Inventory Management

The Goldilocks Problem

🔄 Quick Recall: In the previous lesson, we covered logistics—how goods physically move through your supply chain. Now we tackle the question that determines whether those goods are available when customers need them: how much inventory should you hold?

Too much inventory ties up cash, fills warehouse space, and risks obsolescence. Too little inventory means stockouts, lost sales, and frustrated customers. Inventory management is the art of finding the “just right” amount.

By the end of this lesson, you’ll be able to:

• Calculate reorder points and safety stock levels
• Apply ABC analysis to prioritize inventory management effort
• Use AI to optimize stock levels for any product mix

The Cost of Getting It Wrong

Inventory mistakes are expensive in both directions:

Overstocking costs:

• Storage fees (warehousing, insurance, handling)
• Tied-up capital (money sitting in products instead of growing the business)
• Obsolescence risk (products expire, go out of fashion, or become outdated)
• Markdown losses (selling excess at a discount to clear it out)

Understocking costs:

• Lost sales (customer wanted it, you didn’t have it)
• Customer churn (they found it somewhere else and might not come back)
• Emergency shipping (expediting rush orders from suppliers at premium rates)
• Reputation damage (known as the “unreliable” vendor)

The goal isn’t zero waste or maximum stock. It’s the right balance for your business.

✅ Quick Check: Think about a product you sell (or one you buy regularly). What would happen if the supplier ran out for two weeks? Who absorbs that cost?

The Reorder Point Formula

The reorder point tells you exactly when to place a new order so it arrives before you run out.

Formula:

Reorder Point = (Daily Demand × Lead Time) + Safety Stock

Example:

• You sell 20 units per day
• Your supplier’s lead time is 7 days
• You want 3 days of safety stock

Reorder Point = (20 × 7) + (20 × 3) = 140 + 60 = 200 units

When inventory drops to 200 units, you place a new order. The order arrives in 7 days, during which you’ll sell 140 units. Your safety stock of 60 units provides a buffer if demand spikes or the supplier ships late.

How AI Helps

“I sell 3 products. Product A: 15 units/day, 10-day lead time. Product B: 50 units/day, 5-day lead time. Product C: 5 units/day, 21-day lead time. Calculate reorder points with safety stock equal to 5 days of demand for each. Then tell me which product needs the most careful monitoring and why.”

Safety Stock: Your Insurance Policy

Safety stock protects you from two types of uncertainty:

Demand variability. Some weeks you sell 100 units, other weeks 150. Safety stock covers the peaks.

Supply variability. Your supplier usually delivers in 7 days, but sometimes it takes 10. Safety stock covers the delays.

How Much Safety Stock?

There’s no one-size-fits-all answer. Consider:

How AI Helps

“I sell seasonal products—demand is 3x higher in November-December than the rest of the year. My supplier needs 14 days lead time and delivers late about 20% of the time. Help me calculate appropriate safety stock levels for peak vs. off-peak seasons. Show your reasoning.”

ABC Analysis: Focus Where It Matters

You can’t give every product equal attention. ABC analysis prioritizes your effort based on value:

Category A: ~20% of products, ~80% of total revenue. These are your stars. Monitor daily, forecast carefully, maintain generous safety stock.

Category B: ~30% of products, ~15% of total revenue. Important but not critical. Review weekly, maintain moderate safety stock.

Category C: ~50% of products, ~5% of total revenue. Many items, small impact each. Review monthly, keep minimal stock or order on demand.

Example ABC Breakdown

How AI Helps

“Here are my 15 products with their annual revenue: [list]. Categorize them using ABC analysis and recommend a management approach for each category, including review frequency, safety stock strategy, and reorder method.”

Inventory Turnover: The Health Metric

Inventory turnover measures how many times you sell through your entire inventory in a year. Higher is generally better—it means products move quickly and cash isn’t sitting idle.

Formula:

Inventory Turnover = Cost of Goods Sold / Average Inventory Value

Benchmarks vary by industry:

• Grocery: 14-20 turns per year
• Apparel: 4-6 turns per year
• Electronics: 6-8 turns per year
• Industrial equipment: 2-4 turns per year

Low turnover means you’re holding too much stock. Extremely high turnover might mean you’re cutting it too close and risking stockouts.

Try It Yourself

Use AI to analyze your inventory (real or hypothetical):

“I run a small online store with these products and monthly sales volumes: [list 5-10 products with prices and monthly units sold]. My average supplier lead time is [X] days.

1. Perform an ABC analysis
2. Calculate reorder points for my top 3 products (assume 4 days safety stock)
3. Estimate my overall inventory turnover
4. Recommend which products I should monitor most closely and why”

Key Takeaways

• Inventory management balances holding costs (too much) against stockout costs (too little)
• The reorder point formula (Daily Demand × Lead Time + Safety Stock) prevents stockouts
• Safety stock protects against demand spikes and supplier delays—adjust by product and season
• ABC analysis ensures you focus management effort on the products that drive the most revenue
• Inventory turnover measures how efficiently you convert stock to sales

Up Next

In Lesson 4: Demand Forecasting, we’ll tackle the crystal ball challenge—predicting how much you’ll sell in the future. AI makes this dramatically more accessible, even for small businesses without data science teams.