Save $1000s: Match Inventory to Market and Business Model

By Randall Orser | Small Business

Word cloud for InventoryWhen it comes to managing inventory, companies must match their approach to their business model, their customers’ order patterns, and the requirements of the market they service. Otherwise, the company not only risks alienating its customers, and losing business, but also risks the potential for holding obsolete and outdated inventory. Instead of matching their approach to their market, companies often go with something they believe will work based on something they’ve seen works elsewhere. It’s this critical mistake that not only raises costs, but leads to companies either buying too much, or too little inventory. Given these two extremes, what are the criteria companies must address in order to decide upon their approach to inventory?

What type of market does the company operate in?

When it comes to deciding upon an approach, a company must first understand its market and how their customers order within that market. If the company sends a message to market that they have large amounts of inventory, ready at a moments notice and able to service any demand requirement, but then decides to run a tight JIT inventory system with no safety stock, it’s a sure bet that its customers will be let down, and confused by the mixed signals. If the company’s market demands large volumes of inventory, then it must be willing to carry the inventory necessary to meet customer demand, and capture opportunistic sales. Conversely, if a company services a market requiring custom made components and assemblies, then the inventory must take into consideration long and extended lead times on parts and materials.

What kind of product line does the company have?

Another important criteria is the company’s product line. Is the product line vast in scope, with large numbers of models, but small volumes sold amongst those models? Is the product line small, with few models, but large volumes sold across those models? For instance, in looking at the automotive industry, car manufacturers have a small product line offering, but sell millions of each of those models. Because of the consistency of orders, automotive manufacturers often run a JIT (Just In Time) or “Push-Pull” inventory system, where parts and materials for manufacturing arrive daily. Conversely, companies that manufacture custom made products, or service industries with cyclical and seasonal demand, should concentrate on running a Min/Max inventory system. Because these companies know an order will come, but aren’t sure of exactly when, they must maintain a minimum and maximum inventory level.

What kind of customers does the company sell to?

While every company likes to think their customers are good, and have good intentions, a number of companies operate in industries where the conduct of their customers is dictated by the market they buy in. Does the company sell in a highly competitive market where it seems like every customer decision to order is based on price and price alone? Does the company operate in a market where customers forge strong vendor relationships, where design and engineering capabilities are more valued over the lowest possible price? Each of these requires a different approach to inventory management. That customer that needs those custom made parts, and values a strong relationship with its vendors, will probably be interested in signing a contractual agreement on supply. Conversely, should the company that operates in a commodity based market be willing to hold inventory for one customer, or should this inventory be available on a first come, first serve basis? Obviously, operating in an industry where price is the overriding factor, means the inventory that is available, must be sold immediately. Matching inventory approach to business model, customer ordering patterns and the market a company services, must be the primary motivation behind deciding which approach to use. Several companies become enamored by JIT because it proposes lean inventory levels, and minimum month to month holding costs. For companies looking to lower their cost of inventory, JIT seems like the perfect fit in a perfect world. However, there are hidden costs to JIT, and they come in the form of not having safety stock, high costs of emergency freight when parts aren’t available, and a requirement of high volume, high dollar value orders, making it a drain on a company’s cash flow. Min/Max is that inventory approach of choice for those companies who have large product lines, small volume spread across those lines, and infrequent customer demands from a cyclical industry. To summarize, these are the important questions to ask.

  • What type of market does the company operate in?
  • What kind of product lines does it offer?
  • Are customer demands cyclical and seasonal, or linear and constant?
  • Is the company’s purchasing power large or small?
  • Does the company operate in a price sensitive market, or one that measures vendor performance on other criteria?

When it comes to managing inventory, it’s really about what the company does, and does well. Don’t make the mistake of running an inventory system not conducive to your customers’ requirements. Be sure to address your market’s needs and don’t be enamored with an approach that simply won’t work for your business.

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