Inventory management is a significant investment for any company. While a well implemented inventory strategy can raise company performance, the real truth of inventory is often misunderstood. This article identifies the simple questions that people have in regards to inventory investment, without risking the company's profit margins.
Lets Walk Through A Brief Introduction
Here is it plain and simple, companies succeed by selling more products within the best margins. The top companies feed their growth and margins through excellent market and consumer insight with a well implemented product development and robust supply chain and operations. Inventory management and strategies are primary components of these operations.
Manufacturing companies understand that inventory is a significant asset in their industry. Depending of the type of industry, this could mean anywhere between 20-30% of all assets are invested in inventory. Its also good to note that how well a manufacturing company handles their inventory is closely related to overall financial success.
Building the best optimized inventory strategy is no simple task, but three simple questions can aid in developing a method to reduce overall inventory investment, without risking the money in your own pocket. These three questions include:
- Raw materials
- Finished goods
And addressing how these three topics can improve inventory return-on-investment.
What Is Your Inventory Costing You?
Many companies see the cost of inventory as the “cost of capital” of the inventory asset. But the actual cost is much greater than just the cost of capital. Consider the following costs associated with holding and handling this inventory:
Direct Investment Expenses
- The cost of capital invested in the inventory
- Insurance on the inventory
- Yearly loss from pilferage and shrinkage
- Yearly loss from obsolescence
- Depreciation or rent of material handling equipment
- Direct operating costs of material-handling equipment
- Employee cost to maintain materials
- Freight and transportation costs
Administration and Measurement Expenses
- Employee cost to account for and measure inventory
- Top management time spent on solving inventory issues
Cost Of System Failure
- Lost business and profits or impaired goodwill from improper management or late delivery of materials
When all these additional costs are recognized, the overall cost of inventory can represent 20-30% more than the stated inventory book value. The inventory cost could even be higher if proper methods for managing inventory were not implemented.
Gagging the true overall inventory cost is the first step in possibly improving inventory ROI. After that we can move on to how much inventory is right to carry in the system.
How Much Inventory Do You Really Need?
There are many factor that play in determining the right amount of inventory. Having too much inventory leads to unneeded costs, but having too little risks being out of stock, or even worse, not meeting customer demand.
Four components are needed to determine how much inventory you need to carry. The following is used relative to packaging inventory, but that same methodology applies to raw materials and finished goods.
How much are you going to need in a given year? Past sales history is a good starting point, but the best way to determine quantity is by thoughtful forecasting based on the planned marketing or sales initiatives and a look at the latest market demands. This point is best served through a production line or SKU level, this can be a tricky but critical process. The gives an accurate measure of the total buy, but not how much to carry at any one point.
The more frequent the order, the less inventory you need to carry as you can always replenish it more regularly. But more orders can lead to higher piece-prices and more freight costs and may violate vendor minimums. But, the less frequently you can order or replenish, the greater necessary inventory minimum is understood in order to meet common demand.
If you can order a package on Monday and receive as much as you require by Wednesday, then lead times are simple and not a determining factor. But often lead times can be long and variable. Lead time can vary for a number of reasons including:
- Type of product (Commodity vs. custom)
- Total available suppliers (Many vs. few)
- Location of supplier (Local vs. international)
- Buying power of the purchasing company (Big vs. small business)
If there are longer lead times, then more precision is necessary for planning, resulting in one of the main reasons many companies tend to have larger inventory supplies.
The more uncertainty in the supply chain, the great the cost of failure and the more likely a company will carry more inventory for that emergency situation. There are many factors that contribute to uncertain, some include:
- Variability to supply lead times
- Initial quantity concerns
The inability to manufacture due to out of stock inventory can lead to a “cost of failure” such as customer dissatisfaction, consumer loss of loyalty, and overall brand impairment. Safety stock is the insurance against supply chain miscalculation in inventory planning.
Identifying the amount of inventory to have on hand does not mark the end of inventory optimization. There are still many ways to bring inventory levels down by find alternate places to locate your assets.
Where To Start?
Effective inventory management is a cross-functional issue. From finance to marketing, sales, procurement, manufacturing, and warehousing, all have a role across the entire organization and have means to improve inventory ROI.
The cross-functional team needs to consider the questions outlines here in regards packaging, raw material, and finished goods inventories:
Each business has different dynamics and imperatives, and need to assess their business meticulously. Determining how much your inventory really needs will give insight to optimization based on other corporate needs. The functional expertise can help unlock the savings opportunities outlined in this article. But, be sure to keep your mind open for new opportunities in your supply chain.
We will go a little bit further passed the surface to determine new ways of reducing your inventory cost through ERP implementation. Essentially making the entire process discussed in this article that much easier to determine and develop a money saving plan. Lets see if I can convince you that ERP systems make life easier and can raise your profit margins.