Inventory Management

A.    Inventory Management Targets:

(I thought it is worthwhile to publish this again ... what do you think?

1.    Never miss a ‘sale’. A lost sale costs the gross marging of the sale. That is = Value of the sale less the materials cost in the product to be sold.

2.    Minimise Inventory. Without missing a sale. The cost of holding the necessary inventory is less than the lost sales. System should be goal seeking – it should constantly seek the optimum of never missing a sale and minimal inventory.

3.    Minimise the cost of replenishment. In most cases the cost of replenishment is the incremental or the variable cost. Materials plus transportation costs are the incremental or totally variable costs. (There may be other variable costs to consider like commissions or royalties based on sales volumes - € or amounts). Production cost to consider is only materials cost )totally variable cost). The fixed cost is fixed. It varies only when a significant change occurs.

B.    The way inventory management can work.

1.    Inventory management should be dynamic – constantly moving in the direction of the optimum. It should be dynamic because supply, demand and lead times are dynamic.

2.    We start with a inventory target (by item). The target will change as the parameters change.

3.    The target is split into 3 (equal) zones:

•  The bottom third (in terms of quantity) is the red zone. You do not want to be in the red zone because of the risk of missing sales (current and future.
• The middle third  is your yellow zone. It is where inventory amounts should be. Not to much and not too little inventory.
• The top zone is the green zone. Green does not mean good! It means you have too much.

4.    Increase or decrease an item’s target depending of the location of an its inventory. In the red – increase the target to reduce the risk of a stock out. In the green, decrease the target – you have to much.

5.    When to change the target? You need some rules to change your target . For instance 1 incursion into the red during a defined period (say replenishment time) is not suficient to change your target. You want a responsive but not a nervouse inventory management.

6.    Optimising the zones. You may want to do this. However it may be more work than it is worth. Be careful you do not try to optimise within the noise.

C.     What is such a computerised system worth? What should you expect?

1.    Customer satisfaction increases. You are able to always supply or you can set parameters to ensure 99% or 95% or 90% availability. You set your system to whatev er level is appropriate to customer wishes and how you want your performance vs competition to be.

2.    Sales increase. If customer satuisfaction improves sales will eventually also increase. Of course it depends on how your competitors respond.

3.    Inventory declines. The system moves towards the optimum. Experience tells us that most inventory management reduce their stock levels and increase product availability.

4.    Planning and scheduling production. Production gets an improved view of the inventory and demand situation. They are in a better position to plan production optimally.

5.    Costs and investment decrease. If planning and scheduling can do a better job then production cost decreases and distribution needs less inventory.

6.    Profit and ROI improve. When all the above happens, the profit ann return on investment both improve.

D.    The Future: As all the above happens your capacity utilisation increases. At some point (around 85-90% sales to capacity) your ability to meet all demand on time begins to deteriorate. It is time to act to increase capacity or to limit or stop sales growth. You do not want to lose satisfied customers – it will become more difficult to when them back when you, eventually, do increase capacity. The cost of delay is lost salles and the high cost of recovery. Plan for the future early!