Min-Max supply chains have the reputation for high inventory financing and high holding costs. In order to capitalize on infrequent customer demand, companies tend to use this strategy to avoid the high costs of inventory stock outs. For instance, a minimum and maximum stock level is maintained in order to accommodate the seasonal demand patterns emerging from the market. In other instances, the safety inventory is used to cover higher than normal turn time on parts and raw materials. This allows the company to close infrequent sales, but it also means the company’s holding costs will be higher during slower periods of the year. So, What are the costs of holding inventory in Min-Max supply chains?
Holding inventory for longer periods does have a cost. For instance, holding stock longer means your company’s cost of capital, or financing, increases. It also means you’re more likely to encounter damage, theft and obsolescence. The longer inventory is kept in your warehouse, the higher these costs and the more likely you'll have to liquidate that inventory. Finally, there are always costs of insurance, inventory counting, taxes and general warehouse management costs. In each case, these costs increase the longer you hold product in your warehouse. These costs are often summarized as being 3% of the inventory value on hand in any given month.
Min-Max Protects Against an Inventory Stock Out
For whatever reason, companies think they save money by keeping inventory levels low. Unfortunately, this isn’t possible. Why? In order to answer this question, think of what your company does when inventory isn’t available and you have a chance at a sale, one with an extremely important customer. What do you do in these instances? Well, you’ll probably expedite parts from your supplier. This is your first cost as that vendor is likely to charge you for jumping to the front of the line. Then you’ll have to pay an expedite freight charge to rush those parts into your facility. Further costs are associated with overtime pertaining to receiving, inspecting, repackaging and shipping. If your company is a manufacturer, then you’ll probably incur time and half, in production. In fact, if you’re late with this customer, you’ll probably have to cover the cost of freight to your customer’s location. All of these costs are directly related to the impact of having a stock out. While the holding costs are higher, the impact of a stock out is minimized in Min-Max supply chains.
Losing sales because of a stock out is a cost of not having inventory. This is ultimately why companies run Min-Max inventory. A safety stock protects again the high costs incurred by a lack of inventory. These costs are measured by lost sales, lost gross profit, and potentially, lost customers.
Min-Max (Safety Stock) Protects Against the Following Inventory Costs
The Drawbacks of Min-Max
Companies running Min-Max are able to guard against the high costs of lost sales by maintaining a safety stock. Unfortunately, by maintaining that threshold they must retain inventory for longer periods when faced with a slowdown in customer demand. This means the company will incur additional financing costs. It will also incur additional costs pertaining to obsolescence, damage and theft. So, while maintain a safety stock helps mitigate the high costs of stock outs, and lost sales, it doesn’t help the company manage its financing on inventory or its carrying costs.
No system is ever perfect. Even the best run supply chain encounters issues. The key is to run an inventory strategy that matches your company’s needs and your business cycles. Resist the temptation to go with an approach based on what you’ve read or heard. Instead, define the market you operate in. For instance, are you in a market where orders fluctuate from month-to-month, or quarter-to-quarter? Do you have to hold inventory in order to secure orders? Most importantly, are your customers’ order patterns best described as erratic and infrequent? If so, then running Min-Max is likely your best option as it encourages you to maintain a safety stock.
Please note, safety stocks are also present in Just in Time, but the volumes are typically smaller due to the high frequency of orders needed to make JIT work. Again, there is the possibility of encountering higher carrying costs with Min Max. However, you protect against lost sales cost of inventory by maintaining a minimum and maximum inventory count. Remember, holding costs are costs that pertain to holding inventory without sales. Lost sales cost of inventory occurs when you lose sales because of low inventory.
To read about holding costs in Just In Time inventories, please refer to: What Are the Costs to Hold Inventory in Just In Time - JIT ?
Or, if you manufacture custom-made parts and want to run a version of Dell's Push-Pull, then please read: What are the Costs of Holding Inventory in Dell’s Push Pull?
If you would like to read about how to maintain the proper safety stock count, then please read: Determining Safety Stock & its Impact on Inventory Holding Costs
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