Inventory (stock) management: the costs of holding too much and too little stock, the inventory control diagram with maximum, minimum and re-order levels, and just-in-time (JIT) stock control.

What this key area is asking

Inventory (stock) management is about holding the right amount of stock: enough to keep production running and meet orders, but not so much that money and space are wasted. The SQA wants you to know the costs of overstocking and understocking, read the inventory control diagram (maximum, minimum, re-order level), and weigh just-in-time (JIT) stock control. Higher rewards balanced judgement.

The costs of holding the wrong amount of stock

A firm must balance two opposite dangers.

The inventory control diagram

Firms control stock using an inventory control diagram (stock control graph) that plots stock level over time and uses set levels:

As stock is used, the level falls. When it reaches the re-order level, a new order is placed; during the lead time stock keeps falling towards the minimum (buffer), then the delivery arrives and the level rises back towards the maximum, giving the characteristic saw-tooth pattern. Setting these levels well keeps the firm from over- or understocking.

Just-in-time (JIT) stock control

Just-in-time (JIT) is a system in which stock is held to an absolute minimum (or none at all), with raw materials and components delivered exactly when needed for production, and finished goods made to order.

The advantages are: very low storage costs; cash and space freed up; far less waste from obsolete, damaged or perishable stock; and often better quality, because there is no buffer of stock to hide faults, so problems are found quickly.

The disadvantages are: total dependence on reliable suppliers and prompt, frequent delivery, so any delay, strike or transport problem halts production immediately (no buffer); the loss of bulk-buying discounts; difficulty meeting a sudden surge in demand; and higher delivery and administration costs from many small, frequent orders.

Examples in context

Example 1. A supermarket avoiding overstocking on fresh food. A supermarket selling perishable fresh food must avoid overstocking, because unsold produce goes off and is wasted (a clear cost of too much stock). It uses tight re-order levels and frequent deliveries to keep shelves full but minimise waste, while keeping a small buffer so it does not run out and lose sales. This shows the balance between over- and understocking for a perishable product.

Example 2. A car plant using JIT. A car factory orders seats and components to arrive just in time for each vehicle on the line, holding almost no stock. This frees enormous space and cash and reduces waste. But when a key supplier was hit by a strike, the line stopped within hours because there was no buffer stock, the classic illustration of JIT's main weakness: total dependence on reliable supply.

Try this

Q1. Describe two costs to a business of holding too much stock. [2 marks]

• Cue. High storage and warehousing costs (space, security, insurance); money tied up in stock that could be used elsewhere; greater risk of stock being damaged, stolen or becoming obsolete (any two).

Q2. Explain one advantage and one disadvantage of a just-in-time stock control system. [4 marks]

• Cue. Advantage: stock arrives as needed, so storage costs and waste are cut and cash and space are freed. Disadvantage: the firm depends on reliable suppliers, so any delivery delay or strike halts production immediately because there is no buffer stock.