In this lesson, we're going to look at classifications of inventory. We're going to look at different types of inventory, and we're going to see how we can classify them based on importance as well as some other things. First, if you think about what is inventory, simple definition is it's whatever is kept in stock. Goods in stock is what we define as inventory. A lot of times we use the word stocks to denote inventory. The reason we, organizations keep inventory, or even as individuals, we keep inventory at home in our pantries and our refrigerators is to match supply with demand. You want to match the timing of when the demand occurs versus when you can get the supplies, and that's why you keep inventory. When we talk about organizations keeping inventory, you want to focus on internal as well as external customers. Within an organization, there may be sub-processes and the inventory might be for a customer that is within the organization for a sub-process. It can be internal customers, or it can be external customers and external customers are customers whose demand, there might be more uncertainty about when you compare that to internal customers. You have to think about it differently when you're talking about management of inventory. Finally, you want to think about businesses and individual customers, both, when you're talking about inventory, because a lot of companies have business to business relationships so they are making products to sell to a different business. Companies are outsourcing a lot of their production. A lot of components coming from different businesses, and you want to talk about inventory of that as well. If you think about inventory and the idea of matching demand with supply, you can think about it from a perspective of a lake. The capacity of this lake is how much inventory you can store in your warehouse. The capacity of the warehouse in which you can store inventory. The level of the lake is the current level of inventory that you have. The rainfall is a supply, and the consumption of water is your demand. Put it this way. When the rainfall exceeds the consumption, the level of inventory is going to increase and it's going to get closer and closer to the capacity of your Warehouse, and when the consumption is more than the supply, the lake level is going to decrease. Inventory acts as the matching of demand and supply in this way, and we think about water consumption in a very similar fashion when we store water for our consumption in our households. Let's take a look at why organizations have inventory, why they build inventory. The first reason you can think of is a lead time for supply. For example, if there is a supplier that is at a certain distance from the purchaser, from the buyer, it's going to take a long time or it's going to take some model time for the supplies to get there. There's transportation time, but there will also be lead time that the supplier might quote in terms of we're busy with other things, we'll take so much time to make your particular order, and that's going to get added to the lead time of the transportation time. As a buyer, you are going to have to plan for that lead time during which that it's going to take for your order to get to you so you're going to store some inventory for that lead time. Within a process, within a multi-activity process, you might have activities that are at different processing times. In fact, most times you're going to have activities that have unmatched processing times. For example, one activity could be running at the rate of 10 units an hour, and another activity might be running at the rate of 15 units an hour so one is faster than the other. Now, you're not going to run both of them at 100 percent, but what you're going to do is run the faster one and build up inventory, and pause until the slower one catches up. Different processing times will mean that you will need to have some inventory based on the different processing times of different activities. Economies of scale. You might have a setup time involved with doing changeovers from one type of product to another. In which case you're going to say, well, I'm going to make a large batch of this inventory before I change over to the next item that I make. In which case, you are going to build some inventory. Now, this reason is basically because you want to take your cost of that setup time and spread it over a larger quantity, and that's why you have a batch size. You're going after economies of scale. You could think of a similar reason for economies of scale when you're talking about getting supplies from an external supplier, in which case, you might be thinking about well, I want to get a full truckload in order to take the cost of all items and spread it over lesser number of deliveries. In that case, you're going for economies of scale for an external supplier that you're purchasing from and you are building inventory based on that. You get a big order and you build up inventory until that gets exhausted and then you get another big order. Seasonality. If you're making lawnmowers, they're not going to be sold at the same rate throughout the year. In order to build up inventory for the spring and summer seasons, you'll continue to run your manufacturing plant at a certain rate during the winter months in order to build up inventory for that season. Similarly, with other seasonal items, such as the festive items for Christmas or other festivals that you might build up. Variations of products. When you have many different types of products, you are not going to keep making all of them all the time simply because it may not be cost-effective so you'll make certain items and keep them in stock while you're running other items on your line. Sometimes you'll be keeping inventory on the basis of speculation of prices. You'll say, well, here's a discount that I'm able to get or I know that the price of oil is going to go up in the near future. If I'm an airline, I'm stocking up on how much fuel I'm purchasing, and that might be inventory. That comes in my name, even though it may not be delivered to me, I may be buying those future contracts, and that's inventory that's effectively being held by me. Availability might be an issue if you're expecting a shortage, you're trying to speculate and hold that item so that you have it available when you need it. That might be a reason for you to hold inventory. Finally, talk about uncertainties. Uncertainties in terms of demand, uncertainties in terms of supply, and uncertainties even in terms of the way your process is being run. If it's not running at 100 percent yield rate, you might keep excess inventory for what if it breaks down or what if I have a quality issue or what if I have a strike and my plant has to shut down. I might keep inventory for those purposes to cover for those uncertainties. That's why organizations keep inventory.
