Basing purchasing decisions on gut instinct leads to many mistakes: it is far better to have a rational process set up. Optimal levels of inventory is a typical operations management problem.
It used to be argued that sub-optimal ordering results in a 1-5% loss in expected profit, which may not seem so bad after all as the impact on the business is not especially serious. If it is merely 1% of extra profit, the ROI may not be convincing enough for management actually to deal with the matter.
Is sub-optimal ordering a problem?
However, a recent paper suggests that profits might be boosted by up to 10% if a company adopts a more rigorous approach to ordering, as reported on the website of the INSEAD business school.
Researchers compared the results of a data-driven ordering policy to those of a capable, but inevitably biased purchasing manager. Participants were incentivised by cash to make the best orders. The computer followed a scientific method of calculating the right amount to order. In the end, the profits of humans were 15-20% worse.
Explaining the loss
We humans have a tendency to fall prey to our biases. Our decision making simply isn’t flawless. Many purchasing managers repeatedly under-order. When it comes to ordering the optimal quantity of products, many of them are 10-20% below what would be ideal.
This then leads to customers being unable to obtain the specific product they would like to purchase. They may buy a substitute product, but equally they may just head to the nearest competitor.
-jk-