Interactive Lesson 4.2.1
Inventory Management & The Sawtooth Chart
Master the critical balance between holding costs and stockout risks
The Three Types of Inventory
Raw Materials
Wood, Steel, Fabric
Not yet processed
Work in Progress
Table legs, Half-built cars
Being manufactured
Finished Goods
Complete tables, Ready cars
Ready to sell
The Cost-Benefit Balance
Costs of Holding Stock
- •Storage Costs: Warehouse rent, refrigeration, security
- •Opportunity Cost: Cash tied up, could invest elsewhere
- •Obsolescence: Fashion changes, technology updates, expiry dates
Benefits of Holding Stock
- •Meet Demand Instantly: No customer waiting time
- •Bulk Buying Discounts: Lower unit costs
- •Avoid Stockouts: No lost sales or reputation damage
The Interactive Inventory Chart
Time between ordering and delivery arriving
Minimum safe level (safety net)
How much you buy when ordering
How quickly stock is sold/used
Re-order Level
150
Trigger for new order
Average Stock
150
Holding cost basis
Stockout Risk
MEDIUM
Running out of stock
Financial Impact (Annual):
Holding Cost: £2/unit/month × 150 avg units × 12 months = £3,600
The Stockout Disaster Simulation
You sell umbrellas. Buffer stock = 0. Your supplier suddenly faces delays.
Key Definitions (AO1)
Buffer Stock
The minimum level of inventory held as a safety net to prevent stockouts during unexpected demand increases or supply delays.
Lead Time
The time period between placing an order with a supplier and receiving the delivery of goods.
Re-order Level
The stock level at which a new order must be placed to ensure delivery arrives before stock falls to buffer level. Formula: Buffer Stock + (Lead Time × Usage Rate)
Re-order Quantity
The number of units ordered each time stock reaches the re-order level. Larger quantities reduce ordering frequency but increase holding costs.
Strategic Insights (AO3/AO4)
→Longer lead times force higher re-order levels because stock must last longer before delivery arrives, increasing average stock held and holding costs.
→Higher buffer stock reduces stockout risk but increases cash flow pressure as more capital is tied up in inventory that generates no immediate return.
→The optimal inventory level depends on context: Perishable goods (bakery) need minimal stock; seasonal goods (winter coats) need higher buffers before peak season; just-in-time manufacturers (Toyota) maintain near-zero buffers with reliable suppliers.
→Trade-off judgment is essential: The cost of holding stock must be weighed against the potential revenue loss and reputation damage from stockouts. Most businesses prioritize avoiding stockouts for customer satisfaction.
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