Inventory is required for producing finished goods, extending service to customers and to keep the customer’s manufacturing operations running. Hence, inventory plays a crucial role in the supply chain of an organization. It helps to keep a smooth flow of products across the supply chain. On the other hand, excess inventory in the supply chain means additional cost of holding inventory, which exceeds the benefits derived from it. The benefits and losses of carrying inventory should be examined in light of the following reasons.
1. Meeting Production Requirements
Raw material, components and parts are required for producing finished goods. A manufacturing organization keeps stocks of the material to meet the continuous requirements of production. Companies operating on the JIT principle also keep some inventory on hand to meet contingencies. However, these stocks are quantitatively insignificant. The work-in-progress inventory constitutes a major portion of the production-related inventory. Reduction in this category of inventory results in inventory-related investments in the production process.
2. Supporting Operational Requirements
To support production operations, inventories are required for repairs, maintenance and operational support. These inventories include spare parts of production machineries, consumables such as lubrication oils and welding rods, chemicals, pallets, and the like. Companies do not have a correct picture of their investments in this category of inventory. Many times excess stock is held to avoid rushing to the market for buying inventory in small quantities in an emergency.
3. Customer Service Considerations
Products like equipments, machinery or appliances require replacement of spare parts for trouble- free and smooth operations. Suppliers maintain an inventory of these parts to extend after-sales service to their valued clients. Availability of spare parts when required at the customer’s end is crucial for customer satisfaction and may be used as a tool for competitive advantage. Maintaining a significant level of inventory and keeping it replenished requires a major investment. This is closely related to the level of customer service offered by the company.
4. Hedge Against Future Expectations
To take care of shortages in material availability or an anticipated increase in the prices of products, the customer usually buys in excess of current requirement, stocking a critical material or product, for keeping their operations running without interruptions. This obviously increases the inventory level for a short period. However, in the above circumstances, the benefits derived from keeping excess inventory outweigh its carrying cost.
Source: Sople V.V (2013), Logistics Management, Pearson Education India; Third edition.