Much has been said recently about the importance of inventory management, particularly small business inventory management, in supply chain management. The same could be said about the importance of inventory management in general for the economic success of any company in the retail business or similar.
In that regard, like in any other area, there are some general rules that small business owners can follow to set them on the right path to success. That kind of tips is already a huge step forward.
But not all inventories are made equal. And today we’re not here to give you general insight on small business inventory management. Instead, we’d like to talk about two different types of inventories: independent demand and dependent demand.
Since these types of inventories have different characteristics, they are also managed differently. Understanding which type of inventory you have, or rather, understanding which items fit into each inventory type, will help you develop your own strategy and get a hold of your business.
First, we’ll have to understand what demand is. Market demand is defined as the total amount of a good or service that consumers are willing and have the power to buy at a specific price. Demand is not the same as desire because it is not enough for consumers or businesses to want the product, they have to actually be able to buy it. Following this reasoning, we can conclude that the demand for a certain product decreases when its price increases.
Now that we’ve got the basics of demand, we can go on and define the two main types of inventories: those with independent demand and those with dependent demand.
Independent demand items are one of the types to consider in small business inventory management. Simply put, independent demand items are those whose demand is ultimately determined by the market.
Items in this category are usually finished products, while dependent demand items tend to be component parts of a larger product, also called a finished good.
Let’s imagine your small retail store buys smartphones from a manufacturer and sells them. Demand for smartphones is determined by customer trends and budget, so it is independent demand. For instance, on Christmas, the demand for smartphones should rise.
In order to try and predict demand, you can use a forecasting tool for small business that takes into account several external factors. You can also try and influence demand by doing marketing operations or, for example, lowering the price of your phones.
How to Manage It
Managing inventory is relatively easy for independent demand items. You just have to monitor stock levels and reorder the product as necessary, or preset a minimum level and have your inventory management system reorder automatically. This can also be influenced by forecasts and the time it takes for you to receive a certain product.
The main challenge in forecasting demand for this type of products happens when there is no history of that product (for example, if it is a new product), so there is no past data to base your prediction on.
Now let’s take a look at dependent demand items, which are a tricky aspect of small business inventory management. This category comprises items whose demand depends on the demand for other items, sometimes called “parent” items.
Going back to our previous example, let us now imagine your small business manufactures smartphones. In order to do this, you need to have components in stock such as batteries, screens, and microprocessors. But microprocessor demand is not determined by the end customer because no one wants to buy microprocessors. People want to buy smartphones, which instead are made of microprocessors, along with other components.
How to Manage It
In order to determine which, and how many components are needed, a bill of materials (BOM) is used. This diagram indicates the relationship between the independent demand item (e.g. smartphone) and the dependent demand items (e.g. a battery, two cameras, a microprocessor and a screen).
When you are managing dependent demand stocks, the BOM is used as a starting point, along with any forecasts made for the parent item using a forecasting tool for small business. But reordering the raw materials is not as trivial as with independent demand.
Complex scheduling processes are used to determine order quantities, such as material requirements planning (MRP). This calculation has to take into account not only the quantity but also the lead time for each component. Batteries may take 2 weeks to arrive, while microprocessors could take a month, so you have to play with all these factors to make sure you receive everything at the same time.
Being able to tell in which of these models your products fit is a good start in your path to successful small business inventory management. The hard part is to implement the right systems to manage each of the models.