Stock Management in the Supply Chain Finance Essay

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This chapter reviews the theoretical and empirical literature on the role of stock management in the supply chain. According to Saxenian (1991), inventory management has traditionally been viewed as an internal procedure that took account of inventory within one building, warehouse or location. However, organizations have looked beyond this due to advancement in technology and their quest to effectively manage inventory and reduce costs. In any company inventory management is an important area that the management always focuses on when it comes to improving business efficiencies and cutting costs. Supply chain inventory management is so critical for planning or forecasting for the future needs and for developing strategic plans to handle the market situations (Smeltzer, 1997).

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2.1. Theoretical Evidence of Stock Management

This segment reviews the fundamental concept underlying inventory management in the supply chain. It highlights that there are several roles that stocks can play in the supply chain management in an organization.

2.2 Definition of Terms

2.2.1 Stock

Stock is any stored resources that are used to satisfy a current or future demand and are held in different forms by an organization which typically include raw materials, work in progress (process)-WIP and finished goods. According to Cachon & Fisher (2000), organizations necessarily hold stock to assist in future consumption and sale. While stocks are at times considered to be evil in organizations, most organizations hold stocks for various reasons, which include physical necessities, functional purposes, speculative purposes, etc. Stock control shows how much stock is held by companies at any time and how they are monitored (LaLonde and Masters, 1994). It applies to every item organizations used to produce a good and this covers inventory at every stage of the manufacturing process, from procurement and delivery to usage and re-ordering the stock. Bartlett (1990) stated that efficient stock control allows an organization to have the right quantity of stock, at the right place and at the right time. It also ensures that resources in terms of capital are not tied up, and protects production of goods and services if there are bottlenecks within the supply chain.

2.2.1 Supply chain

Van der Veen and Robben (1997) defined supply chain as ‘the network of organizations that are linked through upstream and downstream activities that produce value in the form of goods and services in the hands of the ultimate customer’. Supply Chain can also be viewed as set of organizations directly linked by one or more of the upstream and downstream flows of goods, services, finances, materials and information from a source to a customer.

2.2.2. Supply Chain Management

Supply chain management has received substantial attention from researchers and practitioners, yet in many companies management is struggling to implement supply chain processes within their firms and across the supply chain. Supply Chain Management is the management of a network of activities that processed raw materials, transforms them into work in progress goods and then to finished goods, and delivers the goods and services to customers through a distribution system. It covers procurement, manufacturing and distribution. Lee & Billington (1995) maintained that ”maximization of the overall performance of the chain and also adding value at reduce cost is the main objective of supply chain management”. In other words, it aims to increase productivity in the supply chain and benefits deliver to all stakeholders and also linked them to work together within the organization (Finch, 2006). According to Mentzer et al. (2001) the management of supply chain is also known as supply chain management. In addition, Lambert (2006) pointed out that SCM deals with a network of businesses and relationships; both intra- and inter- organizational integration and management. Since 1980s the adoption of Supply chain management practices in organizations has gradually risen. A number of definitions have been proposed and the concept discussed at many areas of study. Cousins et al. (2006); Sachan and Datta (2005) and Storey et al. (2006) provided an excellent evaluation on supply chain management literature. These papers determine the concept, principles, nature, and major developments of SCM and also highlighted wider research being done on Supply Chain management. They also critically assessed and analyzed major changes in the theory and practice of supply chain management.

2.3 Stock Management in the Supply Chain

“Inventory management is about optimizing the balance between the costs of supply, cost of production, costs of holding inventory and the need to provide the highest level of service that will exceed customers expectation”(Hughes et al, 1998). Stock management is therefore the set of policies and controls that monitor levels of stock and determines the levels to maintain, when to replenish stock and the size of orders (Davies & Heineke, 2005). In a broad context, stock or inventory could include equipments and inputs meant for further processes in the form of raw materials, components at interim stages of the process, such as semi-finished goods or work-in-progress; and outputs such as parts, components and finished goods (Davies and Heineke, 2005). Towill (2003) posit that inventory management acts as a major component of any supply chain irrespective of whether it is a product or service supply chain. Inventory management plays an important role in matching demand and supply within the entire supply chain, ultimately providing flexibility in coping with external and internal events of the today’s uncertain, globalized business environment. According to Storey (2006), the 17th annual state of logistics report of the Council of Supply Chain Management Professionals stated that, huge amount of cost is recorded as the cost of holding inventory in United States economy. It is evident that this truth is applicable to many other countries of the world especially in the manufacturing sector. In situations where all the partners in a supply chain manage inventory effectively and efficiently, this will be resulted with less interruptions in production process, reduction in storage cost, product availability and many other organization specific quantitative and qualitative benefits leading to the organizational performance. Grablowsky (2005) asserted that the world has been moved towards integrated and collaborative approach to inventory management within the supply chain rather than isolated approach to manage inventory. In previous research studies like Hari (2004), it was found out that most of the inventory managers tend to take inventory management decisions based on intuition due to lack of the professional expertise in the field, no proper analysis of inventory data, human bias by the senior managers that result with use of rule of thumb, no user involvement in inventory management systems, inventory decisions are not integrated with strategic needs of the organizations, and ultimately result with no proper inventory management practices with an organization. Proper inventory management practices are really important for fast moving manufacturing products such as gold, copper, alcoholic and non alcoholic drinks.

Reasons for Keeping Stocks and Inventories.

All organizations keep inventories in smaller or larger scale. They exist to smooth out gaps in the rate or timing of demand and supply. Only if the supply of products occurred exactly when they are demanded, products would never be stored. With high inventory level, many companies may also encounter problems in operations; defective deliveries, poor floor layout, untrained operators, off-standards, re-work, down times, inaccurate quantities etc. Or high stock levels can be consequences of these problems. Either way, these unexposed problems cause wastes; increase costs and prevent smooth output of operations. Waters (2002) identified and summarized the benefits of stock management as; economies of purchasing, economies of production, optimize customer service, transportation savings, hedge against future (Price fluctuation, quantity discounts), hedge against unforeseen contingencies (labor unrests, natural disasters, surges in demand, etc.) and to maintain independence of the supply chain.

2.5 Types of Stock/Inventory Holdings

To increase efficiency and responsiveness this research analyzes the main types of inventory and the way these can be classified (Chopra, 2007).

2.5.1 Cycle Inventory

Represents the inventory used to fulfill the demand in the period between two deliveries of the suppliers. The size of the current inventory is the result of the production, the transportation or of the acquirement of the merchandise in large lots. The companies make or acquire large lots to exploit the economies of scale in production, transportation or the purchasing process. With the increase of the lot, the expedition costs grow too. (Chopra, 2007)

2.5.2 Safety Inventory

Safety inventory is the inventory that needs to be held in the case the demand overflows the expectations or the supplier does not deliver the merchandise in time. If everything were predictable then current inventory would be enough. Because the demand is uncertain and it could overflow expectation, firms keep a safety inventory so they would be able to satisfy a high but unexpected demand. Managers are faced with a key decision as to what they must establish as the size of the safety inventory. If the safety inventory is too large then the merchandise won’t sell and they will have to sell it for a lower price after the season is closed. If the firm has a small safety inventory then the firm will have smaller sales. Therefore, deciding for a certain size of the safety inventory implies a link between the cost of owning too much in a safety inventory and the cost of decreasing the sales because of an insignificant safety inventory.

2.5.3 Seasonal Inventory

Seasonal inventory is used in case the demand has predictable variations. Companies create inventory in periods when demand is low and they deposit merchandise for the periods when they won’t be able to produce a sufficient quantity to satisfy the demand. Managers face the key decisions when they have to decide whether they have to form a seasonal inventory and if they do decide to create it, they must decide on its size. If a company can easily change the rate of the production system at a very low cost then they must not need a seasonal inventory, because the production system can adapt itself for a period when the demand reaches high values without implying high costs. Anyway, if changing the production rate is expensive (for example, when employees must be fired or hired) then a company must establish an appropriate rate of production and they must form an inventory when the demand is low. So, the main problem for the supplying chains managers who form a seasonal inventory is the cost of it in comparison with the cost of having a flexible rate of production.

2.5.4 The Service Level

The service level is a part of the demand satisfied in time by the products in the inventory. A high level of the availability of the products creates a high level of responsibility implying at the same time a growth of the cost because lots of inventory are formed but rarely used. In opposition, at a low level of product availability, the inventory cost is lower but it is possible that a client is not served on time. Traditional supply chain metrics focus on efficiency and productivity (Cohen and Roussel, 2005). Improvements in service levels, costs and inventory levels are the desired outcome of an operations strategy and are measured accordingly. A more strategic perspective looks at these measures as enablers of business objectives such as growth within a specific segment or market, accelerated product development, or immediate product availability. When aligned with key business objectives in the supply chain, service level becomes an added source of competitive advantage.

2.6 Stock Management and Corporate Profit

Inventory Management system provides adequate information to properly manage the flow of goods, proper utilization of people and equipment, coordination of internal processes and communicate with customers. Inventory Management does not only make decisions or manage operations but provides adequate information to supply chain management personnel who make more timely and accurate important decisions to manage and maximize their operations. A successful business organization depends upon many factors, one of which is an effective inventory management system. Effective inventory management consists of effective record-keeping to shipping and timely receipt of goods on time. An effective Inventory management can keep the supply chain of organization running smoothly and efficiently. Inventory management problems can affect an organization profitability and customer service. They can cost an organization more money and can lead to excess inventory or overstocking that is difficult to dispose. A work done by Roman (1999) on the effect of stocks and inventory management on Dell’s corporate profit indicated that average profit has increased between 19.5 to 25 percent per month. This came about as a result of the fact that Dell carries very little inventory and the whole organization concentrates on increasing manufacturing and delivery process of components and products through its supply chain. Dell delivers new products to market faster than its competitors by dealing directly with the customer thereby eliminating middlemen. However, studies done by Richardson (1995) documented that lack of efficient inventory management has led organizations incurring a total inventory carrying costs between 25 to 55 percent of cost of entire production cost. He identified that most of the problems are usually due to improper inventory processes and out-of-date systems. There are a number of problems that caused serious problems with inventory management. He identified some Common Challenges faced by organizations in Inventory Management are: Lack of qualified Supply chain employees. Some organizations do not put qualified supply chain personnel in charge of their inventory systems and they do not have experience, apathy in their job, or don’t have training on logistics and supply chain management. The processes used are not wide enough and do not cover all the aspects and activities in the company. A flawed and unrealistic business plan. To be able to forecast future performance of an organization depends upon accurate and reliable data, and to be able to analyze them accurately. This affects inventory management process because inaccurate data or information may lead to overstocking or under stocking of inventory. Failure on the part of a supervisor in charge of inventory management to check stock in his custody on regular basis and ensuring that there is availability of stock. Identifying shortages ahead of time is an important factor in achieving Customer Satisfaction. Logistic problems and weak points can affect timely delivery of goods and services. This means that if orders for outgoing shipments are not handled in an efficient manner, they can cause delays in the delivery of the products. Falling victim to the “bullwhip effect”. This means an organization may react disproportionate to new information in the business environment. When demand changes in the market, an organization may panic and overstock inventory, thinking that the changes in demand in the market will move the stock. Too much expired stock in inventory. Expired stock is goods or materials in inventory whose potency or efficacy to be sold at the normal price has expired or yet to be expired. This usually occurs in grocery and drug stores. As a particular food product or drug nears its expiration date, the organization may discount the item in order to dispose it quickly before it expires. Excessive inventory and the inability to dispose it promptly. This is one of the challenges facing most organizations. Cash inflow comes from disposing inventory quickly. If an organization procures goods for their inventory and do not dispose them quickly or on time, the organization ends up losing money. Inaccurate computer information of inventory items for production or sale. There are always associated costs like loss of goodwill, if customer goes to a warehouse of an organization or supermarket to order or procure and item found out system stock do not match the physical stock. Inaccurate inventory records can easily result in loss of resources; reduce customer expectation and service level. Inventory management systems are too complicated. Many supply management software programs are available for organization and most of them are not user friendly. Some of the organizations do not have the resources for the procurement of the inventory management software, payment of yearly renewals and training of personnel.

2.7 Inventory Costs

Historically organizations used to carry high inventory and which they view as sign of wealth (Waters, 2003). However this attitude has changed many years ago and companies have found it necessary to manage their inventory efficiently and effectively in the dynamic business environment. The drive to reduce cost in order to stay in business has led to companies using new method of inventory which has considerably reduced stock levels and costs. According to Monczka et al (2010) excess stock ties up capital which an organization could use more productively elsewhere. And the drawback of holding excess stock is the effect it has on the organization working capital and the inventory costs. Monczka et al (2010) identified and elaborated the main factors comprising the total cost of holding inventory which include: Cost of the items (Purchase cost or material cost),Ordering Cost (Processing of order and delivery of materials) , Cost of holding Inventory ( Taxes, Opportunity costs, Insurance costs, Space costs and Inventory service costs), Stock out Costs (Lost sales cost and Back-order cost)

2.7.1 Cost of the items

This is the total cost of acquiring an item from supplier, and production cost of item manufactured in house. Production cost is difficult to calculate as it has to cover direct material used to make the item namely Labour, overheads and opportunity costs ( Monczka et al,2010 ).

2.7.2 Ordering Cost

According to Monczka et al (2010), ordering costs covers all costs associated with the release of an order and accepting delivery of the items. They include all the cost of generating and sending an order or transmitting an order electronically to suppliers, transport, receipt inspection and quality checks.

Monczka et al (2010 ) further emphasized that if an organization manufactures an item in-house the preparation and equipment costs may be the ordering cost.

2.7.3 Cost of holding Inventory

This covers all costs for holding and storing materials and Monczka et al (2010 )summarized them in three main components namely Financial cost , Storage cost, and maintenance cost

Financial cost

This is mainly for capital tied up, but also the opportunity cost. This may also include taxes and various other charges on the amount of stock held (Monczka et al 2010).

Storage Cost

This consist of all cost associated with providing storage for material, providing a warehouse (both internal and external), racking and administration systems (Monczka et al 2010). Other costs may include communication costs, operational costs, consumables and utilities, wages and salaries of supply chain personnel involved in warehouse operations. (Christopher, 2005). Maintenance Costs This involves costs associated in right conditions, stock checks, obsolescence, deterioration, spillages, damage and loss (Monczka et al 2010).

2.7.4 Stock out Costs

These are costs of not having an item available which is needed for production and consumption. Another important function of inventory is to avoid shortages and stock outs. If an item is repeatedly out of stock, customers are likely to go elsewhere which will affect the organization reputation and reliability (Monczka et al 2010). In this view organizations are willing to incur the cost of holding stock to avoid higher cost of shortages (Waters, 2003).

2.8 Models for Inventory Management

Inventory management models helps allocate time and resources in inventory management on one hand and classification system to deal with multiple product line and magnitude of stock – keeping unit on another hand. Therefore, Hanna (2002) has identified four models for inventory management in the supply chain. These models will be discussed and will provide background information concerning inventory management.

2.8.1 Just – In – Time (JIT)

As part of the inventory management principle JIT is not a technique, it is a stock – management philosophy (Giunipero and Law, 1990), that eliminates waste in the supply chain by producing and delivering the required product quality at the time and the place needed (Manoochehri, 1984). A JIT system aims at bringing certainty and smoothness to the flow of materials across organizational boundaries and therefore requires the full support of supply chain members (Daugherty et al, 1994). A JIT approach to supply and distribution develops a network of quality – assured supply partners working towards making the entire network competitive (DTI, 1995), as a result, logistics systems are characterized by closer relations with suppliers and better forecasting techniques based on consumer demand (DTI, 1995).

2.8.2 Economic Order Quantity

One of the challenges most organizations and manufacturers faces is to determine what quantity of a given item to order when ordering supplies. A great deal of literature has dealt with this problem. Many formulas and algorithms have been created, of these the simplest formula is the most used: The economic order quantity (EOQ) or Lot Size formula as analyzed by Cargal (2000). The purpose of using EOQ is to determine the order quantity that balances the order cost and the holding costs in order to minimize total costs of holding stock. This is the most common approach to deciding when stock needs to be ordered.

2.8.3 Economic Production Quantity (EPQ)

The assumption of EPQ model is the instant receipt of stock, thus the whole order is delivered in one batch at a certain time. In many cases, however, an organization may build up its inventory steadily over a period of time. For example, an organization may receive consignments from their suppliers within a certain period of time (Ferber and Les 2003). In a production process, there will be a setup cost instead of having an ordering cost. Both costs are independent of the size of the order and the size of the production run. This set up cost is the cost of setting up the manufacturing facility to manufacture the desired good. It usually comprise of costs associated with engineering and design which make the setup, and the other costs involve include paperwork, supplies, utilities, salaries and wages of employees. The same factors are used to compose carrying cost per unit and the EOQ model, although the computation of the annual carrying cost changes. In EPQ model also occurs when the total setup cost equals the total carrying cost. One should note, however, that making the total setup cost equal to the total carrying cost does not always guarantee optimal solutions for models more complex than the EPQ model. 2.8.4 ABC Analysis: An Important Inventory Management Tool ABC analysis is an inventory classification technique in which goods are classified according to the value generated in annual sales ( Fuerst ,1981). ABC is method of inventory that divide stock items into different categories namely A, B and C based on the value of the item or the quantity held or turned over a period of time .It is the most common and widely used classification model for inventory control (Kilgour et al,2006) According to Onwubolu and Dube (2006) when ABC analysis is applied to inventory situation it determines the importance of items and the level of control placed on them. According to Bloomberg et al (2002) inventory classification allocate resources in the inventory management and allow organization to deal with multiple product line and multitude of stock The segregation of items based on ABC analysis enables the organization to segregate its inventory into significant categories. “A” Category items are about 10% of total number of items, but carries 70% of value of an inventory or whatever importance the organization is using ( Kumar 2010). According to Baily (1987) the inventory policy for A items is to order once a month unless it is possible to cover them by contract for several months supply with monthly, or weekly or even in the case of high volume items deliveries are done daily. The items deserve close attention and effective monitoring by inventory managers in organisations . “B” Category items generally represent about 20% of total number of items and about 20% of the value. According to Baily (1987) the inventory policy for B items is to order four times in a year. The items can managed with a formal inventory system like EOQ Model. “C” Category items are often around 70% of total number of items but carries only 5% of the value (Kumar 2010). The inventory control policy is to order C items once a year (Baily, 1987) Relaxed inventory process can be used for these items by organizations.

2.9 Inventory Management in the Mining Companies.

A good number of studies have been carried out in this area (Parunak, 1999). However, as far as the mining industry is concerned, the literature on this subject is inadequate. But in recent years the mounting accumulation of inventories in public and private mining companies made them to realize the importance of the inventory management. For mining companies, inventory management includes a company’s activities to acquire, dispose, and control of inventories that are necessary for the attainment of a company’s objectives. The management of inventories concerns the flow to, within, and from the company and the balance between shortages and excesses in an uncertain environment (Tersin, 1988). In relation to mining companies, McPharson (1987) stated ,”inventory management systems are designed to obtain concise and accurate information for control and planning of planned goods, issues, cuts, projections, raw materials and semi-finished goods basically for export.” Inventory management has been a concern for practitioners especially in the mining industry, in that overall investment in inventory accounts for relatively large part of the company’s assets. In the mining sector, inventory may account for 40 to 60% of total assets (Tersin, 1988; Verwijmeren et al, 2009). Inventories tie up money, and the success or failure in inventory management impacts a company’s financial status. Having too much inventory can be as problematic as having too little inventory. Too much inventory requires unnecessary costs related to issues of storage, markdowns and obsolescence, while too little results in stock outs or disrupted production. Besides, long-run production associated with a high level of inventory conceals production problems (e.g., quality), which can damage a company’s long term performance (Vergin, 2006). Therefore in the mining sector, the primary goal of inventory management has been to maximize a company’s profitability by minimizing the cost tied up with inventory and at the same time meeting the production requirements (Lambert, Stock, and Ellram, 2004). Traditionally, for mining companies, inventories cause conflicts between functional units within a company. For example, within a company, purchasing, production, and marketing people want to build a high level of inventory for raw material cost reduction, efficient production run, and suppliers service level, while warehousing and finance people want to reduce the inventory level for storage space and economic reasons (Tersine, 2003). As global competition between suppliers in the open markets has increased, power has been shifted from suppliers to customers (Verwijmere, 2008).

2.9.1 Storage, Distribution and Disposal Management

Since materials stored is equivalent to cash and forms a major part of the total product cost, it is essential that the material should be properly accounted for and safe guarded in an efficient and organized store. With a judicious and proper control of management of stores, one can minimize the losses due to the obsolescence, pilferage, excess storing, etc (Lambert, Stock, and Ellram, 2004). Preservation of items in the space provided in the stores is of great importance because floor space accommodation is a costly issue. Keeping of items at various places in stores, particularly the slow-moving and non-moving items is a crucial concern. But this is often given least importance in the mining industry (Ariba, 2004). To have an effective storage programme, factors such as nature of the item, codification of the item, the expected idleness, economic value of the item and the need for protection should be taken care of. To identify the item in an easy way on the shelves and racks, it is necessary to have good lighting (Ariba, 2004). The stores section which is a part of commercial department in the selected mining companies has to maintain good relationship with branches of its own other departments in the organization. The stores and purchase sections’ functions are complimentary and close cooperation between these two sections will result in better standardization, codification, value analysis, variety reduction, inventory control, salvage, disposal of obsolete and materials. Even in the absence of integrated materials management in mining companies, the stores and purchase sections have close cooperation and co-ordination (Stone, 2000). The stores section is responsible for the issue of materials to various departments and sections in the mining companies. Basing on the bill of materials, work order, material requisition notes, the stores personnel need to issue the material as prescribed in the authorized documents as mentioned above. While delivering the quantities of material, the personnel in stores section, enter an entry in the books of stores and also an entry has to be made in electronic data processing (Niak, 2004). The store is expected to maintain documents like bin card, codex, obsolete items, rejected items, suppliers index, indents and bills of materials. Even after the computerization of the stores section, the selected shipyard companies are depending mostly on manual documents because one cannot rely on the information given since inexperienced people work in the EDP (Electronic Data Processing) section. For this, the selected shipyard companies should arrange for training in the area of material information system of EDP people and thereby minimize the expenses of maintaining both (Gofin, 2004). Surplus, obsolete and metallic items management assumed tremendous importance in the materials management activities. Surplus originates from three sources namely scrap, obsolete materials and damaged equipment. Holding these items is costly to the organization. These costs include carrying charges, cost of maintaining the records, loss of the use of capital held up in inventories. In view of this, special efforts need to be made to avoid keeping them (Jawade, 2009).

2.9.2 Critical Evaluation of Inventory Practices in the mining sector

Inventory management is an integral part of materials management and plays a key role in the smooth and uninterrupted running of the mining industry. To have higher operational efficiency and profitability of an organization, reduction of the capital locked up in inventories is very much essential. The same will help in improving the liquidity position of the enterprise. As inventories involve locking up of capital, proper care must be given in dealing with the problem of inventory management. The sum of the value of the raw materials, fuels and lubricants, consumable’s spare parts, processing material and finished products are called as inventory (Richard, 1998). The basic objectives of inventory management in the mining companies would be to keep down capital investment at a minimum level in inventories without endangering the process of extracting mineral, to minimize the idle time of men, machinery and capital caused by shortage of various kinds of materials, to reduce the costs in maintaining the inventory and to minimize the losses of obsolescence. Inventories account for a major portion of working capital of a mining unit. The predominant position in the total working capital obviously warrants for their maximum efficiency. Thus, inventory management in mining sector aim at balancing between too much inventory and too less inventory. A firm cannot afford either excessive or shortage of inventory. To achieve higher degree of operational results, it is inevitable to maintain effective control and management of inventories (Richard, 1998). The structure of inventory of the mining sector undertakings can be studied by classifying their total inventory into five categories: Raw materials, goods in process, finished goods, stores and spares and miscellaneous items. The structure of inventory can be analyzed in two ways. First, the share of each component of inventory is in relation to aggregate inventory. Secondly, appropriate indicators about adequacy or inadequacy of each type of inventory may be developed and applied to capital positions obtained in mining sector enterprises.(Waller and Johnson, 2003)

2.10 Summary of Literature

Various studies reviewed in the foregoing literature have revealed that efficient and effective stock management in a supply chain can play a vital role in cutting stock holding costs across the different stages of the supply chain, thus emphasizing the need of a general model for managing inventories within a supply chain. Studies document that the main reasons for holding stocks of inventories include economies of purchasing, economies of production, optimizing customer service, transportation savings, hedge against future, unforeseen contingences, etc. Holding stocks has it cost which include non-value added costs, opportunity cost, complacency, inventory deteriorate become obsolete, lost, stolen, etc. Models of stock control from the literature indicated that stock management does not necessary mean holding lower stock but ordering stock at a level where total cost of holding stock is minimized (Economic Order Quantity).

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