Raw materials
Inputs and materials waiting to be used in production.
Cambridge International AS & A Level Business · 9609 · AS Level
4.2 Inventory Management
Inventory helps a business keep production and sales moving, but holding too much can be expensive. This topic explains inventory control, supply chains, and the choice between just-in-case and just-in-time approaches.
Exam-focusedComplete Topic 4.2Interactive questions
What you need to know
For high-grade answers, treat inventory management as a trade-off. Holding more inventory can protect production and sales, while holding less can reduce storage, security and opportunity costs. The best level depends on the business and its supply chain.
High-grade habit: when evaluating JIT or JIC, apply your answer to supplier reliability, lead time, demand uncertainty, storage costs and the consequences of running out of inventory.
Subtopics
These subtopics follow the textbook table of contents. Select one to jump directly to it.
4.2.1
Managing inventory
InventoryProducts owned by a business that will be used up during the operations process. Inventory was previously also called stock.
Types of inventory
Work in progress
Semi-finished items that have entered production but are not yet complete.
Finished goods
Completed products ready to be sent or sold to customers.
General supplies
Items needed to keep the business operating, such as cleaning materials.
Why businesses hold inventory
Businesses hold inventory so that production can continue and customer orders can be met. They may also keep extra inventory just in case there is an unexpected problem, such as a supplier delay, a breakdown in one stage of production or a sudden rush of customer orders.
Benefits of holding inventory
- Production can continue if deliveries are disrupted.
- Customer orders can be met quickly.
- Finished goods can cover an unexpected rise in demand.
- Work in progress can help protect later stages from some interruptions.
TRADE-OFF
Costs and risks
- Storage costs: warehouses and handling cost money.
- Opportunity cost: money tied up in inventory cannot be used elsewhere.
- Security costs: inventory may need protection from theft or damage.
- Depreciation or waste: food can perish and fashion or technology can become outdated.
Evaluation: the aim is not simply to minimise inventory. A very low level can reduce costs, but a stockout may stop production or lose customers.
Buffer inventory, lead time, reorder level and reorder quantity
Buffer inventoryThe minimum amount the business wants to keep in case something goes wrong.
Lead timeThe time between ordering supplies and receiving them.
Reorder levelThe inventory level at which a new order must be placed so that supplies arrive before inventory falls below the buffer level.
Reorder quantityThe amount of inventory ordered each time.
Reading an inventory-control chart
An inventory-control chart shows how inventory falls as it is used, when a new order should be placed, and how the level rises when the delivery arrives.
Inventory levelTime →
Reorder level
Buffer inventory
Inventory falls with use and rises when a delivery arrives.
Worked example from the inventory-control model: if a business uses 200 units each week, wants a 100-unit buffer and has a one-week lead time, it needs to reorder when 300 units remain. During the one-week lead time another 200 units are used, leaving the 100-unit buffer when the delivery arrives. If it expects four weeks of usage, a reorder quantity of 800 units would cover those four weeks.
Why a business may run out of inventory
An inventory out can occur if inventory is used faster than expected or if a new delivery is delayed or fails to arrive. The consequences can include stopped production, lost sales and dissatisfied customers.
Example: a retailer may forecast normal demand correctly but still run out if demand suddenly rises. A manufacturer can also run out even with stable demand if a supplier misses the expected delivery date.
What affects the amount of buffer inventory?
- Rate of usage: faster usage generally requires more inventory to be available.
- Storage space: limited warehousing restricts how much can be held.
- Nature of the product: fragile, perishable or rapidly outdated products make large inventories risky.
- Supplier reliability: more reliable suppliers can reduce the need for a large buffer.
- Lead time: a longer wait for deliveries usually increases the amount that must be held.
Exam point: effective inventory management aims to avoid both extremes — too much inventory increases cost and risk, while too little increases the danger of disruption.
Supply chain management
Supply chainAll the stages involved in making, distributing and selling a good or service, from raw materials through production and distribution to the final product.
Supply chain managementManaging the flow of goods and services and the processes that transform raw materials into final products.
Raw-material supplierProvides basic inputs
→
Component / processing stageCreates usable parts or ingredients
→
ProducerCreates the final product
→
DistributionMoves goods towards the market
→
CustomerReceives the product
Effective supply chain management can produce lower costs, fewer mistakes, better co-ordination, better-quality supplies and shorter times between ordering and delivery. Poor management can create delays, higher costs and quality problems.
Businesses are also increasingly judged on how their suppliers behave. Managers may therefore set supplier standards or codes of conduct covering issues such as working conditions, sourcing and environmental practices.
Evaluation: a low-cost global supply chain may be efficient in normal conditions but vulnerable to major disruption. More local or diversified sourcing may improve resilience, although it can increase costs or reduce access to specialist suppliers.
4.2.2
Just in time
Just in case (JIC)
The traditional approach in which a business keeps inventory in reserve in case suppliers are late or demand rises unexpectedly.
- Can protect production from supplier problems.
- Can help meet sudden increases in demand.
- Needs storage, handling and security.
- Ties up money in inventory.
- Raises the risk of waste or obsolescence.
Just in time (JIT)
Production takes place in response to orders, with components and supplies arriving only when needed. The aim is to keep inventory as low as possible.
- Reduces warehousing, security and opportunity costs.
- Can reduce waste and obsolete inventory.
- Supports flexible production that responds to actual demand.
- A supplier delay can stop production.
- No buffer exists to absorb disruption.
- Frequent small orders can increase administration and reduce bulk discounts.
Lean productionAn approach that continually seeks to reduce waste in the production process, including wasted time and materials.
Why businesses use JIT
JIT seeks to produce what is required, when it is required. Instead of forecasting demand and producing large quantities in advance, the business responds more closely to actual orders. This can provide flexibility and lower inventory-related costs.
Example: a fashion business using JIT can produce relatively small quantities, watch which designs are selling and replenish successful products instead of holding large quantities that may quickly go out of fashion.
Problems and risks of JIT
- The system depends on suppliers delivering the correct parts at exactly the required time.
- Supply disruption can stop the whole production process because there is little or no buffer inventory.
- Industrial action or other employee stoppages can be very costly when no inventories are available to keep production going.
- More frequent ordering can increase administration costs and may mean losing bulk-buying discounts.
What JIT requires
Reliable suppliersDeliveries must be punctual and the quality must be correct because there is little replacement inventory.
Reliable employeesStoppages can halt the whole system, so good workforce relations matter.
Flexible workforceMulti-skilled employees must be able to move between tasks as demand changes.
Flexible equipmentMachinery should be capable of switching efficiently between products or variants.
Introducing JIT may therefore require investment in flexible machinery, staff training and multi-skilling, negotiations over flexible working, and close relationships with suppliers that can also respond quickly.
JIT or JIC?
| Factor | JIT is more attractive when… | JIC is more attractive when… |
|---|---|---|
| Supplier reliability | Suppliers are highly dependable and close co-ordination is possible. | Deliveries are uncertain or disruption is likely. |
| Lead time | Lead times are short and predictable. | Lead times are long or variable. |
| Inventory costs | Storage and obsolescence costs are high. | Inventory is cheap and easy to store. |
| Demand | Orders and production can be matched closely. | Sudden demand increases would be costly to miss. |
| Cost of stockout | The business can tolerate small disruptions or has very reliable supply. | Running out would stop critical production or seriously damage customer service. |
Evaluation: JIT is not automatically better because it holds less inventory. Its success depends on the reliability and flexibility of the entire operations system. The right approach may also be a mixture, with low inventory for some items and larger buffers for critical or uncertain supplies.
4.2 revision checklist
Define inventory and distinguish the four main types.
Explain why businesses hold inventory.
Explain storage, opportunity, security and depreciation costs.
Define buffer inventory, lead time, reorder level and reorder quantity.
Interpret an inventory-control chart.
Explain why an inventory out can occur.
Explain the factors affecting buffer inventory.
Define a supply chain and supply chain management.
Explain how effective supply chain management can improve competitiveness.
Evaluate supply chain resilience, cost and supplier responsibility.
Distinguish JIC from JIT.
Explain the advantages of JIT.
Explain the risks and limitations of JIT.
Define lean production.
Explain the supplier, employee and equipment requirements of JIT.
Evaluate whether JIT or JIC is more appropriate for a business.
Questions open in a pop-up. Each answer is marked immediately, with an explanation so you know why it is correct or incorrect.