Answer:
Though inventory is an idle resource, it is almost essential to keep some inventory in order to promote smooth and efficient running of business. To maintain independence of operations, a supply of materials at a work center allows that center flexibility in operations.
Consider the case – an enterprise that does not have any inventory. Clearly, as soon as the enterprise receives a sales order, it will have to order for raw materials to complete the order. This will keep the customers waiting. It is quite possible that sales may be lost. The enterprise may also have to pay a high price for various other reasons.
Another aspect relates to the costs for making each new production set up. Independence of workstations is desirable in intermittent processes and on assembly lines a well. As the time that it takes to do identical operations varies from one unit to the next, inventory allows management to reduce the number of set ups. This results in better performance.
Consider the case of seasonal items. Any fluctuation in demand can be met if possible, by either changing the rate of production or with inventories. However, if the fluctuation in demand is met by changing the rate of production, one has to take into account the different costs.
The cost of increasing production and employment level involves employment and training; additional staff and service activities; added shifts; and overtime costs. On the other hand, the cost of decreasing production and employment level involves unemployment compensation costs; other employee costs; staff, clerical and services activities; and idle time costs. By maintaining inventories, the average output can be fairly stable. The use of seasonal inventories can often give a better balance of these costs.
Inventory can be used, among other things, to promote sales by reducing customer’s waiting time, improve work performance by reducing the number of set ups, or protect employment levels by minimizing the cost of changing the rate of production. Therefore, it is desirable to maintain inventories in order to enhance stability of production and employment levels.
If the demand for the product is known precisely, it may be possible (though not necessarily economical) to produce the product to exactly meet the demand. However, in the real world this does not happen and inventories become essential. Inventories also permit production planning for smoother flow and lower cost operation through larger lot-size production. They allow a buffer when delays occur. These delays can be for a variety of reasons: a normal variation in shipping time, a shortage of material at the vendor’s plant, an unexpected strike in any part of the supply chain, a lost order, a natural catastrophe like a hurricane or floods, or perhaps a shipment of incorrect or defective materials.
Broadly speaking, some other functions of inventories are:
- To protect against unpredictable variations (fluctuations) in demand and supply;
- To take advantage of price discounts by bulk purchases;
- To take advantage of batches and longer production run;
- To provide flexibility to allow changes in production plans in view of changes in demands, etc; and
- To facilitate intermittent production.
Only when considered in the light of all quality, customer service and economic factors – from the viewpoints of purchasing, manufacturing, sales and finance – does the whole picture of inventory become clear. No matter what the viewpoint, effective inventory management is essential to organizational competitiveness.