This article was updated in March 2023 to reflect new trends, current information, and more.
Different business owners and inventory managers will have varied approaches to inventory control. A business owners’ approach to inventory management will determine the company’s inventory levels, which can be make-or-break for any business selling goods.
Getting inventory to an optimum level so that demand is consistently met by supply - and vice versa - is key to the success of companies selling goods. Get the balance wrong, and you may risk running low on inventory and upsetting your customers. On the other end of the spectrum, if inventory levels aren’t ideal, you may also risk holding excess or obsolete stock, resulting in inaccessible cash tied up in old stock.
For these reasons, it is essential that business owners determine the best model possible for nurturing inventory levels to get them ‘just right’. In this article, we look into two key models of inventory management: the deterministic model and the probabilistic model.
The probabilistic and deterministic inventory models are used to structure an inventory strategy based on demand predictability.What is a deterministic inventory model?
A deterministic inventory model is one where inventory control is structured on the basis that all variables associated with inventory are known, predictable and can be predicted with a fair amount of certainty. Because of this, inventory is counted, tracked, stocked and ordered according to a stable set of assumptions that largely remain the same. With a deterministic model, it is presumed that factors such as lead time will remain stagnant.
In practice, a deterministic approach to inventory may see business owners or inventory managers blindly ordering inventory without considering variables that are subject to change. This may lead to, for example, over ordering a certain item in inventory on the basis that it has been popular over the past few months, without considering whether the trend may have passed (or may be about to pass).
In this situation, the company may end up with inventory gathering dust on shelves which is nearly impossible to sell, resulting in reduced profitability.
What is a probabilistic inventory model?
On the other end of the spectrum is the probabilistic model, which says that there is generally some degree of uncertainty associated with inventory variables, the demand pattern in particular. With this model, everything inventory control related is predicated on the assumption that demand may fluctuate and may not always be predictable.
In practice, a probabilistic approach would be informed by the assumption that not everything is certain, especially relating to inventory. A probabilistic approach allows for fluctuations in demand and considers this when it comes to managing inventory.
Because of this, a probabilistic model may be the preferred approach for many business owners and inventory managers. By identifying changes in demand, inventory can be managed appropriately so that supply is neither excessive nor inadequate. When it comes to ordering inventory, historic sales trends won’t be the only factor taken into account but will be one of the various factors that will influence the final order.
By using a probabilistic model, inventory will be more adaptable, and therefore easier to mould along-side external changes.
How well you're able to predict customer demand based on historical data will determine whether you should opt for the probabilistic or deterministic inventory models.Deterministic vs probabilistic: What's the difference?
The deterministic model is where it is assumed that there is no fluctuation in parameters affecting inventory such as demand, lead times and shipping times (which influence supply). On the contrary, the probabilistic model assumes that there is always some level of uncertainty associated with these parameters which must be considered. In reality, the probabilistic model can often be more useful as uncertainties are inevitable and must always be considered.
