One might imagine that a company with a warehouse full of goods to sell, or raw materials to work with, is in pretty good shape: that stock represents an asset, revenue and products that can be sold.
This thought process is accurate, but that inventory also has to be stored and cared for. Some stock requires special storage, like refrigeration or air-tight containers. Some stock is subject to spoilage, like produce. So, while inventory represents an asset, it's an asset that can decrease in value over time, which costs money to store and maintain — and ties up cash in the process of holding and selling it.
Many businesses have become increasingly interested in the concept of zero inventory, in which they keep little or no material in stock, and goods are used to fulfill orders virtually as soon as they're finished or purchased. It requires a sophisticated approach to supply chain management but has the potential to improve profits.
What Is Zero Inventory?
Zero inventory is an approach to inventory management, and broadly speaking, a supply chain strategy aimed at maintaining as little inventory as possible without hindering other business objectives, such as meeting shipping times. While the strategy is called "zero inventory," in reality, companies often end up keeping some level of supplies and product on hand for reasons discussed further below.
Key Takeaways
- Zero inventory is an inventory management and supply chain strategy in which companies seek to keep supply levels as close to zero as reasonably possible.
- The advantages of zero inventory include reducing costs and freeing up capital.
- A zero inventory strategy requires efficient and effective supply chain management to be feasible.
Zero Inventory Defined
Zero inventory can be described as a business strategy in which a company strives to maintain as little inventory as possible. The practical effect is that new orders need to be filled just as new products are created or stocked. With a zero inventory strategy, items aren't accumulating and sitting around in a warehouse.
As a result, zero inventory is sometimes called a just-in-time stocking model. New inventory is produced or purchased just in time to fill new orders.
Why Is Zero Inventory Important for Businesses?
Imagine a company that manufactures and sells wooden lawn furniture. The company purchases raw materials from its suppliers — wood, screws and bolts, paint and stains — and then builds furniture in its shops. Completed goods are moved into a warehouse before being sold to customers. At any given time, assume the company has $1 million in completed products and $2 million in raw materials inventory at its warehouse, for which it pays $50,000 per year in rent.
Now imagine the company is interested in expanding its operations, but it doesn't have sufficient capital to finance that expansion. One of the primary benefits of a zero inventory strategy is that it avoids tying up large amounts of capital in inventory, which can instead be used to pursue other business goals.
Zero Inventory Advantages
The advantages of zero inventory management are primarily financial. With it, a company sitting on millions of dollars' worth of products and supplies can reduce the value of inventory on hand to almost zero, freeing up funds that can be spent on other needs, like payroll or expansion.
Additionally, a zero inventory strategy can cut down on carrying costs. Inventory is expensive to store and maintain, in addition to the financial impacts of tying up valuable capital. Companies need space to store materials, and that space costs money, either through rent or taxes and depreciation or the opportunity costs of not using that space for other productive activities. Moreover, some goods need to be refrigerated, like produce, closely guarded against theft, like jewelry or generally protected from nature's elements. All those special considerations increase the carrying costs.
Keeping large amounts of stock on hand also tends to increase insurance costs for a business. A $500,000 warehouse holding $2 million of goods represents a much more significant risk to an insurer than that same warehouse holding just $50,000 in inventory.
Finally, a zero inventory approach dramatically reduces or eliminates the risk of spoilage and dead stock, or goods that can no longer be sold. Spoilage can refer to anything with an expiration date, like food, personal care products or medication.
Companies sitting on large amounts of perishable goods face the risk of those goods going bad before they're sold, at which point the value of those goods is just lost. Dead stock is more applicable to items that don't "go bad" but can lose their appeal based on changing fashion trends or seasonality, like clothing. That is one reason why retailers offer hefty discounts on holiday decorations after the holiday has passed. Those decorations are on their way to becoming dead stock, and the company wants to sell them while they still have some value, so they aren't a total loss.
Despite the great advantages to using a zero inventory approach there are some potential drawbacks, or disadvantages, to be aware of:
Unexpected peaks in demand may hamper a company’s ability to fill orders in a timely manner and could also disrupt the supply chain. Many companies have faced this situation during the pandemic, especially during its initial emergence. This can also occur during natural disasters (e.g., hurricanes).
Short-term pricing from suppliers may be high adding costs for the company. Again, this has been seen quite frequently during the pandemic as certain types of products (e.g., toilet paper, lumber) became hard-to-find and prices shot up dramatically.
Reliance on one, or just a few, suppliers.
Finding alternative sources of inventory during period of high demand and rising prices may be difficult and can challenge the ability to cost-effectively manage the supply chain. Small companies, in particular, may not have the time or budget to handle these situations and meet customer needs.
The overall process of effectively managing a zero inventory process can be complex requiring more training and experience for employees.
Still, those companies leveraging zero inventory management have found that it can work well in certain situations.
Zero Inventory Examples
To better understand how zero inventory works in practice, it's helpful to consider some examples.
Custom Suits
High-end, bespoke suits are typically designed for a specific wearer. While most formal clothing retailers keep standard pant and jacket sizes on hand for shoppers to pick from in-store, custom suits are created by taking the measurements of a specific customer who also selects the desired fabric type, pattern, color and more.
While the tailor could choose to keep some material on hand as inventory, it does not need to stock a large selection of assorted sizes and styles of pants and jackets because customers don't expect to go into the store and leave the same day with a new suit.
Pass-through Retailers
Online retail's tremendous growth has increasingly allowed retail websites to act as online marketplaces, the middle persons between goods producers and customers. For example, an online retailer like eBay with established relationships with hundreds of individual producers can advertise the products of those producers on its online shopping portal, giving customers a single destination for a wide variety of shopping needs. Whenever an order is placed online, eBay notifies the seller, which ships the goods to the purchaser and eBay profits from the transaction fees it charges on sales.
A company with this business model wouldn't need to keep any inventory of its own. However, the risk it faces is that fulfillment times are entirely under its suppliers' control. For this reason, Amazon and other smaller online distributors maintain inventory for a variety of products that are high-volume sales items.
How to Achieve Zero Inventory
A zero inventory strategy requires tight coordination of supply chains, accurately forecasting demand and the ability to fulfill new orders as they come in through new production or procurement instead of a stock of existing inventory.
Achieving zero inventory, therefore, requires the following:
Demand Forecasting: A zero inventory strategy is all about timing a company's supply of goods to demand from customers. In an ideal world, the company would finish building or acquiring a new product when a customer orders that item, meaning it spends zero time as stagnant inventory. One way to achieve this is to become very good at forecasting customer demand. Companies can do this by looking at historical data to find trends in seasonal buying patterns, for example, or using market analysis to predict future trends. Depending on the industry, a company may contractually agree to long-term purchase agreements with its key customers in advance. That would add more demand certainty.
Swift, Agile Production: Goods-producing companies that pursue a zero inventory strategy try to keep production in sync with demand planning so that new orders are aligned with newly created products via frequent production runs. Companies with swift, agile production capabilities have a significant advantage in achieving this. For example, if an unexpected order for 500 units comes in, a company that can quickly ramp up production to complete and ship end products has an advantage in meeting that unplanned demand without relying on existing stock.
Close Coordination with Suppliers: Companies that sell goods fulfill their orders one of two ways: they either build the goods they sell or buy them from someone else, like a wholesaler. In either case, they typically work with multiple suppliers. To achieve zero inventory, as a company receives new orders or forecasts future orders, it needs to be able to procure just the right amount of new raw materials or wholesale goods. That requires having a solid relationship with suppliers that can quickly respond to the business's needs. Without such suppliers, customer orders go unfilled or are significantly delayed, meaning lost sales and unhappy customers.
Close Coordination with Customers: The end of the supply chain is, of course, the customer. In general, companies want to fulfill orders as quickly as possible to keep customers happy and avoid losing sales to competitors. But some customer relationships aren't as transactional, and customers may be willing to work with suppliers to allow a longer time to fulfill custom orders. For example, a tailor producing custom, high-end suits often make the sale after taking the customer's measurements and agreeing on a fabric and design. Similarly, B2B customers placing large orders often understand that the producer needs some time to complete the order and can't necessarily fulfill it right away from existing inventory.
Zero Inventory and Supply Chain
A zero inventory strategy's success is dependent on properly managing the supply chain. It's essential to understand the dynamics of the relationships between manufacturers and their suppliers when it comes to stock on hand. Most companies want to keep supply levels low, even if they aren't explicitly pursuing a zero inventory strategy.
So, what happens when a manufacturer decides it wants to pursue a zero inventory strategy and only order raw materials in quantities sufficient to meet forecasted demand or to meet new orders? In this case, the manufacturer no longer needs to maintain raw materials in inventory, but the burden is effectively shifted to the raw materials supplier. Instead of providing predictable quantities to the manufacturer every week or month, the materials supplier can only sell what the manufacturer needs or thinks it needs based on real-time demand. That means the supplier's inventory costs are likely to go up unless they can adjust their sourcing or production accordingly.
If a supplier's costs — including storage costs — go up, their customers often bear some of that cost through higher prices. That means that companies looking to pursue a zero inventory strategy should expect their sourcing costs to increase.
Zero Inventory and Stock Control
Zero inventory is an aspirational term and virtually every company that pursues this strategy can expect to have some — even if it's minimal — amount of supplies and products on hand. That inventory can be used to address emergencies and as a natural consequence of imperfect demand forecasting.
Keeping that inventory to a minimum requires clear visibility into all sales channels and inventory across locations. For example, if there is no available stock on hand of either finished goods or raw materials for a particular product, sales staff and online order pages should be updated to let customers know that the item is either unavailable or could take longer to receive.
Many companies pursuing a zero inventory strategy invest in supply chain management software to help provide visibility into the supply chain and manage the complex coordination of raw materials, finished goods and various sales channels. This software often includes a feature-rich inventory management system with order fulfillment capabilities to improve efficiency and traceability.
The size of storage and maintenance costs can be a surprise for many businesses, and minimizing those costs is one of the primary reasons companies pursue a zero inventory strategy. Achieving a zero inventory initiative requires close monitoring of and cooperation throughout the supply chain. Due to the complexity involved, many companies use software to support the leading supply chain management practices required to make zero inventory possible.
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Zero Inventory FAQs
Can you achieve zero inventory?
While many companies make great strides in drastically reducing their on-hand inventory in pursuit of a zero inventory strategy, in reality, it isn't practical to expect to achieve absolute zero inventory. Many companies want to keep an inventory buffer on hand in case of emergencies, and even without such a buffer, it's virtually impossible to ensure production or purchases exactly match sales all the time.
What are the 4 types of inventory?
Companies often divide their inventory into four categories:
Raw Materials: the inputs used to make the products a company sells. For example, wood is a raw material for furniture manufacturers.
Work in Progress (WIP): the partially completed goods a company is still working on, such as a half-built couch.
Finished Goods: the final product a business has created for sale to a customer, like a complete couch.
Maintenance, Repair and Overhaul (MRO): finished goods that have been damaged or require work and aren't currently ready for sale to customers, but they are close to being finished goods.
Would a zero inventory approach make sense for my company?
There's a solid chance it would! Companies of all kinds can benefit from keeping less stock on hand — both supplies to produce their goods and product ready to be shipped to customers. An inventory system that provides reliable data and allows companies to manage inventory tightly can significantly boost the bottom line. Once you understand the concept of zero inventory, you should have a good sense of whether the strategy would work for your organization and how it could be applied to your inventory management practices.
