Inventory Management and Optimization

Published in Operations & IT Articles category by MBA Skool Team, Last Updated: April 21, 2011

Inventory is something without which many businesses would fail or would face losses and missed opportunities.

Inventory is a necessary evil for success of any business.

What is Inventory?

Inventory is the total amount of goods and/or materials contained in a store or factory at any given time.

Inventory is what demand management is all about.  Inventory flows through the supply chain and sits in warehouses, distribution centers, and store shelves.  It’s at the heart of cash flow and  working capital management.  Manufacturing, distribution, and retail can’t function without it.


Inventory Management and Optimization

As per the balance sheet, it’s an asset but from another point of view it’s a liability. Liability to sell.

Inventory exists everywhere.  And it’s very expensive.  Let it build up too much and you have a liability on your hands.

So why do we keep Inventory?

As a major investment, inventory serves many purposes, such as:

• Ensuring the customer’s order is shipped complete and on time

• Providing a buffer against supply chain uncertainty and unpredictability

• Decoupling manufacturing operations

• Assuring an uninterrupted supply of seasonal products

• Taking advantage of volume discounts.


Having an Inventory of stocks is basically to avert risks, Risk against losing orders or future profits.

Also many few business models have zero lead times, so to cover up these lead times you need a buffer stock. Anything that counters your lead times can be called Inventory.

Inventory apart from being expensive within itself also incurs extra expenses.


Inventory incurs substantial cost of ordering, carrying, and storing inventories:

Capital costs – financing the inventory

Service costs – insurance, inventory control, and purchasing

Storage costs – warehouse, equipment, handling, and utilities

Inventory costs – obsolescence, damage, shrinkage, and excess.

These annual carrying costs can amount to 25% of the average value of inventory.  And this doesn't include the cost of replenishment. How do we optimize the inventory and control this necessary evil.

It can be explained through the factors/Drivers that actually drive inventory.

Drivers of inventory and its optimization:


1) Lead Time: It’s the average time a company takes to manufacture a good from a raw material to finished good. If the lead time is too long, inventory has to be maintained and supported for longer periods. If the lead time is too short, larger inventory can be very bad for your business. So for inventory optimization, your lead time should be stabilized and monitored so that the inventory buffer can also be controlled over period of time.

2) Safety Stock: After the lead time optimization, still there can be situations where sharp fluctuations in demand and supply can topple your inventory plans. So you need to know and determine the safety stock required in case of fluctuations. A business needs to carefully monitor the demand and supply variability and also forecast them with higher accuracies.

3) Lot Size Inventory: Imagine a situation in which customer orders a quantity which is more than what is the market demand or his requirement.

Why would he do so?

For Bulk/Volume Discounts which you yourself have announced!

He orders more so that you give him bulk discount. Basically now he is building up his own inventory for future.

So a business needs to plan the amount of bulk discounts and promotional discounts its offering as it is directly related to the inventory you are going to need.

4) Obsolete Inventory: Sometimes a business waste money and resources to hold an inventory which might not be needed anymore as it is obsolete.

What to do with such inventory? It’s better to discard it or clear it off at low prices if still someone is interested in buying. As anyways you will waste much more money in maintaining and supporting it.

It’s very important to regularly check for obsolete inventory as its one of the important steps towards inventory optimization.

5) Know Your Inventory: You should know your inventory and its numbers with highest accuracy possible. As it will form the basis of replenishment decisions. If you have the wrong numbers, then your replenishment would also be wrong. This means full inventory goes for a toss. For Optimization of inventory, Accuracy is very important.

6) Replenishment: If inventory is maintained, it has to be replenished. Sometimes, after full inventory is used up, we think about filling it again. This would lead to a window where there will be no inventory stock with the business. So Replenishment decision has to come at an optimum time before the inventory runs out. Basically here also we need to take lead times of manufacturing into consideration. Basic techniques like EOQ (Economic Order Quantity) and EPQ (Economic Production Quantity) can be used.

When replenishing inventory, organizations operating in both single and multi-echelon environments must be aware of the “bullwhip” effect, and its tendency to drive up inventory buffers all along the supply chain.  When replenishing inventory, organizations with single or multi-echelon operations must be aware of the “bullwhip” effect, and its tendency to drive up inventory buffers all along the supply chain.

So for a successful business (in normal conditions or recessionary times), Inventory Management and Optimization is very important.

Many businesses realize the important in bad times but sometimes then it’s too late. Inventory is a necessary evil which needs to be tamed with care.

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