A critical analysis of BHP inventory policy

The Broken Hill Proprietary Company Limited and its subsidiaries are the sole producers of iron and crude steel in Australia. Being a monopoly with some social conscience, and having been threatened in the past with nationalisation, the Company is very sensitive to its position in this key growth industry. Failures to meet the demand for steel in Australia have occurred a number of times in the post-war period despite the Company policy of planning productive capacity to be at least ten percent ahead of forecast steel demand.

A failure by a Company to meet demand means of course a loss of potential profit. A failure by a company which is the sole supplier however has more serious implications since users have no alternative internal source of supply, and when this failure is in a key industry such as the steel industry the repercussions are felt throughout the economy. In order to avoid such failures a suggestion was made to plan productive capacity fifteen percent ahead of demand forecasts.

This study arose then from simulations to determine the situations which would arise if the Broken Hill Proprietary Company planned productive capacity to be fifteen percent ahead of total steel demand. A study such as this must necessarily be undertaken on a highly aggregative basis. The Company can produce an almost infinite number of steel products and naturally some aggregation would be necessary no matter what the demand study. An idea of the main categories of total steel demand may be gained from Diagram 2. Even this degree of dissemination is too complex a problem and thus only the total of the demand in these categories is taken as the variable: total steel demand.

As would be expected, the simulations consistently lead to substantial excess capacity and therefore, since BHP has a policy of not holding stocks of finished goods, producing only to firm orders, to regularly idle or slowed down plant. Running such plant at less than full capacity means increased costs of production and it was this that lead me to investigate the possibilities of alternative markets for steel. Access to all alternative markets seemed to be reliant to a large degree upon the rapid availability of the required steel. The export market, and the great advantages in meeting demand as it arises in this area is the ideal example.

At present BHP has a firm policy not to hold inventories of iron or steel. There are good financial reasons for this decision. For example, holding costs are incurred by their customers rather than by the company and these costs are considerable. However this study shows that if BHP were to hold inventory the costs are substantially outweighed by attendant gains since the very valid reasons for any firm maintaining inventory must hold also for BHP, both in the competitive sphere and especially in the area of production efficiency.

This paper then first looks at the simulations, the patterns of demand arising from them and their implications for BHP. The major part of the paper then follows in which the costs and likely gains for BHP holding inventory are investigated. The conclusion is that there is an a priori case for the holding of such inventory and that such a policy would warrant intensive investigation.