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Why do companies hold inventory?

There are five major reasons for holding inventory:

(1) Pipeline inventory

A pipeline inventory is the minimum inventory an organisation needs in order to function. E.g. a producer of wine that needs to age for two years in order to be sold needs a minimum inventory of wine for two years in order to exist.

(2) Seasonal inventory

A seasonal inventory is helpful, if an organisation wants to produce at a constant (cost-efficient) capacity, yet the demand varies with the seasons. E.g. a toy company can cheaply produce at at steady pace and build up a seasonal inventory for higher sales during the Christmas holidays.

(3) Cycle inventory

A cycle inventory is helpful if keeping an inventory saves costs associated with buying supplies on time. A private household will, for example, keep a box of water bottles in the cellar for practical reasons instead of satisfying the demand for water at the store every time it comes up again.

(4) Safety inventory

A safety inventory is a buffer agains high external demand, e.g. a burger chain keeping an inventory of pre-made burgers so that customers can be satisfied immediately. Safety inventories are closely associated with the meme “buffer or suffer”, meaning that if a process is not able to buffer for variabilities (such as an unexpected external demand) it will loose on flow rate.

(5) Decoupling inventory

Whereas the safety inventory can be seen as the buffer against heightened external demand, the decoupling inventory can be seen as the buffer against heightened internal demand. Such an inventory decouples supply from demand and supports a higher (and steadier) flow rate.

These lecture notes were taken during 2013 installment of the MOOC “An Introduction to Operations Management” taught by Prof. Dr. Christian Terwiesch of the Wharton Business School of the University of Pennsylvania at

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