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5 Improvements to Drive Inventory Effectiveness

Published on

Dec 10

Sheri Blaho

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Inventory is just the same as cash.

The way you control and manage your inventory may have the greatest potential for improving your organization’s bottom line and liquidity.  Any inventory that you are carrying above what the customer needs is a waste; a waste of cash, a waste of warehouse space, and a waste of all the labor resources it took to procure and stock the materials.    

These 5 Improvements will reduce stock-outs, increase accurate promise-delivery dates, increase customer retention, and reduce costly obsolescence of inventory.

One:  Maintain a Solid Forecast – Constantly

Many companies are now embracing an extension of planning called Sales, Inventory and Operation Planning (SIOP).  At one level, inventory always should have been part of Sales and Operation planning, it was hard enough just to develop a consensus for total sales volumes, let alone targeting the right inventory levels to meet that forecast. But as companies and tools evolve, this is the next level of planning.  

You should analyze stock codes for importance and behavior and then classify them in like groupings. Then generate the best possible estimate of demand or forecast for each stock code. The importance of this process cannot be understated. Its success should be measured through a suitable measure of forecast accuracy. For good reason, high forecast accuracy is often considered the holy grail of inventory management.

Two:  Ongoing Min/Max Level Maintenance

Other than sourcing and vendor negotiation, purchasing should be a “no–brainer.”  With an accurate forecast and the correct Min/Max levels, all necessary information should be readily available for the purchasing staff.  Establishing Min/Max levels is not a “one and done” activity.  They need to be reviewed routinely to accommodate changes in the market and changes in specific customer or supplier behavior. The 80/20 rule applies to almost every area in managing inventory.  80% of sales are typically derived from 20% of individual inventory stock items. Managing and maintaining accurate Min/Max levels for every stock item is not necessary.  Address your 20% fastest moving times and recalculate them at least every 6 months. It is wise to also establish min/max levels for your 20% highest cost stock items.

Minimum Level of Inventory:

Reorder level – Average or Normal Usage x Normal Re-order Period

Maximum Level of Inventory:

Reorder Level + Economic Order Quantity – (Minimum Rate of Usage x Minimum Lead Time)

Three: “Right Size” Your Safety Stock

Randomness is one of the elements identified in a good forecast process.  Randomness can’t be forecasted, but extra stock can be carried to mitigate the effects of it.  On the other hand, you don’t need to carry safety stock for predictable demand.  

Safety stock simply is inventory that is carried to prevent stock outs. Stock-outs stem from factors such as fluctuating customer demand, forecast inaccuracy, and variability in lead times for raw materials or manufacturing. Some operations

managers use gut feelings or hunches to set safety stock levels, while others base them on a portion of cycle stock level—10 or 20 percent, for example. While easy to execute, such techniques generally result in poor performance. A sound, mathematical approach to safety stock will not only justify the required inventory levels to business leaders but also balance the conflicting goals of maximizing customer service and minimizing inventory cost.

Four: Optimize your Warehouse

Warehouse Organization Chart

The efficiency with which inventory is stored directly affect corporate profitability.  Why?  Because receiving material, as well as processing and filling customer orders are costs of doing business.  Traditional warehouse organization or the “grocery store style” (laid out by category or material types) simplifies the locating of materials but impedes the stocking, picking and shipping process.  The cost and time for inventory management will be greatly reduce when the fastest moving products are closest to the shipping, staging and receiving area.  

Five:  Maintain Accurate Vendor Lead Times

If you expect a vendor to take 10 days to deliver goods but the goods are not available for 12 days, then you’ve just generated lost unit sales!  Knowing the correct lead time and having the ability to correct for changes in lead time is crucial.  Vendor lead times are defined as the time expired from when a purchase order is placed until the goods are received and available to sell or ship off the shelf.  Just like min/max levels, these need to be reviewed routinely for inventory stock items that fit the 80/20 rule; both fast moving and high-cost items.

The longer the lead time, the higher the total inventory level. Total inventory includes both stocks on hand and stock on order. Longer lead times also increase the dependence of your company on accurate forecasts. Indeed, when next day delivery is available, an erroneous order (too large or too small) can be fixed in 2 or 3 days by applying corrective measures. In cases involving overseas shipments, incorrect orders can penalize the company for 6 months or more.

BONUS: Make Sure Your Tools are Suitable

Improvements to any inventory process begin with reliable statistical information on which to base assumptions and recommendations.     Having systems in place that embrace current technology and current “Best Business Practices” is crucial.  These five recommendations will yield no value if the underlying data is not accurate or the toolset archaic.  Step one in an attempt to gain control over inventory is to ensure that inventory and ERP systems:

  • Can embrace your required business processes
  • Offer a single repository for all crucial data elements
  • Include decision tools to provide insight for Sales, Customer, and Vendors in addition to Inventory
  • Provide pre-emptive alerts and alarms for all critical business events
  • Provide unique, real-time, meaningful dashboards for each operational area
  • Provide easy to access data for historical analysis

If your business is operating with high inventory levels or inventory reduction initiatives are getting in the way of service delivery, then an inventory optimization tool should be very valuable in the application of the 5 Improvements for Inventory Effectiveness.  

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