What are the Objectives of Inventory Management?

Inventory management is important for operational efficiency, cost reduction, and customer satisfaction. It helps businesses avoid excess stock and shortages, both of which can be costly.

 

Table of Contents

• What is inventory management?
• Objectives of Inventory Management System
• Material Availability
• Minimum Wastage
• Improving Customer Service
• Sufficient Stock
• Increasing Product Sales
• Reducing Cost Value of Inventories
• Cost-Effective Storage
• Types of Inventory Management Techniques
• Selection Criteria for Effective Techniques

What is inventory management?

Inventory management is a systematic approach of ordering, storing, managing, and controlling a company's stock, including raw materials, components, and finished products. It plays a crucial role in ensuring the efficient operation of the supply chain.

Objectives of Inventory Management System

The following are the objectives of inventory management system:

1. Material Availability

One of the main objectives of inventory management is to ensure that materials required for production or sales are consistently available without interruptions. This objective is crucial for manufacturers, where a shortage of key materials can halt production lines, leading to delays and financial losses. For instance, an electronics manufacturer must maintain a steady supply of components like microchips and circuit boards to meet production schedules. Automotive manufacturers often use sophisticated forecasting and supplier relationship management to ensure a steady supply of parts like engines and body panels.

2. Minimum Wastage

Another inventory management objective is minimising waste in inventory, thereby saving costs and promoting sustainable practices. This involves strategies to avoid over-purchasing, efficiently utilizing materials, and reducing spoilage, especially in industries dealing with perishable goods. For example, a grocery store chain might implement a dynamic inventory system that adjusts orders based on sales trends to minimize food waste. Retailers often use data analytics to predict sales trends more accurately, reducing the incidence of excess stock that may become obsolete.

3. Improving Customer Service

Another objective of inventory management is to enhance the customer experience by reliably meeting their demand for products. This involves having popular products available when customers need them, which requires accurate demand forecasting and efficient inventory replenishment processes. For example, an online retailer like Amazon aims to have high-demand items consistently in stock, ensuring quick delivery times. Retailers may use customer relationship management (CRM) systems combined with inventory data to understand customer buying patterns and adjust inventory accordingly.

4. Sufficient Stock

Sufficient stock maintenance is one of the objectives of inventory management. It helps in maintaining an adequate level of inventory to meet customer demands without overstocking. This requires a balance between having enough stock to satisfy customer orders and not so much that it incurs unnecessary holding costs or risks obsolescence. For instance, a seasonal clothing retailer must carefully manage inventory levels to align with changing fashion trends and seasons. Businesses often use inventory optimization tools that consider historical sales data, seasonal trends, and current market conditions to maintain optimal stock levels.

5. Increasing Product Sales

Another inventory management technique is using inventory management to maximize sales opportunities. Proper inventory management ensures that products are available for sale when customers want them, thus increasing revenue potential. A good example is a consumer electronics store that stocks up on the latest gadgets before the holiday season to capitalize on increased consumer spending. Implementing an effective inventory management system can lead to increased sales by reducing stockouts and ensuring that high-demand products are always available.

6. Reducing Cost Value of Inventories

Inventory management’s objective also includes lowering the costs associated with holding and managing inventory. This includes strategies to reduce costs such as storage, insurance, taxes, and shrinkage. A large part of this is streamlining the supply chain to reduce holding times and storage needs. For example, a furniture retailer might use a drop-shipping model to reduce the need for large warehouses. Businesses might adopt JIT (Just-In-Time) inventory practices to minimize the time goods spend in storage, thereby reducing storage and handling costs.

7. Cost-Effective Storage

One of the important objectives of inventory management involves optimizinf storage solutions, maximizing space utilization and minimizing storage costs. This involves using warehouse space effectively and implementing storage systems that are cost-efficient yet ensure easy access and product safety. For instance, a logistics company might use vertical storage and automated retrieval systems to maximize warehouse space utilization. Warehouses may employ warehouse management systems (WMS) that optimize the placement and retrieval of goods, reducing the time and labor associated with storage and retrieval. 

Operational and Financial Objectives

Operationally, the focus is on reducing manual tasks and errors through automation and system integration. Financially, the objective is to balance inventory investment with expected returns, avoiding overcapitalization in inventory. For example, a manufacturing company may use ERP systems to integrate inventory management with other business processes for operational and financial efficiency. Businesses might implement advanced inventory forecasting tools that help in reducing unnecessary stock levels, thereby optimizing financial resources.

Types of Inventory Management Techniques

Each of these techniques has distinct applications and benefits, and the choice often depends on the specific business context, industry standards, and financial considerations.

1. Just-in-Time (JIT)

Just-in-Time (JIT) is an inventory management technique that aims to reduce inventory carrying costs by aligning raw material orders from suppliers directly with production schedules.

• Benefits: JIT minimizes warehousing costs by reducing the need for storing large amounts of inventory. It also lowers waste and improves cash flow.
• Example: Toyota's production system is a renowned example of JIT implementation. By producing vehicles based on actual market demand rather than forecasted predictions, Toyota significantly reduced excess inventory and associated costs, exemplifying lean manufacturing.
• Challenges: JIT requires precise coordination with suppliers and a stable production process. Disruptions in the supply chain or sudden changes in demand can pose significant challenges.

2. ABC Analysis

ABC Analysis is a method of categorizing inventory into three classes, typically known as A, B, and C. 'A' items are high-value with a low frequency of sales, 'B' items are moderate on both counts, and 'C' items are low-value with high frequency.

• Benefits: This technique helps businesses prioritize their focus and resources on the most important (high-value or critical) items. It facilitates more effective inventory control and management.
• Example: In the pharmaceutical industry, 'A' category drugs, such as specialized medications, are prioritized due to their high value, though they have lower turnover rates. This ensures that vital but less frequently used drugs are always available when needed.
• Challenges: ABC Analysis requires regular review and adjustment as sales patterns and product values change over time.

3. FIFO & LIFO

• FIFO (First-In, First-Out): FIFO involves selling or using inventory in the same chronological order as it was purchased or produced. It's commonly used for perishable goods.
• Example: Grocery stores often implement FIFO for perishable goods like fruits and vegetables. This method ensures that items stocked first are sold first, minimizing the risk of spoilage.
• Benefits: FIFO reduces the likelihood of inventory obsolescence and is straightforward to implement. It’s also in line with the natural flow of inventory for many businesses.
• Challenges: In times of inflation, FIFO can result in higher taxable income as older, cheaper goods are sold first.
• LIFO (Last-In, First-Out): LIFO is an accounting method where the most recently produced or purchased items are recorded as sold first. LIFO is less common in physical inventory management and is often used for tax purposes in certain jurisdictions.
• Example: LIFO is less common in practical inventory management due to its potential for distorting inventory value, especially if prices are rising. However, it can be found in businesses where newer stock has a lower cost.
• Benefits: LIFO can be beneficial for tax purposes in inflationary periods, as it assumes that higher-cost inventory is sold first, leading to a lower reported profit.
• Challenges: LIFO can lead to outdated inventory if older items are not sold, potentially causing obsolescence issues.

Selection Criteria for Effective Techniques

1. Business Nature: The nature of the business, whether it’s service-oriented or product-based, influences the choice of technique. For example, a cloud services provider might prioritize real-time inventory data, unlike a clothing retailer focusing on seasonal trends.
2. Inventory Type: Different types of inventory, like perishable goods or high-value items, require different management techniques. For example, a jewellery store may use a different inventory technique than a supermarket.
3. Market Dynamics: Changing market trends can influence the choice of inventory management techniques. For example, an electronics retailer might adjust its inventory management strategy to accommodate rapid technology changes and product life cycles.