Efficiently managing inventory is all about optimization. Minimization, to be more specific. A successful inventory manager will keep the minimum inventory on hand in order to keep the business running. Holding large inventories involves all sorts of costs such as storage, stock shrinkage, insurance and, of course, the opportunity cost of tying up capital in product that is not moving.
Modern approaches such as just-in-time inventory largely remove inventory from the equation. This raises a difficult question: why hold inventory? Although low or no inventory approaches will be appropriate for some businesses, here are some ways in which it might be worthwhile holding some stock after all.
Managing Inventory Risk
Being caught short is an unacceptable outcome for most businesses – missing a large sale or having to shut down a production line due to a stock shortage is both galling and costly. Businesses face demand and supply-side inventory risk, and holding a certain amount of buffer stock can insulate against them both. On the demand side, sudden and unforeseen spikes in customer demand can leave you short and likely to disappoint some of your customers. The other side involves complex supply chains that inevitably fail from time to time, leaving you understocked at the same time as your competitors, pushing up the price of the little stock that is on the market. In these situations, holding some safety stock can keep your business operating until the market is able to respond and correct.
Bulk Purchase Discounts
Some businesses accept inventory holding costs in order to take advantage of bulk purchase discounts. Suppliers sometimes offer discounts or accept a lower price for bulk orders because moving large quantities at a slightly lower price reduces the risk that the supplier will fail to recoup its fixed costs. Obviously this can be somewhat of a gamble for purchasers of bulk stock; if you are considering buying in bulk, you should be reasonably confident that you can move most of the stock quickly enough to keep inventory holding costs to a minimum. The discount should of course be larger than the expected inventory holding costs.
Reduce Transaction Costs for Inventory on Hand
Bulk purchasing is not the only way that inventory managers can benefit from economies of scale. Inventory procurement can sometimes be a complex endeavor, such as when the vendor is overseas or where there are regulatory matters to deal with. In some cases it can make financial sense to split high fixed costs over many units. Again, this involves estimating inventory on hand holding costs ahead of time, so a purchaser should be confident that it can move the large number of units sufficiently quickly.
In some industries, it is not possible to manage seasonal demand using techniques such as just-in-time inventory. During the busy Christmas season, drop shipping online retailers are seen as unreliable due to the risk that postal and logistics providers have to cope with very high volumes. To cope with much higher seasonal demand, brick and mortar shops typically hold large inventory on hand of popular products. This involves forecasting demand based on historical inventory data from previous years. There is, of course, a risk that a retailer can get it wrong and need to move a large quantity of an unexpectedly unpopular product.