Objective:
To balance the benefits of physical inventory versus inventory costs to ensure an organization can meet its patient care needs while obtaining value-for-money from its supply chain expenditures
Definition
The inventory policy addresses how inventory is to be managed across the organization. It is intended to maximize the key elements of the inventory cycle by establishing optimal levels and location through effective demand planning, forecasting and replenishment.
Rationale
The purpose of inventory management is to ensure that customers have access to the right product at the right time in the right place and at the right cost. This must be balanced with ensuring appropriate risk management. In hospitals, effective inventory management minimizes excess inventory levels while ensuring patient needs are met. A clearly defined inventory policy enables the supply chain department to be accountable for the management of inventory items and ensures that the organization’s resources are committed effectively.
Benefits
Patient Care
Establishing appropriate inventory levels and locations ensures that medical staff have the required items to provide the highest level of patient care.
Financial Stewardship
An effective inventory policy helps organizations manage their assets and their return on investment, as well as manage down expenses by decreasing the amount of products procured.
Customer Service
Maintaining adequate inventory levels is a key element of customer service to ensure supplies are available when needed. The inventory policy should establish optimal inventory levels by minimizing the risks associated with stock-outs and stale-dates, without overcrowding point-of-use storage space.
Related Metrics
2.2 Inventory Turnover in One Month
2.3 Operating Costs as a Percentage of Expenditures
3.2 Percentage of Rush Purchase Orders
3.5 Average Number of Purchase Orders Placed to Top 10 Suppliers in One Month
4.1 Stock-Outs at the Cart Level
4.2 Fill Rates to Customers
4.3 Percentage of Items Activated in the Master File in One Month
4.4 Percentage of Items Inactivated in the Master File in One Month
Guiding Principles
An inventory policy should establish a process to determine what to stock, the optimal quantity and locations. Determining factors include inventory and replenishment costs, cost of shortages, inventory classification, and product usage patterns.
Cost
Inventory Costs
Inventory holding and management costs, or carrying costs, can be divided into fixed and variable costs.
Fixed Costs include:
- Cost of warehouse space and support equipment; and
- Weighted average cost of capital (WACC).
Variable Costs include:
- Value of inventory;
- Operating working capital employed;
- Annual operating costs such as heat, electricity and insurance;
- Inventory shrinkage, obsolescence and expiry; and
- Transportation.
Replenishment Costs
To determine replenishment costs, the following should be considered:
- Expected number of times the item is requested annually;
- Average quantity requested each time of use;
- Minimum Order Quantities (MOQ);
- Cost to process a purchase order (from requisition to payment); and
- Transportation costs.
Cost of Shortages
Shortages include both financial and non-financial costs. Financial costs include rush order costs and shipping and non-financial costs include reduced patient care.
Inventory Classification
Categorizing inventory in order of importance (by usage, revenue, profitability, etc.) will aid in determining order quantities and patterns and whether the product should be included as inventory, or as a special order on a case-by-case basis. Priority categories (“Category A”) should have tighter controls and be monitored more frequently than those items that fall in lower-priority categories. Categorizing inventory will also help determine resource allocation – i.e., how much time one spends on managing that class of inventory.
Product Usage Patterns
Product volumes, type and number of customers, and consumption patterns should be considered when determining inventory levels and locations.
Inventory protects against unanticipated events. If an organization can manage its processes or forecast better, then inventory can be reduced. One aspect of this is an IT system that provides inventory visibility along the supply chain.
Key Components
Stock
Stock is defined as products that are kept in central stores inventory that is tracked and input into the costing system.
Non-stock
Non-stock is defined as products that are special order items, and not usually part of the normal set of inventory. Non-stock is usually not tracked in an organization’s inventory system. In theory, non-stock items should be received and distributed immediately. They should have high turnover. However, in practice, non-stock inventory ends up being stored in local locations. If this is not tracked, then cost metrics are misrepresented, as non-stock items tend to become stock. Thus, non-stock items should be entered into the system as non-stock, but tracked as any other inventory item.
Inventory Decisions
The following factors should be considered in determining whether to stock an item.
Is the item already in stock and, if so, is the correct quantity being stocked?
Is an acceptable alternative already in stock?
- If a new stock item can replace an existing stock item in its entirety, consider removing or
depleting the existing item. Likewise, if a proposed new stock item is equivalent to an existing
one, consider whether the value of stocking the new one is worth it.
Ordering versus stocking
- Review the economics of stocking frequently ordered items. An item should only be stocked if the
cost and risk of not having the item exceeds the cost of stocking it.
Order cycle time
- Evaluate the cycle time (including supplier lead time, ordering time, shipping time, and receiving
time) versus the urgency with which the item is required.
Cost of non-availability versus stocking
- Analyze the importance of an item and the risks associated with not having it available. Pareto
analysis can be used to help determine which items to stock. This process involves ranking
items in order of importance to identify the 20 per cent that are of most significance and the
80 per cent that are of less importance. Organizations should consider stocking the most
important items.
Limited lives of products and special handling and storage conditions
- Given that some healthcare products have limited lives, due to expiration or technology changes,
and/or have special handling and storage requirements, special consideration must be given as
to whether to stock these items. Analysis of the frequency of usage will be a key factor.
Are there other arrangements?
- Consider cost avoidance measures such as vendor-managed inventory, consigned inventory, and
sharing inventory with another institution (risk pooling).
Optimal Inventory Levels
Once a stocking decision has been made, the following should be considered to determine the appropriate inventory level.
Usage Patterns
Baseline forecasting plus potential demand growth and demand fluctuations should all be considerations in determining optimal inventory levels.
Effective Order Quantities
The effective order quantity should be determined for each item by balancing inventory holding costs, replenishment costs, inventory space availability, consumption patterns, product shelf life, and supplier minimum order quantities.
Inventory Buffers
Inventory buffers are designed to protect against sudden increases in demand, especially for critical use items. The most important factor is the “cost” of outages in terms of service levels. Other factors to consider are holding cost, replenishment cost, ordering times, product shelf life, and consumption. The greater the desired level of customer service, the greater the required inventory.
Replenishment
Replenishment and inventory levels are directly correlated. Lower inventory means more frequent replenishment and vice versa. An organization needs to balance the level of inventory with the desired frequency of replenishment, taking into consideration inventory holding cost, replenishment cost and replenishment lead time.
Inventory Risk Management
This component of the inventory policy should outline the processes involved in the event of a disruption in the procurement and inventory management process. The contingency plans should include alternative suppliers, product substitution, sourcing/borrowing from secondary facilities (such as other hospitals), guidelines regarding buffer stock, insurance, contractual terms regarding the bearer of risks, and policies regarding premium expedited transportation. As in the case of inventory management during normal operations, costs associated with inventory risk management should be tracked and monitored on a regular basis.
Inventory risk management must also include procedures to prevent pilferage and theft of inventory.
Other Components of Inventory Management
An organization should have documented procedures for the following inventory processes:
- Receiving — systematic regulated stock receiving and replenishment;
- Storage/inventory visibility — maintenance of clean, organized storage locations with appropriate labelling and proper storage of items to support ease of access;
- Audits — regular reconciliation checks;
- Release/return — returns of defective goods;
- Recall and product tracking — tracking of stock in inventory to support replenishment and tracking of serial numbers to enable product recall;
- Classification — categorizing inventory by importance — important, average or relatively unimportant — to ensure resources are focused appropriately;
- Sale/disposal — selling off or safely disposing items no longer being used;
- Loss/redundancy — minimizing loss and redundancy;
- Asset management — keeping proper inventory records;
- Quality management — stock rotation to ensure older stock is used before supplying new items; and
- Handling of “special” inventory — those requiring specialized handling and storage.
Implementation Challenges
Challenges:
- Staff may not understand the importance of using a policy to manage inventory. Staff should receive adequate training to understand the potential risks and benefits of managing inventory.
- The trade-off between investment and service delivery may become unbalanced overtime. This policy must be designed and monitored to effectively balance all the aspects that go into inventory decision making.
