July 28, 2013
Inventory policies drive two types of costs: period operating expenses and working capital requirements. The latest Logistics Cost and Service Report published by Establish Inc./Herbert W. Davis and Company, indicates that, while total logistics costs as a percent of sales are falling and most individual companies have succeeded in reducing inventory levels; total logistics costs per hundredweight are increasing, and inventory costs as a percent of total logistics cost are increasing.
In many organizations, however, the opportunities to reduce inventory costs are often not addressed at all or are not completely exploited. If your organization needs help taking money out of inventory there are strategies you can employ today that will provide payoff.
Some of these strategies address having less active inventory, others how you acquire active inventory, and still others require transferring inventory or relying on vendors for better inventory management. Regardless of which you choose to explore, proactive inventory management policies will make a difference in your operations. Here are some of the most common techniques for lowering inventory levels.
- Base Cycle Stock on Economics: For purchased products, getting a handle on your acquisition transaction costs will either reduce average inventory or allow for reducing purchasing and receiving labor. For manufactured products, if production equipment changeover costs are in a similar state, getting them in place will either reduce average inventory through shorter runs or allow for reducing changeover and receiving labor through longer runs.
- Reduce Order Transaction Costs: In the office, use the computer to generate purchase orders (POs), EDI for PO transmission, advance shipping notices (ASNs) to reduce expediting, and historical vendor performance to prioritize expediting to lower purchasing costs. In the manufacturing plant, pre-planning; pre-staging of needed parts or materials; use of special tools or equipment; changeover initiation prior to completion of the previous run; teamwork and work-division; maintaining equipment temperatures; and minimizing QA / QC work all reduce cycle stock inventory. In the distribution center (DC), pallet manifest-based receiving processes, counting scales, statistics-based inspection and checking, bar code scanners for data entry, certifying key vendors to eliminate receiving functions, and stocking forward storage locations first and reserve locations second can all reduce purchase transaction costs and cycle stock accordingly. Purchase transaction costs are not normally SKU-specific. However, reflecting any extraordinarily low receiving costs associated with specific SKUs will serve to reduce inventory for them. The opposite, of course, is also true.
- Lower Inventory Holding Costs: Improve space utilization in leased, contract, or public warehouses (or to minimize or delay expansion of owned facilities) through narrow aisle handling equipment, mezzanines, layout, or more appropriate storage modes.
- Base Safety Stock on Customer Service: Prioritizing SKUs consistent with corporate objectives, using the appropriate number of product classes, establishing class sizes that leverage the investment to maximize fill rates, updating safety stock levels dynamically and basing the service levels for each class on the financial goals of the business all serve to either reduce safety stock inventory, reduce out-of-stock situations or increase revenue.
- Forecast Routine Demand Forecasting: Using manually edited, naïve, arithmetic / stochastic forecasting models to reduce forecast error will reduce overstock, backorders, and the need for lateral or reverse logistics, holding inventory levels closest to only that required to support the desired customer service level. Editing history to eliminate non-recurring promotions and to compensate for out-of-stock situations is key.
- Forecast Future One-time Events Based on Past Events: Future promotions and other one-time events can be best forecast from extensive data on similar events from the past. Holding records in a centralized database avoids the issue of the data leaving with the last sales representative. Extending the data format to include not just SKU, retailer, date and lift, but also relative degree of advertizing, duration, price reduction, if any number of locations, or other factors, makes the information infinitely more useful for the future.
- Think Postponement: For parent products from which multiple SKUs can be manufactured, only partially completing manufacturing, placing semi-finished product in inventory, and then completing manufacturing of the final SKUs to order reduces total inventory. In a similar manner, component products from which final SKUs may be assembled can be purchased to inventory and then the final SKUs assembled to order, providing that the time for assembly doesn’t exceed the customer lead time.
- Rationalize SKUs: Removal of inappropriate product from the product line can be a controversy-ridden process, but may reduce inventory significantly if handled in a constructive manner, as follows:
Reduce Acquisition Lead Times: For either manufactured or purchased product, any reduction in lead time, whether supplier lead time, transportation time or receiving cycle time, provides a one-time, permanent reduction in cycle stock inventory proportional to the throughput level of the SKU and the degree of lead time reduction. In a similar manner, reducing lead time variability and increasing inbound unit-, SKU-, or order-fill rates both increase supply reliability and reduce safety stock inventory for a given customer service level.
Implement Joint Procurement for Purchased Products: Joint procurement of multiple SKUs from a common supplier serves to effectively reduce unit purchase transaction costs and thereby reduces both cycle stock inventory and annual purchase transaction expenses. In a similar manner, joint procurement of multiple SKUs from different suppliers located in close physical proximity and consolidation of inbound (LTL) volume to form full TLs serves to reduce the incremental transportation cost portion of purchase transaction costs and reduce cycle stock inventory.
- Develop consensus on the objective of maximizing profit
- Develop activity-based costs for each SKU and separate them into three groups:
1. Those with selling prices that create positive gross margin
2. Those with selling prices that cover their variable cost but do not completely cover their fixed cost
3. Those with selling prices that do not cover their variable cost
- Quantify the sales volume correlations between SKUs, based on the analysis of both individual orders and aggregate order patterns by customer
- Identify the combination of SKUs which maximizes profit on a fully-absorbed basis
Minimize Purchase Minimums: Comparing the total cost of ownership, including inventory holding costs (i.e., not just landed costs) for purchased products’ quoted prices with no order quantity limitations with reduced prices requiring minimum order quantities (MOQs) will help determine if the reduced prices really provide savings. An uninformed purchaser’s interaction:
Purchaser: Can I buy _____ at the same volume but at a lower unit cost?
Sales Representative: Sure, we can reduce your cost by __% if you purchase in minimum order quantities of _______ .
Purchaser: Sure, no problem!
(When the annual holding cost for the increased inventory due to the minimum order quantity more than offsets the annual purchase cost reduction, the higher unit cost with no minimum order requirements has a lower cost.)
Get Downstream Forecasts and Send Forecast Upstream: Hard information on upcoming needs from customers reduces demand variability and forecast error, thus reducing the safety stock required for a given customer service level. Sharing demand forecasts with suppliers is more indirect; however, in the long run it will serve to reduce the supplier’s finished goods inventory and associated costs and, with effective negotiation, yield lower unit purchase prices.
Don’t Stock It, or If Some Stocking is Required, At Least Not Everywhere: For a single storage location, manufacturing or purchasing product to order when the acquisition and customer lead time relationships and order quantity relationships allow it is a very direct way to reduce inventory, providing that the acquisition capacity exceeds the potential short-term demand rate. Likewise, in a network of storage locations, not stocking every SKU in every location can reduce both inventory and transportation costs.
Cross-dock Customer Shipments: With effective use of joint replenishment, the potential increases in inbound transportation costs associated with purchasing to order can be mitigated. Cross-docking customer shipments can facilitate purchasing to order even when the order quantity relationship would have otherwise dictated purchasing to inventory. In a similar manner, aggregating purchase requirements for multiple DCs into a single order and cross-docking to multiple DCs effectively reduces purchase transaction costs and reduces cycle stock inventory.
Extend Payment Terms: When negotiating long- term purchase agreements, getting the best payment terms at a given unit price is the most direct way to increase the portion of inventory funded by the vendor. If improving payment terms can be coupled with increased turnover, then the improvement in working capital effectiveness is significant.
Take Advantage of Price/Quantity Breaks: Taking price/quantity breaks into account when purchasing for replenishment seems an obvious way to reduce the inventory investment, but seems to be frequently overlooked. Often this is a result of either not quantifying breaks at the time of sourcing or negotiation, not having an effortless way to take them into account, or through lack of understanding of the impact of purchasing larger quantities at reduced unit cost.
Transfer Instead of Purchase: When an overstock SKU in one location needs to be purchased to replenish inventory in another location, transfers are a smart way to reduce inventory, provided that the additional warehousing and transportation expenses are not so high that the reduction in holding cost does not exceed the cost to transfer.
Liquidate: Although there will always be a short-term price to pay on the profit and loss (P&L) and the balance sheet, when it is absolutely clear that the value to be gained through liquidation –whether through sale at reduced price, sale as distressed product, salvage, or charitable donation – is greater than the most optimistic estimate of future gross margin from conventional product sales, then liquidation is the best decision.
Merge-In-Transit: The concept of in-transit product merging-where, for example, two things are shipped from different locations and then married in transit so that they reach the customer as a single shipment-can be seen as a technique for reducing inventory if the need for the customer to simultaneously receive multiple SKUs is taken as a requirement. If the need for simultaneous receipt is a given, then the concept eliminates the need for inventorying the individual SKUs together. To some extent, merge-in-transit represents an extension of postponement beyond the distribution center walls.
Get Help From Friends: Collaborative Planning and Replenishment (CPFR) is an open set of pre-defined business processes and IT/communications standards created to facilitate collaboration between supply chain partners. CPFR can reduce inventories through inventory balance, forecast, demand and other data visibility and associated collaboration in the planning area.
Use Vendor-Managed Inventory (VMI) and Vendor Stocking Programs (VSP): With the appropriate incentives, allowing VMI suppliers to assume the responsibility for replenishment of your inventory, because of their visibility into both their own inventory and production schedule and your demand data, can almost always reduce your inventory. Used primarily for maintenance inventories but applicable to all, VSPs require a supplier to commit to an extremely high service level for delivery of specific SKUs within a fixed time at a pre-defined mark-up over cost. VSPs can reduce or eliminate inventories for slow-moving products.
Estimate Reserves Accurately: Accurate estimating of reserves avoids year-end surprises. Estimates should be based on a realistic view of both inventory accuracy and the viability of product sale.
Maintain Accurate Inventory Balances: Inaccurate inventory balances undermine the very best forecasting and safety stock management processes. They can always be addressed with effective cycle counting and issue root cause identification efforts.
Exploit Sales and Operations Planning (S&OP): At their very best, effective S&OP programs facilitate good decision-making to compensate for the real life issues, which will always occur above and beyond the best planning efforts. At the least, they begin to get everyone on the same page regarding the capacity, timing and other issues between actual demand and available supply.
Measure Performance: Reporting, posting in public locations internally, and reviewing performance results with natural work teams lay the groundwork for continuous improvement. In highly seasonal businesses, providing last year’s results along with this year’s facilitates same time last year comparisons, which may be much more meaningful than this month versus last month.
There are numerous ways to take better control of inventory and decrease its associated costs. Many of these strategies may seem challenging to implement; however, they have all been used successfully for years. The key to managing inventory successfully is to continuously measure your performance and look for new ways to improve.
These 25 strategies should get your organization thinking about what it can do to lower inventory costs.
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