The Motives for Holding Inventory Explained

In the hustle and bustle of the Christmas season, retailers stock their inventory with dozens of Christmas items in anticipation of the holiday rush. When Christmas has passed, the store is left with Christmas items that did not sell. To make room for the next calendar holiday, the retailer will sell their Christmas overstock at extreme discounts. Whatever doesn’t sell will be restocked in inventory for the next Christmas season.
The retailer is able to get a jump-start for the next Christmas season by placing last year’s Christmas inventory out in October. A good business operation understands that there will be times when holding inventory becomes crucial in their success. From not wanting to spend additional funds on restocking, to preparing for fluctuations in market conditions, motives for holding inventory are indispensable in inventory management.
There are 4 motives for holding inventory: Production smoothing, inventories as a factor of production, stock-out avoidance, and work in progress (Gregory, 2007). Production smoothing, the first of the four motives, involves preparing for fluctuations in sales, as well as seeking a more economically sound way to continue production. When sales offset production either positively or negatively, inventories will rise or fall. With production smoothing, it is more logical to produce items at a constant rate (Gregory, 2007).

The second motive is consideration for inventories as a factor of production. Let’s say that a drama teacher is looking for a Christmas tree in June for his “Christmas in July” production. The overstock from last year’s Christmas season assists in the retailer not losing business because they restocked Christmas trees that didn’t sell from last year. The third motive, stock-out avoidance, protects a business from contractual risk, as well as lost sales in the event of high demand (Fafechamps, 1997). With contractual risk, both the business and the client run the risk of not adhering to a contract, but in the way of business, holding inventory provides better odds that the business will have what the client requires in order to conduct business and comply with their contract (Fafechamps, 1997).
In addition to this motive, being prepared for unexpected demand is imperative in keeping business. For example, an unexpected freeze in the fall could cause people to shop in droves for firewood. The retailer who does not meet the demand will lose business and retain the reputation of not being sufficiently stocked. The final motive, although not really a motive at all, is work in progress. Any unfinished item in the store must also be counted as inventory (Gregory, 2007).
If you have ever walked into a store to buy a specific item and found that the store does not have it in stock, you may avoid the store all together in the future. Holding inventory is important for both the business and the customer. It ensures repeated business and makes for smooth sailing.

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Gregory, Mankiw & Cronovich, Ron C. (2007) Investments and Inventory. January 2007.
Fafechamp, Marcel, Gunning, Jan W. & Oostendorp, Remco. (1997) Inventory, Liquidity and Contractual Risk in Marketing. January 2007.

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