Explain the three inventory control models and the driving factor in each model. Provide examples for each one using current companies.
The three inventory control models and their driving factors are:
1. Economic order quantity - this inventory control model is used to determine that order size that will help in minimizing the ordering costs and the carrying costs. All other costs are assumed to be constant. The average level of inventory is order quantity/2. The driving factor for this model is the need to minimize the ordering costs and the carrying costs.
For example, Procter and Gamble (P&G) uses EOQ as an inventory optimization and control model. It tries and minimizes its ordering and carrying costs for various SKUs (stock keeping units) through this model.
2. ABC analysis - This inventory control model analyses which items in inventory are more important and which items are less important. An organization's inventory is divided into three groups - A, B, and C. The A group has the items that are critical to the functioning of the organization. Items in the B group are important but not critical. Items in the C group have the least importance in the company's operation. The driving factor is the fact that some inventory items are more important than others.
For example, San Miguel uses ABC analysis to determine which items are critical, important and not very important. The company makes ice creams, dairy products, beer, etc. Ingredients used are milk, sugar, preservatives, malt, hops and chemicals. Different items are categorized as per their level of importance.
3. Safety stock - It is the additional stock that is kept on hand so as to avoid stock outs. This helps in reducing losses due to stock outs. Safety stock can be determined by calculating the stock out costs, the service level and the probability of a stockout. The driving factor is that stock outs should be avoided.
For example, 3M calculates its reorder point by taking safety stock into consideration.
Using one of the companies, describe how inventory planning and accuracy can be defined using the Pareto principle?