Inventories are stocks of goods and materials that are acquired and held for sale, such as goods and other assets such as land and real estate, which are held for resale (real estate investments are not a component of inventories). Inventory also includes items which have been already produced or are in the process of production and that, together with materials and goods, are awaiting to be used in the production process. In production and selling processes, inventories are served as subsidiary element to accommodate the situation that item is being received in one pattern and is used in another. For example, if a person buys 12 egg-packs and eats one egg each day, that would mean that person would buy new container every 12 days and inventory of the eggs that are remained in the refrigerator would decrease as per one egg eaten each day.
Inventory decisions are very often crucial starting points for many other business processes such as warehousing and transportation. Therefore, inventory management is very important pillar of supply-chain management. It refers to the process of following three pillars: ordering, storing and using a company's inventory such as raw materials, intermediate goods and final products. Different companies have different inventory management strategies depending on organization functions. For example, marketing division of a company tend to demand sufficient inventory availability for customer demand to avoid stockout situations. On the other hand, finance division usually demands minimum cost tied to inventory holding. In both examples we see cost related concepts of inventory management, in the first example marketing division wants higher inventory levels and in latter lower inventory levels. As can be seen, the cost is one of the most important concerns about inventory management. It is important to stress that inventory costs, increasing inventory level is not always welcomed. For example, a manufacture may produce goods more than it can sell or it may produce products so that warehouse looks full. In both cases, inventory costs money to the firm.
Key classifications of inventory are very crucial because it impacts the way that inventory is managed. There are 4 most frequently used inventory classifications: cycle stock, safety stock, pipeline stock, speculative stock.
- Cycle stock: This type of inventory classification translates into inventory that is needed to fulfill usual demand level during circuit of an order cycle.
- Safety stock: This type of inventory classification translates into inventory that is held on top of the cycle stock in case of uncertainty in demand.
- Pipeline stock: This type of inventory classification translates into inventory that is on the way between different points in the supply-chain like plant, warehouse or store.
- Speculative stock: This type of inventory classification translates into inventory that is held for many reasons like seasonal demand, forecasted price increase and potential deficit of product (Paul R. Murphy. Jr., Donald F. Wood 2004, p. 171).
Inventory management approaches
There are several approaches involved in inventory management. Namely: ABC Analysis, Just-In-Time Approach and Vendor-Managed Inventory.
This type of approach can be implemented in many different ways. This approach states that inventories do not hold equal value to a company therefor all inventory should not be managed equally. A company might have hundreds or thousands of items in the stock and it is really hard to decide importance of every item. One of the most frequently used methods is 80/20 rule; 80 percent of company sales come from 20 percent of its products. This shows that primary focus must be on the 20 percent of the products that creates 80 percent of sales. Therefore, in terms of product importance ABC can be categorized as follows: A presents items with the highest priority, B presents items with the medium priority and C presents items with the lowest priority (Gudehus T., Kotzob H. 2009, p.119).
- Just-In-Time Approach: This type of approach is one of the most popular approaches among others in managing inventories. This approach is being created by Japanese manufactures but actually started in USA in 1920s by Henry Fort. JIT decreases cost of storage and insurance together with cost of liquidation. This approach considers inventory as waste, whereas Just-In-Case approach needs additional inventory just in case something circumstantially occurs. Therefore JIT approach is risky; if the demand increases by chance, the manufacturer may not be able to supply the inventory to match the demand.
- Vendor-Managed Inventory Approach: In this type of approach the size and timing of reinforcement of orders are under the manufacturer responsibility. VMI grants manufacturer access to the distributor or retailer inventory (Wild T. 2011, p.74).
- Gudehus, T., Kotzob H. (2009), Comprehesive Logistics, pub. Springer, New York
- Hedrich, F.D., Barnes F.C., Davis E.W., Whybark D.C. (2001), Inventory Management, U.S. Small Business Administration
- Liu, Z., Zhang, Q. (2013), Contemporary Logistics, School of Management, Xiamen University, 361005, P.R.China
- Murphy, P.R., Wood, D.F. (2004), Contemporary Logistics, VIII edition, pub. Pearson Education International, New Jersey
- Wild, T. (2011), Best Practice in Inventory Management, II edition, pub. Routledge, New York
Author: Iryna Vasilieva