Main causes of the costs and customer service performance

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Main causes of the costs and customer

service performance

A study on the organizational and traditional aspects of

the inventory system at ABS

Name: Y.A. Althuis

Student number: s1654713

Master program: Business Administration Operations and Supply Chains

Year: 2010/2011

Company: ABS Hydraulics BV

University: Rijksuniversiteit Groningen (RUG) Supervisor (ABS): Ing. H.A. Bergsma

First Examiner: Dr. G.D. Soepenberg Second Examiner: Prof. dr. J. de Vries

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Preface

This master thesis is the result of my research at ABS Hydraulics BV, as part of my graduation at the University of Groningen. It marks the end of my study Master of Science Business Administration, with the specialization Operations and Supply Chains.

I wanted this research to result in better insights of, additional to traditional aspects, organizational aspects of the inventory system. Furthermore, it should provide ABS recommendations for achieving better costs and customer service performance. Looking back at the research I believe I have reached the objective. Carrying out the research gave me better understanding of the influence of mainly the allocation of tasks and authorities, decision-making and communication processes to the performance of the inventory system.

I would like to thank several people that have supported me during the continuation of this research. First of all, I would like to thank Peter van Kampen for pointing out this opportunity and helping me with setting up the first contact with ABS. Furthermore, I would like to thank Henk Bergsma for giving me this chance and for his support during the start and the continuation of the research. The critical view of Henk helped me to continuously being focused on the research, both in good times and in bad times. Special thanks go to my supervisors from the university: Dr. G.D. Soepenberg and Prof. dr. De Vries. I am very grateful for their effort and their support during the research. Finally, I would like to thank all people at ABS that provided me the information I needed for this research.

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Abstract

This paper investigates how the costs and customer service performance are influenced by traditional and organizational aspects of the inventory system at ABS Hydraulics BV. Recommendations are provided for improving the costs and customer service performance. The need for this study was the widely economic crises ABS was facing from the begin of 2009. The management aims to further reduce inventory costs, while keeping the customer service at the same level. Therefore, the following research question is formulated:

Which main aspects of the inventory system should be improved in order to get better costs and customer service performance at ABS?

The framework for solving inventory control problems of Zomerdijk and De Vries (2003) is applied in order to investigate both the traditional and organizational aspects of the inventory system. The traditional aspects contains order quantities, order intervals, demand and lead time characteristics and the control system. The organizational aspects includes task allocation, decision making processes, communication processes and behavior. Before diagnosing the traditional and organizational aspects, the current costs and customer performance are measured. It is concluded that the customer service levels are too low and the inventory costs are too high compared to what is aimed. Moreover, several conclusions from the analysis of traditional aspects indicates that the current inventory system does no longer fit with the current demand and lead time characteristics. From the analysis of organizational aspects it is concluded that less allocation of authorities and responsibilities, a lack of specialization, written rules and standard procedures and less integrating mechanisms caused poor performance.

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1. Company profile

In this chapter a short introduction of ABS is provided. The chapter starts with a brief description of the ABS holding, in which the history and the organization chart are described. The paragraph about ABS Hydraulics contains more information about what they aim to deliver to their customers and how the order processes are designed. Furthermore, the markets in which ABS is doing their businesses are outlined. Finally, an overview of the products of ABS Hydraulics is provided.

1.1 ABS Holding

Twenty-six years ago ABS was founded in Veendam (in the north of the Netherlands) as a technical wholesaler of hydraulic components, called ABS hydraulics. Over the years, ABS has specialized more in the construction of hydraulic powerpacks and ultimately, due to market demand, also complete control systems. In 1992, a cylinder factory was added (ABS Cylinders). In this factory single pieces and small series of high-quality (customer-specific) hydraulic cylinders are produced with very short delivery times. ABS Hydromarine, established in 2004, has in the meantime earned its own place in the maritime industry with a range of technical solutions for this sector. Currently, around the 40 employees are working at ABS. Two managers (the executive board) are responsible for the long-term perspective of all three businesses: ABS Cylinders (± 30 employees), ABS Hydraulics (8 employees) and ABS Hydromarine (2 employees). The executive board is also responsible for the sales of cylinders.

Figure 1: Organization chart of ABS

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1.2 ABS Hydraulics

ABS hydraulics is part of a global network which delivers both hydraulic components and complete hydraulic drive systems to mainly the OEM (original equipment market) market. ABS delivers hydraulic components from stock and produces standard and customer-specific hydraulic drive systems for the most diverse applications. The main performance criteria are high-quality products and short delivery times. As stated, two different businesses can be distinguished. First, ABS purchase a wide variety of hydraulic components from Italian suppliers, keep these components on stock for a certain period, and deliver these components to their customers on desired delivery date. The order process starts with a sales order from the customer. Figure 2 shows the main actors and activities within this order process for hydraulic components. After the order receipt, a sales order will be prepared and the inventories will be checked within Navision (the information system) for the availability of the requested components. An order confirmation will be send to the customer. Navision provides a warning signal when the components are out-of-stock. A replenishment is required, see the activities within the yellow circle (4-6, 8). The next activities are the picking and packaging of the components in the warehouse. Sometimes components should be converted to customers’ requirements. The order process ends with the shipment of components to the customer. ABS aims to execute all activities on the same day of the order receipt and so guarantee short delivery times. Around the 10-15 sales orders were received each day and admitted into the order process.

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between 1 day and 9-10 weeks. Delivering within 1 day means a repeat order, all components are on stock, the production time is no longer than a couple of hours and, finally, resources and capacity are available for the production. When it means a complete new system it should be developed (1 day till 2 weeks), customer specific components should be purchased (max 7 weeks), and it should be produced (around 2 weeks). Around the 5 offer requests are received each week.

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Figure 3: AAD scheme order process for hydraulic powerpacks

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exists of two actors which also executes the procurement activities of both order processes. Additionally, a sales-agent is on the road in order to manage customer relations. In the warehouse mainly one person is responsible for picking, packaging and shipping components. At the assembly department three different employees are working which all support the warehouse employee. Finally, one employee is responsible for drawing and developing the new hydraulic systems using AutoCAD (3-d software for drawing new systems).

The markets in which ABS is doing their business can be characterized as highly aggressive and competitive. Quality of components, small delivery times, customer service and product flexibility are main market requirements in terms of operations strategy (Slack and Lewis (2002) and Slack, Chambers and Johnston (2004)). ABS owned gentleman-agreements with a few well-known suppliers from Italy about more than 20 years for the purchase of hydraulic components (approximately 90% of their total purchase costs). The suppliers adopt only a couple of dealers for the merchandise of their products. The relationships with these suppliers makes that ABS has an unique position in the market. Nevertheless, delivery times around the 6-7 weeks are estimated with a high amount of uncertainty. ABS decided to hold components on stock in order to deliver rapidly and on desired delivery date. Over the years inventories became greater and greater.

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1.3 Products of ABS Hydraulics

The products of ABS hydraulics are divided into product groups, groups of hydraulic components with equal characteristics: same technical specifications, substitute products and complementary products. Table 1 shows an overview of the product groups. Respectively, the amount of different components within the product group, the average stock value, the turnover of 2009 and the turnover ratio are mentioned. Finally, for all product groups is determined whether the components are mainly used for sales or for the assembly of powerpacks. Note that end-products (powerpacks and complete drive systems) are not considered.

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2. Problem statement

In this chapter the background of the problem is described in order to provide the motive for this study. The research objective and research question are formulated for studying and solving the problem. Finally, the limiting conditions of this research are covered.

2.1 Background

Turnovers of ABS Hydraulics were still growing during the years 2005-2009 and they invested in new markets, an ERP system and the development of employees. The implementation of the ERP system provided more insight into costs and customer service performance. The executive board defined new company-goals for the long-term, which were focused on taking actions for coping with the widely economic crises ABS was facing from the start of 2009. They aimed to reduce the inventory costs while keeping the customer service on, at least, the same level. The customer service level was defined by the management (executive board) as the percentage of hydraulic components which could be delivered from stock to the customer. Mainly inventory costs were directly related to the inventories of components (purchase costs, holding costs). For reducing the inventory costs, inventories need to be kept small. However, Slack et al (2002 and 2004) outlined that chasing better performance on the costs objective automatically results into poorer performance on other performance objectives (customer service).

For 2009 the management aimed to decrease the inventory costs and asked the procurement executives for better purchase prices and lower stock levels. Although a clear inventory policy for bringing down the stock levels lacked, a decrease of the total stock value of more than EUR 150.000 was created at the end of 2009 (see table 2). The management estimated the customer service level around the 90% based on feelings and information from warehouse employees. However, statistical evidence was not provided.

Table 2: Total stock value 2009

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customer service level of 90% and a reduction of the total stock value in order to achieve a saving of the total inventory costs of around the EUR 100.000. However, reducing stocks drastically can lead to significant problems, for example lost sales of important customers. Furthermore, ABS cope with unpredictable demand and unreliable delivery times of suppliers. Aspects like inventory control, procurement, demand forecast and organizational aspects (task allocation, communication) becomes more and more important in order to improve customer service levels and to decrease inventory costs.

2.2 Research objective and research question

Several studies (see for example Buxey (2006), Wild (1997), Tersine (1982) and Van Goor, Berry and Whybark (1993)) covered traditional methods as fixed order quantities systems, fixed period systems, stock control systems and other replenishment strategies which can be applied for inventory control. Zomerdijk and De Vries (2003) outlined an organizational perspective on inventory control and covered additional to traditional methods organizational points as well. This article will be applied in order to describe the organizational aspects influencing the performance (customer service level, inventory costs). The objective of this research is defined as:

To get insight into how traditional and additional organizational aspects of the inventory system influences the costs and customer service performance of ABS and to provide recommendations for improvements

This research may result in several factors which influences the performance of ABS. The research question is defined as:

Which main aspects of the inventory system should be improved in order to get better costs and customer service performance at ABS? 2.3 Limiting conditions

The research is limited to ABS hydraulics, one of three businesses of the ABS holding. This means that although it can influence the inventory control of ABS hydraulics also, activities and decisions taken at ABS Cylinders and ABS Hydromarine are not taken into consideration.

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3. Research design

In this chapter is described how the research is conducted. A theoretical framework is first outlined applied as the guideline for the entire research. Also a discussion of related literature is added. Based on the theoretical framework the conceptual model is designed. It shows the main variables of the research and how the variables are related to each other. Moreover, sub questions are formulated in order to answer the research question and, finally, it is outlined how data is gathered and analyzed during the research.

3.1 Theoretical Framework

Before continuing with describing the sub questions, the theoretical framework of the research is outlined. Zomerdijk et al (2003) provided a framework for solving inventory problems which is applied for diagnosing the current situation (see figure 4).

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The motive for using this problem solving framework is the feeling that the current inventory system at ABS performs below “pre-set standards”. In the problem statement is described that the management of ABS aims to achieve a customer service level of 90% and to decrease the total stock value and total inventory costs. Therefore, both the customer service level and the inventory costs should be measured in order to assess the performance of the current inventory system.

Furthermore, Zomerdijk et al (2003) argued that within the framework a few guidelines for the diagnosis phase are added. The first guideline of applying organizational perspective on inventory control in practice regards describing an inventory system by paying attention to each of the five dimensions that have been identified to play a part in inventory control. Therefore, table 3 can be used as a tool for describing the organizational perspective on inventory control. It includes additional to the traditional approach also organizational aspects like task allocation, decision-making processes, communication processes and behaviour. For each dimension relevant aspects and their characteristics are mentioned.

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The second guideline described by Zomerdijk et all (2003) regards the analysis of the inventory system. It is important to start with analyzing each of the five dimensions separately and subsequently focus on analyzing the coherence between the dimensions. This implies that firstly for each of the dimensions it should be studied how it contributes to the inventory control problem. Secondly, it should be analyzed how the findings from every dimension are integrated in order to determine how dimensions relate to each other.

Besides the guidelines for the diagnosis of the inventory control problem, also some guidelines for the redesign are provided. The redesign aims to improve the situation or solve the problem by means of recommendations (Zomerdijk et all, 2003). From the organizational point of view and the interrelationships between the dimensions, it is important to take all five dimensions into consideration. However, the five dimensions are not expected to be equally important. Depending on the outcomes of the diagnosis of the inventory system, it might be sufficient to redesign just one of the dimensions.

3.2 Conceptual model

The conceptual model is designed based on the research objective, research question and the theoretical framework and is shown in figure 5. It is conceptualized in order to clarify the goal of this study. It should be investigated how the five dimensions and relevant aspects influences the customer service level and the inventory costs (performance). Additionally, the coherence between the different dimensions should also be taken into consideration.

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3.3 Sub questions

Based on the theoretical framework and the conceptual model the sub questions are formulated in order to answer the research question. It is important to study how the current inventory system performs. Therefore, the first sub question is formulated:

1. How differs the current performance from pre-set standards in terms of customer service level and inventory costs?

The next step is to obtain a comprehensive view of the current inventory system. It should contain detailed descriptions of both traditional aspects of inventory control and aspects from the organizational context of the inventory system. The following sub question is formulated:

2. How can be described the five dimensions of the organizational perspective of the inventory system (traditional aspects, allocation of tasks, decision making processes, communication processes and behaviour)?

Furthermore, it is argued that for each of the dimensions it should be studied how it contributes to the inventory control problem. Coherency between different dimensions should also taken into account. The following sub question is formulated:

3. How contributes the five dimensions to each other and to the inventory control problem and what are the main causes for the inventory control problem?

The final step is to provide recommendations for improvements of the inventory system. Therefore, the following sub questions are formulated:

4. Which recommendations can be provided for the redesign of the inventory system in order to achieve significant better costs and customer service performance?

3.4 Data collection and analysis

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4. Current performance

In this chapter the performance of the current inventory system is described by measuring the customer service level and the inventory costs. At the end some conclusions are drawn.

4.1 Customer service level

The customer service level (fill rate) is the number of products delivered on desired delivery date divided by the number of products ordered (Schonsleben, 2007). Table 4 shows information about how much components per product group are delivered on desired delivery date and which components are delivered too late. The customer service level is represented as percentage by calculating the components delivered on desired delivery date divided by the total amount of components. Data is gathered during 40 days of the first three months of 2010.

Table 4: Customer service level

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4.2 Inventory costs

For measuring the inventory costs several cost-components can be calculated. The well-known Economic Order Quantity (EOQ) methodology balances the charges associated with carrying inventory against the costs of placing and receiving an order (Buxey, 2006). Carrying costs includes cost components as working capital costs, renting, heating, lighting and obsolescence costs (Tersine, 1982). During the research it is concluded that renting, heating and lighting costs are fixed costs for ABS and do not influence the performance of the inventory system. Obsolescence costs are critical to define and to calculate and for that reason not taken into account. Therefore, the working capital costs (interest) are calculated in order to assess the carrying costs. These cost component implies the costs for keeping components on stock and are calculated as average stock value x interest rate. An interest rate of 7% is taken based on information from the accountancy department. Order costs implies costs for all transactions required for placing an order and receiving the components (Slack et al, 2004). In case of ABS order costs can be divided into purchase costs and transport costs. Purchase costs are the costs paid to the suppliers for the value of the components. Transport costs are the costs paid for the physical distribution. The main suppliers are established in Italy and the shipments per product group are analyzed in order to calculate the transport costs. Total inventory costs are the sum of the working capital costs, the purchase costs and the transport costs. Table 5 shows the results of the analysis of data gathered in 2009.

Table 5: Inventory costs

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4.3 Conclusions

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5. Descriptions of traditional aspects

In this chapter the traditional aspects of the inventory system of ABS are outlined. Zomerdijk et all (2003) mentioned 3 relevant aspects in order to describe the traditional inventory control. These three aspects (order quantities, order intervals and the control system) are described in this chapter. Moreover, it is also emphasized by Zomerdijk et all (2003) that demand and lead time characteristics can play a significant role for determining order quantities and order intervals. Therefore, trends of the demand and lead times of suppliers are also covered in this chapter.

Each product group (005, 006, 008 and 009) includes several different components, respectively 764, 360, 176 and 1040 components. Within this research less time was available for the analysis and for that reason not all components are studied. It was decided to chose randomly 4 components for each product group and to study, describe and analyze this components into detail. The chapter starts with a paragraph about order quantities, followed by a paragraph about order intervals. In the third and fourth paragraph, attention is paid to respectively the demand and lead time characteristics. The chapter ends with a paragraph about the control system, in which is outlined how the system is designed and how it support inventory decisions.

5.1 Order quantities

Order quantities are the amount of components which are ordered by the supplier for replenishing the stock levels (Van Goor et al, 1993). Table 6 shows actual data about the order quantities.

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components of product group 009 shows the largest order quantities (150 – 750), which is directly related to the relative higher demand for this components.

Table 6: Order quantities

5.2 Order intervals

The order interval is the time period between the placements of orders (Schönsleben, 2007). Table 7 shows the order dates (respectively day and month) and the order intervals (days) of the components in 2009.

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assumed that higher order quantities usually results into smaller order intervals.

Table 7: Order intervals

5.3 Demand characteristics

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0 100 200 300 400 500 0 50 100 150 200 250

Figure 6a: Inventory curve AKZ Figure 6b: Inventory curve GM5043-24DC

0 30 60 90 120 150 0 10 20 30 40 50

Figure 6c: Inventory curve VRFU9003 Figure 6b: Inventory curve LC-VF1/AB

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0 50 100 150 200 250 300 0 50 100 150 200 250

Figure 7a: Inventory curve HHC10191 Figure 7b: Inventory curve HHT02280

0 30 60 90 120 150 0 10 20 30 40 50 60

Figure 7c: Inventory curve HHC24017 Figure 7d: Inventory curve HHR20304

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0 15 30 45 60 75 0 10 20 30 40 50

Figure 8a: Inventory curve HPMV-OMFB Figure 8b: Inventory curve GR472V028

0 3 6 9 12 15 18 0 30 60 90 120 150

Figure 8c: Inventory curve GR472V045 Figure 8d: Inventory curve PMS12/25/45A

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0 150 300 450 600 750 900 0 150 300 450 600 750

Figure 9a: Inventory curve VR15L Figure 9b: Inventory curve CR15LG12

0 200 400 600 800 1000 1200 0 200 400 600 800 1000

Figure 9c: Inventory curve SP18L Figure 9d: Inventory curve VR18L

Figures 9a till 9d shows the inventory curves for four components of product group 009. All figures shows large peaks in the curves of the inventory level, which indicates a very lumpy demand. The peaks are mainly caused by relative large order quantities from customer and low price per unit.

5.4 Lead times

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Table 9: Supplier lead times of components of product groups 008 and 009

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day. It can be assumed that this orders came from other domestic dealers and are placed as a consequence of out-of-stock, unpredictable demand and a low maximum stock level. The components within product group 006 shows more frequent lead times, minimal 2 weeks and maximum 5 weeks. However, they are continuously different and no relation is found between the order quantities and intervals. For example component HHC24017: replenishments with an order quantity of 100 are delivered within respectively 5 and 2 weeks while replenishments with an order quantity of 5 are delivered within respectively 3, 3 and 5 weeks. The lead times of component HPMV-OMFB (product group 008) shows a high difference between the shortest lead time and the largest lead time, respectively 2 and 10 weeks. This is also observed for component GR472V045 with minimum lead time of 4 weeks and maximum lead time of 12 weeks. The components of product group 009 contains relative the shortest lead times, around 1-4 weeks while the order quantities are the largest. Note that this product group includes hose and pipe components, which has a high usage rate, high order volumes and low value per unit.

5.5 Control system

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Figure 10: Ordering methods (Van Goor et al, 1993)

Two decision rules were applied for determining maximum stock levels and reorder points: 1. The maximum stock level is equal to 6 months demand

2. The reorder point is equal to 3 months demand

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6. Descriptions of organizational aspects

Zomerdijk et all Vries (2003) mentioned 4 different dimensions additional to the traditional aspects in order to describe the organizational perspective on inventory control. These dimensions are the allocation of tasks, decision making processes, communication processes and behavior. In this chapter, the dimensions will be further outlined for the inventory system of ABS.

6.1 Allocation of tasks

Relevant characteristics for the allocation of tasks are the number of people that are responsible for the inventory system, the horizontal differentiation of departments, the layers of the organization and the balance between authorities and responsibilities (Zomerdijk et all, 2003). Totally 8 employees are working at ABS Hydraulics and the organization can be typified as small and flat. Flat organizations has generally a few levels of hierarchy (Jones, 2007). In case of ABS, also a few layers in the organization are distinguished: the executive board which are mainly responsible for long-term goals and annual results, the middle-level which is responsible for sales, procurement, product engineering and customer service and, finally, the executives which are responsible for warehousing, production and support activities. Activities with regard to the inventory system are allocated to the middle-level.

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roles, but executed by the same people. Moreover, although the executive board should hold the middle-level responsible for their actions and results, it is not observed.

The replenishment of components and the control of stocks is executed by the middle-management as a consequence of strong embedded tasks in the organization. One of the founders of ABS (currently working at the middle-level) has a long history of contact with the main suppliers and still executes the replenishments of components. However, they will be mainly responsible for sales and product engineering. Consequences of this allocation of tasks will be discussed in chapter eight. Finally, no time is reserved for the control of stocks.

6.2 Decision making processes

Availability of information, amount of decision makers and rationality of decisions are important dimensions concerning decision-making processes. As described in previous paragraph, authorities and responsibilities are not clearly defined. This situation influences also decision-making processes. The executive board is responsible for the long-term goals and take decisions about strategic choices. A good example of how decisions are taken and communicated through the organization is the change of the strategic view by the executive board: from a more customer service focus to more focus on inventory costs. From the start of the company, ABS intended to hold all components demanded by their customers on stock in order to achieve a high customer service level. According to actual demand and market chances, low prices becomes more important and overhead and inventory costs should be lowered. The decision was taken by the executive board to change the strategic view, but is not clear communicated to other organization levels. As a result, employees did not adjusted their focus of actions and would still satisfy customers with high service levels. A more customer service focus was observed by the employees of the middle-level instead of a focus on internal processes and inventory costs, which was aimed by the executive board.

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points and maximum stock levels are never adjusted to actual demand and supplier lead times. As a consequence, inventory decisions are arbitrary made: sometimes the decisions are based on information from Navision and otherwise, the decision makers made inventory decisions based on own experience and expectations about future demand. Finally, during the research it is found that less time was taken into account for replenishments. Around the 3 – 4 hours a week is spend for the replenishments.

6.3 Communication processes

The reporting system, the amount of feedback and the quality of information are mentioned as main aspects for describing communication processes (Zomerdijk et all, 2003). As stated in previous paragraphs less authorization and responsibilities are allocated to employees. Moreover, formalization and standardization are less observed. The lack of such organizational aspects influences the quality of the reporting system and communication, both top-down and bottom-up. Communication between the executive board and the middle-level of the organization is found as poor. Employees work almost completely independently and most decisions are made without interference of the management. Moreover, in the previous paragraph is emphasized that obscurity exists about the importance of customer service level and inventory costs. It covers the quality of feedback top-down. The message of changing the strategic focus is not understood by the employees. Also persuasive communication between fellow employees, described as the attempt by one party to transmit and share information with another party to secure their agreement and cooperation (Jones, 2007) is less observed. For example about which decisions they take for the inventory control. Finally, information about suppliers (for example price discounts, price increases, delivery times and delays of deliveries) is less shared.

6.4 Behaviour

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7. Analysis of the traditional and organizational aspects

The findings of the traditional and organizational aspects are further analyzed in this chapter. It starts with a discussion how the performance is caused based on a calculation of the EOQ and an analysis of the actual inventory levels. The third paragraph covers an analysis of the reorder point and the maximum stock level as part of the control system and the fourth paragraph discusses the customer demand and supplier lead times. The organizational aspects are further analyzed in paragraph five by using the organizational design challenges of Jones (2007). Conclusions are provided in paragraph six and, finally, the coherence between the dimensions is discussed in paragraph seven.

7.1 The economic order quantity (EOQ)

In chapter 4 is concluded that product groups 005, 006, 008 and 009 contains the highest inventory costs. However, no benchmark is found for assessing the inventory costs. Questions as “are the stock levels and inventory costs too high?” could not be answered. After the entire analysis of the inventory system more information is available about how the inventories are replenished and controlled. Based on the well-known Economic Order Quantity (EOQ) approach is tried to draw more conclusions about the performance of inventory costs. The EOQ approach balances the ordering costs against the carrying costs by using the following formula:

The following variables are used for ABS in order to calculate the EOQ per component: Q = the economic order quantity

D = annual demand per component

F = ordering costs per unit, which are calculated based on the transport costs H = carrying costs as percentage of the unit price (7%)

P = unit price

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includes order quantities which approximates the EOQ. Three components includes order quantities lower than the EOQ (AKZ, HPMV=OMFB and PMS12/25/45A) and six components includes order quantities higher than the EOQ (HHT02280, HHR20304, VR15L, VR15LG12, SP18L and VR18L). Four components includes both lower and higher order quantities compared to the EOQ (GM5043-24DC, LC1-VF1/AB, HHC10191 and HHC24017). Order quantities lower than the EOQ causes relative higher ordering costs (relative more replenishments) and order quantities higher than the EOQ causes relative higher carrying costs (components are relative longer hold on stock).

Table 10: The economic order quantity (EOQ)

7.2 The inventory levels

In paragraph 5.3 the demand is described by drawing the inventory curves of the components. Based on the inventory levels a more elaborated analysis is applied in this paragraph in order to describe how both the customer service level and carrying costs are caused. Therefore, some general and simple inventory rules should be taken into account:

 Relative low stock levels increases the risk for out-of-stock and causes poor customer service (schönsleben)

 Relative high stock levels increases carrying costs (Schonsleben)

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high working capital costs (WCC), see table 11. The minimum stock level indicates the inventory level that is constantly on stock during the year. Comparing the working capital costs with the unit price can be stated that the components should be sold several times before the working capital costs are compensated. Schonsleben (2007) outlined that for covering fluctuations in supplier lead times and customer demand safety stock can be calculated. However, especially for the components AKZ, VRFU9003 and HHT02280 reasons for holding constantly high inventory levels on stock lacked because the demand showed not really high fluctuations. Also components GM5043-24DC (005), HHC10191 (006), HPMV-OMFB, GR472V028 and PMS12/25/45A (008) showed some high inventory levels, but not constantly during the year.

Table 11: The working capital costs (WCC)

Components LC-VF1/AB (005), HHC24017, HHR20304 (006), GR472V028 (008) and SP18L (009) shows some points in time that the inventory level is 0 or near to 0, which negative influences the customer service level. Notice that it was found that the product groups of this components showed also the lowest customer service levels (see paragraph 4.1). The customer service level of product group 009 (91%) is sufficient to what was aimed.

7.3 The reorder point and the maximum stock level

In paragraph 5.5 is described how the control system is designed. A B,S method (van Goor et al, 1993) is applied which means that the timeframe of the ordering method is continuously and the order quantities are variable. Therefore, reorder points and maximum stock levels were determined three years ago. In this paragraph is studied how these parameters are applied for determining the actual reorder points. The inventory curves in paragraph 5.3 shows additional to the inventory curve also the determined reorder points (green line) and the maximum stock levels (blue line). The red circles indicates the actual reorder points.

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maximum stock levels. Component HHT02280 (006) shows two replenishments made approximately on the reorder point and the inventory level did not exceed the maximum stock level. However, it was found that the inventory level is constantly high which caused high working capital costs (see paragraph 7.2). Furthermore, the inventory level of component GR472V045 (008) is relative well controlled. Only one times it exceeded the maximum stock level and there was no risk for out-of-stock. However, three replenishments are made too early compared to the determined reorder point.

Moreover, mainly all components shows replenishments made far earlier than the determined reorder points. It caused high working capital costs for some components (see paragraph 7.2). Otherwise, some components are replenished too late compared with the determined reorder point, which caused a high risk for out-of-stock and a poor customer service level (components LC-VF1/AB, HHR20304 and SP18L). Finally, the inventory levels of mainly all components shows some points in time that the maximum stock level was exceeded.

It can be concluded that the determined reorder points and the maximum stock levels are not used for controlling the inventory levels of the components. However, it should be noted that some parameters of components are not suitable for controlling the inventory levels. Based on the inventory curves can be stated that the parameters of components HHC24017 (006) and PMS12/25/45A (008) are determined too low and causes a poor customer service level. Also components LC-VF1/AB (June) and GR472V028 (March and October) shows replenishments on time (or too early) while the inventory levels decreased to zero. In contrast with this components the parameters of components GM5043-24DC and VRFU9003 (005), HHC10151 and HHT02280 (006) are determined too high, which causes high working capital costs. Additional to the failure to use, it can be also concluded that some parameters are really inapplicable with regard to current customer demand.

7.4 Customer demand and supplier lead time

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expected to be sold in six months. The assumed annual demand can be calculated as follows: 200 x 2 is 400. Table 12 shows both the expected demand and the annual demand of 2009. Moreover, the longest supplier lead time of 2009 is mentioned per component. Note that 12-13 weeks was taken into account for determining the parameters.

Table 12: Expected demand, annual demand and longest supplier lead time in 2009

It can be stated that the annual demand of only one component (VRFU9003) approximates the expected demand. Furthermore, for mainly all components the supplier lead times are much shorter than the calculated 12-13 weeks. Only components HPMV-OMFB and GR472V045 includes lead times of respectively 10 and 12 weeks. To conclude, both the customer demand and the supplier lead times are changed. The parameters can be typified as inapplicable.

7.5 Organizational design challenges

From a theoretical point of view several organizational aspects could cause poor performance. In order to analyze the organization Jones (2007) distinguished four organizational design challenges:

 Balancing vertical differentiation and authorization;  Balancing horizontal differentiation and integration;  Balancing centralization and decentralization;  Balancing standardization and mutual adjustment.

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authority. The need for vertical differentiation increases by organizational growth (Jones, 2007). Although the organization of ABS grew the last ten years, the organization can be still described as flat with few levels of hierarchy. It is found that less responsibilities are allocated and, as a consequence, employees are not hold accountable for their actions. Examples are that employees would not take the responsibility for high stock levels of slow-movers, late replenishments of fast-slow-movers, decreasing turnovers and wrong deliveries.

Horizontal differentiation is mentioned as the way an organization groups tasks into roles. At ABS only a few employees perform all organizational tasks and less horizontal differentiation is observed. Benefits of this situation are learning from one another (joint specialization) and less bureaucratic costs. However, a great disadvantage is the lack of specialization of employees for certain organizational roles, for example for sales, procurement and inventory control. It is embedded in the organization how organizational roles are allocated, which creates also some conflicting roles. Employees executes both sales and inventory control activities and for that reason, would hold a broad range of components on stock with high stock levels in order to be able to deliver components every time to customers. Finally, poor communication is observed while less vertical and horizontal differentiation should prevent the organization for communication problems. Less integration mechanisms are observed in order to improve communication patterns.

The third organizational design challenge involves choices about how to distribute authority and decision-making. Decision-making regarding the operations strategy is highly centralized at the executive board. Decisions about actions for improving customer service, increasing turnovers and decreasing inventory costs are taken by the executive board. However, authority for decision-making about how to achieve such company objectives is not clearly allocated. Decision-making about initiating new projects in order to improve customer service (for example just-in-time deliveries) or decreasing inventory costs (for example ABC classification of components, lean and six sigma projects) is not observed. Also the communication about decisions and choices and reporting systems are less observed.

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maximum stock level replenishment decisions should be made. However, as argued earlier employees hesitated about the accuracy and reliability of the outcomes of Navision. As a consequence employees made inventory decisions based on mutual adjustment. Generally, mutual adjustment (the process through which people use their judgment rather than standardized rules to address problems), embedded values and unwritten rules controlled the organization.

7.6 Conclusions

Conclusions which can be drawn from the analysis of the traditional aspects of the inventory system are:

1. The customer service levels are too low and the inventory costs are too high compared to what was aimed.

2. High ordering and high carrying costs are caused by respectively small and large order quantities.

3. High inventory levels of some components causes high carrying costs and low inventory levels of some components causes poor customer service level.

4. The determined reorder point and maximum stock level are not always used for replenishment decisions.

5. Customer demand and supplier lead times are significantly changed compared to what was taken into account. As a result, the reorder point and the maximum stock level are no longer applicable

Conclusions of the comprehensive analysis of the organizational aspects with regard to the inventory system are enumerated below:

1. The organization can be described as flat with few hierarchical levels. Less responsibilities are allocated and employees are not hold accountable for their actions

2. A great disadvantage of less horizontal differentiation is the lack of specialization of employees for certain organizational roles

3. Less integration mechanisms are observed in order to improve communication patterns

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7.7 The coherence between the dimensions

After the analysis of both the traditional aspects and the organizational aspects should be clarified how different findings are related to each other. Therefore, a cause-effect relationship figure (see figure 11) is designed in which the dimensions of the inventory control are drawn. It provides an answer on the question how the poor performance is caused by the traditional and organizational aspects. Notice that the reorder point and maximum stock level are called ‘parameters’ in the figure.

During the analysis is found that the customer service level is too low compared to what was aimed. Schonsleben (2007) argued that the service level can be satisfied by available inventory. Otherwise, poor customer service level means that less inventory is available at the moment the customer demands (stockout). Stockout is caused by too late replenishments of stocks (paragraph 7.2). Also the performance on the inventory costs is analyzed as poor. Based on an analysis of the Economic Order Quantity (EOQ) is found that both the ordering costs and the carrying costs are too high, respectively caused by small and large order quantities (paragraph 7.1).

But why are replenishments made too late and why are order quantities wrong chosen? Replenishments should be made based on a reorder point and maximum stock level, but these parameters are determined 3 years ago. During this period customer demand and supplier lead times has been developed and changed. The determined parameters are no longer applicable for actual demand and lead times. This means that by decreasing demand the replenishments are made too early which causes higher inventory costs. Otherwise, by increasing demand the replenishments are made too late which causes poorer customer service. Furthermore, by larger lead times the replenishments are made too late which causes poorer customer service. Smaller lead times causes higher inventory costs. This unfit supports the finding that decision makers hesitated about the accuracy and as a result, the parameters has not always been applied for determining the reorder point and the order quantities.

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engineering of powerpacks. Less attention is paid to how inventory decisions (when to reorder and how much to reorder) should be made. During the implementation of Navision 3 years ago, parameters are determined based on demand and lead times characteristics. However, the variability of demand and lead times is not taken into account. Concerning the vertical differentiation of the organization less responsibility and authority is allocated for such inventory control dimensions. Some employees make the decisions for replenishments, but they do not take the responsibility for the performance. Moreover, employees could not be hold accountable for their actions because based on the organizational structure is found that inventory control was not allocated to employees. It can be concluded that the significance of inventory control for the customer service and costs performance was not noticed.

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Organizational aspects

Traditional aspects

Performance

Figure 11: Cause-effect relationships of the inventory system

Low customer service level

High inventory costs  Small / large order

quantities

 Wrong chosen points in times to replenish  Low / high inventory

levels No fit between

parameters and actual demand and lead times

No use of parameters for

replenishment decisions  Flat organization

with few hierarchical levels  Less allocation of authorities and responsibilities  A lack of specialization  Less integrating mechanisms  A lack of written

rules and standard procedures

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8. Recommendations

In this chapter recommendations are provided for the inventory control at ABS. In order to keep the focus on inventory control first recommendations are provided for the traditional aspects of inventory control. It covers a comprehensive method of analyzing components and defining the best inventory policy for each component. These method contains also some organizational aspects which are outlined in the following paragraphs, respectively about functional teams and communication in the organization.

8.1 Inventory control: implementing a multiple criteria ABC analysis

During the analysis is found that for the inventory control of all components one ordering method is applied and no attention is paid to the importance of components. Van Goor et all (1993) emphasized that for realizing an effective and efficient inventory control is required to analyze which components are really important for annual turnovers. The ABC classification is a well-known concept which divides a set of components into three classes based on the annual dollar usage. In all types and sizes of organizations evidence can be found that a small number of products make up the largest portion of the turnover (Schonsleben, 2007). This classification can be typified as single-criterion ABC analysis.

Vollman, Berry and Whybark (1984) discussed also a classification based on multiple criteria because also several non-cost criteria are important for inventory management. Examples of such criteria are the impact of running out, how quickly the item could be purchased, whether a substitute is available, and political consequences of being out. To keep the number of inventory management policies to a workable view the number of combinations of criteria needs to be kept small (Vollman et al, 1984 ). The procedure for applying a multiple criteria ABC analysis consists the following steps:

1. Calculating the dollar usage distribution and defining ABC categories 2. Establishing non-cost criteria and defining 1,2,3 categories

3. Reduce the number of categories

4. Defining inventory control policies for managing each category

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The first step includes the procedures of a single-criteria ABC analysis and consists of separating the components into three categories according to their annual cost volume usage (unit cost x annual usage). A items has a high dollar usage, B items has an intermediate dollar usage, and C items has a low dollar usage. In case of ABS 20% of the components accounts for 78% of the turnover. This components are classified as A components. Another 30% of the components accounts for 17% of the turnover (B components) and, finally, 50% of the components accounts for 5% of the turnover (C components). Figure 12 shows the results of the single criteria ABC analysis based on the annual dollar usage.

Figure 12: Single criteria ABC analysis

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Figure 13: Distribution based on implicit criteria

The results of the first two steps is drawn into a matrix of the dollar usage and criticality classifications (see figure 14). It presents nine possible combinations that could each require a different inventory policy.

Figure 14: Matrix of the dollar usage and implicit criteria classifications

Step 3 consists of reducing the number of categories into a number with which people can cope. Vollman et all (1984) argued that a simple procedure can be applied for combining categories. The procedure simply assigns every component in A1, A2 and B1 to class AA, every component of A3, B2 and C1 to class BB and every component of B3, C2 and C3 in class CC. In case of ABS, an extra class DD is added for components with low annual dollar usage and low importance regarding the implicit criteria (C3). This means that only components of B3 and C2 are assigned to class CC. It results into the classification presented in figure 15.

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The final step is to define specific inventory policies for managing each category. Vollman et al (1984) cover four areas for developing inventory policies. These are inventory record verification, order quantities, safety stock and classification of the components itself. Verification is required for avoiding differences between the inventory record of the system and physical availability. To improve inventory accuracy more frequent counts should be made. This implies a higher frequency for the components of class AA rather than for class BB, class CC and class DD.

For the order quantities and the safety stock of the different classes relative simple policies are mentioned by Vollman et all (1984). However, a more broader and comprehensive view of inventory control is required for this aspects. It was aimed by the management to reduce inventory costs, both ordering costs and holding costs. As mentioned earlier, for balancing the ordering costs against holding costs the economic order quantity (EOQ) can be calculated for each component. Although the EOQ approach ignores random variations in the usage rate and supplier performance, it can be the starting point for a fixed-order quantity system which contains continuous stock review (Buxey, 2006). The situation is monitored after each transaction, and a new replenishment order is generated when the stock level is decreased to below a determined reorder point. In terms of Van Goor et all (1993) the ordering method can be typified as a B,Q method. The order quantity (Q) is equal to the EOQ and the reorder point (B) includes safety stock in order to avoid out-of-stock. Schonsleben (2007) argued that safety stock for critical components with discontinuous or lumpy demand patterns can be best determined by forecasts for future periods.

The B,Q method should be applied for components of class AA and class BB. It can increase both the costs performance and the customer service performance. For components of class CC and DD the focus should be mainly on reducing inventory costs. Components of class DD are of less importance, both for the annual dollar usage as for the implicit criteria. Therefore, this components should not be hold on stock and only purchased to customer order. Also for components of class CC less time should be spend on. However, out-of-stock can be crucial. Van Goor (1993) argued that for such components a s,S ordering method can be applied. The order quantity is dependent of a determined maximum stock level and the reorder point is on a periodic review (1 times per month).

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annual dollar usage and implicit criteria. Mainly for B components (downwards) and C components (upwards) a reclassification contains several changes because the ordering method and the calculation of the order quantity and the safety stock is different. Additionally to possible shifts of components, also the safety stock (AA class and BB class components) and the maximum stock level (CC class components) should be reviewed. Figure 16 summarizes the dimensions of the inventory policies for the AA, BB, CC and DD classes.

Figure 16: Inventory policies

8.2 Functional teams

The organization of ABS is typified as small and flat. It is found that main activities as sales, product engineering, procurement, customer service and inventory control are fragmented and executed by different employees of the middle-management. De Vries (1999) argued that establishing a logistic department is to expensive and organizationally not feasible for small- and medium-sized enterprises (SME). However, several studies (for example Magad and Amos (1989) and Van Goor (1993)) cover the principle of integrating the logistic activities. As part of the total materials management principle all of the pertinent materials sub functions are brought together under one umbrella and tends to reduce conflict and encourage complementary groups to work together as a team (Magad et all, 1989).

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managed by this team and the sourcing of new suppliers is executed in order to secure a certain kind of product quality. Also the authorities for executing the inventory management policies described in previous paragraph are assigned to this team. Classifying components, determining order quantities, safety stocks and maximum stock levels and reclassifying components are main activities for the materials management team. Periodic counting of the components should be applied by warehouse employees. The performance of the new designed inventory policy should be assessed by the executive board based on costs and customer service performance.

A second functional team should be established for activities as sales, product engineering and CRM. With regard to inventory control this team should be made responsible only for demand forecasting. This team is not further discussed because it is out-of-scope of this study.

Working in functional teams of employees with common tasks and responsibilities will enhance both joint specialization and specialization (Jones, 2007). Employees work together and coordinate their actions to find the best way of performing a task. Moreover, members of the teams can expense their knowledge by learning from each other which is also mentioned as strong competence of the current organization structure. For example, members can learn about substitute products and new potential suppliers, about how supplier lead times fluctuates and how ordering and holding costs are caused. Moreover, members enhances their experiences about how to make trade-offs in order to improve performance.

Compared with the current organizational structure separating and allocating tasks to different functional teams increases also specialization of tasks (horizontal differentiation) and avoids conflict situations. Employees becomes more specialized and productive and increases its ability to create value (Jones, 2007). Moreover, it is observed that different employees executes both sales and inventory control activities which enhances the change of conflicting roles. In the new organizational structure of two teams are these tasks separated. A good example is that trade-offs are only based on inventory decisions and sales employees no longer executes also procurement and inventory control activities.

8.3 Communication

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different hierarchical levels and between fellow employees of the same level. Moreover, in previous paragraph horizontal differentiation is stimulated by specialization. Jones (2007) stated that specialization limits communication. Therefore, integrating mechanisms should be implemented in order to avoid communication problems. The simplest integrating technique is the organization’s hierarchy of authority which dictates who reports to whom.

In case of ABS the executive board should determine who reports to whom. Regarding the structure of functional teams at the same hierarchical level (middle-level) both the materials management team and the sales team should report to the executive board. The materials management team reports about cost performance (inventory costs), customer service and internal processes. The sales team reports about turnovers, expectations of future demand and new markets. For the way of reporting formalization plays an important role. Formalization is the use of written rules and standard procedures (Jones, 2007). It clarifies also how authorities are allocated. Communication top-down can be applied by face-to-face meetings. The executive board should clearly communicate about what they expect and which decisions are made for the long-term. Subsequently, the functional teams should reflect about how to make trade-offs. For example, when the executive board decides to aim to further decrease inventory costs the materials management team should think about how to adjust and redesign current inventory management policies (mainly the ordering method, order quantities and safety stocks).

Also for the communication between the functional teams techniques should be integrated. Mainly about demand forecast, market changes and the development of new products periodically communication is required in order to cope with fluctuations of customer demand. Meetings can be arranged which coincides with the reclassification of components.

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References

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 Goor, van, A.R., Kruijtzer, A.H.L.M., Esmeijer, G.W. 1993.

Goederenstroom-besturing, voorraadbeheer en materials handling (2nd ed.). Leiden/Antwerpen:

Stenfert Kroese.

 Jones, G.R. 2007. Organizational theory, design, and change. New Yersey: Prentice Hall.

 Magad, E.L. Amos, J.M. 1989. Total materials management, the frontier for

maximizing profit in the 1990s. New York: van Nostrand Reinhold.

 Vries, van, J. 1999. Logistiek organiseren, een studie naar de relatie tussen

goederenstroombesturing en logistieke organisatie. Groningen: Van Denderen

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 Schönsleben, P. 2007. Integral logistics management, operations and supply

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 Slack, N. Lewis, M. 2002. Operations strategy. Harlow: Prentice Hall.

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 Tersine, R. 1982. Principles of inventory and materials management (2nd ed.). New York: Elsevier North Holland, Inc.

 Vollman, T.E. Berry, W.L. Whybark, D.C. 1992. Manufacturing planning and

control systems (3rd ed.). Chicago, Irwin.

 Wild, T. 1997. Best practice in inventory management. Cambridge: Woodhead Publishing Limited.

Literature (articles):

 Buxey, G. 2006. Reconstructing inventory management theory. International

Journal of Operations & Production Management, 26 (9): 996-1012.

 Zomerdijk, L.G. Vries, van, J. 2003. An organizational perspective on inventory

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Internet resource:

Main causes of the costs and customer service performance