost and Inventory holding or carrying costs. The formula of
economic order quantity is:

√ 2xDxO
EOQ =
C

Where:
EOQ= economic order quantity
D= demand or requirement units for the period
O= ordering cost
C= carrying cost

Example:

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 The demand of a product at a Restaurant is 9,000 servings per year. It incurs
a fixed ordering cost of Php 50.00 each time an order is placed. The carrying cost of
each unit of a product is Php 10.00. Compute for the economic order quantity.

Solution:

√ 2xDxO
EOQ=
C

Transportation
Companies in the light of rapidly changing trends in physical distribution are
actually engaged in transportation decisions, more specifically in the choice of
transportation carriers which have substantial bearings in the pricing of the products.
There are basically four common modes of transportation used by companies
in shipment of goods
a. Waterways. The cost of water transportation is low for shipping bulky, low-
value and non-perishable products. However, water transportation is also the
slowest transportation mode and is always affected significantly by weather
conditions.
b. Railroads. Railroads are one of the most cost-effective models for shipping
large amounts of bulk products. Railroads normally carry heavy items that are
low in value (relative to their weight) over long distances. Railroads ship items
too heavy for trucks.
c. Truck / Motor Carriers. Trucks are highly flexible in their routing and time
schedules. They are efficient in hauling high-value merchandise over short
distances. Motor Carriers are more flexible than rail because they can readily
pick up packages at a factory or warehouse and promptly deliver them to the
customer's door. For all intents and purposes, trucks are faster than rail for
short distances.
d. Airways. Airways are the fastest but the air freights are much higher than rail
or truck rates. This mode of transportation is common for perishables and
high-value, low-bulk items.

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DISTRIBUTION CHANNELS OF HOSPITALITY INDUSTRY
To increase and enhance the sales of the hotels, the hotel management
require using the distribution channels for hotels. The online system helps a lot in
attracting guests and customers to the hotels.

In today's cut throat competition, technology is the only medium through which
one can really push hard to stand in the crowd. But what technology would you
choose to solve your problems. In hospitality there are numerous software which
can really help your hotel to gain new customers and facilitate seamless
activities.

Technology has really changed the hotel industry. There were days when
there was no reliability or guarantee on an arrival guest, and when they arrive, they
will stay if there was a room or else, they are gone. This seriously hampers the
business in the long run when the guests start assuming that your hotel would be
fully occupied. So rather coming to you, they go to check different hotels for the
rooms. Now, to avoid such scenario in the current market scene, it is important to
use the latest technology which helps you to provide an actual status of your hotel to
the customer before they plan or leave their homes.

The digital revolution has really come off age with the latest online reservation
solutions. Today the guests can book their rooms by using their iPad or mobile
phone months in advance or while moving.

As a hotel owner you are required to consider the changes. You cannot
escape the digitalization of the business processing; it helps in the long run strategy
and planning. This revolution opens multiple distribution channels for the hotels
which allow the hotels to increase their visibility on the internet among the online

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users. There are a number of blogs, websites, review sites which helps the hotels to
grow on the internet

For anyone to understand the advantages of online reservation, he/she

should look into the facts that nowadays people are more likely to book and reserve
rooms online than travel agents. It is a lot cheaper in comparison to the services of
the travel agents.

Distribution channel for hotels is an approach currently accepted by most

of the hotels for an aggressive sales and distribution purpose. The matter of the fact
is that the ultimate goal of the hotels is to create better visibility on all distribution
channels so that customers can find them easily and book a room.

Having a better distribution channel for hotels will mean that you can
enhance your reputation among the users and guests. But it requires a better
management to handle the online distribution channels.

A lot of hotels rely on the distribution channels to set their pricing after looking
at their competitors. This can be misleading. The guests always pay for the services
that you are offering than the price you have placed for things that doesn't interest
him/her. So, maintenance of standard of services will increase customers than the
emphasis on pricing. The distribution channels for hotels allow the hoteliers to
earn from direct sales.

An effective management of distribution channel for hotels require an eye on

the reviews and optimization of the hotel on the internet.

OTHER INVENTORY MANAGEMENT STRAGETIES

Optimization Models
Optimization models of supply chain are those models that codify the practical
or real-life issues into mathematical model. The main objective to construct this
mathematical model is to maximize or minimize an objective function. In addition to
this, some constraints are added to these issues for defining the feasible region. We

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try to generate an efficient algorithm that will examine all possible solutions and
return the best solution in the end. Various supply chain optimization models are as
follows:

Mixed Integer Linear Programming

The Mixed integer linear programming (MILP) is a mathematical modeling
approach used to get the best outcome of a system with some restrictions. This
model is broadly used in many optimization areas such as production planning,
transportation, network design, etc.

MILP comprises a linear objective function along with some limitation

constraints constructed by continuous and integer variables. The main objective of
this model is to get an optimal solution of the objective function. This may be the
maximum or minimum value but it should be achieved without violating any of the
constraints imposed.

Stochastic Modeling
Stochastic modeling is a mathematical approach of representing data or
predicting outcomes in situations where there is randomness or unpredictability to
some extent. For example, in a production unit, the manufacturing process generally
has some unknown parameters like quality of the input materials, reliability of the
machines and competence within the employees. These parameters have an impact
on the outcome of the manufacturing process but it is impossible to measure them
with absolute values.

In these types of cases, where we need to find absolute value for unknown
parameters, which cannot be measured exactly, we use Stochastic modeling
approach. This modeling strategy helps in predicting the result of this process with
some defined error rate by considering the unpredictability of these factors.

Uncertainty Modeling

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 While using a realistic modeling approach, the system has to take
uncertainties into account. The uncertainty is evaluated to a level where the
uncertain characteristics of the system are modeled with probabilistic nature.

We use uncertainty modeling for characterizing the uncertain parameters with

probability distributions. It takes dependencies into account easily as input just like
Markov chain or may use the queuing theory for modeling the systems where waiting
has an essential role. These are common ways of modeling uncertainty.

Bi-level Optimization
A bi-level issue arises in real life situations whenever a decentralized or
hierarchical decision needs to be made. In these types of situations, multiple parties
make decisions one after the other, which influences their respective profit.

Till now, the only solution to solve bi-level problems is through heuristic
methods for realistic sizes. However, attempts are being made for improving these
optimal methods to compute an optimal solution for real problems as well.

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