Going Back to Basics

Many inventory professionals are so demand focused that they are not balancing supply, demand and finance in their operations. Too few owners and senior managers are asking tough questions of nor are asking for recommendations from inventory, purchasing and financial managers about how to improve their company’s inventory management approach. 

There are five critical steps your company needs to take when it comes to inventory management. 

Demand forecasting and accuracy: Try putting in place a demand analysis to uncover bias in product forecasts. There’s a tendency to rely entirely on the forecast of demand, which can fluctuate for any product. A a forecast is just that, so why not identify forecasting error exceptions (start with 20 percent), beginning with an emphasis on the process of good demand management?

Vendor lead time: Vendor lead-times vary. Success in reducing inventory and maximizing service levels 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 and/or how fast your computer system recognizes that the product has been received and is available for customer order allocation. Lead times are also often inflated, sometimes intentionally, as a “just-in-case” parameter. Your inventory manager should be able to provide and identify variances in lead time vs. what is expected or planned, as well as the dollar and service consequences of those variances. Put pressure on reducing the order-to-delivery lead time. Make a lean supply chain partnership with your vendors a break-through goal of your company.

Safety stock: Most computer systems provide for some calculation or set parameters by which to protect your inventory service levels against unusual demands or delays in product replenishment. Safety stocks should be a prime area of focus because they are directly related to forecast accuracy and lead-time variability. Often, upwards of 50 percent of a product’s inventory consists of safety stock. Try to stay away from set parameters such as a fixed safety stock quantity or a time-supply – such as two weeks – of stock. These methods generally lead to flabby inventory.

A-B-C stocking strategies (inventory segmentation): Most contemporary computer systems have some way to segment the inventory, typically called A-B-C demand analysis. Whether you do it based on “hits” (SKU velocity/popularity) or gross margin contribution, it’s important because you may want to set some different business rules for how you manage the inventory in each segment. From a business rule perspective, an “A-item” requires less safety stock as 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 that inventory management personnel truly understand the concept of metrics. I often find inventory managers that don’t know the expected value for their company or do not measure the metric at all. Companies should recognize beyond measurements such as inventory turns, “turn and earn” and/or gross margin return on investment to the financial impact a product, a product line or inventory segment has on profit contribution.

Setting Goals

Don’t let your computer system’s inventory replenishment module become a passive commodity. It’s time now to stretch your inventory management capabilities into an execution process. Use your reports to provide exception reporting to identify and analyze the impacts of your current inventory management processes. Use the results as a base line for continuous improvement. 

Establishing a goal to reduce inventory value such as 12 percent to 15 percent over and above getting rid of obsolete inventory within six months is doable. Make inventory reduction a cross-functional effort, with your finance manager in the lead. To start, ask that just 10 hours per week be dedicated to focusing on continuous improvement in demand management, supply and finance, tying your inventory and financial metrics together. Link your processes, organization, people’s knowledge, technology and performance measurement during the execution phase into a critical success factor for your organization. 

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