SCENARIO 3: INVENTORY IS BECOMING VINTAGE… OR RATHER, OBSOLETE
One way to understand the current state of inventories is to divide it into 2 parts. The first part is the ‘balance of the past.’ In essence, this is the net difference between planned and actual sales. The second part of the inventories is based on demand forecasts and inventory policies. This is the inventory that is required in order to fulfil future demand.
When looking for the source of excess stock, inventory policies are a good place to start. After all, even if a company hits their sales forecast, poorly aligned policies can still result in crippling excess stock.
The policy associated with safety stock is one of the main causes of excess stock. As highlighted by Wikipedia, safety stock is: “a level of extra stock that is maintained to mitigate risk of stock outs due to uncertainties in supply and demand”
For example, if a company expects to sell 100 units of a specific type of headlight, you can choose to keep 110 units in stock to absorb any fluctuations in demand, i.e. these additional 10 units are the ‘safety stock’.
The big question is how companies calculate the safety stock: crudely speaking, it is determined by the standard deviation of historical demand (usually over the past 12 months). This works well for items with little variation; however, for items with positive /negative growth, seasonal trends, irregular and sporadic demand this rule causes many errors.
Imagine that you have an item that has an average demand of 141 units (per month) and a standard deviation of 91.
The company wants to have a service level of 95% (z = 1.645) and the lead time is 15 days.
Using a simplified formula available on Wikipedia, the safety stock would be 106 units.
That is, even if the sales forecast points to 95 units, the safety stock can be stated as 106 units. As you can see, this would result in the holding of nearly 2 months of demand for this item.
Understanding the situation by analysing an item separately is simple. Given that many automotive aftermarket businesses offer thousands of SKUs, safety stocks are simply not reviewed often enough. From my experience of working with many automotive aftermarket businesses, safety stock may end up being reviewed every six months or, in some cases, annually.
This is one of the main reasons why there are large volumes of automotive aftermarket inventory that do not turn.
How can you curb excess stock issues? A simple diagnosis could accelerate your performance!
Adopting a good diagnosis can help you to understand:
- The value of excess stock within your business
- what percentage of this excess could be reduced (and what percentage will inevitably need to be written off)
- What causes the excess stock in the first place
- How to correct these issues in order to reduce the excess stock and prevent it from resurfacing.
At the time of writing this article, I have performed over 250 inventory analyses for businesses operating in the automotive aftermarket as well other industries. In the space of a week, an ‘x-ray’ analysis outlining the makeup of the inventory can be performed and provide understanding as to the current situation. This will also provide insight into the main areas that require focus.
As the success of an automotive aftermarket business is often based on their ability to obtain operational excellence; there has never been more focus placed on inventories and the subsequent optimisation. This to me shows that automotive businesses are moving towards greater maturity in the management and integration between the supply chain and finance areas.
Explore how you could define your assortment!