An essential aspect of managing any business that sells physical goods is determining how many goods to produce and how large of a stock of goods to keep on hand for sale. Goods that are available sale are referred to as a firm's inventory or stock. Keeping a large amount of inventory on hand can be advantageous in that it reduces the chance of running out of a product, but a large inventory can also have several notable disadvantages.
Holding a large volume of items on hand means you need a large amount of space to store your inventory. Storage space like warehouses and storage rooms cost money to build, rent and maintain. Storage facilities require workers to categorize and organize items and transport items from one place to another. In addition, high levels of inventory can lead to higher insurance costs.
Deterioration and Obsolescence
Some businesses sell goods that tend to deteriorate or perish over time, such as food products. Keeping a large amount of perishable inventory on hand risks the possibility that you will be unable to sell some of the inventory in time before it goes bad, which can force you to throw away product. Similarly, certain types of products, such as computers and other electronic devices tend to become obsolete quickly. Keeping a large inventory of such products is risky because consumers might not be willing to buy old versions of products at a price that is profitable when new or updated versions become available.
Shifts in Demand
Another disadvantage of keeping a large amount inventory on hand is that certain goods might not sell due to shifts in market demand. For example, a clothing store that stocks too many tank tops during the summer may find itself unable to get rid of the tank tops before fall. During the fall, consumers might demand different types of clothing, like T-shirts or sweatshirts, leaving the company with a large quantity of goods on hand that simply take up space.
While high levels of inventory can be a disadvantage, carrying too few goods on hand can also be harmful to a business. If you run out of a certain product, you could miss out on potentially profitable sales, and this could cause customers to give their business to your competitors. Managers must decide on an inventory level that balances the risk of running out of products with storage costs and the other negative aspects of holding too much inventory.