Can Classical Inventory Management Models Be Used to Explain Aggregate Inventory Levels? Comparison of Korean and Western Firms
Authors:   Asia-Europe Perspective Association, Park Seung Jae 
Published: June 2018

Classical inventory management models which have taught in business schools (e. g., Economic Order Quantity model and newsvendor model), consider individual products. Using these simple models, students can learn which factors should be considered in inventory management, and trade-offs between the factors. For example, the Economic Order Quantity model shows that the ordering cost and inventory holding cost should be balanced when the demand rate is constant. The newsvendor model explores a situation in which demand is uncertain and there is one selling season. The model shows that the overage cost and the underage cost are the factors that should be considered in deciding ordering or production quantity, and thus a firm’s inventory. These models focus on how to manage or control single product inventory. However, managers and executives also want to learn how to explain changes in aggregate(i. e., firm-level) inventory levels. In this study, we analyze how useful classical inventory management models are to understand behavior of aggregate inventory levels. In the literature, most studies focus on to show that how inventory levels change as time goes by or the studies explore relationships between inventory factors and firm performance factors, such as return on sales or return on assets. In this study, we use information on 395 public Korean from 2010 to 2016, which include 110 firms listed on KOSPI 200, to show how the classical inventory management modes can be used to explain aggregate inventory levels and to explore differences on inventory management between Korean and the U. S. firm. Moreover, we investigate that whether there exist differences among firms that belong to conglomerates (i. e., chaebols) and medium- and small-sized firms. Similar to a previous study using data from the U. S. firms, we show that the aggregate inventory level increases as demand or firm size increases. In addition, the aggregate inventory level increases as demand uncertainty or lead time increases, and it increases as inventory holding costs decrease. However, different from the previous study, the aggregate inventory level decreases as the gross margin increases or a positive demand shock exists. This is because Korean firms tend to minimize inventory holding costs rather than maximizing profit from uncertain demand compared to the U. S. firms. In other words, the Korean firms manage inventory in more conservative ways than the U. S. firms, or the U. S. firms manage their inventory more aggressively than the Korean firms. When we compare inventory levels among firms that belong to conglomerates (i. e., chaebols) and medium- and small-sized firms, we find that inventory levels of firms in conglomerates can be mostly explained using classical inventory management models; whereas, those of medium- and small-sized firms can be partially explained. Hence, it seems that the managers in medium and small-sized firms need to learn inventory management models, which enables better inventory control for the corresponding firms. Therefore, the contributions of this study are the following. First, we show that managerial insights obtained from single product inventory management models are useful to explain aggregate inventory levels. Second, findings from foreign firm data should be verified using Korean data to apply the findings to Korean firms. In other words, many findings from the U. S. firm data can be useful to explain Korean firms, but verification of findings using Korean firm data must be accompanied.