CHAPTER TWO

REVIEW OF RELATED LITERATURE

2.1 INTRODUCTION

This chapter introduces different literature and writing on inventory management.

The researcher will highlight the conceptual definitions of the key words which will be
used in the research proposal, theoretical literature review, empirical studies that will
highlight what other researchers observed in the relevant study and conceptual
framework of the study.

2.2 Theoretical Review

Theories are analytical instruments to understand the study, to elaborate and make
assumption about the subject matter. It can also help us to compare the conceptual
framework .This chapter is focused on providing the theoretical and Empirical models
that are related to the topic of the research study. The chapter also presents the
findings of the past researches in regards to the effect of inventory management
practices on performance of organizations. (SHITAYE WODAJO LEMMA June, 2017)
According to Stevenson (2010), Inventory Management is defined as a framework
employed in firms in controlling its interest in inventory. It includes the recording and
observing of stock level, estimatingfuture request, and settling on when and how to
arrange (Adeyemi & Salami, 2010).
On the other hand, Deveshwar and Dhawal (2013) proposed that inventory
management is a method that companies use to organize, store, and replace
inventory, to keep an adequate supply of goods at the same time minimizing cost.
Choi (2012) indicates that effective inventory management is essential in the
operation of any business. Thus, keeping stock is used as an important strategy by
companies to meet customers’needs without taking the risk of frequent shortages
while maintaining high service level. As Axsäter (2006) describes, inventories make
high cost, both in the sense of tied up capital and also operating and administrating
the inventory itself. It is argued that time from ordering to delivery of replenishing the
inventory, referred to as the lead time, is often long and the demand from customers
is almost never completely known (Axsäter, 2006). Therefore, managers should
consider how to achieve the balance between good customer service and reasonable
cost, which is the purpose of inventory management, involving the time and volume
of replenishment.( Daniel Atnafu, July 2018)

2.3 Concept of Inventory

Inventories are materials or resources of any kind having some economic value. It is
also a major asset that should provide return for capital invested and either
awaiting conversion or use in future. Apart from these, there are many indirect
materials such as maintenance materials, fuels and lubricants, and other materials
which are used in a manufacturing or service rendering organizations. They are
also classified as inventories of materials for future use. But they differ only in their
use and classification from raw and other direct materials. All required items are
stocked in to warehouse to be used when the needs arise (Datta, 2003) (SHITAYE
WODAJO LEMMA June, 2017).

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 timber 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.

Inventory is a general term describing goods which are held by organizations. The
bulk of these goods is usually intended for use in connection with production
or operating activities, but also covers finished products awaiting dispatch to
customers, goods awaiting point of sale display, scrap and other arising, and
packages held pending return to suppliers (David Jessop and Alex Morrison, 1994).

Inventory refers the raw materials, work in progress goods and completely finished
goods that are considered to be the portion of a business’s assets that are ready or
will be ready for sale. Inventory represents one of the primary sources of
revenue generation and subsequent earnings for the company’s shareholders /
owners (Investopedia).( Emmanuel M. Tungo,2014)

2.3.1 Inventory Management

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 is a process of efficiently overseeing the constant flow

of units into and out of an existing inventory. This process usually involves controlling
the transfer of units in order to prevent the inventory from becoming too high,
or dwindling to levels that could put the operation for the company into
jeopardy.

Competent inventory management also seeks to control the costs associated with the
inventory, both from the perspective of the total value of the goods included and the
tax burden generated by the cumulative value of the inventory.(Barcodesine.com)

Inventory management is the overseeing and controlling of the ordering, storage and
use of components that a company will use in the production of the items it will sell
as well as the overseeing and controlling of quantities of finished products for sale.
Business’s inventory is one of its major assets and represents an investment that is
tied up until the items is sold or used in the production of an item that is sold. It also
costs money to store, track and insure inventory.

Inventories that are mismanaged can create a significant financial problem for a
business, whether the mismanagement results in an inventory glut or an
inventory shortage. Successful inventory management involves a purchasing plan
that will ensure that items are available when they are needed (but that neither too
much nor too little is purchased) and keeping track of the existing inventory and
its use.(Investopedia) ( Emmanuel M. Tungo,2014)

2.3.2 Inventory Management Practices

Inventory management practices can be defined as an activity that organizes

the availability of goods to the customers from sales items to consumables and
spare parts. A balancing act that enables operations to have long runs of
operation for better efficiency and ensuring high inventory are ready for sale,
purchasing long run orders for better efficiency and balancing act of working
capital and cash flow.

Inventory management practices helps businesses to optimize their stock levels,

a critical aspect for any organization trying to adapt to ever-changing consumers
demands. This practices enabled companies that adopted to succeed boost their
operational efficiency, offering their customers exactly what they need, when
they need it. (Rafael Mayol,) ( Emmanuel M. Tungo,2014)

SHITAYE WODAJO LEMMA (June, 2017) wrote Inventory management practices

involves the use of many techniques of managing inventories in an organization,
According to Agus and Noor (2006), the inventory management techniques that are
universally adopted by firms include Economic Order Quantity (EOQ) model, ABC
model, Vendor Managed Inventory (VMI) and Just-In-Time model. Economic Order
Quantity (EOQ) model, Bar-coding, Just-In-Time model, ABCmodel and Vendor
Managed Inventory (VMI) and Simulation.
1. Economic order Quantity Model

Inventory models deal with idle resources like men, machines, money and materials.
These models are concerned with two decisions: how much to order (purchase or
produce) and when to order so as to minimize the total cost. For the first decision—
how much to order, there are two basic costs are considered namely, Inventory
carrying costs and the ordering or acquisition costs. As the quantity ordered is
increased, the inventory carrying cost increases while the ordering cost decreases.
The ‘order quantity’ means the quantity produced or procured during one production
cycle.

Economic order quantity is calculated by balancing the two costs. Economic Order
Quantity (EOQ) is that size of order which minimizes total costs of carrying and cost of
ordering. i.e., Minimum Total Cost occurs when Inventory Carrying Cost = Ordering
Cost . S. Anil Kumar • N. Suresh (2009 ).

The economic order quantity, which is also recognized as the Wilson EQQ model, is
an inventory management technique that identified the most favorable quantity to
order, which is in line with minimizing the total variable expenses that are needed to
order as well as to hold inventories (Lee, 2002). Economic Order Quantity denotes the
optimal ordering level of an inventory which helps in the minimization of expenses.

This inventory management approach (EOQ) makes the assumption that the
demand for an item is well-known, the lead time is well-known and constant, that the
receipt of an order happens immediately, the discounts of quantity are not computed
as part of the model and that inventory’s shortages do not happen. The EOQ graphs
demonstrate the association between the costs of ordering, the expense of holding
inventories and the economic order quantity (Nair, 1995).

2. ABC analysis

Inventory optimization in supply chain, ABC analysis is an inventory categorization

method which consists in dividing items into three categories, A, B and C: A
being the most valuable items, C being the least valuable ones. This method aims
to draw managers’ attention on the critical few (A-items) and not on the trivial many
(C-items). Joffrey Collignon, Joannes Vermorel, (2012 )

ABC analysis is sound recognized categorization technique as far as the pareto

principle is concerned, whose main purpose is for establishing the items that should
be prioritized in the management of an inventory (Ramanathan 2006). Flores and
Whyback (2007) is of the view that ABC analysis is a method for prioritizing
inventories.

Inventories are classified into 3 sub-classes, including A, B and C. A large portion of

the efforts of management are utilized on administering A I tems A, B in-between and
C items get the least attention.Brown (Bloomberg, Lemay and Hanna 2002) notes
that the ABC analysis categorizes products based on importance. Importance may
come from cash flows, lead time, stock outs, sales volume, or profitability. Once the
ranking factors is chosen, break points are chosen for classes A, B, C and soon.
The 80 -20 concept is particularly useful in distribution planning when the products
are grouped or classified by their sales activity.

The top 20 percent might be called A items, the next 30 percent B items, and the
remainder C items. Each category of items could be distributed differently. For
example, A items might receive wide geographic distribution through many
warehouses with high levels of stock availability , whereas C items might be
distributed from a single, central stocking point(e.g. a plant) with lower total
stocking level than for the A items. B items would have an intermediate
distribution strategy where few regional warehouses are used (Ballou 2004).

3. Vendor Managed Inventory (VMI)

The American Production and Inventory Control Society defines Vendor Managed
Inventory (VMI) as a means of optimizing supply chain performance in which the
supplier has access to the customer’s inventory data and is responsible for
maintaining the inventory level required by the customer. It is accomplished by a
process in which re-supply is done by the vendor through regularly scheduled reviews
of on-site inventory.
VMI , referred to as a program of supplier-managed inventory or direct
replenishment, emerged in the late 1980’s as a partnership to coordinate
replenishment decisions in a supply chain while maintaining the independence of
chain members. In this relationship between a vendor and customer, it is the vendor
that decides when and in what quantity the customer’s stock is replenished. VMI was
successfully implemented by numerous firms including Wal-Mart and Procter &
Gamble (Waller et al. 1999), Campbell Soup Company (Clark 1994), Barilla SpA
(Hammond 1994), Intel (Kanellos 1998) and Shell Chemical (Hibbard 1998).

VMI has also been conceived as a means of enabling operational benefits. Through
the “flexibility” that VMI offers, the supplier may combine routes from multiple
origins (Campbell et al. 1998, Kleywegt et al. 2002) and delay stock assignments,
consolidate shipments to two or more customers (Cheung and Lee 2002), or postpone
a decision on the quantity destined for each of them (Cetinkaya and Lee 2000). VMI
may also come up in a transportation-inventory problem whose tradeoffs are
investment in inventory,delivery rates and shortages (Chaouch 2001), or in a
simulation-study that analyze the impacts of demand variability, limited
manufacturing capacity, and partial channel coordination (Waller et al.1999).

4. Just in Time (JIT) model

Beginning in the early 1980s, a number of US firms followed the pioneering efforts of
Shigeo Shingo and Taichi Ohno and adopted just-in-time (JIT) manufacturing in an
attempt t o reshape their manufacturing environments (Bragg et al., 2005) and to
become more agile (Helo, 2004). JIT requires that a company have a few reliable
suppliers and is believed to enhance productivity and build a leaner manufacturing
system which minimizes inventories (Helo, 2004) which, in turn,reduces risk and helps
minimize the cost of manufacturing (Curry and Kenney, 1999; Rahman, 2004).

The Just in Time is an inventory management practices with the objective of

maintaining just sufficient material at the right place and at the right time in order to
make first the right quantities of inventories(Carlson, 2002).

According to V oss, JIT is viewed as a “Production methodology which aims to improve

Overall productivity through elimination of waste and which leads to improved
quality”. JIT provides an efficient production in an organization and delivery of only
the necessary parts in the right quantity , at the right time and place while using the
minimum facilities”.

Just in time inventory management system helps in reducing inventory costs by

avoiding carriages of excess inventories and mishandling of raw materials. According
to Kortz (2003), Just in time purchasing recognizes high costs associated with holding
high inventory level and as such it has become important in most organizations to
order inventory just in time of production so as to cut costs of holding inventory like
storage lighting, heating, security, insurance and staffing (Dimitrios, 2008).

5. Barcode inventory system

A barcode is an optical machine readable representation of data about the object to

which it attaches.Barcodes are used for identification, handling, retrieval and storage
of goods in warehouses and stores.It is the most popular technology in many
applications. Individual inventory items, cartons or unitized packages are affixed
with a barcode that can be read by a barcode scanner attached to an online
computer system.

Barcode is assigned to a particular inventory item to show its identity during storage,
retrieval and dispatch. Barcodes are further used for communication of dispatched
items for the preparation of bills by accounts departments and making periodic
reports on inventory status and sales. The barcodes facilitate the tracking of specific
items in the warehouse during inventory audit or material pick up. They also help in
tracking a consignment during transportation/ inspection at the customer end. The
information that may be required generally relates to the country code, manufacturer
’ s name, product details, date of manufacture, material content, and so on. The
details are required at the users end for inventory management and are in machine
readable codes in the form of bars and spaces (Sople, 2010).

6. Simulation inventory control system

Maria (1997) describes the simulation of a system as the operation of a model of the
system that can be reconfigured and experimented with. The main reason to use
simulation modeling is to reduce the cost associated with impractical implementation
in the real system. In simulation, the system can be studied and properties of the
actual system can be inferred. The use of simulation is to alter a system or test a new
system and reduce the chance of failure before the system is implemented.
Simulations are very useful to determine where the problem lies in an actual system
or to determine the best design of a proposed system.

Andric et al. (2005) states in an article that modern inventory management

approaches make use of mathematical models and informational systems.. A study by
Gbolagade, et al (2012) is based on the role of simulation modeling for conducting
scientific experiments on inventory control.

Badri (1993) established a simulation based decision-support system for controlling

and managing inventory by taking into consideration the impact of changes in
demand, the point of reordering, the control of the stock level, period between the
reviews, as well as the lead time. Nonetheless, the approach took into consideration
just the case of one product inventory model.

7. Lean inventory system

Lean inventory management is all about cutting the fat out of your business and
finding just the right balance between too much and too little inventory on hand. That
means no more hoarding products just because you can get them cheaper by buying
them in bulk, and no more guessing how many products to keep in stock.Robert
Lockard (2012)

A Lean inventory management system allows a distributor to meet or exceed

customers’ expectations of product availability with the amount of each item that
will maximize the distributor’s net profits. In a Lean system, inventory is regarded as a
sign of a sick factory that is in desperate need of some type of treatment.

The ideal goal for a company should be to have an inventory as close to zero as
possible. Effective inventory management, allows a distributor to meet or beat their
customers’ expectations of product availability while maximizing their profits (Steve
Krar 2008).

2.4 Empirical Review

Different studies have been conducted by varies researchers, concerning the

practices of inventory management aim to investigating and control both public and
private body with the general practices in such companies. More of them have a
problem of managing inventory items.

Ackah & Ghansha (2016) by their study, on the title of Assessment of Inventory
Management, the researchers assessed the Performance of the Production
Sector to find out how the management of inventory within work would be
effective and bring a lot of cost savings for the organization to increase
organizational profitability. In order to reduce the cost of holding to ensure the
continuity of supply at the same time shows, how the management of inventory
within operational works would be effective and bring a lot of cost savings to
the organization. Therefore increasing organizational profitability since inventory
represents the asset account.

Despite the growing concern for non-stock procurement policies, inventory continues
to play a vital role within organization supply chain (Ackah & Ghansha 2016).
According Girma (2016), studies on title of the assessed the problems of inventory
management and stock recorded handling in the warehouse. He stated his finding
that the major problems of inventory management are- Lack of attention of store
management, lack of assigned qualified employees to the right position on the right
time, no planning mechanism to solve problems to improve inventory management
and controlling system and lack of work performance evaluation of employees of
the warehouse. The warehouse management and employees are working on
inventory management and controlling function facing with lack of knowledge or skill
to meet the expected performance. The company inventory items kept unsafely,
misused of some materials and improper guide lines work manual. The researcher
also gave his comment on the company concerning the periodic and perpetual
inventory system, company should attention to inventory management, plan and
evaluate warehouse employees performance, approve employees who are
assigned in warehouse and prepare work related policies and procedures
concerning to inventory management and controlling system.

Chan (2015) by her study of she said that, examine the association between
inventory management and ineffective internal controls and hypothesize those
managers found in firms with inventory-related material weaknesses in internal
control are delayed in their inventory management, thus their firms experienced
more stock shortages and overages. The company and have a higher possibility and
magnitude of inventory impairments. It shown the weak evidence is that inventory
turnovers improve when the weaknesses are corrected.( SHITAYE WODAJO LEMMA
June, 2017)

2.5 Research Gap

Generally, in all the above studies researchers conducted inventory control

management studies by different researchers in different angles, concerning the
factors affecting inventory management, the assessment of inventory management ,
internal control system and the role of inventory control management . These show
that how inventory managing is the key part of the management functions to
perform in manufacturing, service renders company, any public company, small
and large industries.

Inventory management plays a very significant role for any firm and business
Ackahand &Ghansh(2016). However, since it holds without service instead of
generating income it incurs cost. There are a lot of researches done on inventory
control management in different problem areas but most of them done on firm’s
areas. In addition to these, the company role is different from other services
because of the electric services are critical for today’s life. Those studies described
on the above are not assessed the main core areas of gaps of purchasing inventory
controlling system, the finance recording controlling system, the impact of
unavailability of inventory on customer service department work performance, the
revaluation of inventory items, the disposal of inventory obsolete items, the excess
inventory purchase and idle inventory purchases.
2.6 Factors that affect Inventory Management Practices;-

The inventory management practice is carried out by the inventory planners of

the company, in the close coordination with procurement, supply chain, logistics
and finance, besides marketing department. The efficiencies of Inventory
management are largely dependent upon the skills and knowledge of the inventory
planners, the focus and involvement of the management and the management
policies coupled with the inventory management system.

However inventory operation management is not under the control of the inventory
management team but rests with the third party service providers. The following are
few critical areas and action points on the part of operations that can affect
the inventory management of the company:-

Unskilled labor & Staff- Inventory operations management is a process- oriented

operation. Every task and action required to be carried out by operatives will affect
the inventory as the knowledge of what one is required to do and the effects of the
action should be known to the operative who are on the shop floor.

Inadequate Standing operating procedures, training and emphasis on processes

compliance- When inventory management project kicks off at a third party
warehouse location, both the principle customer as well as the third party
service provider work on the project and set up basic processes, document them in
standard operating procedures and conduct training as a part of the project
management methodology.

Product Type – The type of product greatly influence the inventory control policies
assigned to manage the product. e.g. product with short shelf lives , such as
perishable foods require different policy than other type, as short shelf life products
must rotate based on expiration date. FIFO policy works in this case.

Product Cost – Many companies employ additional inventory control policies for
high- value products. e.g. Many warehouses that inventory expensive audio – video
equipment’s keep some of the most expensive equipment secured in cages; only a
few warehouses personnel have access to this equipment and require a
signature from authorized personnel before high value products move from one
location to another.

Lead Times – A major factor that affects inventory control policies is product lead
time; the time from receipt of an order to the time of delivery. Some industries and
products have extraordinary long lead times. e.g. short lead time reduce the amount
of inventory and long lead time product the retailer has to warehouse more inventory
and by having the increased amount of inventory the workload associated with
managing the inventory, such as cycle counting, yearly physical inventory and
general warehouse maintenance

2.6 Relationship between Inventory Management and Operational Performance

Different authors have been doing various endeavors to clarify the relationship
between inventorymanagement practices and the efficiency of a firm. Rajeev (2010)
contends that stock administration practices are a method for procuring intensity.
Factors of his study were Inventory Management rehearses as an independent
variable, and cost diminishment as a reliant variable. The discoveries of the survey
showed a positive relationship between the factors. Koumanakos (2008)
contemplated the impact of Inventory

Management on the solid execution of assembling firms working in Greece. The

theory that is inclined to the stock management stimulates variations in the
business’s budgetar y implementation. The discoveries recommend that the higher
the level of inventories protected by a firm, the lower the rate of return. Eckert (2007)
analyzed Inventory Management and the part it play s in enhancing client benefit
levels. He

found a positive relationship between stock administration practices and consumer

loyalty because of decreased number of stock-outs. Juan & Mertinez (2002) in their
study of 8872 small and medium-sized Spanish firms also demonstrated that
managers of firms can create value by reducing the number of days of
inventory. Effective inventory management processes helps increase operational
efficiency of firms; improves customer service; reduces inventory and distribution
costs; and enables businesses track items and their expiration dates consequently
balance between availability and demand (Pandey, 2004).

2.6.2 Importance relationship between inventory management and

organization’s performance

Inventory plays an important role in the growth and survival of an organization in the
sense that failure to an effective and efficient management of inventory, will mean
that the organization will lose customers leading to poor services delivery and sale
will decline. Emphasizing on the importance of inventory on the balance sheet of
companies. Coyle, Bardi and Langley (2003:188) state that “inventory as an asset on
the balance sheet of companies has taken an increased significance because of
the strategy of many firms to reduce their investment in fixed assets, that is
plants, ware houses, office buildings, equipment and machinery , and soon.

Virtually every enterprise finds it necessary to hold stocks (or inventory) of various
items and materials. That is because it would be practically impossible to operate
with only one of each item to be sold or used in manufacture or used in office
work. A reserve or a fund or inventory of each item or material used or sold
frequently is therefore maintained, so that as items or materials are sold or
used they can be replaced or replenished from the stocks held in reserve.

Due to uncertainty in future demand, and because of the unguaranteed

availability of supplies, stock is therefore held to ensure an availability of goods to
minimize the overall costs associated with the management of stock (Drury, 2000).

Gittinger (1995) argues that precautionary motive is one of the central roles of
inventory management.Accordingly, precautionary motive means that stock held
to guard against risk of unpredictable changes in demand and supply. In most
cases, the level of demand of goods and the time required for supply cannot be
known with certainty. Therefore, to ensure product availability, the organization
maintains additional amount of safety stock to meet regular production and
market needs. Firms should invest in stock control for precautionary motive to act
as a buffer or link between demand and supply so that production can be geared to a
more constant output. Precautionary motive necessitates holding of inventories to
guard against the risk of unpredictable changes in demand and supply forces and
other factors (Pandey, 2002)

Berman, O., and Perry, D. (2010). Shelf Space Management When Demand Depends
on the Inventory Level Production and Operations Management. Production and
Operations Management Society ,

Bicheno, J. (1996). Supplier partnerships. London: National institute for

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Cachon, G. P., and Olivares, M. (2010). Drivers of finished-goods inventory in the US

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Cooper, D., & Schindler, P. (2006). Business research method, 9th Edition. Boston:

McGraw-Hill Irwin.

Deloitte (2014). The Deloitte Consumer Review Africa: A 21stcentury view. Retrieved

September 21 st, 2016 from

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an assessment of inventory management system: the case of ethiopian electric

utility,by shitaye wodajo lemmaid.no. sgs/0090/2007a, JUNE, 2017
THE INFLUENCE OF INVENTORY MANAGEMENT PRACTICESON ORGANIZATIONAL FINANCIAL
PERFOMANCE: CASESTUDY: ByEmmanuel M. Tungo ,2014

The impact of inventory management practiceon firms’competitiveness and organizational

performance: Daniel Atnafu & Assefa Balda | (2018)