InventoriesLoss of customer goodwill
Failure to be able to supply a customer owing to having insufficient inventories may
mean the loss not only of that particular order, but of further orders as well. The extent
to which this is a significant risk depends to a large degree on the nature of the trade
and on the relative market power of supplier and customer.
Production dislocation
Running out of raw material when other production facilities (factory, machinery,
labour) are available can be very costly. How costly depends on how flexible the busi-
ness can be in response to a stockout, which in turn probably depends on the nature of
the inventories concerned. For example, a car manufacturer running out of a major body
section probably has no choice but to stop production. If the business runs out of inter-
ior mirrors, it is probably quite feasible for these to be added at the end of the produc-
tion cycle rather than at the scheduled stage, without too much costly dislocation.
Loss of flexibility
Businesses that hold little or no inventories inevitably lead a ‘hand-to-mouth’ exist-
ence, where purchasing and manufacture must be very closely geared to sales. This
may preclude maximising the efficiency of production runs or of buying materials in
batches of economically optimum sizes. Such an existence also means that, unless
things go precisely to plan, the business risks costly problems. There is also the risk
that even a slight increase in sales demand cannot be met.
Inventories holding, though costly, creates a ‘margin of safety’ that can reduce risk,
so that mishaps of various descriptions can occur without costly major repercussions.
Reorder costs
Any business existing on little or no inventories will be forced to place a relatively
large number of small orders with short intervals of time between each one. Each
order gives rise to costs, including the physical placing of the order (buyer’s time, tele-
phone, postage and so on) and the receipt of the goods (stores staff time, costs of pro-
cessing the invoice and making payment).
13.7 Just-in-time inventories management
Models have been developed to aid managers in their task of balancing costs. Each of
these models seems to have its strengths and its limitations.
One such model can be used to identify the optimum size of order to be placed for
the purchase of new raw materials, given a particular rate of usage of inventories and
other relevant factors. The model is based on the assumption that the level of each
inventories item will be as shown in Figure 13.4. This shows the inventories level
falling evenly over time until just as the inventories completely run out they are
replaced by quantity E. Since the inventories level falls evenly from Eto zero, the aver-
age inventories holding level is E/2. The model seeks to balance inventories holding
costs with the cost of placing orders.
If Cis the cost of placing each order, Athe annual demand for (that is, usage of) the
inventories item and Hthe cost of holding one unit of the inventories item for one
year, then the annual cost of placing orders will be (A/E×C) and the cost of holding
the inventories will be (E/2 ×H). The total cost associated with placing orders and
holding inventories is the sum of these two. (Note that we are not interested in the