Radical Inventory Reduction

January 1, 2011

Companies, like all organisms, only change in response to fear or pain. We can use the current climate of fear and pain to make real change, even radical change. Companies are looking for anyway they can find to keep costs down and reduce the need for working capital. Reducing inventory levels is one of the biggest opportunities to affect real change.

Companies periodically look at slow moving inventory and either reduce its price to spur sales or, write it off and scrap it. A survey of 400 companies conducted by IQR, www.InventoryPerformance.com, revealed that slow/no move inventory comprised about 10% of the total inventory value. If you could dispose of all of that inventory, you could make a meaningful improvement, but 10% is hardly radical.

To bring real change, we need to do something radical. We need a way to reduce inventory 20, 30 or 40%. Below we’ve identified four steps to radically reduce inventory.

  1. Understand what you’ve got
    • Divide your inventory into one of three categories:
      1. active – meaning you have either near term requirements or recent past usage;
      2. excess – meaning you have requirements or history but you have more inventory than you need in the short term;
      3. slow/no-move – meaning there are no requirements and no recent usage history.
  2. Set Targets
    • You need to analyze the real potential for inventory reduction. By definition, you need all of the active inventory. Estimate how much of slow moving inventory you can dispose of through quick price reductions or by throwing it away. The same IQR study, mentioned earlier, found that excess made up 30-50% of the total inventory dollars. Estimate how much of the excess you could reduce by canceling or deferring purchase and manufacturing orders.
    • You may want different targets for different categories of inventory. For example you might want a zero percent reduction of active inventory, a 25% reduction of slow move and a 60 % reduction in excess inventory.
    • You need to define how the bottom line will be affected by the reductions. You should define such measures as contribution to profit, reduction of financial reserves, and impact to cash flow.
  3. Take the actions necessary to meet your goals
    • Do a Pareto analysis (80/20 rule) of the inventory so that you work the part numbers with the greatest reduction for potential first. Each planner and/or buyer should document specific actions that they will take to reduce their excess.
  4. Track performance & take corrective action
    • Keep track of the monetary value of the reduction you are achieving. Graph your progress no less than weekly. Track by inventory segment so you know where you are meeting your goals and where you need to take corrective action.

Reducing inventory levels remains one of the best ways to free up working capital, improve cash flow and bottom line performance. The current recession can be used as a reason to make real, even radical change. Follow these four steps to make a big improvement in your inventory performance.

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