In this article, we will explore the various reasons to hold extra inventory.
While it is recommended to ensure that only the right amount of inventory is kept, there are various reasons for holding extra inventory. Depending on the motive, these reasons can be either good or bad.
Good reasons to hold extra inventory.
The four common good reasons to hold extra inventory include the following:
(1) Meet customer expectations
Safety stock of finished goods for instance, guarantees meeting the demand of your best customers even in period of high demand.
Additional spare parts can be used for emergency service needs.
Extra products to meet customer demands helps to improve customer satisfaction. Happy customer leads to increase in patronage.
(2) Avoid disruptions to operations
Smooth flow of materials for operations helps to maintain efficient production schedule.
The right amount of inventory prevents rush orders. Rush orders attract higher cost.
(3) Safety stock
Safety stock of materials and supplies can hedge against shortage in supply.
Extra stock of raw materials or supplies can also hedge against increase in prices.
(4) Price discounts
To take advantage of price discounts offered by supplier when purchasing large quantities of materials.
The discounted prices can assist in offsetting the holding cost of the materials.
Bad reasons to hold inventory.
Sometimes, extra inventory is kept as means of masking the inefficiencies in operations or in the supply chain process. Your role, as a manager, includes identifying and resolving these inefficiencies in the system.
Also, there are four common bad reasons to hold extra inventory.
(1) Compensate for poor supplier performance.
To cover up for a supplier with unreliable delivery record. In this situation, the purchasing team should identify and resolve the root causes of the poor delivery performance.
(2) Inefficient business processes.
High inventory level sometimes, is used to compensate for increase in the rate of rework or return of products from customers.
Inefficiencies in warehouses, distribution centers and factories are often covered up with high inventory levels. Eliminating the root causes of the reworks or returns will reduce the need for the extra inventory.
(3) Inaccurate forecasting.
Poor forecast of customer demand leads to high level of extra inventory.
Working closely with customers and better understanding of customer demand patterns can help reduce excess inventory.
(4) Compensating for long supply and distribution channels.
When your suppliers and customers are located far from you, it takes longer time to fill their orders.
When dealing with complex and difficult supply channels.
When planning is difficult or inefficient.
To mitigate against high product inventory levels due to challenges in the distribution channel, the marketing team should carry out the following actions:
Review the supply chain /network to identify and solve root causes of the distribution challenges. Collaborate with other stakeholders in the industry to address complex supply chain challenges. Posible solutions include use of local suppliers and setting up of factories or warehouses closer to the customer.
Conclusion
If you are going to hold extra inventory, do carry out thorough analysis to ensure that it is for good reason and the inventory must be managed to the lowest level without affecting production.
Reference: Inventory Management Foundation by Steven Brown
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