You've reduced inventory. What's next?
Follow these simple steps to lower your inventory costs
by Howard Coleman
By this time, in response to the business environment, most distributors have focused on inventory reduction. Surely, as their computer systems respond to decreasing customer demand and the need for more working capital, they’ve reduced inventory. Companies have also taken a close look at slow movers and obsolete inventory, which is a grueling but necessary chore. But across-the-board inventory reduction mandates (reduce the inventory by 15%!) often expose inventory management systems to inequities and result in stock-outs and customer service failures.
In my travels, I’ve noticed that the folks responsible for inventory are so demand-focused that they don’t balance supply, demand and finance. Too few owners and senior managers ask tough questions and seek recommendations from their inventory, purchasing and financial managers on how to improve their company’s inventory management processes.
More companies need to focus on the “organic” components of inventory management to develop corrective actions and future best practices to improve their inventory management capabilities. Now is a good time to review the basics of inventory management.
Demand Forecasting and Accuracy
A demand analysis can uncover bias in product forecasts. Because of the automated replenishment process imbedded in most contemporary computer systems, I often see a tendency to rely entirely on demand forecasts. Demand can fluctuate for any product for reasons beyond the scope of this article. The fact is, a forecast is just that – a forecast. Why not identify forecasting error exceptions (start with 20%) from a perspective of both customer service levels and reducing inventory? Since the process of actual product replenishment is usually automated, this should allow time for a heavy emphasis on the process of good demand management, by inventory managers, and a focus on continuous improvement.
Vendor Lead Time
Vendor lead times vary. Your success in reducing inventory and maximizing service levels, at the lowest cost, is heavily influenced by how fast you can accumulate the proverbial freight pre-paid order and how fast your supplier partner can get inventory to you. Often, lead times are distorted because of supplier unreliability or how fast your computer system recognizes that the product has been received and is available for customer order allocation. Too often, I see lead times inflated, sometimes intentionally, as a just-in-case parameter. Your inventory manager should be able to identify variances in lead time versus what is expected or planned, as well as the dollar and service consequences of those variances. That information becomes the baseline for continuous improvement actions. Put pressure on reducing the order-to-delivery lead time. Get outside the four walls of your own business and ask your major vendors about their vision to reduce lead time. Make a lean supply chain partnership a breakthrough goal of your company!
Safety Stock
Most computer systems provide some calculation or parameter to protect your inventory service levels against unusual demands, delays in product replenishment and potential stockout. I’ve found, over and over again, that safety stocks should be a prime area of focus because safety stock is directly related to forecast accuracy and lead time variability, and can have a direct impact on safety stock inventory dollars. I often see upwards of 50% of a product’s inventory consisting of safety stock! Take a sampling of products you stock, some A’s, B’s and C’s, and I wager you will be surprised! Depending on the computer system you have, it may compute statistically based safety stock quantities or allow you to set a parameter such as a “fixed safety stock quantity” or a “time supply” such as two weeks supply of stock (the latter two rules-of-thumb methods generally lead to flabby inventory).
ABC stocking strategies (inventory segmentation)
Most contemporary computer systems have some way to segment the inventory, typically called “ABC Demand Analysis.” Whether you do it based on business drivers such a hits (popularity) or gross margin contribution, you may want to set different business rules (not assumptions) for managing inventory in each segment. The importance of an A item to customer service requirements versus a C item is obvious. Safety stock inventory investment is critical when you segment inventory. From a business rule perspective, more often than not, an A item requires less safety stock than a percentage of the item’s inventory, because its demand is usually more predictable. I typically recommend segmenting the inventory on a quarterly basis.
Critical Metrics
Make sure the people in charge of your inventory management truly understand the concept of turn-and-earn or gross margin return on investment (GMROI). I’m sorry to say that often I find inventory managers that don’t know the value or do not measure the metric. Beyond the familiar inventory turns measure, T&E/GMROI recognizes the financial impact a product, product line, or inventory segment makes to profit contribution.
Some Final Comments
Don’t let your computer system’s inventory replenishment module become a passive commodity. It is time now to extend your inventory management capabilities into an execution process. Most systems can provide pre-built reports or report writer capability. Use them to provide exception reporting to identify and analyze the impacts of your current inventory management processes. Use the results as a baseline for continuous improvement. The automation provided by most systems gives your inventory managers an opportunity to manage by exception, to use their time more wisely, and to really impact the efficiency of your inventory.
Establishing a goal to reduce inventory value 12% to 15% (over and above getting rid of obsolete inventory) within six months is doable. Make it a cross-functional effort, with your finance manager in the lead. Start by dedicating 10 hours per week from your inventory manager and others to focusing on continuous improvement in demand management, supply and finance. Tie your inventory and financial metrics together. Link your processes, your organization, your people’s knowledge, your technology and performance measurement into a critical success factor for your organization.
MCA Associates, a management consulting firm since 1986, works primarily with wholesale distribution companies providing operational excellence, idea leadership and implementation of continuous improvement solutions. Reach Howard Coleman at (203) 732-0603 or hcoleman@mcaassociates.com or online at www.mcaassociates.com.
This article originally appeared in the Sept./Oct. 2009 edition of Industrial Supply magazine. Copyright 2009, Direct Business Media, LLC.
INDUSTRIAL SUPPLY MAGAZINE
The November/December issue of Industrial Supply magazine features an in-depth cover story about Kimball Midwest. Plus, we're featuring articles by contributing writers Dirk Beveridge, Frank Hurtte, and Mike Marks, as well as interviews with numerous product and distribution industry experts.
