Company A (with larger inventory) will have the following advantages:
Lower ordering costs: For the raw materials they will be able to spread the fixed ordering costs over a larger amount of goods.
Quantity discounts: For the raw materials they would be better positioned to request quantity discounts because they would be ordering in bulk amounts.
Lower transportation costs: For the finished goods they will be able to reduce transportation costs because they can deliver more of the goods in one shipment versus having to deliver individual items.
Lower setup costs: For the work-in-process inventory they will be able to reduce setup costs that are incurred for switching between products.
Higher capacity utilization: With large inventory, they will be able to utilize their installed capacity to the maximum possible level.
Higher customer service: Provide better customer service by avoiding stock outs and backorders on finished goods. By avoiding these two scenarios they will be able to ensure on-time delivery.
Buffer: An excess inventory of finished goods can provide a buffer for increases in customer demand. The business is taking a risk by building and storing finished products in anticipation of customer demand, but it can reduce the lead time and improve customer satisfaction.
Company B (with smaller inventory) will have the following advantages (has smaller inventory):
Less working capital: The working capital (Interest, cost of capital & opportunity cost) will not be high since they will not have large amounts of any type of inventory on hand.
Lower storage and handling costs: The storage and handling costs will be lower as well for all types of inventory. Since they do not have large amounts of inventory they will not need to rent out warehouse space to store the extra inventory.
Insurance costs & Taxes: will not be high since they will not have as much inventory on hand.
Shrinkage: They will not have to invest in as much security and control measures to reduce shrinkage, which can take three forms: pilferage – theft by customers or employees, obsolescence – out of date inventory, and deterioration – items that are no longer good or expired.
Easier Organization: Smaller inventory levels are also easier to manage. It takes less time to organize and retrieve inventory when there is less of it to put away and get out. This makes the process of replenishing short inventory much simpler and more efficient. This is especially important for companies that have high inventory turnover rates and need to quickly get new products onto the shelves.
More Space: Smaller inventory means more space. Retailers are very concerned with inventory turnover per foot of shelf space. By maintaining lower levels of inventory in each product, they have more room to market and sell more products. Retailers that maintain low inventory levels do not need to allocate as much storage space in the building for extra inventory. This means they have more floor space in which to merchandise and sell products.
The relationship between each type of inventory and the nine competitive priorities
The short answer is that higher inventories do not provide an advantage in any of the nine competitive priority categories. The important point is that firms must have the “right amount” of inventory to meet their competitive priorities.
We compare competitors A and B. They are similar in all respects except company A maintains much higher inventory than does company B.
1. Low-cost operations: Costs include materials, scrap, labor, and equipment capacity that are wasted when products are defective. When a process drifts out of control, competitor A’s large lot sizes tend to result in large quantities of defectives. The EOQ (Economic Order Quantity) does not consider the cost of defectives, and erroneously assumes that setup…