While most businesses want to practice optimal inventory control, there are various reasons why a business might instead consider hedging inventory. However, hedge inventory is significant, excess inventory not to be confused with safety stock—a reasonable amount of extra inventory kept on hand “just in case.” And when a business decides to purchase hedge inventory, there are a variety of inherent risks.
In this article, we’ll define hedging inventory, discuss when a business should consider inventory hedging, and review the risks of ordering too much inventory.
- Hedge inventory is inventory procured as protection against a potential supply disruption, change in a trade agreement or government policy, unacceptable increase in cost, or similar significant event.
- Hedge inventory is a form of “insurance,” and it requires spending cash upfront to secure extra supplies.
- Hedging inventory is not the same as maintaining safety stock and typically should not be used by a business to meet customer demand except under special circumstances.
What is hedging inventory?
Hedging inventory—or hedge inventory—is inventory that a business has purchased in anticipation of a significant, uncontrollable event that will likely make the inventory a business needs too challenging to acquire or too expensive to buy. In some instances, a business may also hedge inventory because a deal or promotion is too good to pass up.
Either way, businesses that hedge inventory believe they are mitigating risk by stockpiling excess inventory in this manner. That being said, hedging inventory comes with its own significant set of risks that we will touch on later in the article.
Hedge inventory example
Say a rice cake manufacturer has become aware that a severe drought is expected to drastically reduce rice supply by the second half of the calendar year. This business may purchase as much hedge inventory of rice as possible immediately to ensure its customer demands for rice cakes are met. Even though the business is spending a remarkable amount of cash on rice at the beginning of the year, key decision makers have decided this is the least risky option. That’s because later on, the rice cake manufacturer could face either exorbitantly high rice prices or a shortage that leaves them with no rice to buy at any price.
What businesses should consider hedging inventory?
Because hedge inventory requires businesses to purchase excess inventory that surpasses standard safety stock calculations, most experts agree that only businesses facing significant challenges should hedge inventory. In general, the following businesses might want to consider hedging inventory—if the benefits truly outweigh the risks:
- Businesses very concerned about the rising prices of a particular product
- Businesses that have identified legitimate instabilities that may threaten their access to inventory, including war, strikes, new government policies, or significant supply chain disruptions
- In certain circumstances, businesses whose vendors are offering genuinely exceptional promotions or liquidation sales
Remember that purchasing widespread excess inventory to “hedge” against inflation is often considered risky. Most businesses that purchase hedge inventory identify particular concerns about specific items on their inventory lists. When the prices of all supplies are the main concern, most companies instead renegotiate with their suppliers, raise prices for their customers, or both.
What are the risks of inventory hedging?
There are a variety of risks associated with excess inventory, and many of these risks are heightened when a business truly stockpiles supplies and materials.
In general, the chief risk of any inventory surplus is obsolescence. Obsolescence occurs when a business’s inventory is no longer usable or sellable. At that point, a company will often write the inventory off as a loss or liquidate it. Obsolete inventory is a concern for all businesses, but especially for businesses that stock inventory that expires, quickly goes out of style, or is sure to be replaced with a newer, better version regularly.
Another risk? Your business stockpiles so much inventory it cannot properly manage it. Usually, this happens because a business does not have the physical and strategic infrastructure to handle surplus inventory. Suppose your business decides that hedging inventory is the right decision. In that case, it should ensure that it has both the storage space and the inventory management system in place to keep that inventory organized.
The right inventory management software can help businesses keep track of hedge inventory across multiple locations. This can help you stay organized and try to extract as much value from the surplus inventory as possible. It’ll also help your team keep a close eye on how much of that hedge inventory is at risk of becoming obsolete.
Experience the simplest inventory management software.
Sortly is a top-rated inventory management software solution designed to help businesses keep track of supplies, materials, and assets. With Sortly’s powerful features and customizable reports, your team can better track inventory, understand typical usage, and accurately forecast future demand. That way, if and when you’re business is faced with a tough decision about hedging inventory, you’ll have a solid understanding of what your business truly needs to keep on hand—and whether investing in hedge inventory is prudent.
Curious whether Sortly can help your business understand its inventory better? Start a free, two-week trial today.