A Project Report on the different methods of Inventory Management adopted by different companies. Report submitted as the Practical Assignment of the course Fundamentals of Financial Management

1. FOFM
Practical Assignment
Group: 146 - 157
Class: F.Y. – B

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TABLE OF CONTENTS
GROUP MEMBERS AND PROJECT TOPIC __________________________7
Group Members ________________________________________________________7
Project Topic __________________________________________________________7
INTRODUCTION ________________________________________________9
WHAT IS INVENTORY MANAGEMENT? ____________________________11
IMPORTANCE OF INVENTORY MANAGEMENT _____________________13
Inventory Management Saves Money ______________________________________13
Avoid Spoilage ______________________________________________________13
Avoid Dead Stock ____________________________________________________14
Save on Storage Costs________________________________________________14
Inventory Management Improves Cash Flow_________________________________14
INVENTORY MANAGEMENT TECHNIQUES ________________________15
ECONOMIC ORDER QUANTITY (eoq)______________________________17
What is Economic Order Quantity? ________________________________________17
How Do You Calculate Economic Order Quantity? ____________________________17
What are the Advantages of EOQ? ________________________________________18
Helps Lower Inventory Costs ___________________________________________19
Makes Restocking Easy _______________________________________________19
Helps You Find the Best Deal___________________________________________19
What are the Disadvantages of EOQ?______________________________________19
Requires Numerous Assumptions _______________________________________20
Doesn’t Account for Fluctuations During Seasons ___________________________20
How to Make EOQ Work for You? _________________________________________21
MINIMUM ORDER QUANTITY (moq) _______________________________23
What Is a Minimum Order Quantity? _______________________________________23
What Are the Benefits of MOQ’s for Wholesale Suppliers?______________________23
ABC ANALYSIS________________________________________________25
JUST-IN-TIME INVENTORY MANAGEMENT ________________________27
What is Just-In-Time Inventory and How Does It Work? ________________________27
Benefits of Just-In-Time Inventory _________________________________________28
Drawbacks of Just-In-Time Inventory_______________________________________28
How do you Implement Just-In-Time Inventory? ______________________________29

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SAFETY STOCK INVENTORY ____________________________________31
REORDER POINT FORMULA ____________________________________33
BATCH TRACKING _____________________________________________35
What is Batch Tracking? ________________________________________________35
What are the Benefits of Batch Tracking? ___________________________________35
Easy and Fast Recall _________________________________________________36
Streamlined Expiry Tracking____________________________________________36
Improved Relationships with Suppliers____________________________________36
Fewer Accounting Errors from Manual Tracking ____________________________37
CONSIGNMENT INVENTORY ____________________________________39
What is Consignment Inventory? __________________________________________39
Pros and Cons of Consignment Inventory for Vendors _________________________39
Pros for Vendors_____________________________________________________40
Cons for Vendors ____________________________________________________40
DROPSHIPPING _______________________________________________41
What Is Dropshipping and How Does It Work? _______________________________41
What Are the Pros and Cons of Dropshipping? _______________________________41
Pros of Dropshipping _________________________________________________42
Cons of Dropshipping _________________________________________________42
LEAN MANUFACTURING SYSTEM (LMS) __________________________45
What is the Lean Manufacturing System? ___________________________________45
Muda______________________________________________________________45
Mura ______________________________________________________________46
Muri_______________________________________________________________46
What Are the 5 Key Lean Manufacturing Principles?___________________________46
Value______________________________________________________________47
Value Stream _______________________________________________________47
Flow ______________________________________________________________47
Pull _______________________________________________________________47
Perfection __________________________________________________________48
What Are the Most Useful and Actionable Lean Manufacturing Tools?_____________48
The 5S System ______________________________________________________48
Plan, Do, Check, Act (PDCA) ___________________________________________48
Heijunka (Production and Demand Leveling)_______________________________49

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Kaizen (Continuous Improvement)_______________________________________49
Kanban (Pull System)_________________________________________________49

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GROUP MEMBERS AND PROJECT TOPIC
Group Members
Roll Number Name
146 Mishra Jhanvi
147 Mishra Riya
148 Modh Hemangi
149 Modi Akshita
150 Mori Kripalsinh
151 Modi Soham
152 Not Submitted
153 Mrudul Manojkumar
154 Mundhra Khushali
155 Nakrani Raj
156 Nakum Ankit
157 Nakum Sanjay
Project Topic
Identify and discuss different methods adopted for
inventory management by different companies.

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INTRODUCTION
Ever heard of a business that became successful while mismanaging its inventory?
We haven’t either. They don’t exist.
Sure, there are plenty of mammoth companies that mismanaged their inventories after
becoming successful. Walmart losing $3,000,000,000 because of out-of-stock is a prime
example of inventory mismanagement.
But, if they want to continue being successful, they need to implement better inventory
management techniques.

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WHAT IS INVENTORY MANAGEMENT?
Inventory occupies the most important position in the working capitals structure of
manufacturing and distributive enterprises. For example, on an average 60 % of the
current assets in public limited companies in India are inventories. Therefore, to remain
profitable and competitive, businesses need to use as many cost-saving and profit-
boosting inventory management techniques as possible. They cannot afford not to.
Inventory Management  Inventory Management is a collection of tools, techniques and
strategies for storing, tracking, delivering and ordering inventory or stock.
Inventory Management is the science-based art of ensuring that sufficient inventory
is held by the organization to meet both its internal and external demand commitments
economically. Managing the level of investment in inventory is like maintaining the level of
water in a bathtub with an open drain. The water is flowing out continuously. If water is let
in too slowly, the tub is soon empty. If water is let in too fast, the tub overflows. Like the
water in the tub, the particular items in inventory keep changing, but the level may stay the
same. The basic financial problems are to determine the proper level of investment in
inventory and to decide how much inventory must be acquired during each period to
maintain the level.

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IMPORTANCE OF INVENTORY
MANAGEMENT
A large amount of capital, if not the majority of a company’s capital is wrapped up in
their inventory. For that reason, it’s incredibly important to control the coming and going of
inventory as best you can to minimize losses and maximize profits – which is where
inventory management techniques come into play.
Holding inventory ties up a lot of cash. That's why good inventory management is
crucial for growing a company. Just like cash flow, it can make or break your business.
Figure 1 – Importance of Inventory Management
Inventory Management Saves Money
Good inventory management saves the business money in the following critical ways: -
Avoid Spoilage  If you’re selling a product that has an expiry date (like food or
makeup), there’s a very real chance it will go bad if you don’t sell it in time. Solid inventory
management helps you avoid unnecessary spoilage.
Importance of
Inventory
Management
Saves Money
Avoids
Spoilage
Avoids Dead
Stock
Savings on
Storage Costs
Improves
Cash Flow

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Avoid Dead Stock  Dead stock is stock that can no longer be sold, but not necessarily
because it expired. It could have gone out of season, out of style, or otherwise become
irrelevant. By managing your inventory better, you can avoid dead stock.
Save on Storage Costs  Warehousing is often a variable cost, meaning it fluctuates
based on how much product you’re storing. When you store too much product at once or
end up with a product that’s difficult to sell, your storage costs will go up. Avoiding this will
save you money.
Inventory Management Improves Cash Flow
Not only does good inventory management save you money, it also improves cash
flow in other ways. Remember, inventory is product that you’ve likely already paid for with
cash (checks and electronic transfers count as cash too), and you’re going to sell it for
cash, but while it’s sitting in your warehouse it is definitively not cash. Just try paying your
landlord with 500 iPhone cases.
This is why it’s important to factor inventory into your cash flow management. It
affects both sales (by dictating how much you can sell), and expenses (by dictating what
you have to buy). Both of these things factor heavily into how much cash you have on
hand. Better inventory management leads to better cash flow management.
When you have a solid inventory system, you’ll know exactly how much product you
have, and based on sales, you can project when you’ll run out and make sure you replace
it on time. Not only does this make sure you don’t lose sales (critical for cash flow), but it
also helps you plan ahead for buying more so you can ensure you have enough cash set
aside.
“The money spent on Inventory is money that is not spent on growth.
Manage it wisely.”

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INVENTORY MANAGEMENT TECHNIQUES
Inventory management is a highly customizable part of doing business. The optimal
system is different for each company. Figure 2 shows a list of the most popular and
effective inventory management techniques which can be used to improve business.
Figure 2 – Inventory Management Techniques
Inventory
Management
Techniques
Economic Order
Quantity
Minimum Order
Quantity
ABC Analysis
Just-in-time
Safety Stock
Inventory
Reorder Point
Formula
Batch Tracking
Consignment
Inventory
Dropshipping
Lean
Manufacturing
System

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ECONOMIC ORDER QUANTITY (EOQ)
What is Economic Order Quantity?
Economic order quantity is the lowest amount of inventory you must order to meet
peak customer demand without going out of stock and without producing obsolete
inventory. That’s the ideal use of EOQ.
Its purpose is to reduce inventory as much as possible to keep the cost of inventory
as low as possible.
The EOQ model assumes that demand is constant and that inventory is depleted at
a predictable rate. While this isn’t the case for many businesses, the model still helps
companies better approximate when they need to replenish their inventory and how much
they should order.
How Do You Calculate Economic Order Quantity?
To help you calculate EOQ, here is the formula from Kenneth Boyd, author of Cost
Accounting for Dummies:
Economic order quantity uses three variables: demand, relevant ordering cost, and
relevant carrying cost. Use them to set up an EOQ formula:
Demand: The demand, in units, for the product for a specific time period
Relevant ordering cost: Ordering cost per purchase order
Relevant carrying cost: Carrying costs for one unit. Assume the unit is in stock for the time
period used for demand
Note: -
 Ordering cost is calculated per order
 Carrying costs are calculated per unit
Here’s the formula for EOQ:
Economic order quantity = square root of [(2 x demand x ordering costs) ÷ carrying costs]

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That’s easier to visualize as a regular formula:
 Q  economic order quantity (units).
 D  demand (units, often annual)
 S  ordering cost (per purchase order)
 H  carrying cost per unit.
What are the Advantages of EOQ?
Economic order quantity has been successfully used for decades by businesses of
all types, so it certainly has a few advantages.
Figure 3 – Advantages of EOQ
Advantages
of EOQ
Helps
lower
Inventory
Cost
Makes
Restocking
Easy
Helps you
find the
best deal

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Helps Lower Inventory Costs
 The primary purpose of EOQ is to help keep inventory carrying costs as low as
possible.
 The more inventory you have on hand, the more you have to pay for insurance, taxes,
security, etc.
 Accurately calculating how much inventory you need will help you maintain a budget
you can afford.
Makes Restocking Easy
Economic order quantity can help you understand how often you should be
ordering. You may discover that ordering small quantities more often is better for your
bottom line or vice versa.
By calculating how much you need in proportion to how much you sell over a given
period of time, you can ensure you always have enough stock to satisfy your customers.
Helps You Find the Best Deal
Many vendors advertise deals throughout the year to entice you to buy more of their
inventory which usually ends up increasing your cost of inventory even if you received a
discounted price. The EOQ model helps you purchase only what you’re going to use.
It’ll help you take advantage of a vendor deal if, after plugging the numbers into
your EOQ formula, you find out you’re not over-purchasing but getting the right amount at
a lower price.
What are the Disadvantages of EOQ?
While economic order quantity has some benefits and a long history of use, it’s not without
its shortcomings.

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Figure 4 – Disadvantages of EOQ
Requires Numerous Assumptions
 The largest complaint about EOQ is that it requires numerous assumptions.
 The model assumes that there’s steady demand, steady sales, and fixed costs.
 Plus, the basic EOQ model assumes you have a one-product business. If you sell
multiple products, you’ll have to calculate and track each one separately.
Doesn’t Account for Fluctuations During Seasons
 The biggest problem with assumptions of steady demand and steady sales in the EOQ
model is that it doesn’t allow you to account for fluctuations in demand during holidays
or particular seasons.
 If your sales yo-yo throughout the year, then EOQ won’t be able to keep up.
Disadvantages
of EOQ
Requires
Numerous
Assumptions
Doesn't
Account for
Fluctuations
during
Seasons

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How to Make EOQ Work for You?
Realistically, you’re unlikely (and not lucky enough) to operate a business with fixed
rates and steady sales that almost never fluctuate. If you run a business similar to the rest
of ours, then you’re constantly dealing with uncertainties in your reorder point and
customer demand forecasts.
EOQ can still help you make more informed guesses about when and how much
inventory should be ordered, but to make EOQ calculations work properly, you’re going to
need a way to monitor and track your order quantities, reorder points, safety stock levels,
etc.
With the right inventory management system, you could even forget about EOQ
altogether and use more up-to-date formulas that automate reordering for all of your
products.

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MINIMUM ORDER QUANTITY (MOQ)
What Is a Minimum Order Quantity?
A minimum order quantity (MOQ) is the lowest set amount of stock that a supplier is
willing to sell. If you can’t purchase the MOQ of a specific product, then the supplier won’t
sell it to you.
All MOQs vary, depending on the product. High-ticket items that cost more to
produce will usually have a lower MOQ than low-ticket items that are easy and cheap to
produce.
What Are the Benefits of MOQ’s for Wholesale Suppliers?
The purpose of minimum order quantities is to allow suppliers to increase their
profits while getting rid of more inventory more quickly and weeding out the “bargain
shoppers” simultaneously.
A minimum order quantity is set based on your total cost of inventory and any other
expenses you have to pay before reaping any profit – which means MOQs help
wholesalers stay profitable and maintain a healthy cash flow.
Wholesalers don’t always prefer this way of doing business, but in many cases,
wholesalers are forced to sell using MOQs because they’re forced to buy a minimum of
stock from the manufacturer.
Here’s an example of how to use MOQs in your business:
 Let’s say you sell golf balls. For retail customers who are buying in small quantities,
you sell one pack of golf balls for $10.
 If you want to sell wholesale, then you should reduce your price just enough to make it
a good deal for the buyer, while allowing you to make a larger profit and quickly reduce
your inventory at the same time – like golf ball packs for $5 a piece with an MOQ of 100
packs.
 The goal is to attract a small amount of buyers who purchase the largest amount of
your stock.

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ABC ANALYSIS
The basic work in this ‘always better control’ analysis is the classification and
identification of different types of inventories, for determining the degree of control required
for each. In many firms it is found that they have stocks which are used at very different
rates. So items are classified under three broad categories A, B and C, on the basis of
usage, bulk, value, size, durability, utility, availability, criticality, etc. and should be
controlled with due weightage to differential characteristics.
The items included in group A involve largest investments and the inventory control
should be most severe to these items. C group consists of inventory items which involve
relatively small investments although the number of items remains large. These items
deserve minimum attention of control. In B group that items are included which are neither
of A nor C. This method can be explained by the following exhibit.
Classification of Inventory Items
Class No. of Items Value of Items
A 20 85
B 30 10
C 50 5
Total 100 100
Table 1 – Example of ABC Analysis
From the figure it can be observed that there are comparatively few items in A but
they constitute a large proportion of the total rupee value; B items are in the intermediate
range and C items are numerous but inexpensive.
The purpose behind the ‘distribution by value’ analysis is ‘Always Better Control’.
Donald G. Hall recommends that different attitudes shall be adopted in inventory
management: -
 aggressive for class A items
 active for class B items
 loose for class C items
and that each category should be given the attention as deserves.

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Items in A Items in B Items in C
Control Tight Moderate Loose
Requirements Exact Exact Estimated
Postings Individual Individual Group
Check Close Some Little
Expediting Regular Some None
Safety Stocks Low Medium Large
Table 2 – Recommended Order for Selective Control

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JUST-IN-TIME INVENTORY MANAGEMENT
Just-in-time (JIT) inventory was developed in post-world war II Japan when the
country had few resources, little money, and high unemployment. It helped Toyota
become one of the dominant car manufacturers in the world by making every step of the
production process as “lean” as possible by eliminating overproduction, obsolete stock,
and wasted time.
By the mid 80’s, the concept of just in time inventory was being tested by American
companies with excellent results. In 1983, Omark Industries – which produced chainsaws,
ammunition, and log loaders – saved itself an estimated $7 million in inventory carrying
costs with its own version of JIT called ZIPS (Zero Inventory Production System). Use of
just-in-time inventory continued to grow through to the 90’s…
In 1999, Daman Products reported in a case study a 97% reduction in cycle times,
50% reduction in setup times, lead times dropped from 4-8 weeks to 5-10 days, and their
flow distance was reduced by 90%.
Today, just-in-time inventory can be observed in places like fast food restaurants,
where all the ingredients for a burger are kept ready – but a burger is only made the
moment it’s ordered, or on-demand publishing, where a master manuscript is kept ready –
but a book isn’t printed until a customer order comes through.
To help you fully understand the power and potential of just-in-time inventory, we’re
going to concretely define it, look at some of its benefits and drawbacks, and give you
some principles and practices on how to implement it into your own production process.
What is Just-In-Time Inventory and How Does It Work?
Just-in-time inventory is simply making what is needed, when it’s needed, in the
amount needed.
Many companies operate on a “just-in-case” basis – holding a small amount of stock
in case of an unexpected peak in demand.

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JIT attempts to establish a “zero inventory” system by manufacturing goods to
order; it operates on a “pull” system whereby an order comes through and initiates a
cascade response throughout the entire supply chain – signaling to the staff they need to
order inventory or begin producing the required item.
While a just-in-time inventory system is not easy to create, the benefits are worth the extra
effort.
Benefits of Just-In-Time Inventory
When first trying to implement just-in-time inventory, you’ll notice that you’ll find
mistakes throughout the production process which are made more obvious when you try to
make your system more efficient.
After some initial trial and error, you’ll begin reaping at least a few of the benefits as
listed below: -
 Minimize costs such as rent and insurance by reducing your inventory
 Less obsolete, outdated, and spoiled inventory
 Reduce waste and increase efficiency by minimizing or eliminating warehousing and
stockpiling, while maximizing inventory turnover
 Maintain healthy cash flow by ordering stock only when necessary
 Production errors can be identified and fixed faster since production happens on a
smaller, more focused level, allowing easier adjustments or maintenance on capital
equipment
Even though just-in-time inventory offers high rewards, it also brings with it high
risks. If you want the benefits, you’re should know what the potential drawbacks could be.
Drawbacks of Just-In-Time Inventory
The risks associated with just-in-time inventory should be seriously considered
before implementing a JIT inventory plan for your company.
Below is a list of problems you may run into when you adopt this policy of lean
manufacturing and production: -

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 Stock-outs due to sudden changes in market demand when you don’t have excess
inventory
 Vulnerability to alterations in your supply chain which could disrupt your business
operations if you don’t have backup options
 More stock-outs could occur if there is a breakdown in communication within the
business, or between the business and the rest of the supply chain
 Lack of control over order fulfillment due to a dependency on your supplier’s timeline –
potentially delaying how quickly your customer receives their order
 Increased need for planning and precise processes – which, if you don’t setup correctly,
could cause a major loss in revenue after only a few errors.
Some of these risks will depend on your industry and the volatility of whatever
market you’re serving. But, all of these risks pose serious threats to the longevity and
profitability of your business.
However, they’re only risks. If you think the benefits outweigh them, then let’s take a look
at how you can start implementing a just-in-time inventory management system.
How do you Implement Just-In-Time Inventory?
Creating and implementing a just-in-time inventory management system will
depend in large part on the size and complexity of your business and industry. Below,
we’ve listed some common principles and practices which will give you a better idea of
what’s required for a high-functioning JIT inventory system.
 Develop a strong relationship with your suppliers – and possibly an exclusive
agreement Regarding stock quantity and delivery time period – to ensure consistency in
your supply chain
 Find a long-term supplier for each purchased part who delivers small batches
according to your long-term purchasing forecast
 Work on shortening the production cycle first to make room for shortening the materials
cycle (this helps mitigate the problem of late deliveries when first implementing just-in-
time inventory)
 Separate your repetitive business from your one-stop orders and develop a special
production method for your repetitive orders – using particular machines for particular
tasks and processes, separated by order frequency
 Institute or improve your quality-control program to manage and solve manufacturing
problems that inevitably reveal themselves when implementing just-in-time inventory

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These action steps are just some of the things you should consider doing when
making the switch from just-in-case to just-in-time inventory. The actual steps you’ll take
will once again depend heavily on your unique business and its needs. However, if you
haven’t already, there’s a crucial first step you will want to take before officially
implementing a JIT strategy.

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SAFETY STOCK INVENTORY
Safety stock inventory is a small, surplus amount of inventory you keep on hand to
guard against variability in market demand and lead times.
Safety stock plays an integral role in the smooth operations of your supply chain in
various ways.
 Protection against unexpected spikes in demand
 Prevention of stock-outs
 Compensation for inaccurate market forecasts
 And a buffer for longer-than-expected lead times
 You probably noticed that the benefits of safety stock are all tied to mitigating problems
that could seriously harm your business.
That’s because without safety stock inventory you could experience:
 Loss of revenue
 Lost customers
 And a loss in market share
 A safety stock formula is relatively straightforward and requires only a few inputs for
calculation.
Here’s the formula we recommend using if you’re just starting out:
Safety Stock Inventory = (Max Daily Sales X Max Lead Time in Days)
– (Average Daily Sales X Average Lead Time in Days)

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REORDER POINT FORMULA
A reorder point formula tells you approximately when you should order more stock –
that is, when you’ve reached the lowest amount of inventory you can sustain before you
need more.
Here’s the reorder point formula you can use today:
Reorder Point = (Average Daily Unit Sales X Average Lead Time in Days)
+ Safety Stock
This equation can help you stop being a victim to market spikes and slumps and
instead, consistently order the right amount of stock each month.

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BATCH TRACKING
What is Batch Tracking?
Batch tracking is sometimes referred to as lot tracking, and it’s a process for
efficiently tracing goods along the distribution chain using batch numbers. A “batch” refers
to a particular set of goods that were produced together and which used the same
materials.
For example, a batch of milk is a set of individual containers of milk that used the same
ingredients and has the same expiration date because they were produced together, at the
same time.
From raw materials to finished goods, batch tracking allows you to see where your
goods came from, where they went, how much was shipped, and when they expire if they
have an expiration date.
What are the Benefits of Batch Tracking?
Almost every business uses batch tracking because it offers numerous benefits.
Figure 5 – Benefits of Batch Tracking
Benefits of Batch
Tracking
Easy and
Fast Recall
Streamlined
Expiry
Tracking
Improved
Relationship
with
Suppliers
Fewer
Accounting
Errors from
Manual
Tracking

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Easy and Fast Recall
iSeeCars analyzed new vehicle sales data and recall data from the National
Highway Transportation Safety Administration (NHTSA) from January 1985 through
September 2016. They found that the industry average of car recalls was 1,115 per every
1,000 cars sold.
Almost every car manufacturer had recalls, but here’s why being able to recall your
products quickly is so important: In a study conducted by The Relational Capital Group
and reported on by The Motley Fool, 87% of survey respondents said they’d be “more
likely to purchase and remain loyal to a company or brand that handles a product recall
honorably and responsibly, even though they clearly made mistakes that led to a safety or
quality problem.”
Which means, consumers understand that recalls happen, but if you do a poor job
recalling the product, then you’ll be chastised by your customers. So, if you’re a car
manufacturer, you would want to make sure that you proactively recall any defective
vehicle and publicly or privately apologize and do everything possible to appease your
customers. Regardless of what business you’re in, if you want to be able to recall defective
products quickly and easily, then you’ll need a batch tracking system that can give you the
detailed information you need to identify every defective product within the batch so you
can easily trace them down and retrieve them.
Streamlined Expiry Tracking
Quality control is critical if you’re a food wholesaler. One of the most important
factors for maintaining a high-quality food product is knowing the expiration date for every
product you sell, and making sure your customers know this information as well.
Batch tracking allows you to automatically know the expiration date of each product
and gives you the power to develop a stronger quality control system in the case of any
issues like a product recall.
Improved Relationships with Suppliers
Batch tracking software allows you insight into the quality of your finished goods by
tracking the raw materials your suppliers are providing you. This gives you the ability to
identify your best and worst suppliers, which gives you greater control over who you’ll
purchase your material from.

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Fewer Accounting Errors from Manual Tracking
A manual batch tracking system is extremely time-consuming and error-prone. It’s very
easy to enter incorrect data, omit data, misinterpret data, or misplace your data. An
automatic batch tracking system allows you to enter information that is generated across
all products within your batch and puts that information at your fingertips if you need to
access it quickly, as in the case of a product recall.

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CONSIGNMENT INVENTORY
What is Consignment Inventory?
Consignment inventory is a business arrangement where the consignor (a vendor
or wholesaler) agrees to give their goods to a consignee (usually a retailer) without the
consignee paying for the goods up front – the consignor still owns the goods, and the
consignee pays for the goods only when they actually sell.
For example, a women’s watch vendor might want to break into a new market, but they’re
relatively unknown and have had a hard time selling their goods to retailers.
If the vendor offers their watches on consignment, the retailer agrees to stock the
watches in their store and only pay for the ones they sell. This arrangement can be hugely
beneficial for both parties, but it also carries with it some major risks. To get a balanced
view of consignment inventory, let’s look at some of its pros and cons for both vendors and
retailers.
Pros and Cons of Consignment Inventory for Vendors
Figure 6 – Pros and Cons of Consignment Inventory for Vendors
New Markets
Low
Inventory
Carrying
Costs
Direct-to-
retailer
Shipping
Pros Increased
Cost for
Unsold
Inventory
Uncertain
Cashflow
Cons

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Pros for Vendors
New Markets
As we pointed out in our women’s watch example, selling on consignment allows vendors
to enter new markets at minimal cost to the retailers, which makes retailers more likely to
carry the vendors’ inventory.
Low Inventory Carrying Costs
Inventory is expensive to warehouse. By giving a portion of it to a retailer, vendors lower
the cost of carrying inventory.
Direct-to-Retailer Shipping
Instead of having inventory shipped to a warehouse and then to a retailer, vendors can
have their manufacturers deliver the inventory directly to the retailer.
This streamlines the supply chain, saves labor costs, and gets goods on retailers’ shelves
faster.
Cons for Vendors
Increased Cost for Unsold Inventory
Since the inventory is still owned by the vendor, they still have to count it as part of their
assessment of their costs.
The vendor may profit less the longer the inventory is held without being used or sold.
Uncertain Cashflow
Vendors won’t receive payment until after some or all of the goods are sold by the retailer.
Goods that aren’t sold are usually returned to the vendor.
This makes cashflow uncertain and volatile since they don’t know when or how much of
the goods will be sold.

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DROPSHIPPING
What Is Dropshipping and How Does It Work?
Dropshipping is a business model that allows you to sell and ship products you
don’t own and don’t stock. Your suppliers – wholesalers or manufacturers – produce the
goods, warehouse them, and ship them to your customers for you.
The process is simple: -
 You receive an order
 You forward the order to your supplier
 Your supplier fulfills the order
While dropshipping has many benefits, it also has many drawbacks.
What Are the Pros and Cons of Dropshipping?
Many people start a dropshipping business because they think it’ll be easy to run.
“No inventory, no problem!” they say. The truth is, it’s not “easy.” It comes with its own set
of problems. With that said, dropshipping also solves many problems for retailers and
wholesalers. Let’s take a look at the pros and cons of dropshipping to see if it will solve
your business problems or if it will add to them.
Figure 7 – Pros and Cons of Dropshipping
Low Startup
Costs
Low Cost of
Inventory
Low Order
Fulfillment
Costs
Sell More
Products with
Less Risk
Pros
Less Control
Over Order
Fulfillment
Reliance on
other People's
Stock
Less Profit
Poorer
Customer
Service
Cons

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Pros of Dropshipping
Low Startup Costs  It requires a lot of capital to stock a warehouse. You can eliminate
the risk of going into debt to start your business by using dropshipping. Instead of
purchasing an extensive inventory and hoping that it sells, you can start a dropshipping
business with zero inventory and immediately start making money.
Low Cost of inventory  The cost of inventory is one of the highest costs you’ll have if
you own and warehouse stock. You may end up with obsolete inventory – forcing you to
find ways to reduce your stock – or you’ll end up with too little inventory – leading to
stockouts and lost revenue. Dropshipping allows you to avoid these issues and focus on
growing your customer base and building your brand.
Low Order Fulfillment Costs  Order fulfillment usually requires you to warehouse,
organize, track, label, pick and pack, and ship your stock. Dropshipping lets a 3rd party
take care of all of that. Your only job in this arrangement is to make sure they get your
customer orders. Everything else will be handled by them.
Sell and Test More Products with Less Risk  Without the constraints of a physical
inventory and the costs associated with it, dropshipping allows you to update your
inventory quickly, easily, and cheaply. If you know a product is doing well for another
retailer or reseller, you can immediately offer it to your customers without waiting for it to
arrive in your warehouse. Dropshipping allows you to test new items without the risk of
carrying obsolete inventory. You only pay for what you sell.
Cons of Dropshipping
Less Control Over Order Fulfillment and Lead Times  Even though you don’t carry the
cost of warehousing stock, you will pay for dissatisfied customers. The manufacturers and
wholesalers you do business with are responsible for managing and shipping your stock. If
they screw up, the customer complains to you or buys from your competitor. If you start a
dropshipping business, make sure you work with high-quality partners.
Reliance on Other People’s Stock  Being able to offer new products immediately or
stop selling slow-moving products is a major benefit of dropshipping. The drawback to this
perk is that you don’t control your supplier’s inventory. If they run out of stock, YOU run out
of stock. This will result in longer lead times and lost customers.
Less Profit  The hidden “cost” of dropshipping is the lack of bulk pricing. You will likely
pay more for each item you sell as compared to paying less for a large inventory of items –
leading to less profit. If you want to earn a lot of money using dropshipping, then you’ll
have to sell more products than you otherwise would have if you owned and warehoused
them yourself.

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Poorer Customer Service  If your supplier delivers products late, damages them,
delivers the wrong items, or otherwise screws up your customer’s order, the customer will
take it out on you. We already mentioned this problem when it comes to order fulfillment
and lead times. But it extends farther than that. You won’t be able to maintain the personal
touch that retailers who manage their own inventory can provide customers. You won’t be
able to quickly solve customer issues without overseeing the inventory yourself – you’ll
have to deal with your suppliers to solve problems for your customers. This “man-in-the-
middle” way of helping your customers can lead to issues with your suppliers who may
take a long time to do what you ask them to do, and with your customers – who will quickly
get tired of waiting a long time for their problems to be solved.

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LEAN MANUFACTURING SYSTEM (LMS)
What is the Lean Manufacturing System?
The Lean manufacturing system, often referred to as Lean manufacturing, Lean
production, or simply “Lean” is a system for maximizing product value for the customer
while minimizing waste without sacrificing productivity. One of the first major pioneers of
“Lean thinking” (although he didn’t know it) was Henry Ford who was a major sponsor and
promoter of the assembly line. But Lean manufacturing as we know it today has its roots in
the Toyota Production System (TPS), which was created by Taiichi Ohno and Eiji Toyoda
in Japan between 1948 and 1975. Before it was known as TPS, they simply called it just-
in-time manufacturing.
There were 3 things the Toyota Production System attempted to prevent:
Muda
Muda is the Japanese term for “waste.” Muda is everything in your manufacturing
process that creates waste or causes constraints on creating a valuable product.
According to the Lean Enterprise Research Centre (LERC), 60% of all activities in
manufacturing production add no value at all.
According to TPS, there are 8 wastes you should work to eliminate:
 Defects – The mistakes that require additional time, resources, and money to fix.
 Overproduction – When those who receive the output aren’t ready for it or don’t need it
because workers continue to produce more unnecessarily.
 Waiting – When work has to stop because someone is overwhelmed, something broke
down, you’re waiting for approval or materials, or because you’ve run out of something.
 Not utilizing talent – Under-utilizing peoples’ talents, skills, and knowledge (not part of
the original TPS wastes, but is increasingly sighted as a waste by current Lean
manufacturers).
 Transportation – Too much transportation, leading to increased costs, wasted time, and
the increased likelihood of product damage and deterioration.
 Inventory excess – When there is supply in excess of real customer demand, which
masks real production.
 Motion waste – Any excess movement, whether by employees or machines, that
doesn’t add value to the product, service or process.
 Excess processing – Any task that is processed more than required
These 8 wastes can be remembered using the acronym DOWNTIME.

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Mura
Mura is the Japanese term for “unevenness in operations.” Mura is everything that creates
inconsistent and inefficient work flows.
An example of Mura would be if you stocked a truck with fewer pallets than it can hold for
one trip and then stocked it with more pallets than it could adequately hold for a second
trip – resulting in longer lead times.
Muri
Muri is the Japanese term for the “overburdening of people and equipment.” Muri is all
tasks or loads that put too much stress on your employees or machines.
Muri can cause employee burnout – as in the case of having too much work to do and not
delegating a portion of it to someone else.
Or, Muri can cause the total breakdown of a factory machine – as in the case of running
production for too long or with too many products than is allowed by the standards of that
machine.
By minimizing or eliminating Muda, Mura, and Muri the proponents of TPS and the
Lean manufacturing system believe you can produce the highest-quality products while
increasing your revenue and productivity.
We’ll take a look at the tools that help you prevent “unevenness in your operations”
and stop “overburdening your people and equipment” in a moment, but first, let’s take a
look at how the philosophy of TPS gave way to the 5 cornerstone principles of Lean
manufacturing.
What Are the 5 Key Lean Manufacturing Principles?
In 1996, the book Lean thinking was published, forever solidifying a whole new way
of manufacturing. The authors – James P. Womack and Daniel T. Jones – distilled the
lessons they learned from observing TPS down to 5 Lean manufacturing principles. These
5 principles are still at the core of any Lean manufacturing system.
The 5 principles are:

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Figure 8 – 5 Lean Management Principles
Value
The first principle of Lean manufacturing is value, which says a company should deliver
the most valuable product to the customer. Value is therefore determined by the customer,
not the company or its managers.
Value Stream
The second principle of Lean manufacturing is value stream, which says that after
you’ve determined the value you’re going to provide your customers, you should map out
the steps and processes required to manufacture those valuable products.
In a Lean manufacturing system, you should actually draw out every step of your
process, from raw materials to finished product.
The goal is to identify every step that doesn’t create value and find ways to
eliminate those steps.
Flow
The third principle of Lean manufacturing is flow, which says that after you’ve
eliminated most or all of the waste from your system you undergo the process of ensuring
all of your value-adding steps flow smoothly without interruptions, delays, or bottlenecks.
Pull
The fourth principle of Lean manufacturing is pull, which says that products should
be built on a “just-in-time” basis so that materials aren’t stockpiled and customers receive
their orders in weeks, instead of months.
5 Lean Management Principles
Value
Value
Stream
Flow Pull Perfection

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Perfection
The fifth principle of Lean manufacturing is perfection, which says that you should
make Lean thinking and process improvement a core part of your company culture.
Lean is not a static system, it doesn’t work the same for all companies, and
managers aren’t the only ones who implement Lean – employees play an active role in
making companies Lean, too.
To make the Lean manufacturing system more concrete and less abstract, let’s look at a
few tools you’ll need to implement Lean in your business.
What Are the Most Useful and Actionable Lean Manufacturing Tools?
To get rid of Muda, Mura, and Muri there are a variety of tools you’ll need to implement
and learn how to use.
The 5S System
The 5S system is a method of organizing your workplace materials for quicker access and
better maintenance. This system is essential for eliminating waste that is produced by poor
workstations and tools in poor condition.
The 5 S’s are:
 Seiri (Sort) – Remove all unnecessary items for your current production, leaving only
what is necessary.
 Seiton (Set In Order) – Organize remaining items and label them accordingly.
 Seiso (Shine) – Clean and inspect your work area and everything in it every day.
 Seiketsu (Standardize) – Write out your standards for the Sort, Set In Order, and Shine
steps above.
 Shitsuke (Sustain) – Apply the standards you’ve set for your company and make them
habits for everyone in your organization.
Plan, Do, Check, Act (PDCA)
PDCA is a 4-step method of continual improvement in your process and products. It
applies the scientific method to manufacturing so that you can iterate the best results over
the life of your business.
Here is each step: -

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 Plan – Determine the goals for a process and needed changes to achieve them.
 Do – Implement the changes.
 Check – Evaluate the results in terms of performance.
 Act – Standardize and stabilize the change or begin the cycle again, depending on the
results.
Heijunka (Production and Demand Leveling)
Heijunka (production and demand leveling) is a technique specifically designed to
reduce Mura (unevenness) by producing goods in smaller batches at a constant rate.
This helps reduce lead times and reduce inventory since each product or its variant
is manufactured more frequently at a predictable rate.
Kaizen (Continuous Improvement)
Kaizen is the practice of continually observing, identifying, and implementing
incremental improvements in the manufacturing process.
It encourages all managers and employees to be involved in the process of
manufacturing improvements.
Kaizen ensures that waste will be gradually reduced through the collective talents
and knowledge of everyone in the company working together to change the smallest
inefficiencies daily.
Kanban (Pull System)
The Kanban (pull system) allows employees to “pull” work into their work station
when they’re ready. This prevents Muri (overburdening employees) and allows managers
and employees to focus on the right tasks at the right times without wasted effort or time.

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