A firm just can’t operate efficiently with an empty warehouse, regardless of how hard it wants to practice just-in-time manufacturing. Efficient use of capital requires work-in-process inventory as a buffer between process steps. And carrying the right amount of the right inventory—and having it in the right place—is just as important in efficient and effective materials management.

The key to getting that efficiency is achieving the right balance between the benefits of having the inventory, and the costs of having and managing the inventory. The key to maintaining that balance is adjusting inventory levels to accommodate changes in the factors that affect the benefits and costs.

Let’s look at both sides of the equation, starting with the benefits.

  • With product on hand you can ship on demand. Serving a customer immediately trumps almost anything.
  • Building inventory allows you to buy material in larger amounts, over a longer time, and at better prices.
  • Having the material in hand mitigates against price increases and lets you raise markups as prices increase.
  • You have configuration control. If your product uses version X of a component and the supplier redesigns to version Y, you could be in for some ad hoc redesign.
  • Having goods on hand is a good buffer against the supplier going out of business!
  • For firms in the defense industry, buying now and using later—maybe much later—can offer cash flow opportunities, and even some insurance against contract cancellation.
But there are costs on the other side of the equation.
  • One of the most important arguments against having inventory is the cost of owning it. Prudently managed firms have access to cheap money, and that leverages inventory opportunities. But for those whose debt has gone to junk status, it would be a good time to clean out the warehouse.
  • Perhaps the second most important cost is that of storing and retrieving inventories. In many cases, the cost of getting material into and out of storage exceeds the cost of using it to build product. Automated storage and retrieval systems had their day, but in most cases, their cost and complexity negated any value they might have offered. Simpler is better, and the key is access, not computerization. Stock picking can be expensive, and often the answer is point-of-use storage with the users picking components as they need them.
  • Shelf life and obsolescence can be constraints. Material can become damaged or lost in handling. Design a warehousing facility badly enough and you can’t justify having anything on hand!
  • The market could change and you could be stuck with a warehouse full of obsolete or otherwise unusable goods. Worse yet, you could have an idle factory full of expensive capital equipment, as in the case of many machine tool and capital goods builders in the current economy.
So that’s the equation. If you get, and maintain, the right balance between the benefits and costs of inventory, you can make money at it. Get it wrong and you can’t. Here’s another important point. If you get it right today, don’t assume you have it right for all time. As each of the factors change, the equilibrium changes too, and you have to establish a new level of inventory.

The point is that it is worth doing, and is an important element of a well-managed and well-organized firm. Good inventory management practices allow a firm to take advantage of as many opportunities as possible to be successful in a tough, competitive world.