Question

List and discuss the two necessary conditions for holding inventory. Also, mention the economic factors that would help in reducing the inventory holding cost.?

Answer 1

The first necessary condition is the uncertainty in demand. In this case, holding inventory helps firms cater the demand that can arise on contingent basis. So, firms can achieve more profit with higher service level and it can only come when firms hold inventory. The second necessary condition is prevention of bottleneck and maintain a consistent supply of goods and services. Here, holding inventory helps, because consistent supply of raw materials and other inputs are maintained, even if suppliers delay in their deliveries of input materials. So, negative effects of uneven supply of inputs is prevented.

The first economic factor is the ordering cost. If ordering cost is lowered, then order quantity is also lowered. With lower ordering quantity, the inventory holding cost decreases. The second factor is the interest rates. A lower interest rate, means lower opportunity cost of holding money in inventories. It makes lower inventory holding cost. The third factor is the streamlined supply of inputs. It makes less burden of keeping the inventory. As a result, inventory holding cost also decreases.