High vs. low inventory: pros, cons and the optimal balance

Yes. High inventory buffers demand peaks and delivery delays, securing high availability. It allows larger, cheaper order quantities (volume discounts, fewer orders) and protects against raw-material price rises. In volatile supply chains, stock can be a deliberate risk buffer.

These advantages are real – but they carry a price that is often underestimated, because tied-up capital does not appear in the P&L like a direct cost item.

High stock ties up capital and causes cost of capital of typically 6–12 % p.a., plus warehousing, handling, insurance and obsolescence costs and the risk of write-downs. High stock also hides process problems: whoever buffers enough won't notice for a long time that forecasting or suppliers are unreliable.

Low stock frees capital, lowers warehousing costs and makes process errors visible immediately – a core idea of lean production. The downside: the buffer against demand and supply variability shrinks. Without a reliable forecast the shortage risk rises, and shortages are expensive – through expediting, downtime or lost orders.

Low stock works well when demand is forecast precisely and replenishment is reliable. That is why forecast quality and low inventory belong together.

The answer is item-dependent. Easily forecastable, steady items (classic A/X items) tolerate low stock because their demand barely varies. Sporadic or highly variable items need relatively more buffer – or a different sourcing strategy. Flat coverage across the whole range almost inevitably over-stocks some and under-stocks others.

The optimal balance is therefore not a single value but a per-item calculation: expected demand plus a safety stock that covers exactly the individual spread up to the target service level.

For a long time, inventory was seen mainly as a cost factor to be cut: tied-up capital, warehouse operating costs, limited storage capacity, the risk of unsellable remainders or of write-offs in product recalls, and poor transparency. In times of supply shortages and inflation, the tables have turned.

The winners of such phases are companies that deliver when others cannot. Under some circumstances stock even “earns” money through its appreciation, because procurement becomes more expensive year after year.

That does not apply to every kind of inventory, though. The reason for holding stock is that goods must be available faster than the replenishment lead time would allow. The ideal stock level therefore depends on future demand, on the lead time and on the uncertainty on both sides.

In replenishment planning, one distinguishes mainly by lead time and thus by planning horizon. Strategic sourcing plans for the long term and stocks products with long lead times and strategic importance. Tactical sourcing plans procurement or production in the short to medium term based on forecast demand. Operational sourcing plans the timing and sequence of production and purchase orders in the short term.

Long lead time plus high uncertainty means high coverage. Strategic sourcing usually concerns raw materials or semi-finished products that feed your own production. Relative to the end product they are typically cheap, while a production stoppage is very expensive – so it often pays to build up relatively high coverage in your own warehouse. With longer lead times, higher uncertainty and rising costs, this strategy pays off clearly; the stock can even earn money through appreciation.

Short lead time plus low uncertainty means low coverage. In tactical planning with short, reliable lead times it is usually optimal to hold only low coverage and to align procurement with forecast future demand. It is exactly this tactical planning that AutoDispo can automate optimally.

Strategic sourcing covers raw materials for production. Procurement costs are relatively low and lead times very long (for example one year or more). Sufficiently large stock with coverage of a year or more therefore secures supply to production at manageable cost and space requirements.

Tactically, semi-finished parts are produced to stock (make-to-stock) from the raw materials. The end products are built to order with very short lead times, so the semi-finished products must be in stock. Their production planning takes the forecast demand of the near future into account. (Too) high stock makes no sense here and brings no strategic advantage: it ties up capital and raw material, needs a lot of space and is a risk in recalls, when parts from stock have to be destroyed.

In this example, AutoDispo optimises the planning of the semi-finished parts to stock. This achieves a significantly lower inventory at at least the same availability. That saves resources in production and frees up storage capacity for strategic stockholding.

With vendor managed inventory, the VMI provider operates consignment stock at its customers’ sites and is responsible for planning it. The customer relies on the materials being available on site and saves itself the planning and early procurement.

Strategically, the VMI provider has to ensure timely delivery to its customers. To do so it sets up a central warehouse that supplies the consignment stocks. Coverage in the central warehouse is chosen large in order to absorb any supply difficulties.

Tactically, the individual consignment stocks are planned on the basis of expected demand and rather short-term. High coverage cannot be implemented on site because of changing demand and limited storage space. Coverage that is too high also has the drawback that material tied up in one customer’s consignment stock is not available to the other customers.

In this example, AutoDispo plans the consignment stocks optimally and automatically. Complexity and effort grow with the number of warehouses; demand is forecast dynamically and adapts automatically to the circumstances. Transport costs are optimised by, for example, combining urgent with less urgent orders to reduce the number of deliveries – something that standard planning methods leave to the planner.