STUDENTS' CORNER - 219

In our earlier session, we saw the significance of inventory management; that is,  a system evolved by the company that at the earliest becomes sensitized to overstocking or under stocking; both the kinds actually prove anti-business in the sense that one wastes your precious capital by locking it in the form of raw materials and the other leads to loss of customer because he does not get his product, that is, your product when he wants it and that too because the product was not ready as the production remained incomplete for lack of some components which you failed to have on time in the required quantity.  Both the kinds of stocking ultimately in their own ways cost you.

In order to help the company find out the very near exact level of right inventory which saves money—a penny saved is penny earned, the proverb goes—promising a sort of capital-comfort, experts talk of two kinds of inventory-related costs: Order processing cost and Inventory carrying costs. Of course, a very sensible business mind understands all these academic gimmicks, so to say, instinctively. All the same, let us see how these two kinds of cost help us see the onset of imbalance at the earliest between the right stocking and overstocking and under stocking.  Paying attention to these two types of cost pays back positively to the business, to the bottom line ultimately.

Order processing cost covers, as the title itself suggest, the cost of the process of manufacturing; that is, operating costs; to be exact, in details, the rent for the factory, the salary of the employees, the machinery involved in the manufacturing, the electricity and other incidental expenses, all put together for a day; just a little attention is enough and usually, managers are supposed to be aware of all these things because they are supposed to manage the administration.

The inventory carrying costs include storage cost, warehousing cost, the cost of the components in the inventory and also the transportation cost.  It is pointed out that the inventory carrying costs must be less than the other one; it indicates the company is sensitive to the market demands.  Let us put it in some details so that the concepts can be easily understood.

On any given day, if the components in the inventory happen to more than the components used in manufacturing, the cost of inventory is too much.  Say, for example, if 55 units are there in the inventory and only 45 are used; it means the cost of the inventory is higher. On the other hand, if only 15 units are there in the inventory and 85 units are in the process of manufacturing; then, the inventory cost is less. It means the company out of its relevant understanding of the market demand, has not spent in excess to the need in purchase of the raw materials. It means the inventory cost per day is just in right proportion to the demand; capital is sensibly invested and it leads to enriching the bottom line.

Of course, a sensible business man knows all these things without many difficulties; market dynamics teaches him the business fundamentals and he knows the value of the capital.

Perhaps, we can conclude pointing out what Sony did in inventory building; it calls its principle simply, SOMO; Sell One, Make One. You build inventory to Order and not to Stock. Dell went one step ahead. It will get advance from its customer who wants a Dell product and from the advance the company buys component. That is, the customer pays for his product; that is, the customer contributes to the capital of Dell. It is customer-centric inventory.

Perhaps the importance of inventory management has been explained simply and effectively too.

In our next we shall move on to the next topic in logistics: Transportation and Warehousing.