Are You Inventory Rich and Cash Poor?
A contract manufacturer turns inventory 3.6 times. A retailer turns inventory 4.1 times. A wholesaler turns inventory 4.4 times.
What do these firms, in different businesses, have in common? They carry too much inventory. While where they each have the extra inventory may differ-raw, WIP or finished, they have too much money tied up in inventory.
From accounting and financial views, inventory is an asset, a positive, for businesses. Inventory is a buffer against uncertainty. The cycle time from when inventory is needed until it is received, sold and sales payment is received is very important to company success and longevity. The longer the cycle time is, then the larger the amount of inventory that will be carried to balance against uncertainty.
Inventory turns are important. Think of it this way. The above firms are being paid every 90 days. That is essentially, what four turns really means. No one would want to get a paycheck that infrequently. That is a lot of capital tied up earning nothing while it sits unsold and an incredible float on capital. So why do businesses operate that way and accept such performance?
Inventory has a “limited shelf-life”. There is a window of opportunity to sell the product. Once that window closes then the sales value of it decreases and the profitability and inventory yield are not maximized. In addition to the capital issue, excess inventory influences service and operations. Unnecessary freight costs were expended to bring the products in. The inventory works against having a good warehouse layout to reduce order picking. It adds to labor costs. If the company does cycle counting, then such inventory is counted too often and is a wasted time effort. Too much inventory can also mean having a distribution center larger than is really needed to store the extra items. So the cost and service impact is large. There is also restricts agility to adjust quickly to changing conditions.
WHAT CAUSES EXCESS INVENTORY? Businesses do not decide to carry too much inventory as part of a strategic plan. Inventory increases creep in; it is not a deliberate business decision to tie up too much capital in inventory. The reasons for excess inventory vary but some of the common ones are:
*Loss of sales fear. The fear of not having an item to sell is stronger than the fear of not being able to sell the item. So a hedge factor to carry more items and more inventories is necessary. Also, sales forecasts can be overly optimistic.
*Price deals. Companies take advantage of lower prices for volumes in excess of what they need or will use in a reasonable time. But it is “too good of a deal to pass up” even if it sits forever in inventory. Economical purchases may actually be uneconomical.
*Write-offs. Businesses are hesitant to write off the inventory and take the hit on the profit and loss for the year.
*No measures. Some firms do not aggressively measure and manage inventory, inventory turns, inventory aging, inventory velocity or give inventory a less than adequate recognition. They may not even categorize as to “A”, “B” and “C”.
*Limited inventory planning. Planning is not based on demand management or similar technologies. Instead, it is more of an intuitive activity. With the long lead-times for items, especially those imported, this compounds the problem.
*Supplier performance. Suppliers are not managed even when suppliers fail to ship or deliver more than 25% of purchase orders on time. Firms build in extra time to receive their orders. They carry extra inventory to compensate for the supplier delivery issues. Poor supplier performance generates increased inventories because of its unreliability and extended time to deliver.
*No process. Buying and ordering inventory are transactions, a reaction to a need, perceived or real. It is a form of fire fighting. There are no company-wide strategic processes for customers, sourcing or tactical process for sales and operations planning. Procedures, whether for inventory or other purposes, may be used instead that reflect the lack of process(es). Expediting is another sign of no process. Inventory is used to compensate for the lack of process or for lack of execution.
*One approach fits all. The inventory strategy is not segmented to reflect differences in inventory as to profitability and turn velocity. Firms end up carrying too much inventory, especially for slower turning items-the “C” and “D” items.
A company can have too much inventory for than the reasons shown above. Often the inventory buildup is not done from one cause only. Instead, multiple causes create the over-inventory situation. The multiple reasons reflect the lack of underlying priority, process and control.
WHAT CAN BE DONE? Excess inventory does not have to be accepted as a way of doing business. Eliminating the causes of extra inventory is important. Some options include:
*Strategy and process. Develop a strategy and a process to manage inventory. This must come from the top down within the company. Without sustained executive commitment, this will be a frustrating endeavor. Some of the essentials should be-
– Measure inventory. You have to know where you are and where you are going. Develop metrics as to inventory velocity, aging and turns.
– Implement lean across the company. Excess inventory and additional time are waste and add no value to the product. Many departments can create non-value time and inventory. Lean is very similar to supply chain management with its emphasis on pull for product movement. Lean is a key tool to identifying and reducing unnecessary inventory.
– Look at the entire supply chain. While assessing the total supply chain, distinguish the inbound supply chain from the outbound supply chain in designing and implementing the strategy. Otherwise, the cycle time and resultant inventory are blurred. Also, develop multiple transport and stocking programs to reflect the segmentation of inventory. Firms that have supply chain management as part of the core competency and strategic focus perform better in controlling inventory across the supply chain.
Segment inventory by velocity and by profitability. Unbundle it to understand where inventory exist, why it is and how it occurs.
Make inventory part of the overall company direction with regard to its role in customers, sales and profits.
Implement a sales and operations planning program that ties to both customer and sourcing strategies.
– Compress time. Uncertainty-and inventory buffers-increase with time. Reduce the time from the need for inventory until it is sold. This is very important with lead times for critical items and for imports that have long transit times. Compression should occur both internal and external to the company.
– Develop reliability. Vagaries in the supply chain compound uncertainty and increase inventory. Reliability throughout the supply chain is imperative to reducing uncertainty and inventory.
– Be creative. Find what works for your company. Do not imitate what others do. Do not be restrained by existing company practices and “rules” that were developed for reasons that are long forgotten.
*Distribution network. Warehouse locations may have been established years ago under economic conditions that have changed. Many warehouses can increase the total inventory carried because of the extra safety stock. Too few can mean longer transport distances and can have more inventories in transit than on shelves. Determine the optimal network for today’s business.
*Supplier performance. Make it a key part of the inventory management and of the sourcing strategy. Manage purchase orders. There is much more than low-prices in vendor selection.
*Effect of global sourcing. Long transit times across the Pacific and other trade lanes affect the inventories that firms may carry. Analyze the impact of such sourcing and determine how to address the inventory impact.
*Outside assistance. There are two options here. There is the one-time help that can be provided by a supply chain management consulting firm. There is also the ongoing approach that can be provided by a 4PL or 3PL to manage the inbound or outbound supply chain. The 4PL should be a neutral party whose focus is supply chain management and does not bring a possible “conflict of interest” by wanting the firm’s freight or warehouse activity that some 3PLs do. 3PLs and 4PLs that can see the supply chain, not just freight or pallets, can be valuable partners.
CONCLUSION. Increasing inventory turns and velocity is critical to business profitability and survival. Reducing inventory and preventing buildup of unnecessary inventory is not a quick fix. It took time to get into the problem. It will take time to get out of it. In addition, it is easy to slip back into the same problem. It will take constant focus and determination.
LTD provides logistics consulting for strategic and tactical needs. The scope of capabilities is broad–supply chain management, outsourcing, transportation, warehousing, inventory management, and more for both domestic and international needs. Clients include retailers, wholesalers/distributors, manufacturers, logistics service providers and 3PLs.