Inventory is one of the important factors which helps one company work smoothly and earn profit. Controlling inventory and related costs can affect company performance. Factors affecting these costs are evaluating customers' demands and suppliers' capacities, and determining inventory cost, re-order point, and order size. Related costs of inventory are interests paid for capital loans to purchase inventories, and expenses for warehousing, insurance, inventory taxation, obsolescence and margin lost from stock-outs. If a company can control these factors well, it can minimize related costs. This contributes to reduce costs and improve company performance. Inventory control has been researched for many years, but it is still one of the factors which need to be considered during the year of a company because every business or services supplier needs to control inventory well to satisfy customers' demands on time to maximize net profit. By controlling this, a company can minimize loss from expired products in inventory and property tax which is regulated by law of a certain county appraisal district for all kinds of inventories.
In this paper, I will analyze current research from 2004 to 2010 about factors affecting to inventory and related costs of different industries and give some suggestions considered by managers to improve performance of their companies.
The nature of research and results:
With technology, there are later systems helping control inventories such as Enterprise Resource Planning (ERP) and Radio Frequency Identification (RFID). These systems can identify current inventories to help reach just-in-time inventory. It does not cost much for counting the actual inventory a company has, but it is difficult to forecast how much inventory a company needs in a certain appropriate period to save costs. Depending on company scale and necessity, a company can invest in suitable equipments to read the current inventories or asks other companies to provide counting services weekly, monthly or quarterly. Every company needs to forecast demands of customers and try to prepare inventory to satisfy customers' orders as close to customers' demand as possible and with lowest related costs.
Gupta (2004, December) would like to present four dimensions of materials in controlling inventory including consumption value of materials, consumption pattern, lead time, and criticality of items which are very necessary for us to prepare inventory cost effectively. In consumption value of materials dimension, the author classifies materials in four classes. Class 1 is for materials with high value consumption such as crude oil, iron, and coal requiring frequent monitoring and strict control to maintain safe low stock. Class 2, 3 and 4 are for items with 70 to 90, 10 to 20, and 5 to 10 percent in value consumption, respectively. In consumption pattern of materials dimension, the author classifies items into four classes. Class 1 is for items with high consumption and unpredictable consumption variability. Class 2 is for materials with high consumption but moderately predictable consumption variability. Class 3 is for items with moderate consumption and unpredictable consumption variability. And class 4 is for items with low consumption and predictable consumption variability. In lead time dimension, the time interval from order to arrival of materials or products ready to use or to sell, he classifies lead time dimension into 4 classes. Class 1 is for items with very long and highly variable lead time and unpredictable variability. Class 2 is for items medium length and moderately variable lead time and unpredictable variability. Class 3 is for items with medium or short lead time and moderate unpredictable variability. And class 4 is for items with constant or short lead time and predictable variability. The author suggests that one company needs to have more than one supplier for each item to prevent any shortage of supply. Based on the basis of the criticality dimension, the author classifies it into four classes. Class 1 is for items with a highly critical and vital role in the organization that cannot easily be substituted. If there is a shortage, it will cost the company heavily. Class 2 is for items with request of that are essential and always available in stock. Class 3 is for normally available items which require adequate safe stocks. And class 4 is for substitutable items which do not cost much for shortage. From four classes of each dimension, we can have 256 categories which will shape different policies and rules for ordering, and choosing suppliers respectively.
Sapra, Truong, and Zhang (2010, May-June) organize experiments "as a periodic-review, single-item inventory system" (p. 720) to test the effect of wait-list, the structure of optimal policy for inventories in fashion and luxury item field and inventory-withholding strategy. The authors study the impact of various model parameters and the wait-list effect on the optimal policy from analyzing changes of cost in profit calculation formula, including index for periods, unit selling price of the item, unit purchasing cost of the item, inventory holding cost, percentage of backlogged demand, discount factor, ending inventory of the previous period, demand in a period and inventory level after receiving the order in a period (Sapra, Truong, and Zhang, 2010, May-June, p.722). We can understand the wait-list effect and make appropriate operational decisions for inventory to get expected profits. Sapra, Truong, and Zhang (2010, May-June) state that in the fashion and luxury item field, under-stocking can be the best choice in different periods. Traditionally, retailers try to satisfy customers' demand as soon and much as possible and there is no flexibility in clearing old fashions or exchanges between stores. But this research suggests that by applying "inventory-withhold strategy", a company can take advantage of healthy stream of customer demand and boost customer purchases. By doing this, companies can get higher profits because higher inventory level leads to higher inventory costs and loss from old fashion items, and when those companies skip the wait-list effect, the profit losses increase sharply.
We also know another inventory model for nondurable consumer products in promotional periods researched by Hendel and Nevo (2006). Hendel and Nevo (2006) design a simple inventory model to observe household consumption behavior and store demand of 24 different categories of laundry detergents, soft drinks, and yogurt in promotional periods, and analyze data of Information Resources Inc. which is collected from 9 supermarkets and from 1,039 household-level samples in 104 weeks in the United States, to know how consumers make purchase decisions in sale and non-sale periods. From this, we can know the consumption trend to decide how much inventory we need to approach for these kinds of products effectively. They give out a model of consumer inventory holding which can be applied in various implications for nondurable products such as different kinds of laundry detergents, soft drinks, and yogurt which are storable in different sizes. It means that promotional activities are not always successful to boost revenue and net profit, and prepare high inventory, because if other competitors launch sales strategy earlier than one company, consumers bought those consumer products from those competitors with big quantity and delayed their demand. Managers also should not make constant inventory plan, but need to compare storage costs of products and to choose the appropriate sizes of each products, for example bigger size for detergents and smaller size for soft drinks and yogurts.
Managers also need to forecast customers' demands and the advantages in inventory arrangement to produce profit. Sometimes they have to set low gross margins to attract buyer power and get more profit. For example Wal-Mart is the World leader of retailers. Wal-Mart's management board knows how to apply a buyer power concept and advanced inventory management practices. If manager applies buyer power concept well, but does not take their advantages or arrange inventory well, they cannot boost the companies' profits. Gosman and Kohlbeck (2009) reported their investigation of how purchase power in retail market can affect retailers' profitability. They observe 300 firms for their sample from 1993 to 2004 to test whether suppliers' gross margins affect major buyer power, increase purchase volume, and decrease for inventory cost and anti-theft features. We know that another way to increase customer concentration is to apply low gross margin strategy, which is used as a company's slogan with inventory control well. Companies will have more regular customers and can prepare inventory more easily.
We can better understand the importance of inventory control in sectors of primary products, manufacturing, and wholesale and retail which have SIC codes from 2000 to 2999, 3000 to 3999, and 5000 to 5999, respectively from examine of Basu and Wang (2011, p.4). The authors use over 85,000 observations from 1950 to 2005 to test firm performance measured by earnings, return on assets and market valuation when inventory changes. Firm performance has negatively relation with inventory changes, increasing inventories. Basu and Wang (2011) use a square regression test for performance metric formula to test the negative relation between increasing inventories and firm performance in the wholesale and retail industries. The authors use this formula with real GDP growth and nominal rate, the one year forward change in the earning per share, and the change in the return on assets over similar period. Basu and Wang use ordinary least square regression to measure long term earning changes when inventories increase. The authors recognize that in all periods, the higher rate of inventory wholesalers, retailers, or firms in different industries changes, the lower profitability they approach. Distributors tend to keep lower inventories than manufacturers and firms in the primary product industries. That is why they conclude that there is a negative relation between inventory changes and firms' profit and performance.
Hult, Ketchen, and Arrfelt (2007) show that by using a culture of competitiveness and knowledge development, managers are able to forecast market demand and keep being active to adjust inventory according market demand appropriately. The authors focus on 201 samples from manufacturing firms employing an average 13,688 people. Those replies are responded by their purchasing director, purchasing and material management director, vice president of procurement or chief purchasing officer to design a fit measurement model, a composite reliability, and a higher-order culture of competitiveness and knowledge model. First, they use a hierarchical moderator regression analysis to analyze and to test the variance inflation factors. Second, they use a parsimonious latent-variable interaction to test the hypothesis. From this, we know that one of them by itself, a culture of competitiveness or knowledge development, cannot improve performance. Culture of competitiveness and knowledge development have to be present to create effects together. If managers do not have knowledge development behaviors or the ability to predict market changes, it is easy for preparing inventory in stable conditions, but hard for preparing inventory in strong turbulence markets. Managers need to understand the interaction of culture of competitiveness and knowledge development to increase profits, growth, market share, and performance. Sometimes, competitiveness is a chance for companies, if managers are well-prepared and active to adjust inventory accordingly.
For a manufacturing company, inventory control and the related decisions to choose suppliers are important too. With the contemporary trend, it produces the main skill components and tries to get a competitive advantage from other manufacturers for other minor parts for them to save costs from R&D, producing, and machine investments, and time. To do this, managers need to have knowledge to control all kinds of inventory to produce main skill components and parts ordered from other manufacturers, as well as understand those suppliers. Parmigiani and Mitchell interviewed 11 managers of metal producing firms to know their producing processes and sources of parts such as how much time manufacturers need to produce one specific part, the price of one certain part quoted by different recommended manufacturers, and shipment costs per unit in regular term and in express. Next, the authors collected responses, 809 distinct sourcing decisions, of presidents or general managers from 193 metal forming firms to design multinomial logit models for a pair of complementary components based on dependent variables, explanatory variables, firm component expertise, within-firm shared expertise, and inter-firm expertise. This research shows us the necessities of technology knowledge for metal components with different levels and interrelationships ordered from other manufacturers after gaining more experience to save cost and have better profits.
Another concept we need to consider in controlling inventory is Just-In-Time, which has been mentioned in many articles over the past several years. Meybodi' s research (2011) also demonstrates results of just-in-time practices on performance. The author mailed out 500 questionnaires to fabricated metal, communication, electronics, automotive, chemicals, and paper product firms in the Midwestern United States including Illinois, Indiana, Ohio, Michigan, and Wisconsin. He received 91 completed surveys in which 51 firms were traditional organizations, 33 firms were just-in-time organization, and 7 firms did not declare what kind of organizations they are. His questionnaire was designed to examine whether just-in-time organizations are more consistent than traditional organizations in scanning external factors to set overall corporate goals and objectives, in aligning their core competencies, their competitive priorities, capacities, and manufacturing performance. He tested product reliability, conformance quality, delivery reliability, price, and fast delivery for competitive priorities, and improving elements of time-based competition and customization, reducing inventory, efficiency by reducing costs and increasing capacity utilization for performance. From the analysis results, he shows that just-in-time organizations tend to focus more on elements of time-based competition, improving team work and supplier relationships, manufacturing reorganization in supply chains, and developing collaborative supply chain, and have better competitive priorities and performance. In brief, just-in-time principles can not only be applied to reduce inventory and frequent deliveries, improve firm performance, but also applied in different level of organizations.
The implementations for managers:
Preparing inventory for companies will vary from industries and during different periods. Managers play important roles in controlling related factors to inventory to reduce related costs and improve company performance. Managers need to classify the types of their company products in 256 categories of four dimension classifications of Gupta (2004) to know the dominant characteristics of their products, internal and external demands, products importance in organizations, lead time, and suppliers' availabilities. Manager should review whether they can apply just-in-time principles to improve organization culture, and organizational strategies, especially inventory cost, frequent deliveries and manufacturing firm performance as Meybodi' s examine. Managers should consider whether they can apply an inventory-withhold strategy to refresh customers' demands, get higher profits, and reduce loss from remaining items instead of trying to arrange inventory higher or as customers' demands as Sapra, Truong and Zhang proved in their article in 2010. Managers should estimate how successful promotion activities are or how low margin should be and be careful to prepare too high inventories for promotion activities. Managers are the ones who are active with varieties of external environments to adjust orders and inventories on time. In particular, in fashion and luxury item industries, managers should consider using an "inventory-withhold strategy" to minimize loss from out of date fashion and boost customers' demands. In consumer product industries such as laundry detergents, soft drinks, and yogurt, before preparing inventories and launching promotional events, managers should investigate the available purchasing power of consumers because if consumers still have promotional items from competitors, consumers will not buy at this time. Managers should consider applying a long term low margin strategy for consumer products to get stable consumers because it is easier to prepare inventory during the year. In manufacturing firms, managers need to apply just-in-time principles to get better competitive priorities, reduce inventory costs and higher performance. Manager should pay attention to culture of competitiveness and are the persons who have knowledge development. They are the persons who are always active in forecasting and making decisions and adjustment according market demands on time.
