Inventory optimisation seems like an easy thing to achieve.
On the surface, it’s simply a matter of ordering the right amount of stock at the right time.
‘When’ and ‘how much’ are your two key issues.
The ‘When’ part of the puzzle is guided by the cost of inventory versus the risk of you running out of stock. And ‘how much’ is defined by inventory costs versus order costs.
Optimising these elements can look differently depending on your perspective.
Finance, Sales, IT, Purchasing, Logistics will all have a unique perspective on the correct way to optimise inventory, and even what optimisation looks like.
Your Finance department may want to look at capital costs and make sure obsolescence is taken care of.
Sales wants good margins and satisfied customers.
And what about your IT team? Well, they probably just want peace and to sleep at night.
So, who takes responsibility?
Many businesses don’t know the answer to this. Consequently, they are left with an inventory situation that’s not only not optimised but totally imbalanced.
What is inventory optimisation?
Customer behaviour changes constantly.
Assortments evolve. Demand patterns fluctuate. And your supply’s never stable.
This means fine-tuning your inventory levels to the beat of the market is essential. If your levels don’t match the expectations of your customers, it won’t be long before you wonder where it all went wrong.
It’s crucial to regularly stop and reassess the processes that should deliver cost-effective inventory management. For example.
- Does your inventory get the strategic awareness it deserves?
- Do you know which items need to be stocked? And why?
- Do you know how much of each item you need, to avoid stockouts and lost sales?
- Do you have solid principles in place to keep your inventory in check?
To ensure your inventory delivers tangible competitive advantages, these are questions you cannot afford to ignore.
The ingredients for effective inventory optimisation
‘Good inventory management’ ensures the right goods are available in the right quantity, with the right inventory turnover.
However, focus on the 5 areas below and you’ll build an even more cost-effective inventory management process. One that turns it from good to great.
Reliable forecasts create a trustworthy grounding for all decisions. Whether that’s in assortments, purchasing volume, or safety stocks.
Historical data is often used in combination with knowledge about inventory turnovers, current order levels, and expectations for future sales.
But it’s important to ask whether the existing forecasting processes are up to date.
Equally, is the quality of the forecast satisfactory? Often, even with modest efforts, chances to improve are quickly identified.
Top tip: Want to attain a clearer picture demand? Check our guide to demand planning & find out how you boost forecast accuracy today.
A company’s processes are only as good as the data they’re built on.
Poor data leads to poor decision making.
And poor decisions mean costly excesses, crippling stockouts & angry customers. That’s not good news regardless of the department you’re in.So, how often is your inventory master data re-evaluated?
Do you have the right lead times in the system? Are your suppliers’ minimum order quantities up to date? Are your service levels rules & safety stock levels appropriate?
Top tip: Its easy to forget about this critical component of the inventory optimisation decision process. Make sure all your parameters are in order with our step-by-step guide to Master data success!
Sadly, for some, humans play a pivotal role in making inventory optimisation a reality.
Therefore, its vital your people know which levers they need to pull. Creating a common overview and understanding of the inventory workflows is therefore not optional. Everyone involved must have sufficient knowledge.
It’s also essential supply chain roles and responsibilities are clearly defined.
- Who owns the master data?
- Who’s responsible for ensuring the forecasts are accurate?
- Who ultimately determines the service level?
Without the right knowledge and accountability, the entire inventory management process could be hindered by errors & inefficiencies.
The next area that contributes to successful inventory optimisation comes down to how well customer and supplier relations are managed.
No chain’s stronger than its weakest link.
Communication and information sharing is crucial to make effective decisions. As well as to take corrective actions where supply fails to align with demand.
Inventory optimisation typically requires tons of data & hundreds of algorithms.
But that’s not useful information if you’re in the middle of a battle with a spreadsheet fanatic. Someone who try to give decision-relevant information through a depressingly manual and drawn-out process. But combine this with a cumbersome tool and this becomes a fast track to disaster.
To make good inventory decisions, inventory processes should be supported by the right tools.
Top tip: Over 1300 businesses around the world count on our supply chain optimisation platform. Find out how Slim4, could help you take control of your inventory.
5 steps to navigate your inventory optimisation journey.
We have talked about the prerequisites to successful inventory optimisation. But steps should you follow to realise your supply chain gains.
Think of this next section like a recipe for success. Off course, the proofs in the pudding. But you can’t bake a cake without breaking a few eggs!
Here are the basic steps you’ll need to take:
- Cleaning up obsolescence
- Determine inventory composition
- Define priority control
- Calculate inventory optimum per item
- Optimising logistics costs
1. Cleaning up obsolescence
Like many journeys in the life, the first step is to accept you have a problem. In the context of inventory optimisation, this means acknowledging that you are holding on to inventory you probably don’t need.
Analysing which products within your assortment are obsolete is your top priority. This will give you insights for immediate consideration, and also help with long-term planning.
You can then ‘clean up’ your warehouse from these decisions. What stays? What’s sent into the abyss?
Double checking the parameters you’re making these decisions by will give you peace of mind you’re making the right moves at every step.
It’ll also ensure you’re giving the business accurate settings to prevent erroneous purchases in future stock.
A mix of new, mature and end of life articles then become apparent.
2. Determine the inventory composition
Not all inventory is created equally.
So, what shape should your inventory composition take? How many new items should you hold? What reserves should you give yourself on ever-present, well sold items? And what can you cut your losses on?
Inventory optimisation is all about fine-tuning what you can. And looking at the table below, you can see which types of stock it makes sense to tinker with, and which items you should leave as they are.
Fixed stock is your inventory constant. Your baseline. Your ever-present products. You may even be contractually obligated to hold this stock. Therefore, your hands are tied. You probably couldn’t much to reduce it, even if you wanted to.
Strategic stock’s there to take advantage of market conditions.
Maybe your supplier offered you a deal you could not say no to & you made a conscious decision to forward purchase all the inventory you need for the next year.
Maybe you hold a special level of stock to win that new customer your sales guys have been chasing.
Either way, the decision has been made. And that inventory is now sat in your warehouse.
These are the items you decided to take a punt on.
Maybe you can do some clever analysis to work out how much you might sell. But ultimate, this stock is here to get the ball rolling. Once you some real sales data to work with, you can start optimising these products.
This is the stock that’s on the move. The order has been placed; the stock might even be on water.
Off course, if your order is already making its way across the Panama Canal, you are probably out of options. But if the order is still with the supplier, you may be able to push the order back or expedite it so its hits your warehouse sooner.
Everyone makes mistakes. Some more than other. Incorrect stock should never had been ordered in the first place. But now you need to do something about it.
Thankfully, incorrect stock has a strategy already associated to it. Normally that revolves around the incinerator. (Please note other more eco-friendly options may be available!)
Batch size and safety stock
Finally, some inventory we can properly optimise!
Batch size and Safety stock are two categories you can and should have influence on.
However, a major cause of overstock is that safety stock and order quantity are seen as static numbers. They’re not.
The quantity you order, or produce, naturally depends on the Minimum Order Quantity or MOQ per supplier.
Top tip: We can go step further here and work out the economic order quantity. Click here to find out more about how you can apply the EOQ formula to strike the perfect balance.
3. Define priority control
he Pareto principle comes into play when thinking about defining priority.
Just as “80% of wealth is owned by 20% of the population”, so, in many businesses, 80% of sales are driven by just 20% of the product portfolio.
Not all products are created equally. And you’ll know without even thinking about it, which products in your assortment contribute the lion’s share of your profit margins.
If you’ve been working through this article with your own business in mind, you’ll have realised where your working capital threatens to evaporate, which stock you can and can’t tinker with, and therefore know the potential savings on working capital.
The question now… how should you optimise stock to achieve that saving?
And doing so without impacting availability, and therefore service levels for your loyal customers.
Mr. Vilfredo Pareto enters from stage left.
The 80-20 rule applies to many cause and effect relationships. And it’ll be no different in your business when you dig into the data.
Which 20% determines 80% of your turnover? Or 80% of the order lines? Or 80% of your stock?
To find out, undertake an XYZ analysis, with X being the most important, and Z the least.
This will help provide insight into which 20% of the articles determine 80% of the turnover AND, for example, the margin.
Top Tip: A good assortment analysis can realise some shocking insights about the state of your inventory. Here are some practical tips to conduct and ABC analysis on your assortment.
4. Calculate inventory optimum per item
There’s a famous saying, author unknown, who states you should only worry about the things within your control.
Anything outside of that isn’t worth the effort, as there’s little possibility of you affecting the outcome anyway.
Whilst it’s an admirable intention to cover the businesses’ risk as much as possible, some things will always be outside of your control.
Like a snowstorm suddenly affecting your delivery times, for example.
Or another pandemic. Or another political disaster coming to the fore, as sadly predictable as that might be.
The key to calculating your inventory optimum per item is to balance supply with demand as closely as you can.
When’s the optimal moment for your business to buy?
Order too soon and you’ll test the company’s limits. You’ll take up more space and use more capital. You’ll be less agile to changing market conditions and put the business up against it.
Order too late however and you’ll also expose the business to risk. You might lose short-term custom, and potentially harm the long-term brand position.
You should be reverse engineering your inventory levels from future demand forecasts. It’s far easier to make decisions if your demand is stable.
If your demand looks like the graph above, it’s a fairly easy calculation to make sure you’re covered for the baseline stock in place. All the while ensuring you have safety stock to cover the best-case scenario.
Demand that looks like the graph below however it’s much trickier to predict and cover with inventory.
Knowing the average sales, MOQ, delivery time, current stock and safety stock of an item still won’t give you enough data to make incisive decisions.
You need information about the demand pattern. You need to understand the profile of demand. You need to understand emerging trends.
You need to identify you known demand side risk factors. And you need to protect yourself against the demand volatility factors you can’t control.
Only then can you start planning for an optimised inventory.
5. Optimising logistics costs
Do you have the inventory available to make sure your orders are fulfilled?
If not, can you order it on time? What added costs might that incur? Will ordering with a shorter lead time impact the costs of the entire business? Will not having stock create bigger disruption? And in either case, is the increased cost covered in the margin of the sale?
It’s absolutely imperative for you to understand the implications of holding or not holding stock.
How does it affect the wider business?
Do you understand how holding or not holding stock impacts the company? Having a warehouse is great. But if it’s filled with products, you don’t need and never will, that comes at an unnecessary cost.
Filling it with products you do need is an opportunity.
Slim4 > ERP and Excel
Inventory optimisation is simple (at least in theory) but that doesn’t mean isn’t easy.
Therefore, relying on simplistic methods to make complicated analyses is not your best option. In fact, using your ERP system or even Excel to make complex decisions is more likely to leave you with more questions than answers.
Questions like, “where did we go wrong?” Or “why’s our actual profit so much lower than expected profit?”
If you sell one product, to a steady stream of regular clients that never fluctuate in demand, Excel’s probably fine. But I’d guess that’s probably not the case.
If your business is more intricate than that, you need a more robust product. One that’s efficient, transferable, reproducible and scalable.
You need Slim4.