lec keys to inventory reduction

7/31/2019 Lec Keys to Inventory Reduction

1/82001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 1

A-09

Mark K. Williams, CFPIM

Ten Keys to Inventory Reduction

Companies exist to service their customers. Theprimary service provided by manufacturing and dis-tribution companies is in the form of a raw materialor component that the customer then processes intoits own product, or a finished goods item that thecustomer resells. It is therefore critical that eachcompany has a set of inventory objectives that allowit to provide this service profitably. The main inven-tory objectives for most companies seem deceptivelysimple: Provide the right product at the right place

in the right quantity at the right time and at the right price.

If a company does these five things, it will sat-isfy its customers and become extremely profitable.Although this inventory objective sounds simple,hard and often painful experience tells us that it isnot. A forecast of the customers demands is basedon past history, but if a customer places an item onpromotion, the supplier may not have the rightquantity. Most of the required product is in theTexas warehouse, and suddenly the demand is heavyin Boston. A company stocks up on a new productthat Marketingknowswill be a hit, and it turns out to

be a dud. Or worse, a new product is suspected ofbeing a dud so very little is stocked, and it turns outto be a hit, leaving Marketing and the customersmad.

The days are long gone when customers wouldroutinely accept shipments from suppliers that were70 percent complete. Many companies will ceasedoing business with a supplier that cannot maintaina service level of at least 98 percent. Of course, asupplier without customers will quickly go out ofbusiness. Therefore, if a company experiences ful-fillment problems, the solution demanded by theSales Department and the corner office is usually,Bring in more inventory and get rid of these stock-outs or else!

INVENTORY ISNT FREE

A company can indeed add more inventoryandmore, and more, and morein an attempt to pro-vide customers with better service. Many companiesdo this, but then they run into a few problems. Theirwarehouse begins to fill up, and soon they need torent another one. Their employees report that it isbecoming more difficult and time-consuming to find

the product that is in stock. The company has to goback to its bankers repeatedly to borrow money tosupport the higher levels of inventory. At the end ofthe year they receive a nasty surprisetheir taxeshave increased! Then the company often has to con-front one final problem; their service level has notincreased despite the increase in inventory.

What does increase is the cost associated withholding the inventory. This is because even thoughinventory is listed on the books as an asset, increas-ing the amount of inventory a company holds has animpact on many individual costs not recognized by

many companies. When we look at the componentsof inventory carrying costs (see Figure 1), it be-comes clear how increased inventory levels lead toincreased costs.1

Our challenge is to reduce our inventory, lead-ing to a reduction in the associated inventory carry-ing costs. However, we must simultaneously increaseour service levels to our customers or risk losingthem. Is this possible?

Fortunately, yes, it is possible to reduce inven-tory while increasing service levels. There is nomagic bullet, but by working diligently to implementthe following 10 keys to inventory reduction, thosetwo vital goals can be achieved.

1. Improve Inventory Accuracy

A rush shipment is being prepared for a key cus-tomer. According to the figures in the computer,there is enough stock of each item on hand to fulfillthe customer needs. Based on this information, thecustomer is assured that the shipment will be com-plete. However, when the order is picked, 3 of the10 items come up short! Now the customer must begiven the bad news. In order to make sure this doesnot happen again, the supplier considers addingmore safety stock to its inventory.

By simply adding safety stock in hopes of en-

suring enough inventory the next time, the coreproblem is not addressed. After all, according to thecomputer records, there was enough stock to com-plete the order. The real problem in this situation isthat the inventory on the shelf did not match theinventory figures in the computer. Will increasingsafety stock solve this problem? No, quite often it is

1 Ross, David Frederick, Distribution Planning andControl, Chapman and Hall, 1996.


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2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 2

aggravated because now there is more inventory totrack.

Overall inventory accuracy depends upon con-ducting each process flawlessly, including Receiving,Putaway, Picking, Shipping, and Invoicing. Somethings that help improve inventory accuracy are: unique SKU numbers for each part well-identified aisle/bin locations use of bar codes for inventory tracking a workforce that understands the consequences

of inaccurate inventory figures a cycle counting program aimed at detecting

and correcting errors in the process

2. Eliminate Obsolete Inventory

Do some companies keep inventory that has been instock for over five years? They hesitate to get rid ofit for fear that if they do, they will receive an orderfor the item the very next week. And if that happens,the salespeople will go absolutely ballistic. Unfortu-

nately, for many companies that scenario is all toofamiliar. They hold on to old, probably obsoleteinventory because they feel that keeping it is saferthan getting rid of it.

However, there is another way to look at inven-tory that is doing nothing more than taking upspace. First of all, it is taking up valuable space! Asdiscussed earlier, inventory carrying costs are notfree, they average 20 to 36 percent per year. If thecompany has a 36 percent carrying cost, in threeyears the inventory will have been paid for twiceonce when purchased with cold, hard cash, and asecond time through the costs associated with carry-

ing inventory.If we decide to get rid of the inventory, we canget some benefit from it. Many closeout companieswill pay between $0.10 and $0.40 on the dollar forthe inventory. This may not sound like much, but itis better than nothing. In addition, any inventorythat is disposed of for less than cost can be writtenoff against the companys taxes.

3. Implement ABC Inventory ManagementStrategies

Do the people with inventory management respon-sibility have enough time to focus on each part of

their job? Do they have enough time to strategizeand monitor each SKU in their inventory on a dailybasis? Or have their job responsibilities increased somuch that they sometimes do not know if they arecoming or going?

A manager who has ample time to monitor eachSKU daily and strategize the optimal ordering andstocking of each of those SKUs is a rare breed in anideal situation. Those who manage inventory in thereal world have to decide what to doand what notto do. One of the most powerfulyet simple

decision-making tools in the arsenal of the inventorymanager is the use of ABC stratification in settingpriorities regarding inventory ordering and stockingdecisions.

The concept behind ABC stratification is thatsome items are more important than others andtherefore deserve more managerial attention. If oneis in charge of office products, and the range ofproducts extends from computers to paper clips,does it make sense to pay as much attention to howmany computers are in stock as it does paper clips?Common sense says, Of course notcomputersare so expensive, they demand more attention.Does this mean a department can afford to run outof paper clips on a routine basis? No, that also is notone of the options. So how does one set thesepriorities?

This is where ABC stratification emerges as animportant option. There are a couple of steps thatmust be taken in order to prepare for using ABC

stratification. First, an ABC analysis spreadsheet isneeded. To do this, the cost of each item is multi-plied by its annual unit sales to get an annualizedcost of sales, and then each item is ranked in de-scending order by this amount. In most companies,the top 20 percent of items are fast moving and usu-ally account for approximately 80 percent of sales.These items fit the A category. The next 30 per-cent of items are mid-movers and usually repre-sent about 15 percent of sales. These go into Bcategory. Finally, there are the slow movers, usuallyabout 50 percent of items that combined only repre-sent 5 percent of sales. These slow movers are classi-fied C items.

Once sorted into the appropriate ABC classifi-cations, it is time to apply the principle of prioritiza-tion. In many companies, the same relative amountof inventory is maintained for all items. For exam-ple, a company will set the inventory level for allitems to equal two months sales. A companyswitching to the ABC approach sets inventory levelsdifferently. Realizing that the fast-moving A itemsmake up a much larger portion of sales and areprobably always on order, the company tries tomaintain relatively less inventory. Instead of eightweeks of inventory, the company maintains a four-week level. The company compensates for the low-

ered inventory level by paying more attention to theA items to make sure they do not run out. Al-though the relative amount of inventory is lower, theabsolute value of the A inventory is higher thaneither B or C items, because the sales level ofA items is so much higher. The B items wouldmaintain the inventory level of eight weeks. In orderto concentrate our attention on the fast-moving Aitems, we increase the inventory level of our Citems to double the previous level. Because thisrepresents so many items50 percent of our total


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keep safety stock to compensate for those inevitableinstances when we receive late deliveries from ourdelinquent suppliers.

One way to solve this problem is to switch sup-pliers in the hope that the new one will have betterperformance. However, before taking this drasticstep, ask one question. Could your company be amajor part of the problem? Is your companys orderpattern extremely erratic, making it difficult for asupplier to anticipate its needs? Does it provide itssuppliers with its anticipated needs? It was statedearlier that a customer and supplier should commu-nicate their scheduling information in order to an-ticipate each others needs. Has your companyprovided the same information to its suppliers? Ordoes your company send them a purchase order andexpect them to respond to its ever-changing needs?

Partnering with suppliers, supplying them withanticipated needs so they can be prepared for them,is often the quickest and most effective way to im-

prove a suppliers delivery performance. Groupingyour purchases by supplier in the computer systemand sending your key suppliers a copy of the portionof the purchasing report that relates to them willallow them to prepare to meet your needs.5 Will italways work? Unfortunately, no, some suppliers justdo not understand the importance of on-time deliv-ery. Replacing such suppliers is often the only way toget better performance. However, providing mostsuppliers with their customers anticipated needs willturn poor performers into on-time deliverers!

8. Reduce WIP Space

In a manufacturing plant, there is one piece of con-ventional wisdom that is usually trueinventory willgrow to fill the space given it. This is particularly thecase with work-in-process (WIP) inventory in a jobshop. If there are 50 square feet allotted to inven-tory, it will not be enough, so it is increased to 100square feet. This will suffice for a few weeks untilmore is needed. This is because inventory is oftenused to cover a multitude of sins. Everything fromfrequent machine breakdowns (due to lack of a pre-ventative maintenance system) to long setups (nosetup time reduction program) or frequent high lev-els of scrap (no statistical process control program)are compensated for by keeping lots of inventory

between operations so that part supplies are main-tained even when problems are encountered.

In order to counter these problems, companiesshould reduce the amount of space between opera-tions where inventory can be stored. As space isdecreased, it will force underlying problems (ma-chine breakdowns, long setups, poor quality) to the

5 Williams, Mark K., Information and TeamworkKeys to Supply Chain Success,APICS 43rd Interna-tional Conference Proceedings, 2000.

surface where they will be visible for all to see. As anunderlying problem surfaces, companies should di-rect all efforts to solving the problem. Once theproblem is solved and the operation is functioningsmoothly with less space, reduce the WIP spacesome more to uncover even more opportunitiesfor improvement!

9. Eradicate Individual Incentive Systems

Compensation exerts a strong influence on peoplesbehavior. In many traditional manufacturing envi-ronments, individual incentive systems based onproduction are the norm to boost productivity. Un-fortunately, when individuals can earn a bonus bysimply producing more, quality or reduced inventorylevels will be the furthest thing from their minds,and instead they will strive to produce more units,whether or not the product is needed. By contrast,inventory reduction should be a team goal andachievement. Once all employees understand that

inventory reduction is desirable, they can band to-gether to make it happen. Few things can compro-mise the drive toward inventory reduction morethan individual incentive systems based onproductivity.

In order to change the mindset of employeeswho are used to individual incentives, the wise com-pany will move in two directions. First, instead ofindividual incentives, the company will move to agroup incentive involving everyone in the depart-ment or plant. This will encourage employees towork with the team, instead of just pushing outmore of a given item, regardless of whether it is

needed. Second, instead of basing the incentives onproduction only, the new group incentives should bebased on other important goals such as quality, in-ventory reduction, and safety in addition to produc-tion. This will focus employees on the myriad ofelements needed to make manufacturers successful.

10. Educate and Train!

The tools and drive to reduce inventory are notsomething innate to managers or employees. Theymust be learned. Many companies with inventoryproblems decide their salvation lies in the newestsoftware program on the market. They do not seethe wisdom of first educating their employees aboutthe basics of good inventory management. If someof their employees cannot count, and they are re-sponsible for keeping track of their production, nosoftware program in the world will help them.

Most companies can reduce their inventorywhile improving their service level by making a con-certed effort to train their employees in proper in-ventory management techniques. These employeesare not just those in inventory management or pur-chasing positions (although they are definitely in-cluded), but the rank and file employees who do


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the work in the organization. If a receiving clerkroutinely enters the wrong data into the system, if astocking clerk often places goods in the wrong place,if a picker does not bother to accurately count theproduct being picked, or if a shipping clerk puts thewrong label on boxes, the inventory wont ever beaccurate. In these instances, a company will neverhave the ability to safely reduce inventory withouthurting its service level. Only by training the em-ployees in the importance of doing their jobs cor-rectly and giving them the tools necessary will yoube able to create the best kind of inventory reduc-tion teamyour entire workforce!

CONCLUSION

Companies exist to service customers. However, if acompany attempts to service its customers by main-taining an extremely high level of inventory, it mayfind itself with a serious cash flow problem. Compa-nies have even gone bankrupt while having plenty of

assets because too large of a percentage of thoseassets were tied up in inventory, and the companycould not meet payroll or pay its bills.

If a company aspires to maintain a high servicelevel while minimizing inventory, it will take hardwork, dedication, and teamwork. Ensuring an accu-rate inventory of items that supplier and customer

agree must be in stock is a good starting place. Thisrequires precise recording and counting processes,along with an understanding of ABC inventorymethods and a commitment to clear, timely, confi-dential communications regarding needs and expec-tations. Within either company, steps should betaken to educate all people responsible for inventoryaccuracy in proper procedures for reducing inven-tory and the space allotted to WIP storage. Teamgoals and incentives should be established to bringabout these ends, thus phasing out counterproduc-tive individual incentives. Improving communica-tions and processes, increasing accuracy, and raisingthe awareness and commitment of workers at alllevels to inventory reduction will ultimately enhanceany companys bottom line. There are no magic bul-lets, but if a company employs the tools and tech-niques found in both this article and in the APICSbody of knowledge, it will be on the right path to-wards achieving these dual goals.

ABOUT THE AUTHOR

Mark K. Williams, CFPIM, is a manager with theNorth Highland Company and executive vice presi-dent of APICS.


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Cost of Capital 1015%

Storage & Warehouse Space 25%

Obsolescence & Shrinkage 46%

Insurance 15%

Material Handling 12%

Taxes 23%

Total Annual Inventory Carrying Costs 2036%

FIGURE 1.

FIGURE 2.

Part Monthly Sales% of Total

Cost ofSales

Value of EqualInventory(8 Weeks)

ABC Inventory

A 785,000$ 78% 1,570,000$ 785,000$ (4 weeks)B 160,757$ 16% 321,514$ 321,514$ (8 weeks)C 63,215$ 6% 126,430$ 252,860$ (16 weeks)

Total 1,008,972$ 100% 2,017,944$ 1,359,374$ 33%InventoryReduction


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FIGURE 3.

Part A-45

Month MonthlySales AverageSales Deviation AbsoluteDeviation

January 99 100 -1 1

February 102 100 2 2

March 103 100 3 3

April 95 100 -5 5

May 103 100 3 3

June 98 100 -2 2

600 16

Total Ab-

solute De-viation 16MAD=

Number

of Periods

=

6

= 2.67

Part B-14

Month MonthlySales AverageSales Deviation AbsoluteDeviation

January 10 100 -90 90

February 13 100 -87 87

March 241 100 141 141

April 24 100 -76 76

May 280 100 180 180

June 32 100 -68 68

600 642

Total Ab-

solute De-

viation 646MAD=

Number

of Periods

=

6

= 107

FIGURE 4.

Item #January February March April May June Total

A-45 99 102 103 95 103 98 600

B-14 10 13 241 24 280 32 600


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Service Level % Safety Factor

50% 0.00

75% 0.67

80% 0.84

85% 1.04

90% 1.28

95% 1.65

98% 2.05

99% 2.33

FIGURE 5.

FIGURE 6.

Part #

MAD Safety Factor

(SF)

Safety Stock (MAD x SF)

A-45 2.67 1.65 4.4 (or 5)

B-14 107 1.65 176.5 or (177)

lec keys to inventory reduction

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