Why inventory matters: role in supply, demand, and financial health

1 & 2. Introduction to inventory management & types of inventory

Why inventory matters: Overview of inventory’s strategic role in balancing supply, demand, and financial health. 

In simple terms, inventory acts as a buffer, allowing companies to meet customer demand while smoothening out fluctuations in supply (e.g. raw materials arriving late or a delay in production) or demand (e.g. a large order comes in which wasn’t expected). 
 

There’s a fine balance between too little and too much inventory: Holding the right amount of inventory allows you to meet customer demand without delay, which is critical for maintaining service levels and customer (and internal salespeople!) satisfaction. At the same time, carrying too much inventory ties up cash and adds holding costs.  

Basic inventory management concepts & terms 

This article by Slimstock gives a good overview of inventory management basics, and covers concepts like ABC analysis, safety stocks, reorder points, economic order quantity (EOQ) and minimum order quantity (MOQ), the types of inventory (raw materials, WIP = work in progress, finished goods, transit inventory), COGS, deadstock, holding costs, order cost, lead time, and purchase orders. 

 

This article by Kinaxis gives a higher-level view on inventory management: how and why to execute it. Logility’s article gives an overview of what an inventory optimization system does.  

2. Types of inventory by stage, function and type of company 

Types of inventories by stage of the product and by function or resulting from a certain policy 

Inventory management and optimization is complex, so nuances are needed before talking about specific policies. It’s important that we consider which type of inventory we’re talking about and the type of company we’re setting inventory policies for.  

 

The following classification is often used, based on the stage (not function) of the product:  

  • Raw materials that will go into manufacturing 

  • Work-in-process (WIP): partially completed products 

  • Finished goods: products ready to be sold – still in the factory or in a central warehouse 

  • Distribution inventory: products at a distribution center  

Another very common classification is based on the function of the inventory. This article by Slimstock gives an overview of such types of inventory and these types are briefly summarized as follows:  

  • Lot size: Stock produced or purchased in batches to optimize order costs vs. holding costs. Reducing lot sizes may free up capital but risks increased ordering costs. 

  • Seasonal stock: Inventory held to meet seasonal demand spikes. Effective demand forecasting can help optimize this stock, reducing excess during off-peak periods. Netsuite’s guide to cycle stock is related to seasonal stock.

  • Stock capacity: Extra stock produced to match maximum production capacity, used when demand is low. Managing production schedules and aligning with demand helps balance this stock.

  • Work in process (WIP – notice that this was also part of our classification by stage of the product): Partially finished products that support fast response to demand. Reducing WIP requires streamlining production stages to improve flow and reduce lead time.

  • Strategic stock: Critical items essential for uninterrupted operations, often influenced by sourcing risks. Minimizing strategic stock requires strong supplier relationships and risk mitigation plans. 

  • Obsolete stock: Items with no movement, often due to demand changes. Clearing obsolete stock releases capital tied up in non-productive items. 

  • Warranty stock: Kept for customer claims, particularly in machinery. Regularly reviewing warranty stock needs can avoid excessive levels. 

  • Fixed stock: Essential items with minimum order levels. Optimizing reorder points and safety stock here helps manage working capital. 

  • Stock pending to receive: Inventory ordered but not yet received, impacting financial inventory records. Efficient supplier management reduces delays and excess pending stock. 

 Depending on which type of inventory, different policies and desired levels might be required.

Flow of demandFlow of demand to the suppliers from Introduction to Materials Management












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Type of manufacturing company, which will impact the required inventory policies 

Types of manufacturing companiesTypes of manufacturing companies from Introduction to Materials Management

Furthermore, inventory policies are highly dependent on the type of company. Before you consider which inventory policies to use, first look into which category/categories your business falls. 

  1. 1. Engineer to order – e.g. ASML 

  1. ASML designs and manufactures highly customized lithography machines for semiconductor manufacturers. Each machine requires specific engineering based on the customer’s needs, leading to long lead times and a deep level of customer collaboration. 
  1. --> Inventory impact: ASML manages high-value, specialized inventory with long lead times. Since each order is unique, inventory levels of components are carefully planned and only built upon confirmed orders, which helps minimize carrying costs for specialized parts but increases complexity in forecasting. 

 

  1. 2. Make-to-order – e.g. Boeing 

  1. Boeing manufactures commercial airplanes and defense products tailored to individual customer specifications. Unlike mass production or assembly to order, every aircraft is built only after receiving a confirmed customer order. 
  1. --> Inventory impact: Long lead times make collaboration with suppliers crucial but there is no approach needed for inventory on finished products.  

 

  1. 3. Assemble to order – e.g. Tesla 

  1. Tesla operates on assemble to order (except for a range of standard vehicles), especially for customizable features in its vehicles. The base model of a car is manufactured, and specific features are added based on customer orders, allowing Tesla to respond quickly to demand while offering customization. 
  1. --> Inventory impact: Tesla keeps a steady inventory of base vehicles and components, enabling rapid final assembly based on demand. This approach balances inventory levels, ensuring flexibility in responding to customer preferences while avoiding overproduction.  

 

  1. 4. Make to stock – e.g. Coca-Cola 

  1. Coca-Cola produces large volumes of bottled drinks based on forecasted demand, storing them in inventory for quick distribution to retailers and wholesalers. 
  1. --> Inventory impact: Coca-Cola maintains high inventory levels of finished goods to meet immediate customer demand. This allows for quick delivery but requires efficient inventory management to prevent stockouts or excess stock, especially for such perishable goods. 

Deterministic, stochastic and discrete supply chains compared with type of manufacturing company 

In this book on inventory optimization, Nicolas Vandeput classifies supply chains into deterministic, stochastic or discrete for the purposes of inventory optimization. Hereunder is a summarization of these types of supply chain vs the classification made hereabove: 

  1. Deterministic supply chains are often applied in make-to-stock environments, where accurate forecasts and stable demand allow for precise planning. 

  1. Stochastic supply chains suit engineer-to-order and make-to-order setups, where demand uncertainty is higher, requiring adaptable models with buffer stocks. 

  1. Discrete inventory optimization is useful in assemble-to-order and make-to-order contexts, where inventory is optimized based on periodic orders or production runs, with flexibility for adjusting inventory at specific points.