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Master the Art of Inventory Optimization

By Nelson Valderrama

Staying afloat in today’s business climate is no small feat, but by mastering the art of inventory optimization, distributors will improve inventory and working capital to beat many challenges.

When sales projections start to soften and inventory rises, sales and purchasing tensions begin to simmer. Rather than relying on guesswork alone, distributors should learn how to work smarter, putting processes in place that will save money while delivering results. 

Three things are essential when optimizing a company’s inventory: materials, information, and money. Unless these critical resources flow smoothly, little else matters. After all, the distribution function’s strength depends entirely on ensuring these building blocks stay in place. 

To begin, ask these six questions that get to the heart of what makes a successful inventory optimization initiative:

1. Is demand planning/forecasting a strategic senior-level position, or is it a part of an operations activity?

2. Is the movement of information and money as critical in the supply chain as the movement of materials? In other words, does it take longer to create paperwork and process payments than it takes to deliver the goods?

3. Is there an easy-to-understand report or visualization supporting customer demand?
Does it measure service levels?

4. Is it clear who will take responsibility for ensuring the organization’s overstock situation? Do frequent touchpoints measure the health of the inventory? Is there “a designated hero” experienced and able to avoid surplus disasters?

5. Is there a record of success in returning excess inventory with vendors who allow annual returns?

6. Is the CEO or manager supporting intuition and experience in inventory optimization with data? 

Answers to these questions provide a self-assessment tool to spark an internal dialog around the importance of materials, information, and money. 

Information Is Queen

Accurate forecasting presents a difficult balancing act for distributors. They must strike the perfect balance between (1) correctly predicting demand variability,
(2) considering rapid market changes, (3) and navigating new products added last year. 

Just as Netflix applies machine learning to our viewing history to personalize the recommendations – so we all stay glued to the screen longer – distributors must be able to anticipate their customers’ future choices. They need the data to decide what products to stock and how much to put on the shelf.

One way to overcome this challenge is to use data analytics to track customer buying patterns and forecast demand. With deep analysis of the quote and sales data, distributors can identify trends and practices that can help them predict future demand. They can also use customer feedback and market research to gain insight into what products and services customers are likely to need (or discontinue). Accurate sales forecasts are essential for businesses to make smart shopping decisions. Knowing what, when, and how much to buy ahead of time is vital to ensuring success. Predicting the future like that takes some serious forecasting finesse.

Managing the cost of inventory presents another challenge to inventory optimization. Distributors must balance the cost of holding the stock against the cost of stockouts. If distributors carry too much inventory, they risk wasting valuable resources. They lose money while financing that inventory by not providing a fair return on investment from the owner’s capital or interest paid for a revolving credit line.

On the other hand, if they hold too little inventory, they risk stockouts and lost sales. To overcome this challenge, distributors can leverage their ERP system to track
inventory levels and set replenishment parameters. Moreover, distributors can use cost-benefit analysis to evaluate different inventory strategies and determine the optimal inventory levels to hold. 

Delving into distributors’ inventory strategies has revealed that most only use the bare minimum of their ERP’s capabilities. For instance, one distributor relied solely on “min/max” settings for each item even though they offered little assistance when dealing with their spot buys. Even worse, they applied just one or two replenishment parameters to all items. Distributors will feel comfortable with current inventory strategies if they know all the replenishment parameters in their ERP. 

Dealing with supplier issues creates a third challenge to inventory optimization. Distributors often rely on various suppliers to provide them with the products and services they need. However, supplier issues − late deliveries, quality issues, price fluctuations, and more − can disrupt inventory levels and lead to stockouts and lost sales.

To mitigate these risks, distributors must establish strong relationships with key suppliers and work with them to develop reliable delivery schedules and quality standards. They must use supplier scorecards to track supplier performance and identify potential issues before they become problematic by managing their inventory
on order. 

Managing inventory on order has to be a top priority. After all, that 45,000-piece order from September should not go into the excess inventory bucket this year. To stay on track and keep up with the ever-shifting data points − forecast, backlog, open Pos, and sales – distributors need an effective process to track trends; at least a Push-Pull Report.

Money Is King! 

Too often, chasing profits distracts many business leaders. They need to remember the importance of their balance sheet. But proper working capital management is a powerful tool to free up liquidity and avoid dramatic staff cuts, something every leadership team must explore.

Optimizing working capital is challenging. Leaders are often blind to liquidity performance. P&L-focused financial reporting fails to capture the nuances of working capital performance, and managers’ incentives often must be more in line with working capital. The biggest challenge lies in getting everyone on board − from the top brass down through the daily operations staff. Only then does the cash conversion cycle improve; the “pipe dream” becomes an achievable reality across all functions.

Identifying Areas Of Opportunity 

Companies striving to improve their working capital know that a deep understanding of the existing cash situation is critical. An experienced team is vital to
detecting all potential opportunities, including: improved inventory turnover rate, increased DPO (Days Payable Outstanding) efficiency, or integrated payment technology solutions. One technique worth consideration is suspending extra discounts for customers who do
not pay within the terms.

• Managing payables: Successful distributors give their suppliers the VIP treatment they deserve and ensure that payments arrive on time! They streamline internal processes, gracefully extend payment terms, and make transactions that fly efficiently.
• Managing inventory: Successful distributors will cut the fat but not skimp on service! They will trim unhealthy stock to streamline operations. They look hard at those products that are not performing, so they can focus attention where it counts – a healthy inventory. These distributors will start with Gross Margin Return on Inventory Investment. This sneaky tracking technique knows who, what and when to ask for a higher profit result with one streamlined equation that instantly identifies two money-making levers easily understood by all.
• Managing cash: Successful distributors know that effective cash management is the key to unlocking their full business potential. Improving working capital can provide advantages from added liquidity and higher enterprise value to improved credit ratings – everything needed for a company’s success. 

Of course, each organization must tailor its approach to fit its operational environment. Its leaders must commit to building an embedded culture focused on maximized working capital. 

Nelson Valderrama is CEO of Intuilize, a web-based application designed to work in tandem with your ERP (and other digital technologies) to provide price optimization for forward-thinking distributors. For over two decades, he has managed the exponential growth of large and midsize companies, including GE and private equity firms, to increase their profits by optimizing pricing and inventory systems without compromising their original model. He can be reached at: nelson@intuilize.com

This article originally appeared in the March/April 2023 issue of Industrial Supply magazine. Copyright 2023, Direct Business Media.

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