The Locational Time Value of Inventory

A vital part of a strategic, forward-thinking inventory management process is an organisation's recognition of the significance of upholding inventory levels to fulfil customer demands and safeguard the supply chain against the loss of sales orders. The organisation's ability to manage and anticipate is demonstrated through its meticulous equilibrium between the financial resources allocated to inventory and the risk of revenue loss from extended lead times in sourcing inventory after receiving customer orders.

The value of inventory increases as it progresses through the supply chain following the end user's consumption. This highlights the organisation's proficiency in overseeing inventory movement to ensure timely availability while minimising costs and maximising customer satisfaction. By maintaining a proactive approach to inventory management, organisations can enhance operational efficiency and competitiveness in the market.

Maintaining increased inventory levels is a common practice among organisations, driven by the strategic objective of prioritising efficient service and prompt delivery. Conversely, lower inventory levels are deemed satisfactory when the availability of products or services is less important than unit pricing. This is a clear testament to organisations' influential role in this process. Given its dynamic nature, the significance of inventory flow and its value in inventory management cannot be overstated.

Optimising the Time Value of Inventory

Inventory management is pivotal in ensuring customer satisfaction and operational efficiency because it delicately balances and manages the time value of inventory. By strategically holding inventory levels based on customer demand patterns and service requirements, an organisation can optimise its supply chain processes and enhance overall performance, underscoring its essential role in a business's success.

Understanding the trade-offs associated with inventory levels is essential for businesses to effectively meet customer needs while minimising costs and maximising profitability in a competitive market environment. Inventory can be classified as:

• Raw Materials: Raw materials are generally held in bulk, and the unit price is at its lowest. Inventory is held in anticipation of maximising the use of production facilities to reduce manufacturing costs by levelling off demand patterns and producing more during periods of low demand to fulfil the higher demand periods.
• Parts: Parts are generally held as “C”-class inventory items, where the demand could be moderate to high, but the unit price of the goods is towards the lower end of the inventory unit pricing spectrum.

• Subassembly: Subassemblies are parts constructed for fitting into finished goods and are typically held in sufficient quantities to meet production needs. The price of subassemblies is directly proportional to the cost of their constituent parts but generally is higher when considering the cost of assembly.
• Finished Goods: These are goods with a higher unit price. They are produced and stored to fulfil sales orders. An organisation's sales policy determines the amount held, where inventory levels tend to be higher, and availability is the most significant factor. Usually, the unit price is of lesser concern. This comprehensive understanding of the types of inventory and their characteristics is crucial in effectively managing the supply chain.

Traditionally, inventory is categorised based on its unit price and demand patterns. Class “A“ items have the highest unit prices, while class “C” items have the lowest. Regarding demand, class “A” items typically account for 80% of the total demand value. As a result, inventory managers primarily focus on managing these items. On the other hand, class “D” items are considered obsolete and are classified for scrappage.

Balancing the Value and Placement of Inventory

Organisations tend to reduce inventory levels when the unit price becomes critical. In such cases, they heavily rely on inventory demand data to determine the appropriate inventory levels. The goal is to maximise stock turn ratios, lowering an organisation's average level of capital tied up in inventory. Despite this reduction, the aim is to maintain delivery performance.

It should be emphasised that the average unit price and the capital tied up in inventory tend to rise as inventory progresses through the supply chain towards the final consumer. A range of factors, including availability, price, location, and time, influence this increase in value.

These factors are meticulously customised to fulfil the end user's specific requirements. Consequently, the value of inventory is not solely dependent on its unit price or demand patterns but also on the value added throughout the supply chain process.

Leveraging the Value of Inventory

At the start of the supply chain, the inventory primarily consists of raw materials. The overall inventory level decreases as these raw materials are transformed into parts, subassemblies, and finished goods. In this phase, the main objective is to secure the accessibility of raw materials, components, and subassemblies to uphold production effectiveness and reduce production expenses. This includes optimising resources such as facilities and machinery to their total capacity.

As inventory progresses along the supply chain, the emphasis shifts from availability to inventory value. This is particularly important in anticipation of customer orders. As the goods move closer to being consumed by the end user, the volume of items in inventory generally decreases. However, it is essential to note that the overall inventory value may not necessarily be lower due to the increased unit price of the goods, which reflects their higher unit value.

Therefore, the value of inventory fluctuates throughout the supply chain. It starts at its lowest point when inventory consists mainly of raw materials and gradually increases as these materials are converted into parts, subassemblies, and finished goods. Inventory management's strategic nature and focus shift from availability to inventory value as customer orders are anticipated.

Balancing the Placement of Supply Chain Inventory

While the volume of items held in inventory decreases as they move closer to the end user, the overall inventory value may not decrease due to the increased unit price of the goods. Inventory allows for the separation of demand and fulfilment, resulting in benefits for both the end user and the flexibility of the supply chain. As inventory levels decrease, the supply chain becomes more adaptable.

However, it is crucial to consider an organisation's sales policy when determining inventory levels. Factors such as availability, price, location, and order fulfilment time can serve as significant marketing advantages, leading end users to be willing to pay a higher premium for fulfilling their orders.

On the other hand, specific market sectors prioritise price above all else. In these sectors, the quantity of inventory held can significantly impact the profitability of sales fulfilment. The absence of available inventory can result in lost sales, while effective inventory control becomes crucial for an organisation's success. Organisations can strategically meet sales demands and generate profits by ensuring the accuracy and availability of demand data.

Inventory management plays a vital role in optimising supply chain performance. By effectively managing inventory levels, organisations can enhance their flexibility and meet the demands of both end users and market sectors. Considering specific sales policies and utilising accurate demand data can provide a competitive advantage regarding availability, price, location, and order fulfilment time. Ultimately, the successful control of inventory can contribute significantly to an organisation's overall success and profitability.

More articles can be found at Procurement and Supply Chain Management Made Simple. A look at procurement and supply chain management issues to assist organisations and people in increasing the quality, efficiency, and effectiveness in the supply of their products and services to customers' delight. ?? Procurement and Supply Chain Management Made Simple. All rights reserved.