Inventory Analysis and Inventory Management

How Much Inventory Should I Hold?

One of the laws of supply of goods to a market is that companies hold enough inventory to satisfy customer demand, without holding too much. So intuitively, just the right quantities of stock to satisfy demand will minimise cost. However, when dealing with thousands of SKU's the art of balancing demand with supply is intricate. It becomes even more complex when multiple storage facilities are used, and customer service times are short and/or varied according to criticality of products.

What are the Cost Elements of Holding Stock?

Facility Costs; Inventory holding costs which includes rental on warehousing, mobile and static equipment, utilities, compliance costs e.g. for dangerous goods

Human Capital: Cost of labor to manage the stock and to move it, handle it and count it

Finance costs; When capital is tied up in inventories the cost of finance (interest), and/or lost opportunity cost of gaining returns elsewhere must be counted

Management Costs; White collar personnel and IT costs

Procurement Costs; Cost of purchase, including transport

Inventory Turnover: as a rule of thumb, the faster the stock turns over, the less it will cost to hold. However stock turns in some businesses (e.g. spare parts) will be very low (say 1-3 times per annum). Whereas stock turns in a FMCG business could be as high as 15-20 times per year. Regardless, increasing stock turns for any business to an optimal level will be beneficial.

Stock Accuracy: if stock records are wrong, large amounts of time and expense can be absorbed sorting them out. Ideally stock accuracy should be above 98% I.e. 98 times out of 100 the stock ‘on system’ matches the stock ‘in bin’

Pillage: Theft of goods. Unfortunately this occurs and is a cost to be factored in.

Ullage: Unexplained loss or damage to goods

Service Levels: Too rigid or a ‘single’ service level approach can cost dearly. For example the ‘Quality’ era maxim of supplying all goods anywhere, anytime, in any quantity can cost companies unduly as they attempt superhuman deliveries to unusual places.

So what is the Solution?

Know thy customer Service Levels
Note levels are plural! Companies that offer a single service level encourage margin erosion. Smart organisations profile their stock into three or four service classes to which they apply a specific service strategy. E.g. Class 1 is critical products e.g. medical products, or IT spare parts which must be supplied on a same day or next day basis. Class 2 are goods that are non critical but maybe needed to meet a specific market need e.g. cosmetics, home PCs etc. Typically they can be delivered to a schedule. Class 3 are goods that are needed over a longer time frame which the customer readily accepts e.g. furniture, made to order goods, luxury products etc. A further delineation must be made between retail, wholesale or end user customers. In any case, it pays to start with a good understanding of customer needs before advancing to the next stage.

Profile the Stock
Analyse your stock and demand history regularly to ensure that you know which items are generating 75% of your sales revenue and to which class of customers they are being delivered to. Then check your services levels and holding costs of the remaining products represented by 25% of sales. An additional exercise to review your warehouse order picking profiles in the same manner will also provide an interesting story. Reviewing, for example, movement by product by tonne, pallet, carton, each etc can lend amazing insight to operational issues and dynamics. With both of these analyses, Managers can detect issues and formulate strategy without too much difficulty.

Consider Vendor Managed Inventory Strategies
Some companies involved in manufacturing, integration or assembly rely on vendors to manage their own stocks until they are used at the production line. Under this arrangement, the manufacturer doesn't have to carry any stocks, and only pays for stock when used. This strategy is generally ideal for manufacturers but can load certain costs upon the vendor.

Consider Postponement logistics
Common to many international manufactures is the strategy of postponing final assembly of goods until demanded in the off shore market where they will be sold. This enables efficient storage of a smaller range of goods while offering a faster response to the designated market. This strategy has been used in the fashion industry with good effect, and also in hi technology industries such as appliances, computers and gaming. With a large number of companies moving manufacturing off shore to Asia, postponement logistics is becoming more fashionable and feasible for small scale production.

Excellent IT Systems that are well understood by both Managers and Employees
There is an enormous number of ERP and Warehouse Management Systems on the market which seemingly host and facilitate excellent management of inventory. Alas, often vendors of such and eventual operators do not really understand the science and art of inventory management. This can significantly impair effective use of these systems. It is therefore critical that knowledgeable and skillful practitioners are developed and used to manage inventories.

Inventory Forecasting
This is a challenging and inexact science and should only be attempted by courageous people who understand the dynamics of inventory management and how to use ERP sales and operations planning tools. Issues of independent, dependent demand materials requirement planning and master production schedules must all be understood to achieve forecasts within agreed parameters.