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Managing Inventory in a Reset Economy
The year has started on a positive note for most distributors. In fact many of you reported that 2010 was a good year, as well. Most economic indicators show that the economy is heading in the right direction. Manufacturing activity as tracked by the Institute of Supply Management continues to recover. In this newsletter, The Distributor Board offers some suggestions on how to manage inventory, one of the largest asset classes for most distributors, in the new "reset" economy.
Key Performance Indicators
How do your key performance indicators (KPI) stack up to those of your peers? Here are a couple of KPIs and some industry specific values that may be helpful in your own review of inventory.
Sales and Marketing Plans
You have developed a sales and marketing plan for this year. Sales and Inventory management people should meet to review the sales volume forecast for the next 12-24 months. Are there new products, customers, or programs built into the plan that would be at risk if your primary supplier's capacity were to get tight? Is there an upside factor that should be built in to the volume forecast based on the market that your company serves?
If you have an ABC analysis of your items, you should update it with the latest data available in your system. Then a review of target stock levels for at least the A and B items should be completed.
Excess and Obsolete Items
If any of the above leads to the need to increase inventory levels, or even if it doesn't, have someone review your excess and obsolete items. There may be an opportunity to remove some inventory that is costing you money and taking up valuable space.
Meet with Purchasing and Inventory People
From an over-all supply perspective, you should meet with your purchasing and inventory people. Ask them to review and update current system parameters (i.e. lead time, planning values), critical commodities, inventory targets, and anything else in your business where good planning against the upside will reduce your risk.
Resist the Temptation to Increase Inventory
Even though your sales volume has increased, resist the temptation to increase inventory. If you feel comfortable with current levels and have been maintaining good customer service, there is nothing wrong with maintaining the status quo. If you do decide to increase inventories because of an increase in business, do it selectively, don't decide to add 5% in total, add what is needed item by item.
Expect Inventory to Fill the Space Available
We have walked through hundreds of warehouses. Rarely do we find one that is not almost full, or with open space in the racks. Before you add warehouse space, especially "temporary" outside storage, challenge yourself and your people to find a way to not take that step.
Reduce Cumulative Lead Times
Your business processes each take a specific amount of time. If you can reduce the amount of time or do more processes in parallel rather than sequentially, you can reduce the total system's lead time. You will have less inventory in your system as a result. For example, if the purchasing people can reduce the time it takes to issue orders to suppliers by 2 days using e Procurement techniques, 2 days worth of inventory should be permanently eliminated from your process. If new ERP software allows you to ship customer orders in 2 working days, rather than 4, take 2 more days of inventory out of the business.
Measure Accuracy, Velocity and Customer Service
Good inventory management starts with measurements, not software. Record accuracy is a measure of how well your "book" inventory matches the actual count by item and location. If your record accuracy is not at least 95-98%, your ERP system is giving your people bad information. If you rely on physicals to maintain inventory accuracy, consider initiating a cycle count program. You will get much better results.
The most common measure of velocity is turnover. Inventory turns are calculated with this equation
Turnover = Annual cost of goods sold / Average inventory in dollars
If you have $5.0 million of inventory and have $20.0 million annual cost of goods sold, you are turning your inventory 4 times a year (20,000,000/5,000,000). Turn rates vary by industry and type of business.
In a recent article published by Microsoft, John Schreibfeder suggests that once you have calculated your turns, you can multiply turns by gross margin percentage to create a Turn Earn index.
Turn Earn Index = Turnover x Gross Margin
For example: If a distributor has a turnover rate of 4 and a gross margin of 50%the Turn Earn index is 4 x 50 = 200. A distributor with 6 turns and 40% margin would have an index of 240. The index can be used at the product line or item level of detail which will provide you a good way to analyze various parts of your total business.
Customer service measurements can include orders shipped on time, unit or line fill percentages, returns, etc.
What are the big "upside" risks in your business? If the economy continues to improve and your business takes off, have you asked your suppliers about their capacity? Is there an opportunity to reduce your dependence on your biggest customers? Contact us if you need help determining the proper strategy and tactics to deal with the Reset Economy.