Inventory – can’t live with with it, can’t live without it. Let’s talk about how to balance the competing trade-offs of high service levels, the need to control costs, and freeing up cash – and how to make managing your inventory a whole lot easier.
We want to have sufficient inventory on hand to service customers and maximize sales, especially in a make-to-stock environment. Inventory, is of course, necessary. And there are plenty of reasons to hold lots of it.
Why Inventory is Good
By committing to higher levels of inventory we can optimize batch sizing to lower production costs and cost per item. By ordering more stock/materials we can optimize transportation costs. We can get price breaks by ordering higher volumes on a monthly basis vs lower volumes on a weekly basis.
Having inventory on hand limits fines for late delivery in the case of retailers like Walmart and Amazon. And a high level of inventory limits costs for expediting delivery for stock we didn’t have readily available. Having inventory ahead of a sale is cheaper than having to source it last minute.
The flipside is the cost of tying up cash in stock that isn’t selling. Right now we have a perfect storm of rising inflation where inventory/materials are more expensive to source, debt is more expensive to service, and sales are going down. In such an environment your CFO will be on your back to reduce inventory.
Why Inventory is Bad
Beyond the hard cost of dollars being tied up in assets sitting in storage, there is an opportunity cost associated with tying up capital in inventory. With that extra cash your company could shore up the balance sheet, service debt or deploy it for new initiatives. Storage is also a cost, not just in terms of the space but in terms of people and equipment required for warehousing.
Inventory also comes with damage and pilferage. What’s more, companies with short lifecycles face obsolescence, never being able to shift stock for certain items which have to be disposed of (another cost). Insurance is yet another cost, the premium being paid on the total assets your company holds.
So there are advantages to holding inventory and disadvantages to holding inventory. Finding a balance between the two that is right for your company is the holy grail of planning.
Lean Into Your Company’s Priorities
If you’re thinking I want on-time, in-full to be 99%, I want to have 24 turns a year, I want to have less than one week’s worth of inventory in stock, and I want to maximize my margin – wonderful, everybody wants that! One of those objectives, one is going to win, and it is up to you to decide which is most important. What are your company’s objectives? In the Cost-Service-Cash triangle, your company will naturally lean into one dimension more than the others, and it’s up to you make the trade-offs that support enterprise strategy.
Prioritize customer service, and your costs will increase and cash will be tied up. Prioritize cash, and you’ll have to accept that customer service will suffer and costs will increase. Prioritize lower costs, and service will decrease and cash gets tied up. Which dimension you need to prioritize most will inform your safety stock levels.
Stop Self-Inflicted Uncertainty Now!
There are certain things companies do that unintentionally introduce demand uncertainty, making it more difficult to know the required safety stocks. There are certain supply planning actions we can take to make inventory management more effective.
Beware Demand Shaping: IBF research reveals that a 1% reduction in uncertainty equals a 6% reduction in my safety stock. Dynamic pricing and promotions shift demand, causing uncertainty that has makes inventory management more complicated. While promotions may be necessary, there are consequences to adding in that demand variability.
Reduce your lead times: It’s not just about demand forecasting; proper supply management pays dividends when it comes to reducing the cost of holding inventory. On average, every 1% reduction in lead time results in a 0.95% percent reduction of safety stock.
More SKUs equal more inventory: I can’t believe that some people don’t understand that logic. More SKUs serving the same demand adds uncertainty without increasing the top line. A 10% reduction in SKUs represents a 5% reduction in safety stocks.
Lower your service levels for a given customer: Some customers won’t necessarily need the service level you’re providing, meaning that you can afford to carry less inventory. What does customer X really need, and what can you reasonably get away with?
Improve your supply chain planning at IBF’s Supply Chain Planning Boot Camp in Nashville, TN, from August 9-11, 2023. Learn best practices across demand management, supply planning, S&OP, distribution planning, inventory models, and more. Register your place.