A few weeks ago I posted an article 3 Tips to Increase Inventory Turns. In this article we discussed three areas of inventory management and replenishment that could possible help improve your inventory turns. The areas mentioned were:
Order Cycle Analysis
Scheduled Orders and
In this article we will review more areas that could lead to increased turns and some areas that require a better understanding of what can and should be changed to optimize your turns.
Safety Stock Investment Strategies
The Safety Stock Strategy is one of if not the most important factor in determining the amount of safety stock you plan to maintain and invest. When discussing this topic with my students I start by advising them to invest in your company’s inventory as if it was your own money. With that mindset, let’s start to determine how and where to invest in safety stock so that we see the most effective return on investment.
Most replenishment systems today assign a higher service level goal on the “A” or top moving items in your inventory, but few managers actually know and understand why this is done. Notice I did not say fast moving items because the criteria for an “A” ranked item in your company may be defined by dollar sales and may not include the unit movement. When the ranking includes units in the criteria the “A” items tend be have a more consistent and predictable demand pattern resulting in a lower demand standard deviation percent. Because the demand is more predictable, less safety stock is required to cover the variance and the invest required to achieve the targeted service level is less.
If you follow Pareto’s Law that the remaining 80% of the items in your inventory make up 20% of the revenue, then what level of safety stock should be invested for this group or groups? As the demand is typically more predictable for the “A” moving items it is transversely less predictable for the lower ranked items causing the need for more safety stock investment dollars to achieve the same level of service. Because of this requirement, the lower ranked items should have a safety stock investment that is more in line with the business goals and expected return.
Try this exercise on a group if the lower ranked items. Start by assigning a moderate service level goal of say 95%. Then calculate the total safety stock dollar investment for the group. Next, raise the service goal to 96% and sum the safety stock dollars. Did you gain enough revenue with the added 1% to justify the additional safety stock investment? Odds are that as you approach 97% the return per investment dollar will decrease.
Lead Time and Deviation
Lead Time and Lead Time Deviation can mean days of additional inventory that can be removed with a little effort and collaboration with both internal departments and with your supplier.
Most advanced replenishment systems today utilize lead time days in the calculated order quantity and many track and measure the deviation of the receipts from the supplier over time. Both of these factors are used to calculate the safety stock needed to achieve the service levels in a JIT system. The greater the deviation in the average lead time the more safety stock is required.
By collaborating and working with your supplier to develop more accurate lead times you can reduce the amount of safety stock maintained in your inventory. In turn, working with your operations department and reducing the amount of time your inventory sits at the receiving dock can also improve your turns.
Which would you rather work with – 7 days’ lead time with 30% deviation or 8 days’ lead time and 10% deviation?
Inventory layering is offered in many of the more advanced replenishment systems today and is essential in understanding the amount of inventory to be considered in the turns calculation and inventory that can be addressed for improving turns.
If you use the accounting method for calculating your inventory turns you are considering the past 3,6 or 12 months’ sales to determine the turns. The problem with this method is that it does not consider that your current inventory level is driven based on the future events and not history. In order to get a true picture of the current inventory you need to understand the different layers of current inventory and why that layer was purchased.
Inventory layering tracks the on hand dollars of inventory and manages the different layers of the inventory based on when and how it was purchased. For example, if you take advantage of a forward buy opportunity and purchase an additional 6 months of inventory at a cost that will more than cover the inventory carrying cost for that time period, how much of that inventory should be included in the turns calculation? Another example would be inventory on hand for a future promotion. You may not have determined the expected lift for the promotion, but the inventory is on hand and the promotion is not considered normal sales, so should it be included in the calculation?
These layers of inventory provide increased visibility into the inventory and allow for surgical precision when developing a turns strategy.