9 (J JOURNAL OF BUSINESS LOGISTICS, Volume It), Number 2, 1989

INVENTORY MANAGEMENT:

A COMPARISON OF A TRADITIONAL VS. SYSTEMS VIEW

David J. Closs
Michigan State University

The ongoing interest in cost reductions ttirough improved inventory effectiveness has in-
creased the interest in better approaches to inventory management. Wtiite advances in information
technology offer potential for performance improvements, ttiis articte suggests that significant
inventory improvements require that an overall systems perspective be used. In addition to the
computerized system, the design to actiieve maximum performance must include other functionat
areas, poticies and procedures, atong with technotogy. For eacti major adjustment, the articte
suggests the steps to take to devetop an integrated inventory system.

INTRODUCTION

Inventory management includes the policies and procedures used to set inventory levels,
locations, and replenishment rules with the objective being inventory reduction. Many infor-
mation systems and management techniques have been proposed as approaches to better
manage inventories. '"
While these approaches have improved performance in terms of meeting desired service
levels at lower costs, a total systems perspective considering the functions of purchasing,
production, marketing, and logistics as well as the processes and procedures that integrate them
must be taken to achieve maximum inventory performance.
The traditional inventory management approach has been to develop systems and
capabilities which react to the firm's environments and constraints. In effect, the system is
designed to accept and stochastically deal with these external uncertainties. The information
revolution has allowed this process to become more proactive by allowing firms to time phase
their inventory planning to identify and reduce the impact of ftiture uncertainties. The future
requires inventory management to take a more strategic view as well. The strategic view
suggests a review of the firm's internal and external environment with an objective to modify or
eliminate the binding constraints.
 JOURNAL OF BUSINESS LOGISTICS, Votume Iti, Number2, 1989

OBJECTIVES

This article reviews inventory management from both a traditional as well as the systems
perspective including the typical physical and information flows as well as the major constraints.
The major objective is to identify the tactics to manage inventory from a total systems perspec-
tive and to suggest strategies for removing constraints.

BUSINESS PROBLEM

The distribution channel structure incorporates suppliers, raw material inventories,

manufacturing, field w^u•ehousing, and customer demand as illustrated in Figure 1. As
Bowersox et al. suggest, the objective in such a distribution channel is to meet the desired
4
customer service levels at the lowest total cost. The problem, then, is the identification and
implementation of inventory management policies tbat can effectively meet these objectives.
While there has been significant literature documenting the impact of order cycle and demand
uncertainty on service levels and inventory requirements, there has been limited literature
discussing tbe systematic integration of detailed inventory policies.

THE TRADITIONAL INVENTORY SYSTEM

The inventory system is a series of stages that products pass through as they move from
raw material through to finished product. The system can be characterized by: 1) product and
information flows; 2) objectives; 3) parameters; and 4)inventory management policies. The
following sections discuss these elements and their impact on the system.

Flows
As Figure 1 illustrates, distribution channels include both product and information flows.
The product flow from the supplier to the consumer is characterized by significant economies
of scale in transportation and handling. Traditional inventory management approaches seek to
obtain improved inventory performance through faster product flow. In addition, traditional
policies often seek to optimize inventory performance at a single location at the expense of the
overall system.
The less obvious inventory system flow is information in the form of orders or forecasts.
This bi-directional flow of information requires significant detail and has not historically been
tracked well prior to the economic use of electronic data transmission.
 JOURNAL OF BUSINESS LOGISTICS, Votume 10. Number 2, 19S9

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Inventory Objectives
The inventory function's objectives, which evolve frora the overall logistics channel
objectives, are to provide the desired level of customer service at the minimum total cost. The
desired level of customer service may be measured in terms of fill rates, order cycle time, and
backorder recovery time or, more recently, quality, return policies, and flexibility. The desired
service level is typically set by management based upon a combination of corporate strategy,
customer needs, and competitive pressures. While providing this desired service level, the firm
incurs expenses to purchase, handle, transport, store, and process orders.
The secondary objective is to minimize the total cost of serving these customers. Since
the inventory carrying costs typically total from 20% to 40% of channel operations, effective
inventory management can significantly reduce total channel costs.

Parameters
While the inventory management objectives are obvious, there are significant manage-
ment, product, and economic parameters that are used to meet these objectives within the
firm's economic and operational constraints. In order to understand the requirements for a
systematic view of inventory management, it is necessary to define and discuss these
parameters. The parameters are: 1) Demand Patterns; 2) Order Cycle; 3) Competition; 4)
Forecasting; 5) Scale Economies; 6) Marketing Strategies; and 7) Product Characteristics.
The first parameter is the demand pattern experienced by the firm. While some pat-
terns may be smooth and relatively predictable, most demand patterns incorporate elements of
trend, seasonality, promotions, as well as elements of randomness. Traditional approaches
often take demand as a "given" not subject to change or influence.
The second parameter is the order cycle time which includes the total time for replenish-
ment initiation to shipment receipt. The major uncertainties within this parameter include the
averages and variances associated with communication, order processing, and transportation
lead time.
The third parameter includes competitive tactics and capabilities. While the short term
capabilities might include actions such as trade or retail promotions, longer term competitive
capabilities include width and depth of product line, customer service policies, and inventory
positioning.
The fourth parameter is the firm's ability to develop and apply timely forecasts by
product and location. This ability is demonstrated by both the development of a detailed
forecast through the use of an appropriate technique and the procedures to communicate the
forecast for consistent planning application throughout the firm.
94 JOURNAL OF BUSINESS LOGISTICS, Vi^umem Number Z 1989

The fifth parameter includes the scale economies that are characteristic of the produc-
tion, materials handling, and transportation processes. Due to the nature of the production and
movement technologies, it is usually desirable to operate in large product quantities to mini-
mize per unit costs. As a result, production attempts to produce in large lot sizes, material
handling desires to move product in unit loads, and transportation attempts to move product in
full vehicle loads. As a result of these significant economies, traditional inventory management
methods attempt to consider the economic lot sizes for production and replenishment.
The sixth parameter includes the marketing strategies that require specialized inventory
requirements such as high fill rates or very short order cycle times. While contemporary
logistics policy attempts to direct specialized offerings for key items or accounts, traditional
inventory management techniques have not been designed to provide controls at such a
detailed level.
The last parameter includes the product characteristics such as value and density. The
product's value is a major factor in the cost of maintaining the product in the field. For ex-
ample, it is not desirable to have decentralized inventories for high value items. On the other
hand, inventory movement should be speculative for products that are bulky and relatively
cheap to minimize transportation expense.
The firm can exert various amounts of control on the above parameters. For some of
the parameters such a forecasting and economies of scale, the firm can change performance
through implementation of new hardware, software, or procedures. In other cases, such as
demand patterns, it may be difficult for the firm to change. In either case, the traditional
inventory management view has been to take the above parameters as "givens" which must be
"reacted" to rather than incorporated into the decision process. The following section reviews
some of the approaches used to react to these environments.

INVENTORY MANAGEMENT POLICIES

In order to operationalize the distribution channel and meet its objectives, the firm
utilizes inventory management policies to affect and control inventory movement through the
channel. These policies are designed to decide where to place inventories, when to trigger
replenishment inventory movement, and the size of replenishment shipments or allocation. As
Figtire 2 illustrates, the inventory management policies form the interface between the objec-
tives and the constraints or parameters. Broadly speaking, these policies include combinations
of elements including: 1) Review cycle; 2) Reactive inventory management; and 3) Inventory
planning. Most traditional inventory systems are implemented as a combination of these
 JOURNAL OF BUSINESS LOGISTICS, Volume 10, Number 2, 1989 95

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elements to create management policies which are a trade-off between cost of operations and
service level. The following sections briefly review the characteristics of each of these elements
along with their performance implications.

Review Cycle
The review cycle represents the length of time between reviews of the inventory position
to determine whether a replenishment order or production request Is needed. The inventory
review must include the capability to initiate replenishment action. For example, even if the
inventory position is reviewed each day, if it is not possible to initiate a replenishment order or
a production schedule change until the end of the week, the effective review cycle is actually
weekly. The constraint of only weekly modifications may be due to limitations in modifying the
production schedule, requirements to build vehicle loads, or the purchase order process. As
this review cycle is extended to obtain these economies, the actual order cycle time uncertainty
also increases resulting in a more difficult inventory problem.

Reactive Inventory Management

In addition to defining the appropriate review cycle, inventory management must define
guidelines for initiating decisions. One approach for these guidelines is a reactive or pull
approach where replenishment orders are initiated when the available stock at a warehouse
drops betow a predetermined minimum or reorder point. The order amount is typically based
on a lot-sizing formula although some approaches compute an order quantity based on a target
or maximum level. Although the reorder point and target levels are based on forecasted
demand, the actual physical product movement is postponed until demand is experienced in the
channel.
Although the reactive inventory management approach bas numerous characteristics
which impact its ability to assist in inventory management decisions, the approach was imple-
mented in times when it was difficult to process information regarding the inventory position at
distribution and manufacturing facilities. As a result, reactive inventory management tends to
use guidelines which apply "just-in-case" stock with quick reaction re-supply to meet the cus-
tomer service objectives.

Inventory Planning
Another approach facilitated by the information technology explosion is more proactive
inventory analysis and planning. Inventory planning systems such as Time-Phased Inventory
 97
JOURNAL OF BUSINESS LOGISTICS, Volume 10. Number 2,1989

Management and Distribution Resource Planning (DRP) proactively manage inventory re-
quirements based on forecasted customer needs, order cycle times, capacity availability, and
7
production resources.
The information planning concept attempts to process and manipulate information
rather that speculating with product movement. Rather than allowing each distribution facility
to initiate replenishment orders based upon their individual requirements, the inventory plan-
ning approach attempts to trade-off the distribution site requirements with the manufacturing
capacity. With this centralized viewpoint, as well as the ability to plan into the future, it is less
likely that the demands on either facilities or products would exceed capacities. In addition,
since an inventory plarming approach can consider all products jointly, it is possible to build
loads to take advantage of material handling and transportation economies.

Conclusion - Inventory Management

Most firms use inventory management procedures which incorporate a combination
including aspects of periodic and perpetual review, reactive inventory management, and inven-
tory planning. Historically, most firms have used some form of reactive inventory system due to
a lack of sophistication in terms of communicating and processing the combined inventory and
order system. The successful application of inventory planning systems such as DRP for a
number of firms has increased the interest level for other firms as they attempt to reduce their
inventory investment.
While more sophisticated reactive and inventory planning logics certainly can offer more
effective inventory management, these techniques alone do not provide the total answer for
optimum inventory resource management. However, further increases in inventory productivity
are necessary to maintain competitiveness. While it is possible to further enhance inventory
productivity through more refinements of the inventory management logic and parameters, this
article suggests other strategic adjustments that can provide better returns than parametric fine-
tuning.

A SYSTEMS VIEW OF INVENTORY MANAGEMENT

While an adequate inventory management system is a prerequisite in today's environ-

ment, it will probably not provide the edge necessary to maintain a competitive advantage.
Strategic adjustments to these traditional inventory management approaches offer a potential
means of developing and maintaining this competitive edge. As Figure 3 illustrates, these
strategic adjustments represent refinements to the standard inventory management policies
 JOURNAL OF BUSINESS LOGISTICS, Volume 10. Number 2. 1989

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which can yield enhanced logistics system perfortnance. These adjustmetits can be broadly
categorized into three types: 1) Itiformation based; 2) External operations based; and 3)
Internal operations based. The information based adjustments represent those activities where
information technology is used to foresee or reduce the uncertainty of demands placed on
inventory. The external operations based adjustments are those activities which attempt to
reduce inventory demands through co-operation with external itistitutiotis such as suppliers or
carriers. The internal operations based adjustments are those activities through which inven-
tory demands are reduced through coordination with other firm functions. The following
sections discuss the specific actions that can be used to implement these strategic adjustments.

Information Based Adjustments

The information based adjustments are actions which attempt to use information regard-
ing demands upon inventory resources by manipulating information about consumer demands
rather than maintaining inventories. The traditional inventory management approach is to
accommodate for the demand and forecast uncertainties by utilizing safety stocks of "just-in-
case" inventories. This amounts to using inventory to speculate on the location and timing of
product demands. As such, the traditional approaches attempt to refine what the safety stock
level should be as opposed to looking for an approach to use information about demands so
safety stocks would not be necessaty. The infonnation based adjustment strategies suggest the
capture and early application of demand and order information to allow the logistics system to
move product as the needs are indentified. There are two broad infonnation based adjustment
strategies that can be applied to inventory management. As Figure 3 illustrates, these are
demand management and forecasting.
Demand management is the process of identifying key accounts and developing the
systems and procedures to work with these accounts to match timing and quantity requirements
with the firm's ability to supply products. In general, this capability enables the firm to identi^'
opportunities to match out-of-pattern product requests with the firm's ability to meet these
demands. This does not imply that the firm dictate to customers where and when they buy,
although it could if there is a mutual benefit. However, this does imply thai the firm work
jointly with their customers to identify potential "win-win" situations. The selling firm gains
through a reduction in demand uncertainty by having more knowledge of customer orders as
well as the ability to affect the items, the quantity, and timing of deliveries. The purchasing
firm can benefit through reduced demands upon receiving and storage, more certain availability
of suitable product, and possibly better purchase, delivery, or payment terms.
J (JQ JOURNAL OF BUSINESS LOGISTICS. Votume 10. Number 2, 1989

As part of this demand management process, the firm must be willing to review current
customers and products to identify those that should be dropped for strategic reasons as well.
The requirements to institute a demand management program are; 1) identification of the
major accounts and products whose demands significantly impact distribution system require-
ments; 2) development of a mutually beneficial set of trade-offs that can be used to offset the
abili^ to modify demand requirements; 3) institution of a procedure to provide timely iden*
tiflcation of orders that should be coordinated and the follow through of the required
negotiations; and 4) ongoing review of customers and products for inclusion in the demand
management program or potential deletion.
The second information based resource that can improve distribution inventory effec-
tiveness is forecasting. Since the inventory management system attempts to schedule product
availability to meet forecasted demands, its effectiveness is significantly impacted by the ac-
curacy of the forecast. There are two requirements for developing an effective short-term
forecast for inventory management. The first, and most obvious, is the forecast technique. The
technique includes the quantitative calculations which generate the forecasts on the basis of
history of other observed relationships. Typical forecast techniques include moving averages,
exponential smoothing, and regression. The second, and equally important element for effec-
tive forecast development is the procedure used to develop, coordinate, and integrate the
forecast into the firm's planning functions. This includes activities to develop consistent
forecasts between all firm functions, the timely integration of this forecast into all firm planning
functions such as procurement, production, finished goods inventory management, along with
marketing and sales.
While the precise forecast technique is sometimes the source of the accuracy problems,
the overall procedure is often a larger problem such as when the most current information
regarding sales projections and activities are not communicated throughout the orgatiization in
a manner that is timely enough to impact inventory stock levels. Two firms have told the
author of their experience where forecast errors have been reduced by 30% or more due simply
to improved communications and consistency throughout the firm. The tasks required to
improve inventory management through more effective forecasting are: 1) insure timeliness
and consistency between all firm functions; 2) insure that all available information is used in
forecast generation; and 3) use forecast techniques that are appropdate with the needs of the
application.
The above two strategic adjustments offer more effective inventory management by
improving the information upon which inventory allocation decisions are made.
 JOURNAL OF BUSINESS LOGISTICS, Volume 10, Number 2. 1989 101

External Operations Adjtistments

Unlike the information based adjustments which utilize information to better predict or
control demands placed upon inventory, the external operations adjustments attempt to reduce
inventory demands by minimizing external uncertainties. TTiese strategic adjustments suggest
(he coordination of inventory levels throughout the channel both inside and outside of the firm
to reduce the uncertainties associated with inventory planning. There are two broad-based
categories of external operations based adjustments. As Figure 3 illustrates, these are order
cycle time adjustments and product mix adjustments.
The order cycle time impacting inventory management includes order communication,
order processing, and transportation components. The replenishment may be from a distribu-
tion facility at another echelon in the channel, an outside supplier, or a production site. While
the firm's performance is influenced by both the average length and variance of this order cycle,
research has indicated that the major contributing factor for inventory performance is the
9
uncertainty in the order cycle.
Recent advances in both information processing capability and transportation
availability and performance offer opportunities for reducing the average time and improving
the consistency of the order cycle. Specifically, electronic data interchange (EDI) and
computer-to-computer ordering can reduce the elapsed time between realization of need and
receipt of the correct replenishment order at the supply point.
On the delivery side, the availability and maturation of alternative carrier types such as
premium air or package carriers, contract carriers and multi-modal suppliers offer oppor-
tunities for re-assessing the current carriers and suppliers with an objective to reduce
uncertainty.
As an example of an order cycle adjustment, the firm would probably obtain better
inventory performance by using a more consistent mode of communication or transportation
rather than attempting to parameterize the inventory management system to deal with the
uncertainty. The requirements for instituting these adjustments are; 1) identification of sourc-
ing and transportation alternatives; 2) evaluating the economic and operational impact of the
alternatives; and 3) implementation.
The second external adjustment is the modification or control of the product mix such as
a reduction in the number of stock keeping units through postponement of final product
fabrication. While such a strategy is not new, examples of form and temporal postponement
offer significant opportunities for reducing inventory management system demands.
Realizing that current and future marketing strategies require that product characteris-
tics be refined to meet the needs of specific market segments, inventory management must
IQ 2 JOURNAL OF BUSINESS LOGISTICS, Volume 10, Number 2, 1989

nevertheless be in a position to identify the implications of these strategies and influence their
implementation. As an altemative to reducing the effective number of stock keeping units
through package reduction or product coordination, the finalization of the product form can be
postponed until the last possible minute.
The process of reducing inventory demands by modifying product should be approached
as two tasks. First, the existing product line should be audited to identify opportunities for
consolidation or postponement. Second, there should be an inventory management impact
review of proposed product line or package extensions. The role of this review is to insure that
the firm proceeds into the extension with the "eyes open" from the perspective of the inventory
and service impacts.
The above two strategic adjustments reduce the demands that are placed upon inventory
management to meet service objectives in two \vays. The first reduces the amount of variance
placed upon the system by reducing the length and increasing the consistency of order cycles.
The second would further reduce the uncertainty by aggregating the demands into fewer items.

Internal Operations Adjustments

The fmal set of strategic adjustments is in the form of modifications to the inventory
management and production scheduling processes. These modifications suggest the review and
possible adjustment of the policies, procedures, and information systems used to manage
inventories and schedule production. This use of internal adjustments attempts to accurately
balance the trade-offs between customer service requirements, environmental uncertainty,
production economics, and management capabilities.
As Figure 3 illustrates, the internal operations adjustments are the inventory manage-
ment process and the production planning process. Each category is described briefiy below
along with the guidelines for implementation.
The inventory management methodology includes the systems and procedures used to
make the "when," "where," and "how much" inventory decisions. Historically, this has often
implied the use of some type of re-order point and quantity logic or allocation procedure. In
more recent times, inventory planning logics and DRP have received significant interest. In
both cases, the objective is to use the available information processing technologies to control
inventory movements. The concept is to better control the movements rather than speculate
with actual product. The system includes the computerized routines to track inventory levels,
identify when replenishment is required, and schedule replenishment. The corresponding
inventory management procedures include the human and other non-system interfaces that are
required to make the total package operate. This includes, but is not limited to, accurate
 JOURNAL OF BUSINESS L0GIST7CS, Volume 10, Number 2, 1989 10S

inventory level balances, forecasts, production schedules, along with known shortages and
overages.
This strategic adjustment requires that the firm accurately assess its requirements and
capabilities and then implement the system and procedures that are consistent with those. The
requirements and capabilities include inventory control accuracy, timeliness of data, personnel
expertise and training, and system capabilities. The system should ideally represent a trade-off
between providing reasonable replenishment suggestions for management to implement while
also being able to identify inventory decisions which require management involvement TTie
tasks required to implement such a system are: 1) identification of the system and procedural
interfaces; 2) evaluation of the inventory management alternatives; 3) selection and modifica-
tion of the inventory management option; 4) development of system parameters; 5) training;
and 6) implementation.
The second internal adjtistment is the re-evaluation and potential integration of the
production scheduling process with the finished goods inventory requirements. In many firms,
the production scheduling process is usually accomplished independently of the finished goods
inventory management process with an objective to minimize production costs. Since many
production operations involve economies of scale, there is often a tendency to schedule with
longer production run lengths. This strategic adjustment requires an assessment ofthe relative
production economies compared to the distribution planning and the service requirements. For
example, with shorter production runs, distribution is not forced to maintain extensive finished
good inventory levels nor is it required to forecast for correspondingly long periods between
runs. In some situations, it has been found that the increase in the production cost is more than
offset by the reduction in the inventory carrying cost required to meet desired service levels.
The tasks required to implement this adjustment are: 1) evaluation of the production sched-
uling procedures and trade-offs; 2) test the trade-offs between production cycles, inventory
levels, and service level; and 3) identify the optimal strategy to minimize total system costs.

CONCLUSION

This article positions the process of inventory management within the firm's require-
ments, capabilities, and parameters. The current focus on inventory reductions has placed
more emphasis on sophisticated inventory management logics and parameters. This article
suggests that in order to achieve maximum inventory performance, it is necessary that manage-
ment take an overall systems perspective of the inventory management process. The system
must include much more than the computerized inventory management programs and
104 JOURNAL OF BUSINESS LOGISTICS, Votume 10, Number Z 1989

parameters. In addition, the firm needs to utilize strategies to reduce the constraints on inven-
tory management through reductions of the internal and external constraints. While the
computerized inventory management system may be a necessary condition for improved inven-
tory performance, it is not a sufficient condition. The article has identified the interfaces that
must be considered when attempting to develop an inventory management approach that
maximizes overall system performance.

ENDNOTES

t. Herron, David P., "Integrated Inventory Management." Journal of Business Logistics.

Volume 8, Number 1, (1987), pp. 96-99.
2. Jackson, George C, "Just-in-Time Production: Implications for Logistics Managers,"
Journal of Business Logistics. Volume 4, Number 2 (1983), pp. 1-19.
3. For discussions of inventory planning, see: Buffa, Elwood S. and Jeffrey G. Miller;
Production-Invemorv Svstems Planning and Control. (Homewood, IL: Richard D. Irwln,
Inc. 1979), pp. 171-193. Also, Martin, Andre J.. DRP Distribution Rgjiource Planning.
(Englewood Cliffs, NJ: Prentice-Hall, Inc., 1983), pp. 1-10. Also, International Business
Machines, "Inventory Forecasting and Replenishment Modules - II Base," (International
Business Machines, 1981), pp. 1-24.

4. Bowersox, Donald J., Phillip L. Carter, and Robert M. Monczka, "Computer Aided
Purchasing, Manufacturing, and Physical Distribution Coordination Materials Logistics
Management," Proceedings of the 1984 Annual Meeting of the National Council of
Physical Distribution Management (Chicago, IL: 1984), pp. 131-142,

5. Bowersox, Carter, Monczka, p. 133.

6. Peterson, Rein and Edward A. Silver, Decision Sysjgms for Inventory Maggggpient and
Production Planning. (New York: John Wiley & Sons, 1979).

7. Buffa and Miller, pp. 186-192. Also Martin, pp. 1-10.

8. Martin, pp. 1-10.

9. Speh, Thomas W. and George D. Wagenheim, "Retailer Logistics Problems: Impacts on
Supplier Marketing Strategy," in Robert G. House and James F. Robeson, Eds.,
Interfaces: Logistics, Marketing, and Production. Proceedings of the Sixth Annual
Transportation and Logistics Educator's Conference, (Columbus, Ohio: The Ohio State
University, 1976), pp. 105-110.
10. Bowersox, Donald J., David J. Closs, and Omar K. Helferich, Logistical Management.
(New York: Macmillan Publishing Co., 1986), pp.57-58.
 JOURNAL OF BUSINESS LOGISTICS, Votume 10, Number 2,1989

ABOUT THE AUTHOR

Dr David J Closs is Associate Professor of Marketing and Logistics at the Graduate
School of" Business Administration, Michigan State University. For the past two years^Dr
Closs has served as the President of Dialog Systems, Inc.. a logistics consulting and software
company Dr. Closs has worked extensively in the development and application of computer
models in logistics for both research and industiy applications^ One o the P""\aO' f f^f ^^
focus for these applications has been invemory management and forecasting. Dr. Closs is a co-
author >.fingkv>.iM.nH,.ement and numerous articles discussmg logistics strategy, inventory
management, and information systems.