The amount of inventory required to run a business effectively is always a concern. If you have too much cash flow problems can result, too little and you run the risk of poor customer service. How can you run your business effectively and still maintain a reasonable amount of inventory? The cost of carrying inventory can run 30% or more of the value of the inventory per year. $10,000,000 of inventory can cost you $3,000,000 per year for the privilege of carrying it.
This article does not attempt to tell you in detail how to reduce your inventory. Rather it gives you a method and points you in the right direction. The rest is up to you.
Here is the general principle: Ignoring obsolete inventory (we’ll talk about that below) you probably have the inventory required to provide the customer service you desire. If this is true, it follows that you cannot reduce your inventory without affecting customer service unless you change your business process to provide a higher level of service with less inventory.
Here are seven ways to do that.
- Improve your data accuracy – If you don’t know how much you have or where it is, it’s as if it doesn’t exist. The question “What is your inventory accuracy?” often gets the answer, “I don’t know”, “Lousy” or some low percentage. Its difficult to maintain inventory accuracy without a well designed cycle counting system. Our experience has been that a well designed and implemented cycle counting system pays for itself in a very short time. This is not merely counting things from time to time. It is a system designed to identify and solve inventory system problems.
- Reduce your lead time – The longer your lead time, the more inventory you have in your system. A client with a 22 week customer lead time could produce a “rush” order in one week. The manufacturing process was the same. The difference was that the rush order didn’t sit on the shop floor in long lines of WIP inventory waiting for something to happen. Don’t put it on the floor unless you intend to do something with it.
- Increase the velocity of your operation – The amount of inventory you have has little to do with your level of customer service. It has more to do with how fast you can replace it. If it takes six weeks to replace an item, you must reorder with at least six weeks (plus safety stock and “Just in Case” inventory) supply or you risk a stock out. If you can replace the same item in one day, a two day supply will give you more than enough to fill any order and a stock out is only for one day, not until the next batch is produced.
- Eliminate misalignment from your process – Many companies buy raw material in thousands, produce product in hundreds and sell in units. These misalignments create large quantities of inventory that run the risk of slow movement, obsolescence and damage, not to mention tying up valuable cash. Most companies justify this behavior based on “economies of scale”. Careful analysis shows that this should be called “false economy of scale.” Buy just what you need, produce at the rate of customer consumption. Refine your material acquisition process and change your manufacturing process to produce in smaller batches. Just in Time techniques are targeted at eliminating misalignment.
- Clean your attic – Many companies want to be “all things to all people”. I’ve had clients tell me, “If we don’t carry that item (typically ordered once a year if that often), our customer won’t buy from us.” My response is “Where else would they go to buy it, no one else carries it!” I’ve also heard, “Someone will buy it some day,” “We spent too much money on it to throw it away”, and, the best one of all “We’ve written it off, so it doesn’t cost us anything”. Turn all those mistakes into whatever cash you can. Liquidate, donate, have a sale. Set an inventory turns target and increase an item’s turns by increasing its velocity or get rid of it. If your customers leave you because you don’t carry some obsolete inventory item, you’ve got bigger problems than this paper can address.
- Eliminate variation – Erratic vendors, yield problems on the shop floor and other quality problems cause unneeded inventory to pile up because the response is order early, order more than we need, start more than the forecast and increase safety stocks throughout the system. If a product has an 80% yield and you need 100 units, on average you need to start 125 units to average 100 units completed. The trouble is you will only get 100 units 50% of the time! So one quickly learns to start 140, 150 or more to insure a yield of 100 every time! Sometimes this results in 120 units completed and the extras go into inventory, not to mention the extra raw material and capacity required.
- Replenish based on market demand – Forecasts are great and necessary but they are no more than educated guesses. And the farther out into the future the forecast the higher the probability that the guess will be very wrong. To use market demand to replenish finished goods keeps the inventory level aligned with what customers are actually buying. Of course you will have to do all of the above six things well to do this effectively, but it’s possible. So there it is. In these days of ERP systems, information technology and other high tech systems, it almost seems too simple. I can assure you that these things are easier to talk about than to execute, but the payoff is worth it.
Categorised in: Supply Chain Management