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Inventory Management: Definitions and Concepts Research Paper

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Updated: May 30th, 2020

Introduction

Inventory management is an important aspect employed by manufacturing companies to control the flow of raw materials and goods. Inventory management increases organizational efficiency by reducing costs associated with obsolescence, pilferage, spoilage and storage. It is important to note that poor inventory management often results in business closure. For example, production process may close down if critical raw materials run out of stock. What is more, poor inventory management may result in the loss of customers.1 This happens when the retailer fails to provide adequate stock of goods on time thereby leaving potential shoppers frustrated.

There is no doubt that e-commerce plays an integral role with respect to the inventory management of a variety of goods. The internet has turned out to be a critical channel in the supply chain for many manufacturers who use online channels to distribute products directly to consumers. However, e-commerce is characterized by a number of problems which are different from those encountered in the traditional retail outlet (i.e. Bricks-and mortar). It is important to mention that the online channel and the traditional channel are different in terms of access to information relating to demand and supply, the level of market segmentation, the expected quality of the products, logistical needs, cost structure, and the types of consumers.2

Definitions & Concepts

As noted earlier, inventory management is important in any business organization. There are various definitions of inventory management. For example, Kotler notes:

Inventory management refers to all activities involved in developing the inventory levels of raw materials, semi-finished materials (work-in-progress) and finished goods so that adequate supplies are available and the costs of over or under stock are low…3

In other words, inventory management not only deal with the efficient management of production inputs but also it also ensures that a proper supply chain mechanism is put in place to ensure that order requests are fulfilled on time and in an efficient manner. Other authors have suggested that inventory management entails preserving a sustainable amount of a particular asset (human resources and material inputs) in order to improve the competitiveness and profitability of a firm.

According to Drury, inventory management refers to the quantity of goods/products that an organization preserves to meet the unexpected rise in demand.4 A similar sentiment is echoed by Schroeder who describes the influential role of inventory management in supporting a number of business activities such as finance, accounting and marketing. The author suggests that manufacturing firms undertake inventory management for three main purposes. These are: speculative purpose, precautionary purpose and transaction purpose.5 In many cases, a manufacturing firm may preserve stock in order to achieve sales and production targets (transaction purposes). What is more, an organization may maintain a certain amount of inventory (precautionary purpose) to meet unanticipated requirements relating to sales and production. Finally, a firm may opt to procure additional manufacturing inputs if it expects to reap substantial returns (speculative purpose). 6

As a matter of fact, inventory management entails two important aspects. These are: scheduling and control. Under the scheduling aspect, the manufacturing firm must determine the amount of raw materials it requires from the suppliers and the frequency of the orders to ensure that production processes run smoothly. Under the control aspect (also known as stock control), the firm undertakes continuous/periodic evaluation of inventory levels and uses this information to make appropriate decisions.7

Many organizations are currently using several economic models to compute their optimum stock levels. For example, economic order quantity (EOQ) is one of the models that manufacturing firms use to mitigate flaws stemming from the conventional methods of stock assessment and control. As mentioned previously, poor inventory management can result in detrimental outcomes. For instance, a manufacturing firm which disregards inventory management is susceptible to production holdups and consequently cannot sustain the minimum stock levels it needs to maximize returns. What is more, poor inventory management may result in irreversible loss for manufacturing firms that carry out their operations in industries characterized by high competitions.8

Inventory Management and E-Commerce

The advent of the internet has dramatically altered the manner in which the social and economic activities are carried out at both individual and organizational levels. According to conservative estimates, 32 percent of internet users procure goods via online outlets. What is more, approximately 43 percents of internet users in the United States pay their bills via internet. The emergence of the internet has also changed the manner in which business organizations carry out their operations via e-commerce.9 Supply chain management entails collaboration among retailers, distributors, manufacturers and dealers. What is more, an efficient inventory management system ensures that consumers receive goods and services in a timely manner. Thus many manufacturing firms have adopted lower inventory processes in order to reduce total costs. It is against this backdrop that some manufacturing firms have embraced e-commerce to improve their supply chains and reduce inventory costs.10

Sameh Elnikety and Elrich Nahum assert that e-commerce is an important technological advancement that allows both businesses and shoppers to sell and procure goods on the internet in a comfortable manner. The main objective of many online businesses is to achieve a permanent presence on the internet in order to meet customer requirement and increase profitability. However, there are two major challenges that businesses encounter when they introduce e-commerce online sites in their supply chain management. The first problem is known as site overload. This happens when the number of requests for a particular product provisionally surpasses the processing capacity of the web site. As a result, the website may stop working. The second problem is known as responsiveness. Some websites take a long time to respond to customer requests. This is a major problem because it discourages potential shoppers from using the website thereby leading to revenue loss.11

There are three components in an e-commerce website. These are: Front-end component, application component, and back-end component. The first component (front-end web server) typically deals with the inert section of the workload (i.e. HTML pages and images). The second component (application server) employs a number of methods (i.e. Java Servlets and PHP scripts) to issue several queries and modify the returned results of the query in an HTM format. These results are relayed back to the first component (front-end server) and the cumulative content is finally dispatched to the client via the web server. The third component (admission server) prevents the website from crashing as a result of transitory overload. To be precise, the admission server decreases the volume of work when the site experiences an overload. In addition, the admission server classifies potential shopper in the order of priority so that customers can be served immediately in the event of an overload.12

Leonard and Cronan assert that business organizations that have embraced e-commerce incur lower inventory costs than their non-internet counterparts given that electronic supply chains amalgamate stakeholders in a well-organized manner.13 For instance, it is easier to sell some goods (i.e. Electronic products, TVs, CDs, and magazines) via the internet than using the traditional channel. Conversely, it is difficult to sell other goods (i.e. Shoes and clothes) via the internet since some shoppers have a habit of physically touching these types of goods before procuring them. Thus, e-commerce is an important tool in inventory management because it can help an organization to realize flawless and synchronized supply chain integration. What is more, business organizations can achieve synchronized efficiency if they adopt a multi-layered e-commerce system with swift decision-making capabilities. In addition, e-commerce platforms with capabilities to provide first-rate services can enable businesses to realize the limitless connectivity to the worldwide supply chain system.14

Emerging online merchants have struggled in the current internet era since they rely on other organizations to handle their inventory processes. As a result, some brick and mortar retailers have come to appreciate the importance of setting up an online presence to manage their inventories and supply chains. Supply chain management is an important aspect in any business organization. For example, it accounts for over 70 percent of operating outlays. What is more, inventory management is an important aspect in any business because it improves the inventory turnover of a business. It is important to mention that business organizations can reap benefits that emanate from e-commerce if they adopt flexible systems that are responsive to consumer requirements as well as inventory uncertainties.15

A number of studies have been carried out to explore the relevance of e-commerce in inventory management and supply chain management. For example, one of the studies carried out in the early 1990s, revealed that prices for goods such as CDs and books were approximately 12.5 percent cheaper in electronic channels than in the traditional outlets.16 This means that e-commerce is increasingly growing popular as many businesses employ electronic outlets to manage their inventories as well as fulfil order requests. However, other studies have highlighted the challenges that businesses encounter as they adopt e-commerce in inventory management.17

Challenges of Inventory Management in E-commerce

Inventory management is a complex phenomenon that entails a number of challenges. To be specific, online shoppers may get impatient if goods and services are not delivered on time. What is more, businesses must deal with problems that emanate from variations in demand. For instance, reverse logistics is a major issue that must be addressed by online retailers. Reserve logistics is defined as a procedure whereby the retailer, supplier, or manufacture systematically handles returned goods for possible disposal, recycling, or reuse. Snyder Rell and Hamdan Basel state that ‘retailers and e-retailers with brick and mortar or click and mortar operations have a tremendous advantage over e-retailers that use third party distribution methods… (Drop shipping)… in reverse logistics…’18 In other words, product returns are more prevalent among internet retailers compared to brick and mortar retailers. It is against this backdrop that manufacturing firms must manage reverse logistics in an efficient manner to reduce product returns and maintain a competitive edge in the market.

Consumer Satisfaction

Internet shoppers expect goods and services to be delivered on time and in a consistent manner. Therefore, business organizations must adopt efficient inventory management systems, automatic material flow systems, order management systems, enterprise resource planning systems and web management system in order to meet consumer requirements on time. What is more, an efficient transportation management mechanism must be adopted to handle the shipping process efficiently. There are a number of distribution channels that business organizations can employ to sell their goods. In terms of e-commerce, the type of distribution channels a firm employs to sell products is determined by the inventory management system used. For instance, online businesses can adopt inventory ownership and drop shipping strategies to plan their inventory. Businesses can also use a hybrid strategy (which combines the first two strategies mentioned above) to manage their inventories.19

Drop-shipping & Inventory Ownership Strategies

Drop-shipping is an outsourcing strategy in which online retailers outsource their inventory management processes to third parties in order to pursue other business activities. On the other hand, inventory ownership is a traditional inventory strategy in which business enterprises use their own warehouses to store goods and sell them to consumers at the appropriate time. Drop-shipping is an important inventory strategy in supply chain management because it allows businesses to keep inventories at a single centralized place to be distributed to retailers at the same time. There are various benefits a firm can get by adopting drop-shipping strategy. For instance, a firm can expand its market reach by supplying goods to multiple retailers. What is more, the strategy can assist manufacturing firms to increase their profit margins by making appropriate inventory decisions.20

As noted earlier, drop-shipping is an important inventory strategy that helps wholesalers to supply their goods to different retailers at the same time. However, retailers pursue their own objectives in a selfish manner. For example, statistics suggest that approximately 28 percent of online businesses are currently using drop-shipping as their principal method of the order fulfilment. However, it deserves merit to mention that both strategies have their own advantages and disadvantages. Although businesses typically pursue their own objectives, they collaborate on a number of issues. The collaboration among different businesses lends credence to transshipment, a mutual relationship in which wholesalers and vendors help each other to ensure there are adequate inventories to meet rising demand of products in any locality. What is more, some retailers and wholesalers have adopted a hybrid system to meet customer requirements. Businesses that have adopted hybrid system usually serve consumers from their own depots. On the contrary, they employ drop-shipping strategy when the demand for a particular product surpasses supply.21

It is important to note that older firms that sell high-margin goods tend to use drop-shipping in their supply chain management. In addition, these businesses have a limited range of product variety. Alternatively, the click and mortar strategy is commonly employed by younger firms which sell a wide range of goods characterized by high levels of demand uncertainty. As noted earlier, inventory ownership and drop-shipping strategies are useful in a number of ways. For example, drop-shipping allows online businesses to provide a wide range of goods to potential shoppers. However, businesses that adopt this strategy are more susceptible to demand uncertainty compared to brick-and-mortar retailers.22

What is more, large and established enterprises have stable financial resources which enable them to keep their own inventories. On the contrary, small firms have limited financial resources which limit their ability to keep their own inventories. For example, small enterprises cannot afford costly e-commerce systems which must be amalgamated with front-end systems to facilitate efficient management of online inventories. What is more, product size determines the inventory strategy that a firm adopts. This is because high inventory costs are directly associated with bulky products. In addition, bulky products require large storage space and substantial financial resources to store and distribute. Thus, drop-shipping strategy is more suitable than the traditional approach for those businesses that deal with bulky goods.23

Dual-Echelon Dual-Channel Inventory System

Under the dual-echelon dual inventory system, a producer employs both an online-enabled platform and a conventional retail depot to supply goods. The retailer normally uses inventories from the lower echelon to fulfil order requests made by shoppers at the retail depots. On the other hand, inventories from the upper level are used to meet order requests of the customers via the online-enabled platform. This system is commonly described as a multi-level multi-channelled supply system. Many enterprises have embraced the internet as an online channel for selling products. It is worth mentioning that the emergence of the internet has enabled many businesses to distribute a wide range of products using different outlets. For instance, one recent study revealed that approximately 41 percent of top merchants from different sectors (i.e. Apparel, sporting products, and electronics) use the internet to sell products directly to shoppers.24 In other words, many businesses are now using both the conventional retail outlets and online-enabled sales platforms to realize a flexible supply chain system.

There are several managerial challenges that a firm may encounter if it opts to implement a dual-channel supply system. For instance, the demand structure of a particular product may be altered when a firm combines the conventional retail supply chain with the online-based supply chain. Therefore, business organizations may be compelled to restructure their optimal inventory distributions within the dual-echelon supply settings. The elementary mission, with regard to the challenges posed by the dual-echelon supply system, is to balance the volume of inventories between the upper level and the lower level.25

Kevin Chiang and George Monahan note, ‘while multi-echelon inventory control policies have been extensively studied, the theoretical basis for multi-echelon multi-channel inventory problem has not yet been well developed…’26 For example, the multi-level inventory models presuppose that the distribution chain system is made up of different locations whereby the relationship between supply and demand produces a pecking order. In other words, each location collects order requests from numerous direct descendants who share the same level. Nonetheless, a limited number of studies have been carried out to explore this phenomenon.

Recent trends in the business environment suggest that the efficient management of inventories is hampered by challenges emanating from product complexities, product range and customization. The demand for products such as clothing merchandise, spare parts, electronics, appliances, and furniture is typically low. What is more, these products attract huge inventory costs, especially if they are kept in large quantities to meet consumer requirements. Consequently, the supply chain is likely to experience immense pressure that emanates from sales and inventory costs associated with these types of merchandise. Several studies have demonstrated the manner in which an enterprise can use order-for-order replenishment strategies to manage goods that are characterized by low levels of demand. In addition, Kevin Chiang and George Monahan suggest that a firm can dramatically decrease the overall inventory costs if it implements order-for-order strategies in the multi-level two-channel inventory system. In other words, a firm must use both the traditional retail store and the online-enabled direct platform to reduce costs associated with the various types of products identified above.27

Hybrid Strategy

As noted in the previous section, a hybrid strategy entails a combination of the inventory ownership and drop shipping strategy. A number of enterprises prefer the hybrid technique it decreases the risk that emanates from keeping inventory at a different location. With regard to inventory management, the hybrid system compels the enterprise to maintain lower inventory levels because the enterprise uses other distribution means other than drop-shipping. In addition, the hybrid technique allows the wholesaler and merchant to keep lower inventory levels compared to when they employ either the conventional channel or drop-shipping strategy.28 E-commerce allows the wholesaler to augment the number of retailers with the supply chain because the channel allows the wholesaler to carry out multiple transactions relating to supply management at the same time.

However, there are a number of factors that influence the choice of strategy for inventory management. Transportation cost is one of the factors. For example, when the cost of transportation increases, the retailer will opt to use both the hybrid strategy and drop-shipping strategy. As a result, the wholesaler stands to gain from reduced costs of transportation in view of the fact that retailers are likely to use the conventional channel to procure large quantities of inventories. What is more, all parties within the supply chain can reap additional benefits when more retailers are included within the drop-shipping outlet.29

However, the hybrid channel presents a different scenario because the profit margin reduces as more retailers are included in the supply chain. Therefore, online businesses prefer to use hybrid and drop-shipping techniques when the number of retailers increases within the supply chain. Nonetheless, the hybrid system has a number of limitations. For example, some business may discard the hybrid system on the basis of the following scenarios: when the traditional approach is favoured by the structure of the transportation cost, and when the profit margin of the wholesaler is less than that of the retailer.30 To put it another way, the manufacturers will increase the stock levels if they anticipate an increase in profitability. Equally, the retailer will increase inventory levels if the profit margin increases.

Stockouts

Many scholars have demonstrated the various advantages that emanate from having lower inventories. Nonetheless, there are several risks associated with stockouts. For example, Stockouts increases back-end outlays and consumer discontent. In addition, it reduces sales volume and consequently the competitiveness of an enterprise. It is against this backdrop that businesses must make swift macro-economic decisions to deal with this problem. For instance, they can stabilize the prices of products, resort to stick-out compensation (i.e. Decreasing prices of products that are out of supply). It is worth mentioning that some businesses have augmented their competitiveness via stockout compensation since this strategy increases the demand for goods that run out of supply. What is more, some enterprises deliberately initiated stock-out strategies in order to augment profits, reduce outlays and improve product demand. However, stock-out compensation strategies have come under intense criticism because they destabilize the supply chain system. In addition, stock-outs result in higher backorders and reduce sales volume.31

Conclusion

Inventory management is an important strategy used by manufacturing companies to control the flow of raw materials and goods. Several scholars have attempted to define inventory management. According to Drury, inventory management refers to the quantity of goods/products that an organization preserves to meet the unexpected rise in demand. A similar sentiment is echoed by Schroeder who describes the influential role of inventory management in supporting a number of business activities such as finance, accounting and marketing. The author suggests that manufacturing firms undertake inventory management for three main purposes. These are: speculative purpose, precautionary purpose and transaction purpose.

Inventory management increases organizational efficiency by reducing costs associated with obsolescence, pilferage, spoilage and storage. It is important to note that poor inventory management can result in business closure. This paper has also demonstrated the relevance of e-commerce in inventory management and compared it to other traditional approaches. For instance, e-commerce has enabled many internet businesses to fulfil consumer requirements in an efficient manner. The various challenges facing the adoption of e-commerce in inventory management have also been discussed. For instance, site overload is one of the major problems associated with e-commerce. This happens when the number of requests for a particular product provisionally surpasses the processing capacity of the website. This problem may render the website dysfunctional and result in revenue loss. Nonetheless, e-commerce remains an important channel with respect to inventory management.

Previous studies have shown that there is a positive correlation between consumer contentment and decreasing the price of products that are out of supply. Thus, businesses must adopt and re-evaluate their e-commerce processes and strategies given that many shoppers are currently using the internet to procure items. A majority of online businesses has previously undermined the significance of the efficient supply chain mechanism in inventory management. As noted in the preceding sections, large enterprises have strong financial bases which enable them to manage their inventories without relying on third-parties. What is more, large enterprises appear to enjoy the synergies that emanate from the ability to use different channels (such as e-commerce) to sell products. For example, enterprises that adopt click and mortar techniques are in good position to provide a wide range of products to meet consumer needs. It is important to note that the ultimate objective of many business organizations is to satisfy their customers and achieve a competitive edge in the market. It is against this background that many enterprises have adopted e-commerce to provide a wide range of products to their customers in a timely and efficient manner.

This paper has also discussed various strategies that businesses use to manage inventories. These include Drop-shipping & Inventory Ownership Strategy, Dual-Echelon Dual-Channel Inventory System, and stock-out strategy. For example, Drop-shipping is an outsourcing strategy in which online retailers outsource their inventory management processes to third parties in order to pursue other business activities. Under the dual-echelon dual inventory system, a producer employs both an online-enabled platform and a conventional retail depot to supply goods. The hybrid strategy entails a combination of the inventory ownership and drop shipping strategy to meet customer demands.

Bibliography

Adeyemi, SL & AO Salami, ‘Inventory Management: A Tool of Optimizing Resources in a Manufacturing Industry. A Case Study of Coca-Cola Bottling Company, Ilorin Plant’, J Soc Sci, vol. 2, no. 23, 2010, pp. 135-142.

Chiang, WK & GE Monahan, ‘Managing inventories in a two-echelon dual-channel supply chain’, European Journal of Operational Research, vol. 162, 2005, pp. 325-341.

Drury, C, Management and Cost Accounting, International Housan Business Press, London, 1996.

Elnikety, S & E Nahum, ‘A Method for Transparent Admission Control and Request Scheduling in E-commerce web sites’, WWW, 2004, 276-286.

Johnson, ME & S Whang, E-Business and Supply Chain Management: An Overview and Framework, Stanford, CA, Stanford University, 2002.

Kotler, P, Marketing Management, 2nd edn, Prentice Hill of India, New Delhi, 2002.

Leonard, KN & TP Cronan, ‘Website Retailing: Electronic Supply Chain Replenishment’, Journal of End-User Computing, vol. 15, 2003, pp. 45-55.

Rell, S & H Basel, ‘E-Commerce and Inventory Management’, Proceedings of ASBBS, vol. 16, no. 1, 2009, pp. 1-5.

Schroeder, RS, Operation Management: Contemporary Concepts and Cases, International Edition, USA, 2000.

Footnotes

1 SL Adeyemi & AO Salami, ‘Inventory Management: A Tool of Optimizing Resources in a Manufacturing Industry. A Case Study of Coca-Cola Bottling Company, Ilorin Plant’, J Soc Sci, vol. 2, no. 23, 2010, pp. 135-142.

2 ME Johnson & S Whang, E-Business and Supply Chain Management: An Overview and Framework, Stanford, CA, Stanford University, 2002.

3 P Kotler, Marketing Management, 2nd edn, Prentice Hill of India, New Delhi, 2002.

4 C Drury, Management and Cost Accounting, International Housan Business Press, London, 1996.

5 RC Schroeder, Operation Management: Contemporary Concepts and Cases, International Edition, USA, 2000.

6 Adeyemi & Salami, p. 137.

7 Adeyemi & Salami, p. 135.

8 Adeyemi & Salami, p. 136.

9 S Rell & H Basel, ‘E-Commerce and Inventory Management’, Proceedings of ASBBS, vol. 16, no. 1, 2009, pp.1-5.

10 Ibid.

11 S Elnikety & E Nahum, ‘A Method for Transparent Admission Control and Request Scheduling in E-commerce web sites’, WWW, 2004, 276-286.

12 Elnikety & Nahum, p. 277.

13 KN Leonard & TP Cronan, ‘Website Retailing: Electronic Supply Chain Replenishment’, Journal of End-User Computing, vol. 15, 2003, pp. 45-55.

14 Rell & Basel, p. 1.

15 Rell & Basel, p. 2.

16 WK Chiang & GE Monahan, ‘Managing inventories in a two-echelon dual-channel supply chain’, European Journal of Operational Research, vol. 162, 2005, pp. 325-341.

17 Ibid.

18Rell & Basel, p. 2.

19 Chiang & Monahan, p. 325.

20 Rell & Basel, p. 3.

21 Ibid.

22 Ibid.

23 Ibid.

24 Chiang & Monahan, p. 326.

25 Ibid.

26 Chiang & Monahan, p. 327.

27 Chiang & Monahan, p. 328.

28 Rell & Basel, p. 4.

29 Rell & Basel, p. 4.

30 Ibid.

31 Rell & Basel, p. 5.

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