Hedge Inventory

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Hedge inventory finds its roots in the term ‘hedging’.  Hedging which means reducing or controlling risk is a common practice in many industries and a not so common one in others.  Hedge inventory is actually very similar to anticipation inventory, except there is more risk and quite a bit less certainty in increased demand and decreased supply.

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​Hedge inventory is the excess inventory that is purchased in advance or held in stock as a protection against price increases.  The main objective of hedging is reducing or limiting any risk associated with future price fluctuations.  A secondary objective of hedging is to take advantage of future price fluctuations.
Examples of Price Fluctuations:

• If industry prices are rising, you would want to hedge when the supply cost is low.  This helps protect your net profit.  There are many reasons that price fluctuations could occur.  It may be the simple result of seasonal variations or even sudden market disruptions. 
• Changes in exchange rates.
• Political situations.
• Economic promotions.
• Clearance sales.
• Employee strikes.
• New government policies.
• Vendor shutdowns.

Hedge inventory can also be inventory that is built up for an event that has a very rare chance of happening.  Of course one should weigh the risk closely as this approach is avoided by most businesses since there is no guarantee on return.  
Example of Hedging:

• Let’s assume that our example involves a company that depends on a certain commodity.  Suppose that K&K’s oil is worried about the volatility in the price per barrel of oil. The company would be in deep trouble if the price of oil were to skyrocket because this would severely impact profits.  To protect against this, K&K can enter into a futures contract.  This contract hedging tool allows K&K to buy the oil at a specific price at a set future date and time.  Now, K&K can budget without worrying about the fluctuating price of oil.  Another way that K&K can hedge is by strategically buying up all the barrels of oil and holding the hedge inventory.  This now guarantees that if prices fluctuate, K&K’s cost will always remain constant and allow them to control their profit margins.

Two Types of Hedging:

1. Hedging inventory for a sale - Hedging inventory for a sale is when an organization hedges inventory so that they can avoid fluctuations in future sales.
2. Hedging inventory for a purchase - Hedging inventory for purchase is when a company hedges inventory to avoid future fluctuations in supply or purchases.

Summary:

• Hedge inventory is a method of building up inventory to protect against future events.  This requires a great deal of forecasting and speculation and should be done with caution.  Remember, inventory whether hedged or part of a regular cycle ties up assets.  And that’s it, Hedge inventory.

Challenge:

• What examples of Hedge Inventory can you think of?  Share your thoughts in the comments section below and receive a coupon to one of Lean Strategies International LLC's courses.