A Handy List of Keys to Careful, Comprehensive Inventory Management

I’m sure there are a lot of ways to summarize a careful, comprehensive approach to inventory management.  You may even be able to add to this list below or create your own, but this may be one handy way to think about it.

It might seem a little “corny”, but as a memory aid, I call this approach 5A6σ. 

1. Anticipate market requirements
2. Account for your actions
3. Accurately calculate safety stock
4. Access information and use it instead of inventory
5. Accelerate by continuously reducing lead times and lot sizes
6. Leverage the 6σ techniques of process control to reduce variation

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Anticipate – anticipate market requirements

The more you are able to accurately anticipate the demand from your end customer in the marketplace, the more you will be able to move, make, buy, and store the inventory that will sell quickly.  This may seem like a self-evident axiom, but this is not easy, and the benefits of incrementally better anticipation go directly into additional revenue as well as more efficient inventory and use of cash.

Large bodies of knowledge have been built around this subject from rigorous quantitative models for forecasting to methodologies for collaborative forecasting, both within an organization and across organizations.  The point of diminishing returns can be reached fairly quickly, but if you are not there yet, it may be your most significant point of leverage for improved supply chain performance.

Account – for your action

This is perhaps the simplest, but yet most difficult aspect of careful, comprehensive inventory management. 

When different functions of the business such as sales and manufacturing do not have harmonized goals, then inventory efficiency will suffer.  For example, if manufacturing is rewarded only for efficiency and overhead absorption, while sales is only rewarded for volume or even total margin dollars, and purchasing is rewarded for lowering per unit costs, then inventory is left to someone who does not have the ability to fully influence it. 

This is one of the benefits of a functional Sales and Operations Planning or Integrated Business Planning process that is supported by shared and consistent metrics across business functions.

Accurately – calculate safety stock

We cannot know for certain what demand will be tomorrow.  Even organizations dedicated to consumption-based replenishment of “true demand” cannot know exactly how much will be required of which products, at which locations, and at which times.

Make-to-order businesses have an easier time of this, but, even then, orders can change and often do.

So, demand varies, but so does the lead time to meet the demand which is affected by several factors:

• Variation in the ability of manufacturing to respond in a timely and accurate fashion, driven by batch sizes and setup times, variation in the conversion process, and by other factors
• Variation in the transportation operation (caused by traffic volume or accidents, road construction, weather, illness, and any number of other factors)
• The capability of warehousing to know what is exactly where and pick, pack and ship it in a timely and efficient way.

For these reasons, you must have more inventory than you will actually be needed if everything goes perfectly.

Any other approach implies the intentional loss of revenue.  Done poorly, this can put you out of business.

Fortunately, there are techniques for doing a good job of this through optimization.  Do a bit of research to identify the technique that fits the structure of your operations (single-tier distribution or multi-tier manufacturing, for instance) and get the analytical and software support (if necessary) to embed that technique into the normal planning process.  This can often yield a step-function improvement in both reducing the necessary investment of working capital in inventory as well as in improving customer service.

Combined with the set of decisions around supply chain flexibility with which inventory decisions are interdependent, decisions about inventory are essential to increasing the value of your enterprise.

Access – information and use it instead of inventory

Data is now more available than ever.  However, there are two key challenges in making use of it.  The first is the acquisition of data.  For everything, from the location of a particular serial number of an item to syndicated data of leading indicators of demand, there exist methods, technologies and markets for the acquisition of data. 

Once you have the data, you must then organize, summarize, and analyze the data into information in such a way that better decisions can be made in less time.  As an example, knowing more about your customer’s demand sooner may help you operate your operations more effectively and efficiently to meet that customer’s demand when it actually comes to fruition.  Knowing the exact location of inventory as it transits and is transformed through your value network can, in some cases, help you respond more quickly to the changes in the market without adding more inventory.

Accelerate – continuously reduce lead-times and lot sizes

Whether you consider yourself a “lean” operation or a “six-sigma” shop or both (“lean six-sigma”), the reality remains that all manufacturers are obliged to constantly search for ways to reduce lead times and run times (batch or lot sizes) during which variation can occur.  This sometimes requires analysis of fixed versus variable cost such as the fixed cost to modify equipment so that changeovers can be completed more quickly against the variable cost of carrying inventory for a longer time, or perhaps indefinitely.

6σ – leverage techniques of process control reduce variation

In conjunction with continuously reducing lead-times and lot sizes, a careful and comprehensive approach to inventory management requires that you make use of what we have known for decades about statistics to identify variation (the reason for safety stock) and its sources, so that you can work continuously to reduce it.  As with the “Anticipate” process, you will reach diminishing returns, but your progress may not be linear or only incremental, and it will be difficult to anticipate when a step-function improvement will occur, so this is an ongoing responsibility.

So, there you have it, the “5A6σ”approach for inventory management, if you will. 

You need to do all of these in order to manage your inventory carefully and comprehensively. 

I suspect you are already careful and comprehensive in your approach to cash management.  And, since you spend so much of your cash on inventory, you need to take an equally intelligent approach to managing inventory.

And here’s a final thought to ponder from Henry David Thoreau as we begin to approach the weekend , “If a man does not keep pace with his companions, perhaps it is because he hears a different drummer.”