Question

Explain the three inventory control models and the driving factor in each model. Provide examples for each one using current companies.

Answer 1

ABC Control

ABC inventory control is a method of classifying and controlling inventory according to its level of importance. Typically, dollar usage serves as the criteria used to determine importance, but other criteria, such as sales volume, also gets used. ABC inventory control works on the old 80/20 rule--a small amount of items normally dominate the results in most situations.

Italian economist Vilfredo Pareto was the first to observe this principle, now known as Pareto’s Law. The ABC inventory method classifies items into groups according to pre-determined criteria. “A” class items receive the highest priority and tightest control. For example, a company performs a Pareto analysis using dollar usage as the criteria and decides to hold only two-weeks worth of class “A” inventory, one-month of class “B” inventory and three-months of class “C” and “D” inventory. Because the class “A” inventory has the greatest dollar usage, the company focuses on reducing the on-hand inventory of this class of items. This reduction increases inventory turns and thus reduces the carrying cost associated with holding the inventory.

Aggregate Control

Another inventory control method involving groups is the aggregate control method. Using this method, a business classifies its inventories into separate groups, each receiving a different level of inventory control. For example, a bakeshop might use three different classifications—ingredients such as flour, sugar and cream comprise one classification, work-in-process or partially finished items comprise the second classification and finished goods or items ready to sell make up the third classification. The way the bakeshop controls each class of inventory depends on the rules established for that class. For example, all ingredient inventories might use a minimum/maximum policy--whenever the inventory reaches a minimum level, the bakeshop orders more inventory to reach its maximum inventory level.

Safety Stock

Some companies use a very basic method of inventory control called safety stock. Companies use safety stock because of the uncertainty of consumer demand, uncertainty of supplier performance or uncertainty of product availability. Safety stock represents an amount over and above the average use or demand of a product. For example, a bakeshop’s monthly flour usage averages 300 pounds. Because the bakeshop uses a special process to procure flour, it always keeps an additional 50 pounds on hand to cover the uncertainty of supply. Using safety stock to control inventory increases a company’s cash outlay, plus it increases the carrying cost associated with owning inventory.

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