Irrespective of its location in the supply chain, product inventory essentially serves the following functions:
Balancing Supply and Demand. The production and consumption cycles never matches. The sudden requirement of a product in large quantities may not be fulfilled immediately as the production cannot be taken up so soon. In such a case, the products are manufactured in advance in anticipation of demand and kept in stock for supply during the peak period.
Periodic Variation. For seasonal products the demand is at its peak for a certain period while it is lean for the rest of the year. Production runs in the factory are taken based on the average demand for the year. Excess production during the lean period is kept as inventory to take care of the peak demand. In cases where raw material for manufacturing food products is available seasonally, the products are manufactured and stocked as inventory to meet the demand of the finished product throughout the year.
Scale Economics. Products are manufactured at focused factories to achieve economies of scale. This is done because of the availability of the latest technology, raw materials, and skilled labour. Hence the produce is kept in stock for distribution to consumption centers as and when it is required. Distribution is done in economical lot sizes for system efficiencies in speed and cost.
In short, inventories provide demand utility for products at the time and places they are required for consumption.
Source: Sople V.V (2013), Logistics Management, Pearson Education India; Third edition.
Great post.