Optimizing inventory across a supply chain increases the number of inventory turns and frees cash for productive investment

by Michael Fickes for MHI Solutions

Supply chain managers have always known that poor inventory management costs money while an optimized inventory frees up cash. Today, the industry is learning just how much cash is involved.

“Inventory turns are a tonic for cash flow,” says Robert B. Footlik, P.E., CEO of Footlik & Associates, LLC, a supply chain consultant. “If you receive a shipment of just the right number of widgets on the first of the month, get them to your stores and sell them by the 15th, collecting payment before the invoice comes due, you are working off the float.”

“When product sits in storage for an extended time, the money you used to buy those goods isn’t generating revenue,” adds Phil Quartel, senior director, Supply
Chain Services with Fortna Inc. “If you have to move those products around, your costs are going up, too.”

Managing the many types of inventories
“Today there are three kinds of inventories to manage: wholesale, retail and e-commerce,” says Dr. Edward F. Knab, president of Productivity Constructs, Inc. “Each has different demand characteristics and different material handling systems. Wholesale inventories move on pallets; retail goes in cases; e-commerce ships in ones and twos.

“That means facility designs are different. Wholesale inventories need pallet racks; retail needs flow racks, and e-commerce is moving toward shuttle systems that  bring goods to pickers.

“Today’s inventory challenges involve figuring out how to do three kinds of distribution with one inventory, while paring down to a safety stock.”

Add to that the fact that inventories come in what Footlik describes as multiple flavors. ‘A’ through ‘F’ designations rate the speed with which items move. While  speed is a key consideration for determining inventory levels, it isn’t the only one.

“’A’ items move fast every day…‘F’ items — like CRT television sets — shouldn’t be in anyone’s inventory today, unless this is the specific purpose of the business.”

“I might live with a slower turn on high margin products because the cost of missing a sale is greater than the inventory carrying cost,” says Jim Schwender, vice
president of SD Retail, a retail supply chain consultant. “If I pay $500 in extra carrying costs to get an extra $1,500 in margin, I’ve probably made a smart decision.”

“Brand costs also figure into these considerations,” adds Sheldon Church, director with SD Retail. “Big box hardware stores must have certain low margin products  that probably don’t move all that fast. If you need a three-quarter inch bolt, the store had better have it because that’s what the brand means.”

Find and eliminate inventory problem items
“We identify problems by analyzing the velocity of the product,” says Quartel. “How fast is it flowing against inventory levels? We might find chunks of inventory that haven’t moved in six or even 12 months. That is unproductive. That’s the biggest inventory problem you can have.”

Fortna recommends that distribution centers look into product life cycle management tools. “Decisions made regarding product lifecycle management can directly impact how efficiently a distribution center operates,” he says. As an example, he asks, “Does it make more sense to mark down and move parkas sitting in inventory in March, or is it more cost-effective to store them in a DC until the next parka season?”

Quartel calls that “SKU rationalization.” He states, “Not long ago, a large multi-channel retail client asked for help building a new distribution center. We analyzed their inventory and recommended tightening up the existing inventory first.”

The retailer took that advice and edited the inventory. The process pared down or eliminated 30 percent of the SKUs and enabled the company to put off spending $35 million on a new distribution center for eight years.

Forecasts must be flexible
“Forecasting demand in the future starts with history,” says Quartel. “If customers bought three widgets every day with no variation, then you need cross-docking capabilities. But if customers bought three one day, 10 the next day and five the next, you will need to hold product in the store and the DC.”

Different products call for different kinds of forecasts. “For core products that you have experience with, you can update past forecasts based on recent performance,” says Schwender. “A seasonal product you’ve never sold before would be forecast based on the historical performance of similar products.”

There are a number of forecasting tools on the market, adds Schwender. These include solutions that provide a sales forecast and do nothing else as well as solutions that incorporate demand forecasting with all of the other factors that are required to optimize inventory — such as carrying and acquisition costs.

The important thing is to have your forecasting capability integrated with inventory management and exception management. Forecasts won’t be perfect. When sales for a particular SKU begin to decline, you’ll want to know right away so you can adjust.

As an example, Church points to a new product launch that is overselling its forecast. Everyone selling the product will catch on sooner or later. Those that
catch on first and boost inventories will  get the sales that others lose.

What if a product that has performed well for a long time suddenly goes into decline? You need a system that will detect and report this so you can react fast.

Local issues can affect sales at particular stores. Management changes, road construction and any other conditions can alter sales trends. Again, you need a system that reports this early on and enables you to respond early.

Visibility of inventory is key
Warehouse management systems (WMS) provide visibility about what is flowing through and stored in various facilities.

“WMS tools can do a good job for one or two kinds of inventory in a facility, but they have trouble mixing three kinds of demand in one warehouse,” continues Knab. “So you have to set up the WMS to manage the order process for each inventory independently. The exception is the safety stock, which is aggregated so it can service all three inventories until optimized inventory levels are restored.”

Supply chain visibility tools integrated with a WMS as well as forecasting and inventory management systems can add intelligence and exception management capabilities across various supply chain links and further optimize inventories.

Suppose the forecast and inventory management tools indicate that stores in Washington, D.C. metropolitan region will need more widgets in several different lines within a week.

Fresh stock should have arrived or should be arriving in the distribution center. If something happened to delay those shipments several days ago, a visibility tool would have sent out an alert and appropriate inventory could have been diverted from another inventory in the chain — and, if necessary, shipped by a faster mode of transportation.

Turn, turn, turn
When all of the different inventories in the supply chain link up according to a reasonably accurate demand forecast plus sufficient safety stock, inventory can turn many times throughout the year.

“That’s the secret to success in inventory management,” says Footlik. “If you pay continually for inventory all year long and have a turn rate of less than two, you’re going out of business unless the margins are incredibly uncompetitive.

“But if you turn it 12 or more times a year and pay for it 12 or more times a year, then it’s all on the float and vendors own your inventory.”

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