Inventory Management Systems: Costs and Modern Trends
Inventory Systems
An understanding of inventory systems is essential before attempting to manage different components of inventory. A system, in simple terms, is defined as how things are organized together with their inter-relationships. We can define an inventory system as one consisting of three components: inventory customers, inventory storage points, and inventory sources.
The second component, inventory storage or stocking points, may include:
- Warehouses
- Distribution centers
- Storage bins
- Any physical location where inventory is stored temporarily
Stocking points are required because bulk transportation to these locations is efficient and cost-effective, allowing stocks to be redistributed in smaller quantities to retail outlets.
Costs in Inventory Systems
Managing costs is a primary responsibility for any manager. The focus is not merely to eliminate or minimize costs, but to compare costs against benefits to minimize the cost per unit of benefit. Modern inventory management has shifted from eliminating inventory to optimizing holding levels.
For example, in cotton spinning and textile units, a key success factor is purchasing quality cotton during the season when prices are low. In industries exposed to price volatility, inventory holding is essential. Therefore, the cost of holding inventory must be weighed against the benefits. There are five different costs associated with holding inventory:
- Purchase Cost: The value of the inventory itself, including materials and components. For internally manufactured parts, work-in-progress, or finished goods, this includes material, labor, and production overheads.
- Acquisition Cost: The expenses associated with procuring inventory.
Emerging Trends in Inventory Management
Traditional assumptions that inventory holding is an inescapable necessity are being challenged, leading to innovative management techniques. Two primary reasons for holding raw materials are to avoid price fluctuations and to ensure production continuity despite supply delays.
Alternative strategies to mitigate price volatility include:
- Entering into long-term supply contracts at fixed prices.
- Taking positions in the futures market.
Reasons for holding work-in-process inventory include complex production processes, economic batch processing, and insurance against manufacturing breakdowns. While not all technology-related problems can be overcome, firms can adopt new technologies to accelerate production or outsource specific components to eliminate the need for bulk production to achieve economies of scale.