Managing the Volatility in Demand: Inventory Buffers

To offset shifts in consumer demand and rising commodity prices, many companies are scrambling to finding ways to reduce their overhead costs while, simultaneously, maintaining product standards and profits. There are several ways to accomplish this; however, one of the most important factors to consider is inventory management. By selecting the appropriate inventory management strategies and clearly understanding the cost and benefits associated with each method, a company can lesson or avoid the burdens associated with demand volatility or unexpected events like a recession.

Traditionally, many companies supply chain methodology has been to build, or hold, excessive inventory so that all fluctuations in demand were absorbed within the inventory. Unfortunately, having high levels of inventory tied up a lot of those companies cash, and had a negative effect on the businesses when consumer preference changed or a recession hit.  As companies started to experiment with other supply chain methods, the concepts of Just-In-Time inventory and Lean manufacturing emerged to help reduce inventory liabilities.  While this method did “free-up” cash, it caused major delays in the manufacturing process and was considered more of a head ache than it was worth.  For example, a Toyota facility sat idle for 20 days waiting on one of its supplier to deliver raw materials needed for production.  The delay cost the automotive giant thousands in lost time and revenue.  

What’s the proper method?  While maintaining high levels of inventory can be expensive and retaining low inventory levels can negatively impact customer service, a middle ground can be found by building carefully planned inventory levels.  By putting in measures that buffer against demand variations and harmful supply disruptions, a company can successfully mitigate and manage shifts in consumer demand and commodity prices. 

What is buffering?  Smallbusiness.com explains that, “The purpose of buffering is to account for variability in manufacturing processes, while also maximizing efficiency and profits. In an ideal world, buffering wouldn't be necessary because variability wouldn't exist. However, since variability does exist, it's necessary to use buffering as a means of minimizing the impact of these variables. Through buffering, manufacturers can alter their processes through manipulating inventories, capacities and times. As an example, consider a bottleneck system in which an upstream station frequently breaks down, limiting capacities. To keep the line operating efficiently, the manufacturer could place an inventory, or work-in-place, buffer at that station to maintain optimal production levels.”

To effectively “buffer” inventory against demand fluctuations, a company should identify the expected life of its product since demand volatility varies at each stage of the process.  For example, demand volatility is often at its peak during a products launch phase thus inventory levels should ensure that product availability is on par with consumer demand.  Once the product secures a spot within the market place, demand becomes stable and inventory levels should be based on the product’s importance and position within the marketplace.  Lastly, as consumers’ start to desire less of the product, inventory levels should be kept at a minimum or non-existent. 

Other factors that should be considered before selecting an inventory management level is storage location, demand variation, and the possibility of supply disruption.