Reasons for Maintaining Inventory
Organizations maintain inventories for several reasons. These include
1. To protect against uncertainty. For purposes of inventory management. we examine uncertainty in three areas. First. there i~ uncertainty with re'pel'! to ra« materials. which necessitates raw material inventory. Here. uncertainty pert.un-, both to the lead time that can vary due to unexpected delays and to (he amount of raw material received.
Uncertainty also occurs in the transformation process. Here work-in-process (WIP) inventories absorb the variability that exist between of the ~races. thereby providing independence between operations and improving efficiency. In addition. this WIP inventory can be used to cl'le the stages in a process..sect to the demand for a firm's finished products. the demand for a product were to be known precisely. then it could be possible to manufacture product so that demand would be exactly met. However, more often demand is not totally known, and a safety stock of finished goods inventory is therefore maintained to absorb these variations.
]the previous chapter on aggregate planning. when a firm adopts a level strategy, an inventory of finished goods i required to buffer the cycle demand for product from the level output generated by the transformation process. Under these circumstances. when demand exceeds production. he difference i withdrawn from inventory: when demand is less than production. the difference i placed back into inventory. To take advantage of economies of scale. Each time we place an order or do a setup to perform an operation, we incur a fixed cost, regardless of the quantity involved. Thus; the larger the quantity ordered or produced. the lower the average total cost per unit. However, as we shall see shortly. there are trade-offs to be considered in determining the proper lot size.In addition. companies often offer discounts for larger-quantity orders. as an incentive to customers to buy more than the normally would. This results in accumulations of items that otherwise e would not exist. Firms offer quantity discounts for several reasons, including the need to reduce excessive stockpiles and to generate positive cash flow. In addition, there are economies of scale with respect to transportation costs, especially when products are shipped in either full
t railer loads or full car load').