Overage Inventory – How does it occur and why is it important?
Authors: Geoff Relph and Peter Barrar
Well planned inventory is important to the successful operation of most healthy businesses. What this means is that planning needs to be carried out to deal with three conditions;
- the possibility of too little inventory due to uncertainty
- the replenishment of the inventory cycle due to depletion through normal demand
- the probability of overage – or too much inventory, when assessed against planned levels
The consequences for businesses are important at both item level and in the aggregate. At the item level, the inability to supply can have dire consequences for customer service and at the aggregate inventory level, for the operational, cash flow and working capital requirements of the business.
The paper argues that overage is important because there is evidence that, even in well managed businesses a significant proportion of the inventory is in overage at any given time. Evaluations of twenty-inventory profiles from companies in different business sectors show between 10% and 98% of the inventory values were ‘in overage’. For most businesses this will not be a trivial amount and any actions that can reduce it will bring significant benefit. The paper concludes that overage should be recognised in the same way as safety stock and thus, formally planned. Hence the effective control of overage will enhance the business’s profitability by minimising the inventory investment.
The paper will review the issue of planning and control of inventories, briefly addressing the issues of safety and cycle stocks, and will then consider the issue of overage. The paper will describe what overage is, how it occurs and some ideas as to how it might be measured and therefore planned. The paper draws on previous research into safety and cycle stocks and the early stages of doctoral research on overage by one of the authors.
The issue of planning and control
The planning and control of inventory is an ongoing source of research opportunities, it has focused on planning for failure of supply using safety stocks and the capability of manufacturing to reduce batch sizes through lot size analysis. The area that appears to have received little attention is the subject of excess inventory. Shah (1992) used the term Overage in his classification of when describing excess inventory. In this paper, it will be used to describe excess inventory in the context of planned inventory levels.
There are many accepted arguments for the need to plan inventory, in particular safety stock and appropriate batching rules. However, the argument for including overage in the planning process has not been well articulated. We may consider an example; management set an objective to achieve a plan of £1 million of inventory and this is then acted upon by the planners. The planners implement this by setting the parameters of the planning and control system to achieve this business objective. If the possibility of overage is ignored then there is a high probability that this plan will be exceeded. If however overage was considered in the planning process, to achieve the same plan of £1 million the parameters would need to be set lower giving more aggressive operational targets for batch quantity, safety stock and lead-time in the business. The resulting plan would then have a lower probability of being exceeded and thus demand less reactive attention from management.