It is more expensive to keep inventory in several warehouses than in one for several reasons – you’ll have to pay rent, utilities, and maintenance costs for more than one location and you’ll have to hire staff to perform identical functions for each location. If your different locations are across the country, this may make sense; if your locations are relatively close together, this is an extra and unnecessary expense.
Another extra cost is the amount of money it will require you to order, receive, and store safety stock. The farther your inventory is spread out, the more safety stock you’ll need. Safety stock, as we’ve mentioned before, should be kept as low as possible without allowing backorders and a loss of customer satisfaction – a necessary evil, if you will.
How do you know how much extra safety stock will cost you? The required safety stock increases by the square root of the number of inventory locations. That is, if you are starting out with inventory at one location and you decide to disperse that inventory over four warehouses in different locations, then you will have to increase your safety stock by a factor of two.
This is called the square root law of inventory. There is a great deal of industry research and practice that supports it and in 1975 it was mathematically proven. Knowing this rule is extremely useful for parts inventory management.
Using our above example and looking at the law in reverse shows that keeping inventory under one roof rather than under four will reduce your safety stock requirements by 50%, which is a big savings.
Of course, there are other considerations that affect your costs. Freight expenses, delivery schedules, order quantities, and other similar things. The more widely distributed your client base is, the more important such factors – and the number of locations you have – become. If your clients are spread far and wide, keeping more than one location may be the key to customer satisfaction.
Something else to consider before consolidating multiple inventory locations is that the suppliers that are local to your centralized inventory may not have the capacity to keep your inventory at the required levels. If you have other warehouses in different parts of the country, you may need a supplier for each location.
While the square root law of inventory is important and can be a good indicator of how you’re managing your inventory, it shouldn’t be used in isolation of other factors.
Want to learn more about how to use the square root law of inventory or just about inventory management in general? Contact Acumen Information Systems today.
