Don’t Reduce Excess Inventory, Avoid Creating It

January 1, 2011

Many articles have been written over the years on how to reduce excess inventory. I want to tell you how to avoid creating excess inventory in the first place.

Excess inventory is to be avoided for several reasons. First, it takes cash to buy or build inventory. Many companies borrow to support their short-term cash needs. When you borrow, you pay interest. Every dollar paid in interest comes right off the bottom line. Second, excess inventory takes up space. You may have to rent space to store the excess materials you are carrying. Third, you typically have to count your inventory either in a year end physical or by cycle counting it on an on going basis. Either way, counting costs you money. I could go on, suffice to say there are many reasons why you want to avoid creating excess inventory.

The following method of avoiding excess inventory comes from a methodology called Inventory Quality Ratio.

If you want to avoid excess, you have to understand the root causes that create it and take steps to eliminate them. Some typical root causes of excess inventory include; not adjusting order quantities and due dates when requirements change, accepting orders early from suppliers, and planning factors that are either out of date or just plain wrong. In the short space I have here, I’ll focus on the planning factors. Critical planning factors include safety stock, lead times, lot sizes and order policies such as minimum order quantities, and order multipliers.

To identify and correct these root causes, you must have a way to identify the parts that have potential problems. For example, you need to compare safety stock to future requirements. A good rule of thumb is to question the reason that any part has safety stock greater than one month’s requirements. Following that rule of thumb, you want to create a list from your planning system of all parts where safety stock is greater than one month’s requirements. For each part on that list, you should verify that you have so much variance in demand or supply that you need that level of safety stock. If you do not have high levels of variance, reduce the safety stock level to a more reasonable level.

The same process should be applied to each potential root cause. Extract a list of parts with lot sizes that are large compared to the current requirements. Identify all parts with order policies that bring in large number of periods worth of inventory. Look at parts with significant minimum order quantities or high order multipliers. With those lists in hand, verify that all these planning factors are appropriate to current requirements and correct those that are not.

Notice that in all the root cause analysis, I recommend comparing the planning factors to the current requirements. All too often companies set planning factors on parts once and don’t make the time to adjust them as circumstances change. Comparing planning factors to current demand is a great way to avoid excess.

Instead of trying to figure out how to reduce excess after it already exists, avoid excess in the first place by identifying the root causes of excess and correcting them on a regular and on going basis.

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