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Concept
Inventory theory
Summary
Material theory (or more formally the mathematical theory of inventory and production) is the sub-specialty within operations research and operations management that is concerned with the design of production/inventory systems to minimize costs: it studies the decisions faced by firms and the military in connection with manufacturing, warehousing, supply chains, spare part allocation and so on and provides the mathematical foundation for logistics. The inventory control problem is the problem faced by a firm that must decide how much to order in each time period to meet demand for its products. The problem can be modeled using mathematical techniques of optimal control, dynamic programming and network optimization. The study of such models is part of inventory theory.
One issue is infrequent large orders vs. frequent small orders. Large orders will increase the amount of inventory on hand, which is costly, but may benefit from volume discounts. Frequent orders are costly to process, and the resulting small inventory levels may increase the probability of stockouts, leading to loss of customers. In principle all these factors can be calculated mathematically and the optimum found.
A second issue is related to changes in demand (predictable or random) for the product. For example, having the needed merchandise on hand in order to make sales during the appropriate buying season(s). A classic example is a toy store before Christmas: if the items are not on the shelves, they cannot be sold. And the wholesale market is not perfect; there can be considerable delays, particularly with the most popular toys. So, the entrepreneur or business manager will buy speculatively. Another example is a furniture store. If there is a six-week, or more, delay for customers to receive merchandise, some sales will be lost. A further example is a restaurant, where a considerable percentage of the sales are the value-added aspects of food preparation and presentation, and so it is rational to buy and store somewhat more to reduce the chances of running out of key ingredients.
Official source
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