Strategies for smarter inventory management

Maintain accurate inventory records

It’s difficult, if not impossible, to effectively manage inventory without an accurate record of what you have.

You make promises to your customers (accept orders and quote ship dates) based on what you know is in stock. If the reality is different from the records, you may not be able to keep those promises, resulting in disappointed customers and lost business.

The accuracy of any inventory tracking system, whether manual, spreadsheet or software depends on timely and accurate transaction reporting. Any inventory movement must be reported to the tracking system promptly and accurately.

While this is a simple requirement, it is not necessarily easy. Any human-based procedure is subject to error, delays, lost transactions, incorrect calculations, and misidentification.

Timely and accurate transactions only occur when the people reporting the transactions understand their importance and are properly motivated to do a good job. There’s no magic here, it all depends on motivation and management.

For example, if an employee is moving items to put together a customer order, their primary focus is on getting the right things into the box and doing it quickly. Your challenge is to find a way to make it important to also report what was picked, from what location, identifying information (lot or serial number, if needed), or whatever else you need to track.

Automating data collection: implement cycle counting

Some data collection can be automated, most often through barcode scans. Most inventory software will produce barcoded lists and labels, interface with scanners, and manage the data collection effort.

Not only is automated data collection more timely (data goes right into the inventory records, doesn’t have to be keyed in), but it also eliminates errors that are part of manual data collection.

Whether automated, manual or a combination of both, inventory records are error-prone. You might complete an annual physical count and learn that your records are only a few percent off, but that is a false measurement. It is likely that as many as half of your inventory balances are inaccurate, but the physical count only looks at total value and the plusses and minuses balance each other out to give you a misleading total difference.

A much more telling measure of accuracy is to count 100 items and see how many are correct and how many are not. Most companies are shocked to learn that, by this measure, accuracy is less than 50 percent.The solution is to implement the cycle-counting process to improve accuracy by eliminating the cause of errors, which are part of the transaction reporting process.

Cycle counting involves counting a certain number of items every day or week such that groups of items ‘cycle’ through the counting scheme so that they are all counted according to their importance – more important items are counted more frequently.

The benefit of cycle counting is that it allows you to identify how errors occur and fix the faulty procedures so errors are eliminated. Accuracy improves and can be maintained at a high level (>98 percent) even in an organisation with thousands of items and many daily transactions.

Proactive planning

Replenishment describes the process of bringing inventory into the warehouse to replace inventory which is used or sold.

The most efficient replenishment will plan for the new supply to arrive just before it is needed, or just before the supply runs out (just in time). Reorder point (ROP), another methodology does that based on average or assumed usage and typical lead time, but there are other approaches.

Businesses can use an approach called Material Requirements Planning (MRP) that calculates how much of each material and component items is needed, and when, to be able to complete the master production schedule.

Distributors can use a similar technique called Distribution Requirement Planning (DRP). Both techniques are based on a forecast of demand (sales) and work backwards in time through the distribution network (DRP) or bill of materials (MRP) to line up replenishment orders (quantities and start dates/due dates) to minimize inventory while preventing shortages.

Both approaches rely on accurate data (inventory record accuracy included) and good forecasts.

There are other approaches that some companies find more beneficial for their particular markets, but the point is that while inventory is costly, shortages can be devastating to the business. Simple management approaches like reorder point may not deliver the combination of low inventory and high availability that you need. Inventory management, planning, and optimisation systems offer a wide range of tools that allow you to be proactive in managing inventory in the plant, the warehouse and throughout the supply chain.

Safety stock

No replenishment planning approach is perfect—because we cannot know the future (demand) exactly, and because demand will vary from day-to-day and week-to-week.

In order to protect the availability from these variations, companies carry a little extra inventory, called safety stock. More safety stock will reduce the risk of a “stock-out”, of course, but more safety stock also adds to your inventory investment.

The same holds true for other safety measures like shrinkage factor, yield allowance, padded lead times (telling the supplier to deliver before you expect to need the items just in case they deliver late)—they all add to inventory.

Inventory control improvement

With any inventory planning and control strategy, the objective is to avoid shortages while minimising the amount of inventory.

The easy way to reduce or avoid shortages is to have more inventory, since reducing inventory is likely to increase the risk of shortages.There is a way to change this relationship because there is a third factor involved—and that is variability.

Safety stock is the customary way to compensate for variation including swings in demand (otherwise known as forecast error) and other unexpected changes in demand or supply (including inventory accuracy errors).

Since the future is unknown, it is impossible to cover all possible variation. We are left to cover the majority of the expected problems and live with a level of availability (fill rate) less than 100 percent. The more safety stock, the higher the fill rate.

If you can reduce variability, however, you can increase fill rate without increasing inventory.

Alternatively, reducing variability would allow you to reduce inventory (safety stock) without reducing fill rate. Simply put, to reduce inventory while maintaining or improving fill rate, reduce variation.

How can you reduce variation?

The most obvious ways are:

• Improve inventory accuracy (use cycle counting)
• Improve forecast accuracy (collaborate with customers, distributors)
• Reduce lead time (improves forecast accuracy)
• Become more reliable (tighten up procedures and controls)
• Consider implementing integrated systems and other technologies that will improve accuracy

Reduce lead times and lot sizes

Shorter lead times equals less wastage.

If lead time was zero, you wouldn’t need inventory. The longer the lead time, the more inventory you’ll need, and the more safety stock because variability is a time-sensitive phenomenon. There is more risk of variation over the course of a week than there is over one day. Forecasts are also more accurate in the near term than they are further out.

Replenishment planning is focused on replenishment lead time. With shorter lead time, replenishment quantities can be smaller, meaning that less inventory is brought in at a time and used up more quickly—so overall inventory level is reduced.

The economics of ordering

Replenishment lot size is usually determined by the general concept of economic order quantity or EOQ.

EOQ balances ordering costs (fixed costs associated with purchasing or making an item regardless of quantity) and carrying cost (larger order quantity means higher inventory and therefore higher carrying cost). EOQ finds the lowest cost replenishment order quantity.

While many companies do not use the actual EOQ formula to determine lot size, the concept still holds in informal logic and intuitive methods–a successful business minimises overall cost by avoiding unnecessary inventory and minimizing the number of orders at the same time.

The key to reducing the “economic” replenishment order size (thereby reducing inventory) is to reduce the fixed ordering cost (there isn’t a lot you can do to reduce carrying a cost, unit cost or usage—the other major factors). For purchased items, ordering cost includes the operating cost and efficiency of the purchasing department, receiving and inspection, and material handling (put-away).

Integrated purchasing applications with supplier portals for collaboration, links to planning systems for automated or semi-automated ordering, blanket orders (based on good forecast-based plans), electronic communications (through EDI or direct), and other technologies can help ease the ordering process. Pre-qualified suppliers and certified quality simplify and expedite receiving and handling.

For manufactured items, the focus is on set-up and changeover times. Companies often invest in automation–flexible machines that can easily switch from one product or variant to another with little or no human intervention—to reduce changeover and thus reduce economic production quantity. Other less costly changes include fixturing and mistake-proofing, scheduling to minimize the changes between one job and the next, and process redesign to simplify changeover.