For many manufacturers, or distributors, as the end of a fiscal quarter or fiscal year approaches, it’s not uncommon for directives to come down from management to reduce inventory, slash safety stocks, delay purchases, delay receipts, or cut overtime.
Too often, a nearsighted approach is taken, simply to improve the balance sheet (or the financials for the investors). We tend to refer to this as ‘muscling’ the inventory down, simply to hit a number, without a more rigorous, or methodical, approach.
It’s vital to understand the long-term business ramifications of these inventory reduction initiatives, that may, or may not, achieve a short-term goal. Do the gains truly outweigh the costs and pains?
Lowering Safety Stocks and Eliminating Overtime
Many companies have a ‘blanket’ safety stock policy. This means that every item’s safety stock is set at X number of weeks of demand, as opposed to a statistically calculated safety stock, that takes into account factors like lead time, demand variability, and forecast error.
The approach doesn’t discriminate between items based on demand volume value, or variability. Thus, higher value and higher volume items are treated the same as lower volume/value items. This is where the business begins to suffer.
As the demands continue on the higher volume items, the lowered safety stock value is not sufficient for spikes in that demand. In combination with eliminating overtime, as the inventory levels continue to fall on the high runners, and there isn’t a way to catch up or re-supply inventories, as the overtime is avoided.
In addition, efficiencies are lost, as the company now has more set-ups and changeovers, due to the inability to align safety stocks, or inventories with economic run/order quantities. Inventory value may have been lowered, but at what cost?
As a result, the customer suffers as on-time delivery and service level performance deteriorates, oftentimes incurring fines on late/missed deliveries. Additionally, millions of revenue dollars are lost as a result of lost sales. Operating costs increase, due to excessive set-ups and changeovers in manufacturing. It can take a company 6 plus months to recover from a situation such as this.
Removing Safety Stock Values from the ERP System
Sometimes, a company will lower, or eliminate, safety stocks on the items that make up the significant portion of the business, eventually leading to delivery and service level issues. This is commonplace but not leading practice, as many companies have too much of the wrong inventory and not enough of the right inventory.
As a result, the only way to significantly influence the overall inventory metric is to reduce inventory on the items that are turning with the most frequency. These also tend to be the items with the highest customer demand and require the greater service levels. Consequently, a hand-to-mouth scenario emerges as there are consistent shortages across purchased components, manufactured assemblies and finished goods.
Subsequently, expedites of incoming materials and outgoing shipments increase costs. In addition, many sales orders then do not ship complete, requiring multiple shipments per sales order and incurring excess shipping costs.
Conversely, it is difficult to reduce inventory on items that carry excess levels of inventory, as they will only decrease at the mercy of the rate of sales. Many of these are slower moving items, and in some cases obsolete items. The inventory on these likely will not decrease quickly enough to match desired results, nor timing of management’s targeted directive.
Reducing Inventory While Making Business Improvements
The simple answer is to right-size the inventory, versus a generic across the board inventory reduction approach.
- Create segmentation models of your products. These segmentations may be one-dimensional or multi-dimensional.
- After building a segmentation model, deploy service level and inventory strategies per segment.
- Create a simple metrics dashboard to easily monitor several conflicting KPI’s. Companies cannot simply measure inventory alone. Sales wants higher service levels and more inventory, while operations wants less inventory and longer production runs. Sales and marketing want more variety of SKUs, while manufacturing prefers more standardization.
If you are looking to improve your working capital position, Tribridge may be able to help you quickly identify opportunities to improve your inventory levels strategically. To learn more, reach out to Tribridge to help.