In the first of this mini-series, Pat Bower of Combe Inc. reveals the quickest and easiest ways to reduce inventory. Detailing the preferred methods used by leading S&OP professionals and consultants, he discusses how to cut poor quality or obsolete inventory for significant cost savings. Read on for quick improvements that can be leveraged easily in any supply chain focused organization. This week Pat discusses the two easiest inventory reduction initiatives: improving inventory quality and inventory classification.
Identifying Easy Targets For Inventory Reduction
As a consultant hired looking to improve supply chain efficiency in many different businesses, I would look for inventory reduction opportunities that could be implemented without much in the way of research, tool, or infrastructure changes, with the intent of yielding measurable inventory reduction results within a two-to three-month time frame. I call these Inventory Quick Hits. But where do these opportunities lie? In most cases, Quick Hits are a subset of the below inventory reduction solutions, but are narrower in scope and focus:
- Improve inventory quality by reclassifying R&D inventory and removing junk inventory.
- Testing and get control over forecast bias.
- Keep an eye on products in transition so you can manage supply chain parameters reflective of their phase in the product life cycle.
- Examine waste and yield percentages as well as QC (Quality Control) hold time.
- Examine “actual” buy-side tolerances.
- Investigate size, component, and formula consolidation opportunities. Look for easy-to-implement product and component.
Quick Hit 1: Improve Inventory Quality
Inventory has many classifications: active, slow-moving, obsolete, and inactive or run-out mode. Inventory that turns quickly and is actively sold is thought to be of high quality, while inventory that is slow moving, has no turn over, is obsolete, or residual is considered low quality. This “junk” or low-quality inventory is a favorite target of inventory consultants trying to reduce inventory. Slow-moving inventory has low volume sales or consumption relative to on-hand inventory. It simply does not turn over that fast or frequently. There are countless potential reasons why inventory is slow moving.
It’s possible that inventory turns slowly because of batch sizing, where each production run makes a large portion of an annual forecast, or because the product’s demand is slowly eroding, or for other reasons. Reducing slow-moving inventory requires a reassessment of supply chain parameters such as batch sizes, EOQs (Economic Order Quantity), and the like.
By contrast, obsolete inventory has no demand, and is often a combination of residual finished goods and leftover components. Obsolete inventory has lost the primary customer base, and the only sales opportunities it has are typically in distress or closeout channels. Run-out inventory is typically a combination of finished goods and components that are still being sold, but clearly are at the end of the product life cycle. Inventory is often placed in a run-out mode to help reduce the final inventory liability and may be kept as an active finished good, even with a greatly reduced customer base as a placeholder for a new product introduction. Run-out inventory usually requires a greater understanding of what the total inventory liabilities are as well as the possible disposal options. Inactive inventory generally has no raw material or packaging consumption for some period of time, typically six months to a year. It is not uncommon for ongoing finished good sales to be maintained for a variety of reasons, including trying to exhaust raw and packaging liabilities, or to cater to a niche market, or a special customer.
Analyse Inventory Holding Costs Vs. Potential Liability Savings
Eventually, when the finished goods or components are exhausted, the product ceases to exist, and the raw and pack components will be inactivated. In one company, for example, we observed there was a considerable inactive inventory for components sold into foreign affiliate markets. Despite the fact that components were ordered in the smallest possible increment, a single production run yielded enough finished goods inventory to cover demand for a couple of years. These unused components sat idle for a number of years waiting for the next production run. An analysis of inventory holding costs vs. potential liability savings are typically a first step in determining whether the inventory should be held. Most planning systems (ERP or SCM) have some variation of reporting tools for slow or not-moving, obsolete and excess inventory (often referred to as SLOB) that planners can run to examine any inventory that has not been used in the last 12 months or more, or that has exceeded coverage tolerances. Such reporting is very helpful in targeting inventory that falls into the junk classification, yet in our experience it’s often under-utilized. The quick-hit opportunity for inventory reduction is really focused on becoming very familiar with this reporting.
Understand Why Inventory Is Not Turning
Certainly, finished goods inventories should be examined, but the real opportunity is usually with the raw, pack, and component inventory left unused for 12 months or with excess coverage. There are many reasons why this excess inventory exists, including discontinuations, poor EOQs, packaging changes, and formula changes. The real magic in this suggestion is not to simply toss out the old inventory, but to get to the root cause of why inventory is not turning, and see if there are ways to correct the problem from a planning perspective. To get a better grasp of this “junk” and to create a unified metric for inventory quality, you may want to use tools that provide an Inventory Quality Ratio, (IQR) in which active inventory (net of excess, slow-moving, inactive, or obsolete) is divided by the total inventory.
In a newly developed S&OP process, the inventory quality ratio (IQR) can be an important metric used to track overall inventory values. Some companies have a very high percentage of slow-moving, inactive, or obsolete inventory. When I was consulting, it was not uncommon to see clients with low-quality inventory in the range of 25% to 50%. Periodic reviews and measurement of inventory quality, followed by purging the warehouses and plants of useless products, is among the simplest ways to reduce inventory.
Quick Hit 2: Reclassify R&D Inventory
This is a bit of a variation on the “cleanup of junk inventory” theme. Inventory should be properly classified from an accounting perspective and yet it is not uncommon for companies to accidently place inventory used for research and development purposes into an active (everyday use ) status. For example, a company that makes mixes, compounds, or blends chemistry may have a slew of random R&D chemicals, materials, or components that have been mistakenly classified as active production inventory. The list of companies with misclassified inventory includes more than just big industrial/commodity chemical companies— OTC pharma, cosmetics firms, health, beauty, and even food manufacturers blend chemistry. How does inventory get misclassified?
Cut 2% Of Misclassified Inventory Right Away
Sometimes inventory is ordered using the wrong accounting code, and sometimes-unused production inventory (mostly chemical compounds) of obsolete products are saved for a future R&D use. Either way, this inventory is often sitting on the books in an active status yet has no consumption or use against it, historically or planned. A full review of inventory may reveal a number of these odd ducks; one such review at a client revealed that over half of the inventory saved for future R&D use was expired and unusable, even for research purposes. While the percentage of this type of misclassified inventory is relatively small (usually within 1%- 2%), experience has taught us that most of it serves little useful purpose and occupies valuable storage space, making it a relatively easy target for reducing your total inventory tally. A full review of all active items with little to no consumption over the last year or more is likely to turn up in some of these stray inventory exceptions.
These two quick hits are easy targets for inventory reduction, and should be your first port of call when attempting to streamline inventory. They often provide significant cost savings in a relatively short amount of time, and with relatively little effort. Next weeks Quick Hits are Testing for Forecast Bias and Keeping An Eye On Product Transition. Stay tuned!
This post has been adapted from an article that appeared in The Journal of Business Forecasting, Fall 2011 issue. To receive the Journal of Business Forecasting, and wide range of other benefits, become an IBF member today.
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