Supply planners are often given responsibility for inventory, but few have an understanding of the strategic and tactical role inventory plays. Invariably inventory is seen as evil, it is a mantra of the modern supply chain. Yet many costs are incurred keeping inventory as low as possible, often several multiples of the cost of holding inventory. Here is the first sensible article I have seen on inventory management in a long, long, time. If you are struggling with setting inventory levels, this article spells out why. The usual response to ‘high’ inventory levels comes in two flavours: The forecast needs to be better or the IT system is poor. Cue massive spending on IT systems and yet another study on how to improve forecasting. And nothing changes. Why?
In our experience, and according to the article’s author, Lora Cecere, now backed with some solid research results, there is a significant lack of understanding why inventory is necessary and the role that it plays in supply chains.
‘In the benchmark data, companies that had clarity on inventory goals and understood inventory drivers cross-functionally make the most improvement.’
So what drives inventory levels? Here’s a short list, not exhaustive, but some of the most important factors.
Demand volatility: The forecast is invariably wrong, and by how much is important and will drive your inventory strategy.
Manufacturing capacity: The drive for Lean processes, and the emphasis on asset utilisation means there is less spare capacity to buffer demand volatility.
Out-sourcing and off-shoring: This may reduce piece-costs, but it will increase inventory, usually in finished goods in warehouses and in the distribution channel.
Production cycle-times: To meet cost-targets, manufacturers want longer runs, fewer change-overs and longer lead-times.
In-transit materials and finished goods: Globalisation has lead to significantly longer freight times for many products.
Material costs: Many processes use highly valuable materials, often in small quantities, but the total cost of this inventory can have a huge impact on inventory turns.
Promotions: Marketing promotions can frequently require stock-piling of inventory to meet a one-off demand spike.
Inventory then is valuable, both in terms of the investment in working capital and its role in satisfying customer requirements. It is therefore getting the right amounts of it that is important.
Decisions about inventory need to be reached based on a full understanding of the business strategy. For example, production cycle times that are too short will increase costs and impact on gross margins. High finished goods safety stocks can both increase inventory carrying costs and reduce production and distribution cycle times, further destroying value. Using a more agile manufacturing strategy to increase manufacturing buffer capacity may be a more successful tactic, especially if asset utilisation improvement is not a key supply-chain success factor.
Inventory decisions are usually trade-offs vs other key business tactics and strategic aims. If demand is highly elastic towards price, then large inventories and long supply-chains may be the only way to survive, as manufacturing in lower-cost locations is essential. The key-point is understanding how your customer’s demands are changing, and how the supply chains need to react. In the UK for example, omni-channel is already real, and those slower to react have taken a beating, not on price, but on customer service. On the other hand, once mighty players such as Tesco have taken a pounding as newer retail players have cut away vast swathes of customers with highly innovative customer offerings, that demand cost-effective supply chains, and pricing that moves inventory swiftly through their channel.
Inventory management is an important part in how you keep your supply chain Triple-A, and the skill in managing inventory is highly indicative of how successful you are as a company. All functional areas need to have input into the decisions, and the end-to-end inventory level required is an emergent factor of the strategy and tactics of the entire supply chain. Inventory management is not an isolated discipline that supply planners set parameters for based on arbitrary decisions about safety stocks, cycle-times, order-fill rates and the year-end closing inventory targets. Driving inventory down requires changing strategic choices and tactics, and just cutting safety stocks or reducing cycle-times may not always be the process that yields the best results.
About: Rob Ward has extensive global experience working in supply chain organisations. He co-founded Cosmapec to help companies and executive teams establish, develop and optimise their supply chains.