A few years ago, a colleague recounted a consulting job he had just undertaken. The client was struggling to make a large enough profit, which was threatening to derail their expansion plan. This revolved around moving to a larger facility as they had outgrown their current warehouse. The client perceived the problem as lack of sales and wanted my colleague to look at ways they could increase revenue so as to fund the expansion.
The real problem, however, was inventory. The client had a warehouse full of old inventory that they hadn’t sold in years and not enough room to accommodate the inventory that they were actually selling.
Problem easily solved, right? Just get rid of the old stuff and then there is plenty of room for the inventory that sells and no need to move to a larger, more expensive facility. Well, it wasn’t that easy. When deciding what to get rid of, more often than not it was a case of 'Hey, I need that – I might sell it one day.'
What is the right inventory level for your business?
If you left it to the sales team to decide, it would be as much as possible of every stock item in every location at all times, just in case they get that big order that needs to be delivered tomorrow. If left to finance, it would be as little as possible of as few as possible stock items in the least possible locations, and 'let’s not pay the supplier until we have sold it and have the money in the bank.' The trick is, how do you find the right level and maintain it.
Spring clean – Look at all items that have a low stock turn and look to get rid of them. At worst you free up shelf space and the resources to maintain that inventory, and best case you can sell it to a liquidator or similar and realize some cash that can be used to purchase good, fast-moving stock.
ABC rating – Categorize your inventory. Your fast-moving, high margin items will be ‘A’s; ‘B’s will be fast moving with lower margin; ‘C’s are steady sellers with high margins etc, down to the ‘E’s which are the slow movers with low margin. Once you have done this, make sure you always have enough ‘A’s and look to ditch your ‘E’s. Then think about your strategies for each category and use common sense. For example, if you were looking to run a promotion it would be obviously unwise to do it on your ‘A’ category stock as you don’t have trouble selling it and it already makes good money. It would make far more sense to run the promotion on, say, a ‘C’ item whereby perhaps you can get a real kick-up in sales by offering an appealing discount.
Pareto – The 80/20 rule. That is, 80% of your business comes from only 20% of your inventory and then 20% of your customers and 20% of your suppliers. For your business, it may be a different ratio, but make sure you have identified the inventory items (products), the customers and the suppliers who sit in that group, and therefore are of most value to you, and make sure you act accordingly. For example, if you found yourself running low on an inventory item and you didn’t have enough to satisfy all orders, make sure that you, at least, satisfy your best customers. For your best inventory items, make sure you have an alternative supplier or two as you can’t afford to be out of stock. Also, the more that you can get those customer, product and supplier groups to overlap, your business becomes easier to manage and more profitable. It is a simple process to run a Pareto chart across your product, customers and suppliers and if you haven’t already, this will give you great insight into what to focus on to improve inventory and your overall business.
Fact not fiction – Most transactional systems like ERP’s allow you to set up a bunch of measures like safety stock, economic order quantity, supplier lead time, etc. However, these are usually done on a set and forget basis and often it is just someone’s best guess at the time. Over time, you can gather the actual data (facts), then use your business analytics package, analyze this data and use it to refine the process. You will be amazed at the savings you will make, very much the opposite of death by a thousand cuts.
I need it when I need it – Another colleague tells the story that during a proof of concept presentation they were looking at supplier delivery times and the customer was concentrating on the suppliers with late deliveries. My colleague suggested looking at suppliers who were delivering early, to which the customer replied, 'Why would I be bothered about early supply?'
My colleague then showed the customer that four of their largest suppliers early deliver, often weeks early, for orders of large volume (both physical size and quantity) for readily available commodity items that, not only fill up their warehouse, but significantly impact on cash flow. The penny dropped – the CFO promptly excused himself from the meeting as he said he had four important phone calls to make. A good analytics package will help you to easily see these sorts of issues or opportunities.