Inventory risk pooling is the concept that the variability in demand for raw materials is reduced by aggregating demand across multiple products. When properly employed, a business can use risk pooling to maintain lower inventory levels while still avoiding stockout conditions.
Organizations tend to suffer from bloated inventories. One reason for this excessive investment is that it can be difficult to forecast the amount of raw materials inventory that should be kept on hand. Available balances can vary considerably, depending on the outside demand for the products of which they are a part. For example, if a green widget contains six ounces of stainless steel, and the demand for the green widget is highly variable, it may be necessary to retain a large quantity of stainless steel to ensure that there is always enough in stock to produce a sufficient number of green widgets to meet demand.
However, what if the same raw material item were to be included in a number of products? In this case, the varying demand levels for the multiple products may very well offset each other, resulting in a net level of variability for the raw material item that is quite low. If so, it may be possible to use this pooling of fluctuation risk to reduce the amount of raw material safety stock that is kept on hand.
This risk pooling approach works best when the same components are used in different product lines, since entirely different products are more likely to have offsetting demand fluctuations than products within the same product line. Since there may not be much commonality of parts among different product lines, this means that the risk pooling concept may only be applicable to relatively generic parts, such as fittings and fasteners.
When rolling out the risk pooling concept, follow this approach:
- Identify those components being used in multiple products.
- Monitor actual demand levels for these components on a rolling quarterly basis.
- Adjust safety stock levels to slightly exceed actual demand levels over the monitoring period.