The short answer is that higher inventories do not provide an advantage in
nine competitive priority categories. The important point is that firms must have the
“right amount” of inventory to meet their competitive priorities.
The only relevant costs considered in this chapter are ordering costs, holding costs,
and stockout costs. In the economic order quantity (EOQ) model, costs of placing
replenishment orders tradeoff against the costs of holding inventory. Under the
assumptions of the EOQ, average inventory is one-half of the order quantity. The number
of orders placed per year varies inversely with order quantity. When we consider
stockout costs, an additional inventory (safety stock), is held to trade-off costs of poor
customer service or costs for expediting shipments from unreliable suppliers.
In the lean systems chapter, we see order quantities (lot sizes) that are much smaller
than the “ideal” suggested by the EOQ model. As a result, lean systems average
inventory is also much lower. Are there some other relevant costs of holding inventory
that we have not considered in the EOQ model? If there are, a firm that ignores these
costs will make the wrong inventory decisions. These wrong decisions will make the firm
Let’s examine the relationships between inventory and the nine competitive priorities
discussed in the operations strategy chapter. We compare competitors H and L. They are
similar in all respects except H maintains much higher inventory than does L.
Costs include materials, scrap, labor, and equipment capacity
that are wasted when products are defective. When a process drifts out of control,
competitor H’s large lot sizes tend to result in large quantities of defectives. The
EOQ does not consider the cost of defectives, and erroneously assumes that setup
costs are constant. Small lots cause frequent setups, but the cost per setup decreases
due to the learning curve. Competitor L will enjoy competitive advantages with lower
setup, materials, labor, equipment, and inventory holding costs.
Superior features, durability, safety, and convenience result from
improved designs. High inventories force competitor H to choose between scrapping
obsolete designs or delaying introduction of product improvements until the old
inventory is consumed. In either case, L gains a competitive advantage.
Consistency in conforming to design specifications requires
consistency in supplied materials, setups, and processes. Small lots made frequently
tend to increase consistency. Again, advantage goes to L.