Inventory Management

Seasonal Production

Many industries are subject to dips and rises in demand due to seasonality. Logically, sourcing the same amount of a given product each month for inventory is not a practical choice in these industries. Inventory management in seasonally impacted businesses can become quite complex, as the accuracy or inaccuracy of forecasts can have substantial impacts on overall profitability.

Reasons to Keep Inventory

In an ideal world, a business would avoid the need for inventory through perfect operational management and completely accurate projections. Of course, this is impossible. As a result, businesses must balance risk and opportunity to ensure that inventory is available when needed and waste is minimized. Inventories are kept due to:

• Time – No supply chain is perfect, and often enough time lags can ruin potential business opportunities. Playing it safe and having certain items in stock ahead of time can avoid opportunity costs.
  
  
• Uncertainty – Supply and demand are not perfectly predictable. Uncertainty means keeping enough on hand to meet fluctuations in demand.
  
  
• Economies of Scale – Many businesses exist solely because they take the risk of buying a high volume of a given product at a lower price in hopes of marking up the price and selling each one individually to customers. This is called economies of scale, and by nature, it requires some storage and inventory. Grocery stores function this way.
  
  
• Appreciation in Value – Some businesses keep inventory as an investment. Fine wines and cheese, for example, will appreciate in value over time. The downside is it will cost money to keep them (both require appropriate temperature conditions, for example).

Determining Seasonality

Among the many reasons to keep inventory is planning for seasonality. Businesses should first measure whether or not consumer demand and subsequent inventory requirements are subjected to predictable seasonal trends.

There are a number of ways to do this, using existing historical sales data as well as data from external research on the industry itself. There are countless models and methods of organizing seasonal data to determine, but from the managerial frame, most analysts preferred that the distribution of data should ultimately communicate the same correlations (or lack thereof) for differences in sales on a monthly basis.

Once seasonality is determined, businesses should measure the fluctuations from year to year and the opportunity costs of having too much or too little on hand. Once this is accomplished, the business can order the ideal amount based on data-driven projections to capture as much opportunity as possible without taking the risk of overordering (and thus overpaying for storage).

Perishable Goods

An important aspect of seasonal inventory management is the concept of perishable goods. From food to fashion to technology, many goods simply either go bad or lose most of their value for no other reason than that culture has passed it by. This is called a perishable good.

Perishable goods have an even greater opportunity cost when it comes to mismanaging (and erroneously predicting) demand. If too much of a perishable good is ordered, not only will it cost the organization unnecessary inventory fees, but it also adds the risk of never being sold at all (a complete sunk cost at that point).

As a result, understanding a good's shelf life, the risk of over or understocking, and the ebb and flow of seasonal demand can greatly enhance an organization's profitability.

Seasonality Plot Example In this chart, electricity consumption (demand) over a 12-month time frame is illustrated. Higher capacities are required in certain months (in this case, August), and capacity must be expanded to account for this.