Plan and Manage Inventory

Exam weight: approximately 14% of scored questions.

Inventory is the shock absorber of the supply chain — and one of its largest investments. Too little and customers wait; too much and cash stagnates. This chapter, the exam's heaviest domain, covers planning inventory levels, managing replenishment, controlling costs, keeping records accurate, and handling returns.

A. Inventory Planning

Target Inventory Levels and Service Goals

Target inventory levels translate service and financial goals into stock numbers. Higher service targets require more inventory; tighter financial goals require less. The planner calculates the level that hits the chosen point on that trade-off — and makes the trade-off explicit rather than letting it emerge by accident. Sourcing risks (financial, political, transportation, environmental) push targets upward: riskier supply needs more buffer.

Stocking Trade-offs Across Environments

Trade-offs among stocking levels, customer service, sustainability impact, and network constraints differ by environment. MTS finished goods protect service directly; MTO environments hold component buffers instead; perishable or hazardous goods add regulatory and waste constraints that pure cost-service math misses.

Centralized vs. Decentralized Inventory

• Centralized: stock pooled in fewer locations. Risk pooling reduces total safety stock (variability cancels across locations); but customer lead times lengthen and transportation costs rise.
• Decentralized: stock forward-positioned near customers. Faster service; more total inventory because each location buffers its own variability.

Types of Inventory

• Raw materials: inputs awaiting production.
• Work in process (WIP): started but not finished.
• Semifinished goods: partially completed, storable intermediates.
• Finished goods: ready for the customer.
• Floor stock: low-value consumables at the point of use.
• MRO (maintenance, repair, and operating) supplies: keep the plant running, not the product.

Classifications of Inventory

• Cycle (lot-size) stock: from ordering in batches larger than immediate need.
• Seasonal/anticipation stock: built ahead of known demand peaks, trends or promotions^[1].
• Hedge stock: a buffer against a contingent event such as a price increase or a strike^[1].
• Decoupling stock: between operations so one stoppage does not halt the line.
• In-transit (pipeline) stock: moving between locations^[1].
• Consignment stock: at your site, paid for only when used^[1].
• Point-of-use stock: at the consuming workstation.
• Service parts: for warranty and repair obligations.
• VMI stock: managed by the supplier.
• Excess, obsolete, and scrap: the classifications planners work to minimize.

Item Segmentation

Not every SKU deserves equal attention. ABC classification segments by annual usage value: A items (roughly 80% of value, 20% of items, under the 80/20 Pareto rule^[1]) get tight control and frequent review; C items get simple rules. Further segmentation by perishability, hazardous materials, special handling, supply risk, and customer risk directs appropriate policies to each segment.

B. Inventory Management

Push vs. Pull Replenishment

• Push: supply is allocated from a central plan (MRP, DRP) based on forecasts and requirements.
• Pull: replenishment is triggered by actual consumption (reorder point, kanban).

Replenishment methods:

• MRP: time-phased explosion of dependent demand.
• DRP (distribution requirements planning): time-phased replenishment across the distribution network.
• Reorder point (ROP): order when inventory falls to the ROP (demand during lead time + safety stock)^[2].
• Periodic review: order at fixed intervals up to a target level^[2].
• Visual review / two-bin system: the empty first bin is the reorder signal^[1] — simple, robust, low-tech.
• Min-max system: order when below min, up to max.
• Kanban systems: cards or signals pull replenishment through production and supply.

Dynamic vs. Fixed Lot-Sizing

The Exam Content Manual groups the lot-sizing techniques this way:

• Dynamic techniques: lot-for-lot (L4L) (order exactly the net requirement^[1]; minimal inventory, maximum orders), fixed order quantity (FOQ), and landed cost considerations.
• Fixed techniques: economic order quantity (EOQ) and period order quantity (POQ).

EOQ finds the order quantity that minimizes total variable inventory cost — the trade-off between ordering costs (fewer, larger orders) and carrying costs (more average inventory): "to find that particular quantity to order which minimizes the total variable costs of inventory"^[3]. The EOQ answers how much to order; the reorder point answers when^[4]. Under constant demand, average inventory is half the order quantity, so larger lots directly raise carrying cost.

Safety Stock and Days of Supply

Safety stock buffers against demand and lead time variability. It is calculated from inventory costs and customer service level objectives: higher service targets need larger safety stocks. Under constant demand and lead time, the reorder point is simply demand during lead time; variability adds the safety stock term^[5]. Standard Z values for cycle service level: 1.29 ≈ 90%, 1.65 ≈ 95%, 2.33 ≈ 99% — higher Z lowers stockout risk but raises average inventory^[5]. Days of supply (DOS) expresses the same protection in time units (inventory ÷ average daily usage).

MRO Inventory Management

MRO inventories are managed on reliability inputs rather than product demand: mean time between failures (MTBF), mean time to repair (MTTR), mean time to failure (MTTF), plus forecasts and sales history. A critical spare for a high-MTBF/low-MTTR asset needs different treatment than a wear part on a failure-prone machine.

Special Handling

Comply with regulations, environmental standards, and protocols for materials handling, personal protective equipment (PPE), and safety. Hazardous, perishable, and controlled materials carry handling requirements that override standard inventory logic.

C. Monitor and Manage Inventory Costs

Carrying, Ordering, and Stockout Costs

• Total carrying costs: capital, storage, insurance, taxes, obsolescence, shrinkage — everything paid to hold inventory for a year^[6].
• Total ordering costs: the fixed cost per order (processing, setup, receiving) times order frequency.
• Total stockout costs: lost margin, expediting, customer penalties, lost goodwill — the opportunity cost of not meeting demand^[1].

The EOQ trade-off is carrying vs. ordering; the service-level trade-off adds stockout costs. All three must be visible — optimizing one in isolation misleads.

Inventory Valuation Methods

• FIFO (first in, first out): earliest costs go to cost of goods sold; most recent costs remain in ending inventory^[1].
• LIFO (last in, first out): latest costs go to COGS; earliest remain in inventory^[1].
• Average cost: COGS and inventory at the weighted average unit cost — cost of goods available for sale divided by total units^[7].
• Transfer pricing: the price at which goods move between divisions or subsidiaries (with tax implications).

In rising prices, FIFO reports higher profits (old cheap costs to COGS) and LIFO lower; the choice affects taxes, reported earnings, and behavior.

Standard vs. Actual Cost

Compare projected/standard cost versus actual cost and investigate variances — purchase price variance, usage variance, overhead variance. Persistent variances signal that standards (or the process) need updating.

Inventory Metrics

• Inventory turns: cost of goods sold ÷ average inventory value^[1]. Higher turns mean leaner, faster-moving inventory.
• Days of supply (DOS): inventory on hand ÷ average daily usage (or COGS ÷ 365). Turns and DOS are reciprocals scaled by 365^[1].

D. Inventory Control

Storage, Flow, and Material Handling

Manage locations and quantities considering trade-offs among storage methods, flow, material handling options, and transaction management:

• Stock location systems: fixed (each SKU has a home) vs. random (system assigns space) — random uses space better, fixed is simpler to manage.
• AS/RS (automated storage/retrieval systems): density and accuracy at capital cost.
• VMI and consignment: ownership and management alternatives.
• Hazardous materials: segregated, compliant storage.

Inventory Accuracy

Monitor accuracy through audit programs, physical inventory, cycle counting, and spot checks. Cycle counting — counting a few SKUs daily on a rotating schedule (A items most often)^[1] — sustains accuracy without wall-to-wall shutdowns. Accuracy targets should reflect the cost of being wrong: MRP multiplies record errors into wrong orders.

Reducing Inaccuracy and Loss

Sources of inaccuracy: put-away errors, picking errors, BOM errors, registration/transaction errors, data entry errors, labeling errors. Sources of loss: shrinkage, scrap, theft, shelf-life expiration, damage. Attack each with its own countermeasure — better transactions for inaccuracy, security and handling for loss.

Traceability and Tracking

Track inventory from origin to final destination:

• Advance ship notice (ASN): electronic notice of incoming shipments.
• Identification and traceability: country-of-origin declarations, documentation, chain of custody and integrity.
• Tracking techniques: barcoding, RFID tagging, IoT sensors, location intelligence, satellite.
• Standards: ISO traceability standards, GTIN (global trade identification number).
• Lot control and serial numbers: granularity for recalls and quality containment.
• Product recall guidelines: the procedures that make traceability pay off when it matters most.

Monitor off-site/deployed inventory and assets: tooling at suppliers, consigned equipment, customer-owned materials, supplier-owned materials — what you cannot see, you cannot manage.

E. Manage Returns and Product Disposition

Reverse Logistics

Manage reverse logistics around the waste hierarchy, respecting company acceptance guidelines, regulatory requirements, recall guidelines, and customer expectations. Returns are not just cost — they are a customer-service and sustainability touchpoint.

Timing and Volume of Returns

Monitor the timing and volume of returned deployed inventory and assets — rentals, leases, subscriptions, samples. Returns have their own demand pattern; planning for them reduces surprise.

The Waste Hierarchy and Disposition

The waste hierarchy ranks management strategies from most to least environmentally preferred^[8]. In EPA's version the order is source reduction and reuse → recycling and composting → energy recovery → treatment and disposal, and source reduction (waste prevention) is the most preferred strategy^[8]. Keeping a returned product in use — reuse, repair, refurbishment, remanufacturing — therefore ranks above breaking it down for recycling, and remanufacturing is treated as a form of source reduction^[8]. Disposal is always last. Disposition decisions support sustainability, quality, financial, and supply goals simultaneously — a remanufactured return can become sellable inventory, not scrap. Circular economy implications include company rules, regulations, environmental standards, product costs, ownership models, lead times, life cycle assessment (LCA), distressed goods, and material handling.

Alternate Providers for Reverse Logistics

Evaluate 3PL providers and brick-and-mortar locations for returns processing — specialized handlers often process returns cheaper and faster than the forward network run backward.

Key numbers & deadlines

Key takeaways

• Set target inventory from explicit service-vs.-financial trade-offs; ABC segmentation focuses control where the value is.
• EOQ balances ordering against carrying cost (how much); ROP with safety stock answers when; Z-values (1.29/1.65/2.33) link service targets to buffer size.
• Track the full cost picture: carrying, ordering, and stockout costs; valuation (FIFO/LIFO/average) shapes reported profit and taxes.
• Accuracy is a prerequisite — cycle counting, transaction discipline, and traceability (ASN, RFID, lot/serial, GTIN) keep records honest.
• Manage returns through the waste hierarchy (prevent → disposal) and circular-economy thinking; disposition is a value decision, not just waste handling.

Chapter 6 quiz — 21 questions

Answer each question, then check the key that follows.

1. Which of the following is an inventory carrying cost?

• A. Purchase price of the item
• B. Storage, insurance and obsolescence
• C. Inbound freight charges
• D. Cost of issuing a purchase order

2. Ordering costs include:

• A. Taxes on stock owned
• B. Rent for warehouse space used
• C. Insurance on inventory held
• D. Placing and receiving orders

3. The cost of placing each order rises while demand and holding cost stay the same. What happens to the economic order quantity?

• A. It falls to lot-for-lot
• B. It stays the same
• C. It decreases
• D. It increases

4. At the economic order quantity, how do annual ordering cost and annual holding cost compare?

• A. Holding cost is twice ordering cost
• B. Ordering cost is twice holding cost
• C. They are equal
• D. Holding cost is zero

5. If annual demand is 10,000 units, ordering cost is $50, and holding cost is $2/unit/year, EOQ is:

• A. 500 units
• B. 1,000 units
• C. 1,414 units
• D. 707 units

6. Daily demand averages 50 units, the supplier's lead time is 4 days and safety stock is 75 units. What is the reorder point?

• A. 125 units
• B. 275 units
• C. 200 units
• D. 350 units

7. Safety stock protects against:

• A. Known seasonal demand patterns
• B. Regular replenishment cycles
• C. Planned promotional increases
• D. Demand and lead-time variability

8. Which inventory valuation method assumes the oldest units are sold first?

• A. Specific identification method
• B. FIFO (First-In, First-Out)
• C. Weighted average cost method
• D. LIFO (Last-In, First-Out)

9. Under rising prices, FIFO produces:

• A. Lower net income than LIFO
• B. Higher COGS than LIFO reports
• C. Higher ending inventory than LIFO
• D. Lower taxes than LIFO incurs

10. The weighted average cost method calculates:

• A. Average cost of units available
• B. Cost of the oldest units held
• C. Cost of the most recent purchase
• D. Replacement cost at market prices

11. Cycle counting is preferred over annual physical inventory because it:

• A. Eliminates the need for safety stock
• B. Increases order quantities placed
• C. Reduces the number of SKUs stocked
• D. Keeps records accurate, less disruption

12. ABC analysis classifies items by:

• A. Alphabetical order by description
• B. Physical size and weight
• C. Annual dollar usage volume
• D. Supplier lead time length

13. A items in ABC analysis typically represent:

• A. 5% of items, 50% of value
• B. 50% of items, 5% of value
• C. 20% of items, 80% of value
• D. 80% of items, 20% of value

14. Which of the following is a dependent demand inventory?

• A. Raw materials for production
• B. Retail merchandise on shelves
• C. Service parts for field repairs
• D. Finished goods awaiting shipment

15. A distributor's annual cost of goods sold is $2,400,000 and its average inventory at cost is $400,000. What is its inventory turnover?

• A. 6 turns per year
• B. 16.7 turns per year
• C. 60 turns per year
• D. 0.17 turns per year

16. A stockout cost includes:

• A. Lost sales and expediting expenses
• B. Lower inventory holding charges
• C. Reduced warehouse space needs
• D. Decreased insurance premiums

17. Which inventory policy orders a fixed quantity when stock hits ROP?

• A. Continuous review (Q) system
• B. Optional replenishment method
• C. Periodic review system
• D. Base stock policy approach

18. In a periodic review system, orders are placed:

• A. When suppliers offer discounts
• B. At fixed time intervals
• C. When inventory hits zero level
• D. Only during annual counts

19. The two-bin system is a simple form of:

• A. Visual continuous review method
• B. Computerized MRP planning logic
• C. ABC classification analysis
• D. Periodic review inventory control

20. Dead stock refers to inventory that:

• A. Has high turnover rates
• B. Has no demand and will not sell
• C. Arrived damaged from suppliers
• D. Is stored in remote warehouses

21. Which of the following reduces inventory holding costs?

• A. Raising safety stock levels
• B. Shorter, steadier lead times
• C. Increasing order quantities
• D. Adding more warehouse locations

Sources cited in this excerpt

1. CSCMP Supply Chain Management Terms and Glossary (2013). https://www.cisco-eagle.com/uploads/cscmp/cscmp-glossary.pdf
2. The Business Behind the Business (UEN Pressbooks) — Planning Inventory. https://uen.pressbooks.pub/scmintro/chapter/planning-inventory-how-much-is-too-much/
3. Spreadsheet Operations Manager, Chapter 3: Inventory Management. University of Houston (Bauer College of Business), University of Houston Bauer College, Spreadsheet Operations Manager Chapter 3. https://bauer.uh.edu/departments/disco/som/ (chapter PDF)
4. Economic Order Quantity (EOQ) Model: Inventory Management Models: A Tutorial. NC State University, Supply Chain Resource Cooperative, NC State University, Supply Chain Resource Cooperative tutorial. https://scm.ncsu.edu/scm-articles/article/economic-order-quantity-eoq-model-inventory-management-models-a-tutorial
5. Safety Stock Analysis: Inventory Management Models: A Tutorial. NC State University, Supply Chain Resource Cooperative, January 28, 2011. https://scm.ncsu.edu/scm-articles/article/safety-stock-analysis-inventory-management-models-a-tutorial
6. Bauer et al., Chapter 3 Inventory Management. https://bauer.uh.edu/departments/disco/som/ (chapter PDF)
7. Inventory Costing Methods. Texas State University, Texas State University (course material). https://gato-docs.its.txst.edu/ (Inventory Costing Methods PDF)
8. US EPA, Sustainable Materials Management: Non-Hazardous Materials and Waste Management Hierarchy.