Chapter II - Theoretical Background

Review of Related Literature

It is a well-known fact that running and managing a florist business

can be a daunting task. A professional florist needs to have in-depth

knowledge about the flowers and the industry if he/she really wants to taste

success for a long-term. The right combination of planning and management can

take your florist business on the next level of success and profitability.

Since flowers belong to a category of products which have very short shelf-

life, a florist business owner needs to have Inventory Management to reduce

or avoid losses.

The Concept of Inventory Management

Inventory refers to the value or quantity of raw materials, supplies,

work in progress (WIP) and finished stock that are kept or stored for use as

need arises (Lyons and Gillingham, 1981). Raw materials are commodities such

as steel and lumber that go into the final product. Supplies include items

such as Maintenance, Repair and Operating (MRO) inventory that do not go into

the final product. Work in progress is materials that have been partly

fabricated but are not yet completed. Finished goods are completed items

ready for shipment (Kothari, 1992).

Inventory management is the art and science of maintaining stock levels

of a given group of items incurring the least cost consistent with other

relevant targets and objectives set by management (Jessop, 1999). It is

important that managers organizations that deals with inventory, to have in

mind, the objective of satisfying customer needs and keeping inventory costs

at a minimum level. Drury (2004) asserts that inventory costs include holding

costs, ordering costs and shortage costs. Holding costs relate to costs of
having physical items in stock. These include insurance, obsolescence and

opportunity costs associated with having funds which could be elsewhere but

are tied up in inventory.

Ordering costs are costs of placing an order and receiving inventory.

These include determining how much is needed, preparing invoices, transport

costs and the cost of inspecting goods. Shortage costs result when demand

exceeds the supply of inventory on hand. The costs include opportunity costs

of making a sale, loss of customer goodwill, late charges and similar costs.

Inventory Management

Inventory management permeates decision-making in countless firms and

has been extensively studied in the academic and corporate spheres (Rosa et

al. 2010). The key questions – usually influenced by a variety of

circumstances – which inventory management seeks to answer are: when to

order, how much to order and how much stock to keep as safety stock (Namit

and Chen 1999; Silva 2009). According to Wanke (2011a), inventory management

involves a set of decisions that aim at matching existing demand with the

supply of products and materials over space and time in order to achieve

specified cost and service level objectives, observing product, operation,

and demand characteristics.

Inventory management or control is something that should be front-of-

mind for anyone in the wholesale distribution business. According to

Carr(2015) “Understanding what you have, where it is in your warehouse, and

when stock is going in and out can help lower costs, speed up fulfillment,

and prevent fraud”. When you have control over your inventory, you’re able to

provide better customer service. It will also help you get a better, more

real-time understanding of what’s selling and what isn’t. Key to proper

inventory management is a deeper understanding of customer demand for your

products. Inventory management is vital to the survival of your business. If

you don’t have a good handle on your inventory you’ll never have a true

account for how your business is doing. It’s a competitive market out there.

Don’t let inventory excess or shortages become your downfall.

According to a survey conducted by the Aberdeen Research Group, 56% of

supply chain professionals participating reported that improving inventory

management was a top priority. The process of determining which items to

stock, how many to keep in each warehouse, and when to order more from

suppliers involves several functions, including physical inventories and

effective inventory planning and optimization.

METHODS OF INVENTORY MANAGEMENT

Choosing the most adequate inventory management model is essentially an

empirically-based decision that may involve the use of simulation, scenario

analysis, incremental cost analyses (Silva 2009; Rosa et al. 2010; Rego and

Mesquita, 2011; Wanke 2011b) or qualitative conceptual schemes also known as

classification approaches (Huiskonen 2001). The latter usually considers that

the impact of product, operation and demand characteristics constitute

intervening .An analysis of the literature dealing with inventory management

model selection shows that it originally focused on production and

distribution environments in which demand and lead time tend to be more

predictable or, in other words, in which it is easier to answer the questions

of “what” and “how much” to order (Wanke and Saliby, 2009; Wanke 2011b; Rosa

et al. 2010). However, there is a growing literature related to the specific

problems raised by low and very low consumption items such as spare parts

(Botter and Fortuin 2000; Silva, 2009; Rego and Mesquita 2011; Syntetos et

al. 2012).
 Closer management of the supply chain to try to ensure the right

product is delivered at the right time to the right place in the right

condition is a driving ethos of supply chain management, and where the

product is perishable the task is even more challenging. Perishable items

that become spoilage impact directly on the profit of the business and the

customer service level. The management of the replenishment policy will

directly impact on these items and it is critical to analyze and manage the

process.

“The two best methods to reduce spoilage is to have rigorous inbound

quality testing and rejection of marginal inputs and to turn inventory

quickly and carry as little inventory as possible. Having the flexibility to

balance these variables and still maintain customer satisfaction requires

good information about supplier quality and systems which can deal with lots

and lot quality rankings.” -PHILIP BRUNS (2012), United States

The analysis of inventory systems is primarily focused on the tactical

question of which inventory control policies to use and the operational

questions of when and how much inventory to order. By and large, these are

the main questions for managing the inventory of perishable items as well.

In order for an organization to survive and be effective in meeting

their market demand, the organization must be cognizant of its supply chain

management for better performance and sustained survival. The reason of

carrying inventory management practices is to ensure regular supply of

materials as and when required. A robust inventory management is required to

be in place to ensure timely delivery and quality standards are observed. For

organizations to survive they need to embrace the changing competitive trends

in the market.

Importance of Inventory Management

 Inventory management practices are very vital to the competitiveness of

organizations. As such, inventory management practices affect profit

maximization, customer satisfaction, market share growth and product quality

targeting return on investment, Inventory shrinkage, inventory investment and

inventory turnover affects the competitiveness of an entity. To avoid

carrying of excess inventory that might be a risk to the Company, accurate

forecast, (supply & demand) should be in place. The management of an entity

needs to have its modernize inventory management system to increase

efficiency. To curb various challenges in the Company, the management should

consider implementation of a vendor managed inventory to lower incidences of

stock-out situations, increase the levels of customer services and reduce

costs due to an increase in inventory turnovers and a decrease in the levels

Forecasting and optimization have traditionally been approached as two

distinct, sequential components of inventory management: the random demand is

first estimated using historical data, then this forecast (either a point

forecast of the future demand or a forecast of the distribution) is used as

input to the optimization module. In particular, the primary objective of

time series analysis is to develop mathematical models that explain past

data; these models are used in making forecasting decisions where the goal is

to predict the next period’ observation as precisely as possible. To achieve

this goal, demand model parameters are estimated or a distribution is fitted

to the data using a performance metric such as Mean Square Error, which

penalizes overestimating and underestimating the demand equally. In practice,

however, the optimization model penalizes under- and over-predictions

unequally, e.g., in inventory problems backorder is viewed as particularly

undesirable while holding inventory is more tolerated. In such a setting, the

decision-maker places an order in each time period based on the demand

prediction coming from the forecasting model, but the prediction of the

forecasting model does not take into account the nature of the penalties in
the optimization process and instead minimizes the (symmetric) error between

the forecasts and the actual data points.

Demand Forecasting

Demand forecasting includes the prediction, projection or estimation of

expected demand of the products over a specified future time period. The

demand products frequently changes in the marketplace due to the seasonality

factor, trend factor, and economic factor. As soon as the main selling season

passes, the extra inventories of the product are devalued greatly. Therefore,

demand planning is considered the first step of a supply chain planning

process, which provides a continuous link to manage the inventory position

and the product demand.

Inventory Management based on Demand Forecasting

Efficient management of supply chains consists in particular in ensuring

possibly highest quality of customer service and striving for minimization of

the costs generated by flow between the links. Typical cause of constantly

increasing costs is excessive inventory levels throughout the chain. The

reason for this situation is maladjustment of the level of supply to the

level of demand in the market, which results in surplus stock. The starting

point for reduction in inventory levels is forecasting of demand in the

market through market prognoses in cooperation with all the links in the

supply chain. Therefore, in the aspect of demand forecasting, the character

of data flow and the type of cooperation between the links is essential.

Inventory control has become an important component in supply chain

management. One of the critical success factors in inventory management is

accurate demand forecasting.

Significant gains have been made in forecasting for inventory management.

Advances have occurred in the development of methods based on combining

forecasts. We have also occurred for methods based on statistical data, such

as extrapolation and rule-based forecasting methods. Most recently, gains

have come from the integration of statistical and judgmental forecasts.

Demand forecasting allows retailers to make better decisions about which

prices to adjust and when, which products to promote, and what promotional

tactics to deploy, in order to achieve objectives. The benefits are

significantly more profound and productive than simple sales forecast. The

best informed decisions will help we increase profits, sales or market share.

By combining forecast we knowledge of past performance under similar

circumstances with forward-looking promotional pricing plans, we can make

better buying, allocation, and replenishment decisions. In turn, we will

reduce the cost of over-stocks and minimize the frequency of out-of-stocks.

Understanding consumer expectations at given times and under different market

conditions delivers tangible benefits to both on the demand side and supply

side of business.