What Is Inventory Optimization?

Malcolm Tatum

Inventory optimization is a type of inventory management strategy that seeks to create the ideal balance between the demand for items kept in the inventory while also keeping the costs of supplying those items as low as possible. Many approaches to this type of inventory control focus on setting limits on the number of units of any given item kept in the inventory, while also tracking the usage of those items so that orders can be placed with suppliers at just the right time to prevent delays in production. A number of different inventory optimization tools may be used in this process, with inventory management software being one of the most effective.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

The process of inventory optimization typically requires creating and following specific guidelines that help to identify how many units of a given item must be kept on hand in order to benefit the production process. In order to accomplish this, it is important to address the issue of usage. Usage is simply the number of units of a given item that are consumed or used within a specified period of time. For example, a specific gear may have to be replaced once a week in order to maintain optimum production levels. This would mean that on average, the business would need to maintain four gears on hand to accommodate the usage for any thirty-day period.

Along with usage, inventory optimization must also consider the ordering process for replenishing that inventory. Suppliers may require a certain amount of time in advance to process an order, especially for items that must be custom made. This means that inventory managers must allow for the time necessary for the supplier to process and deliver the order, compare that to the usage, and determine a schedule that makes it possible to place those orders so the items arrive and are available for use shortly before they are needed. For example, if the gear supplier requires two weeks to process and deliver the gears, the manager may set a reorder point that calls for placing a new order when the number of units on hand is two. This would allow the order to arrive just as the last gear from the inventory is exhausted, making it possible to avoid delays in production.

When inventory optimization is managed effectively, the business benefits in several ways. By avoiding the accumulation of a high inventory, the business pays less taxes on that inventory. A strategic combination of setting limits and strategic ordering based on usage means that production is never delayed due to a lack of resources. The company can also avoid storage fees associated with maintaining unnecessarily high inventories, or even free up space at the plant itself for uses other than storing inventoried items. As a lean and mean approach to inventory management, establishing and following an inventory optimization process simply makes sense.

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