The five functions of inventory

While for the financial area stock is a villain, for the commercial area the more stock the better! And the stock manager is at this crossroads, trying to guarantee availability with the lowest possible stock. To arrive at the best sizing, meeting all the needs of the company and, at the same time, minimizing costs, it is essential to understand each of the functions that the stock can fulfill:

1. Cycle Stock

These are the inventories needed to meet average demand during the time elapsed between successive replenishments. The amount of this inventory is highly dependent on production lot sizes, economic quantity shipments, storage space limitations, lead times and handling costs, among other factors.

2. Safety Stock

It is in addition to normal stock, functioning as a buffer against variability in demand and replenishment lead times. The safety stock combines the uncertainties related to demand oscillation and also to the variability of the delivery time. These two uncertainties are combined into a single indicator and confronted with the risk of default that the company accepts to assume.

3. Inventory in Transit

Inventory that is being transported along distribution channels, existing because of the need to get an item from one place to another. The average stock in transit is directly impacted by the time in transit of the product.

4. Buffer Stock

It is difficult for a company that has a very concentrated demand in certain periods of the year to project its production capacity based on its peak demand, as this would mean a large investment in assets that would remain idle for a good part of the year. Thus, to meet periods of greater demand for products, an alternative is to manufacture products in excess of what is needed in periods when demand is less than capacity, forming buffer stocks that will be consumed later.

5. Speculative Stock

A speculative stock is a stock that is bought before it is needed to take advantage of some current condition. The speculative stock aims, for example, to protect a foreign exchange operation or to take advantage of a special discount.

The same product in stock can fulfill different functions. For example, if we have 100 units of a certain product in stock, 60 units are there to cover expected demand until the next replenishment (cycle stock), 10 units were added to guard against uncertainties (safety stock), 5 extra units were planned to cover future demand, when there is no capacity to meet them (buffer stock), 20 units are not in the warehouse, but have already been paid for and are in transit (transit stock) and 5 units are left over, because in the last purchase the supplier offered a discount if 5 additional units were purchased to the order, generating an extra stock to take advantage of a commercial advantage (speculative stock). Although the 100 units in stock are composed of different motivations, at the end of the day, the stock is only one and will be consumed according to demand, regardless of what was thought at the time of planning.

The cases presented below present different situations that impact inventory planning. Can you identify which of the 5 inventory functions each case refers to? The correct answer is at the end of this post.

a) “With the entry of competitors, demand is less and less predictable. Sometimes we think sales will be good, but we don't sell even half of what we expected, and other times demand exceeds expectations and we sell out of stock. We need to increase our stocks to be prepared, we cannot run the risk of losing customers to our competitors.”

b) “Even though we don't have demand this month, we need to start producing, because when demand increases, our capacity won't be enough to meet it.”

c) “The government has announced that there will be an increase in cigarette taxes soon, which has created a real rush to buy cigarettes.”

d) “With the change in the supply policy, the company will no longer receive its order every week and will start receiving it only once a month. The company needs more warehouse space as this will certainly increase their inventories.”

e) “We need to change our transport to a faster mode. Perhaps we should import the lower volume material by plane to reduce the cost of that inventory.”

f) “Our storage capacity is reduced due to the entry of our partner. We will have to change our inventory policy, reducing our order lots to maintain a lower average inventory.”

And there? Was it difficult to identify the functions of stocks in each of these cases? In the end, there is only one stock, but it is important to understand its functions in order to size it in the best way. The following figure presents a summary:

Figure 1 – Inventory Functions

Source: ILOS Inventory Management Course

Answers: a) Safety Stock; b) Buffer Stock; c) Speculative Stock; d) Cycle Stock; e) Inventory in Transit; f) Cycle Stock

References:

www.ilos.com.br/web/cursos/cursos-de-atualizacao/gestao-de-estoques-na-chadeia-de-suprimentos/