Explore Inventory Management, its Importance in a Company, and More

Explore Inventory Management, its Importance in a Company, and More

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Syed Aquib Ur
Syed Aquib Ur Rahman
Senior Executive Content
Updated on Dec 26, 2023 18:07 IST

Ever wonder how a successful firm never runs out of stock with its high demand products? It is because of efficient inventory management, which ensures successful firms to maintain constant stock of high-demand products. Understanding its significance aids in optimising resources and sustaining market advantage. Discover the principles behind it for seamless operations and sustained growth.

inventory management

Picture this. 

A company manufactures and sells a product that has high consumption value.  

From a supply chain perspective, the question arises, ‘does it have enough stock for the next bulk order?’ 

If the answer is ‘no’, the company risks losing its customers to another competition. It also means there is no steady flow of raw materials to produce the final product. 

But the company can keep a track of the raw materials transported from the supplier and stored in its warehouse. It has to restock inventory and order in an adequate amount to avoid excess storage costs and waste. 

By doing so, it can fulfil the immediate demand of the product anytime and together maintain its market advantage. All these activities form a process called inventory management. 

Inventory management is integral to supply chain management and important for all sizes of business. Let’s explore more of it in detail. 

  1. What is an inventory?
  2. Inventory management definition
  3. Importance of inventory management
  4. Objectives of inventory management
  5. Inventory management techniques
  6. Best practices to learn in effective inventory management 
  7. Case study of Amazon's inventory management strategy

What is an Inventory?

An inventory refers to the raw materials or goods that go through multiple stages to the point of sale. 

This term is quite common in the accounting world, and is usually reported as a current asset on a balance sheet. (You can even refer to accounting interview questions to learn more related terms and concepts.)

So what are the basic characteristics that make an inventory?

To answer this question, there are some types of inventory to consider. 

  • Raw materials – Used for producing finished goods
  • Work in process (WIP) – Unfinished goods that are still getting manufactured
  • Finished goods – Products that are ready for selling
  • Cycle inventory – Any number of products or raw materials that keeps the company maintaining its minimum production quota
  • Buffer inventory – An additional safety stock of raw materials or finished goods when there are unexpected manufacturing or distribution delays

Now that you have an idea about inventory, let’s move on to inventory management. 

Inventory Management Definition

Inventory management is a component of an efficient supply chain strategy that keeps track of the company’s inventory. The practice involves maintaining the stock’s storage through controlling the production process to fulfilling the order of the consumer. 

In this method, professionals prioritise the flow of items in the inventory that are more frequent in need. They create and keep records of the inventory, track sales, order restocks when stock levels go down and use inventory management software (in case it is a large business). 

Importance of Inventory Management 

You can say that inventory management streamlines operations. Without it, a company is unable to organise its resources and optimise them to the fullest to grow its revenue. 

Let’s explore further how it supports other departmental activities in a firm.

You may have read the marketing mix blog, which describes how the product can differentiate itself with packaging and other characteristics. Put simply, if the inventory is not managed well, the product with not reach the right customers at the right time. The right inventory quantity will ensure that the company will not miss out on any sales. 

Speaking of inventory management’s role in the finance department, it can help in cutting costs in daily operations.  As inventory is classified as a current asset, you can find out if you are spending too much on maintaining inventories or if you are earning enough from customer transactions. 

There are various techniques and formulas in inventory management that help in giving a clear picture of the cash flow in the process and maintain a low working capital as well. We will cover this in a later section below. 

Objectives of Inventory Management 

As you read previously, the process is necessary for day-to-day operations, it will now be useful to know some of its main objectives. 

Ensuring Materials are Available

Inventory management makes sure that the flow of goods is uninterrupted. That’s why many companies create a buffer inventory. Some even prioritise the flow of items that are bound to be delivered slowly. By doing so, it becomes easier for firms to create a demand in the market and maximise revenue. 

Reducing Wastage 

This is another important objective that needs to be regulated. At times, there can be a surplus of items when the market demand for a product goes down. More stock also means there are more storage costs, and that can be detrimental to the firm’s finances. 

According to inventory management best practices, it is ideal to have a permitted threshold beyond which the waste or excess should be controlled. 

Satisfying Every Customer

If you have come across our logistics management page, you must know about the 7 Rs of logistics. That is, for any successful customer order, it has to be the right product; in the right quantity; in the right condition; at the right place; at the right time; sent to the right customer, and sold at the right price. 

Let’s say, if a company’s sales rep takes more orders from the customers and the stock is less than the orders, it indicates that all operations will be affected negatively. 

Now, there are automated inventory management systems that ensure every cross-department member is aware of the stock beforehand. 

Inventory Management Techniques

The process of inventory management can quickly become complex. But there are some useful solutions around it. 

Just in Time Inventory Management 

It is a type of inventory management strategy where firms strategise to reduce waste. Here, a firm can demand goods or raw materials from the supplier as and when they are required in the market. 

ABC Analysis

ABC or Always Better Control analysis is another useful inventory management technique. Here the items are categorised into three groups – A, B, and C. 

In the first group (A), the items have the highest consumption value and these should always be stocked in a warehouse. 

Items in the second group (B) should be the ones that are less sold than items in the first category (A). Likewise, in the third group – C –  the items that have the lowest consumption value stay. 

With ABC analysis, it becomes easier to forecast the pricing of the products and their demand in the market. 

Economic Order Quantity (EOQ)

It is a formula that is used for calculating how much a company should be spending on its inventory, and at the same time, reduce storage expenses and meet market demand. Utilising this technique can save a company from unnecessary expenses. 

The formula is 

EOQ = √ (2 DK / H)

Here 

D represents the cost of orders

K represents the demand for the products 

H represents the costs of holding

Best practices to learn in effective inventory management 

When you are delving into this concept, it is ideal to know the industry standard practices. Here are some.  

Balancing the Inventory Seesaw: Lower Stockouts vs. Lower Costs

Imagine a seesaw with inventory level on one side and costs on the other. The goal is to find the balance point where both sides are in equilibrium, representing the optimal inventory level for your business.

Holding more inventory means a lower risk of stockouts. Customers are more likely to find what they need, leading to higher customer satisfaction and potentially increased sales. But, there's a price to pay.

  • Increased carrying costs: This includes storage space, warehousing fees, insurance, depreciation, and even the opportunity cost of tying up valuable capital in unsold inventory.
  • Increased risk of obsolescence: Products can become outdated or expire, leading to write-offs and lost revenue.
  • Increased risk of damage or theft: The more inventory you have, the greater the chance of something going wrong.

On the other hand, holding less inventory means lower carrying costs. You save money on storage, insurance, and other expenses. But this comes at the risk of stockouts:

  • Lost sales: If you run out of a popular item, customers may go to a competitor, and you lose the sale.
  • Damaged customer relationships: Stockouts can frustrate customers and erode trust in your brand.
  • Increased ordering costs: You may need to place more frequent orders, which can be expensive.

Finding the right balance is crucial for optimising both customer service and financial performance. This ideal point will vary depending on factors as the following. 

  • Demand variability: How predictable is your demand? More volatile demand requires higher safety stock levels.
  • Lead times: How long does it take to get new inventory? Longer lead times necessitate larger buffers.
  • Product value: Higher-value items justify carrying more inventory to avoid stockouts.
  • Storage costs: The cost of storing inventory will impact the optimal level.

Tools and techniques can help you find the right balance.

  • ABC analysis: Classifies inventory based on value and turnover, helping you prioritize control efforts.
  • Safety stock calculations: Determine the minimum inventory level needed to avoid stockouts during lead times.
  • Inventory forecasting: Predict future demand to avoid overstocking or understocking.
  • Inventory management systems: Automate tasks and provide real-time data to optimise inventory levels.

Peering into the Future: Demand Forecasting and Inventory Planning

In inventory management, predicting what lies ahead is key. That's where demand forecasting comes in, like a crystal ball for your products.

Let's delve into how it works and how it's used to plan your inventory wisely.

Basic Forecasting Techniques

  • Moving Average: Smooths out fluctuations by taking the average of past demand data. Good for stable demand patterns.
  • Exponential Smoothing: Gives more weight to recent data, adapting to changing trends. More flexible than moving average.
  • Trend Analysis: Identifies long-term upward or downward trends in demand. Useful for planning production and resource allocation.
  • Seasonal Adjustment: Accounts for predictable fluctuations like holiday seasons or weather patterns. Crucial for accurate forecasts.

Considering the Big Picture

Forecasting isn't crystal clear—it needs context. It is important to look into the following factors. 

  • Seasonality: Festive seasons mean ice cream spikes, while winter chills sweater sales. Adjust forecasts accordingly.
  • Trends: Emerging food trends could skyrocket quinoa demand, while fad gadgets might quickly fade. Track and adapt.
  • Promotions: Planned discounts or marketing campaigns can temporarily inflate demand. 

Inventory Planning for the Unexpected

Demand can be fickle, so we need buffers. Here are some ways to handle variability. 

  • Safety Stock: A minimum level of inventory to avoid stockouts during lead times or unexpected demand surges. Acts as a safety net.
  • Buffer Stock: Additional inventory to handle short-term fluctuations like sudden spikes or delays. Provides breathing room.
  • Reorder Point: The level at which you trigger a new order to replenish your inventory. Calculated based on lead times and safety stock.

Finding the Sweet Spot

The ideal inventory level is a dance between satisfying customer needs and minimizing costs. By combining accurate forecasting with flexible planning strategies, you can:

  • Reduce stockouts: Keep customers happy and avoid lost sales.
  • Minimize overstocking: Save money on storage, insurance, and write-offs.
  • Improve resource allocation: Plan production and procurement efficiently.

Case study of Amazon's inventory management strategy

Amazon, as a global eCommerce giant, has implemented a highly effective inventory management strategy that revolves around Vendor Managed Inventory (VMI) among other innovative tactics. This strategy places a significant responsibility on suppliers to maintain appropriate inventory levels in Amazon's warehouses. Shipping, returns, and processing became other critical factors to cover.
Here are key aspects of Amazon's inventory management strategy. 

  • Inventory Tags: Amazon uses an internal inventory management system categorizing products into different inventory tags. These include available, inbound, unfulfillable, reserved, fee preview, and fulfilled by. Each tag serves a specific purpose in tracking inventory levels and order processing.
  • Trajectory Alerts: Amazon's system includes trajectory alerts that automatically generate reorder alerts based on sales volume on specific days as specified by the vendor. This allows suppliers to anticipate demand and factor in lead times efficiently.

Order Distribution Options: Suppliers have two choices for order distribution:

  • Fulfillment by Amazon (FBA): Amazon manages fulfillment through various warehouse locations.
  • Fulfillment by Supplier: Suppliers handle distribution, managing their supply chain and order delivery.

Amazon's approach to inventory management is dynamic, leveraging technology and supplier collaboration to ensure efficient stock control, timely replenishment, and streamlined operations. This strategy allows Amazon to maintain a vast array of products efficiently and cater to customer demands promptly.

One key differentiator of Amazon's inventory management strategy compared to other companies in the eCommerce industry lies in its emphasis on leveraging third-party businesses and vendors for a significant portion of its product offerings. While many eCommerce giants maintain massive inventories under their direct control, Amazon, with over 50% of its products sourced from third-party sellers, utilizes VMI, which places the responsibility on suppliers to manage and maintain inventory levels within Amazon's warehouses.

This approach enables Amazon to focus more on logistics, customer service, and platform improvements, distinguishing itself by creating a vast marketplace while offloading inventory management responsibilities to its suppliers. Unlike traditional eCommerce models that stock inventory directly, Amazon's model minimises the need for excessive inventory investments and associated holding costs, thereby allowing a broader product range without the burden of holding excess stock.

Parting Thoughts

So these are the basics of inventory management. Currently, the domain is quickly shifting to the advances in technology.  The process is becoming more complex yet more accurate with the adoption of artificial intelligence to remove repetitive tasks. One of the popular contemporary examples includes the digital signage on warehouse management systems that show real-time data of stocks and supplies. 

If you are aspiring to learn more about inventory management for professional development, do take up the useful online courses such as Inventory Management and Economic Order Quantity on FutureLearn, or Inventory Management A-Z: Supply Chain & Business Operations on Udemy. 

And, if you are completely new to the domain, you can always explore free supply chain management courses

FAQs

How can inventory management software benefit businesses of different sizes?

Inventory management software offers tailored solutions adaptable to various business sizes. For small businesses, it aids in automating manual processes, managing limited inventory, and providing cost-effective solutions. Medium-sized enterprises benefit from improved inventory accuracy, streamlined workflows, and enhanced order fulfilment. Larger businesses utilise advanced features for multi-location management, real-time tracking, and integration with ERP systems, ensuring efficient inventory control across extensive operations.

What are the common challenges faced in implementing inventory management systems, and how can they be overcome?

Challenges in implementing inventory management systems include data migration complexities, staff training, system integration issues, and ensuring data accuracy. Overcoming these challenges involves thorough planning, conducting comprehensive data audits before migration, investing in staff training programs, selecting compatible systems, ensuring continuous support, and regular system checks for accuracy and consistency.

What role does forecasting play in inventory management, and what are the key methods used for accurate demand prediction?

Forecasting is vital in predicting future demand, reducing excess inventory, and minimising stockouts. Key methods for accurate demand prediction include moving average, exponential smoothing, trend analysis, and seasonal adjustments. Moving average smoothens demand fluctuations, exponential smoothing adapts to changing trends, trend analysis identifies long-term trends, and seasonal adjustments account for predictable fluctuations, enabling more accurate inventory planning.

How does inventory management contribute to sustainability and environmental impact reduction within supply chains?

Efficient inventory management practices contribute to sustainability by reducing waste, optimising stock levels to prevent overstocking, and minimising the environmental impact of excess production and disposal. By maintaining lean inventories and employing just-in-time principles, businesses decrease waste generation, lower energy consumption in storage, and contribute positively to sustainable supply chain practices.

What impact has the integration of emerging technologies like AI and IoT had on inventory management practices, and what are the future trends in this field?

The integration of AI and IoT in inventory management has revolutionised operational efficiency, enabling predictive analytics, real-time monitoring, and intelligent inventory control. AI-driven demand forecasting and IoT-enabled smart sensors have enhanced accuracy and automation, reducing human error and manual intervention. Future trends include increased AI-driven automation, expanded IoT applications in inventory tracking, and the emergence of blockchain for transparent supply chains.

About the Author
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Syed Aquib Ur Rahman
Senior Executive Content

Aquib is a seasoned wordsmith, having penned countless blogs for Indian and international brands. These days, he's all about digital marketing and core management subjects - not to mention his unwavering commitment ... Read Full Bio

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