A major ongoing debate within many departments of a company is the appropriate level of inventory to maintain. Though every business would attempt to reduce its inventory level [but] without impacting the customer service [support] level. On my previous post I have talked about the risk of having too much inventory is just equal when having it too little. You may want to read it if you haven’t yet. If the marketing and sales managers want to achieve high service levels, then stocking a high level of inventory seems necessary. However, this increases working capital requirements and greatly increases the risk of incurring obsolete inventory expenses. The accountant may find it helpful to use a set of analysis tools I am going to reveal through this post to assist management with the calculation of the best possible investment level for service parts.
Here are some tools to consider:
- Throughput per customer – Know which customers generate the company’s cash flow. This requires knowledge of exactly which products each customer purchases on an annualized basis, as well as the throughput (revenue minus totally variable costs) of those products. It is entirely possible that a high-volume customer may generate such an insignificant amount of cash that it is not worth an excessive level of servicing, so there is no need to maintain a large inventory of specialized service parts for it.
- Customer quality standards – Ever notice how some customers are pickier than others? Some customers will require replacement of parts that would be considered well within the quality specifications of other customers. If these customers are the same ones with low throughput levels (see last item), then the company needs to question not only its stocking levels, but also why it permits them to be customers. Consequently, be sure to review the proportion of inventory returns by customer.
- Customer complaints – Which inventory items do customers actually want the company to have on hand for immediate delivery? Management may be surprised to find that only a few items are ‘‘small bolts’’, and those small bolts may not even be overly expensive to keep on hand. It makes sense to spend a few hours combing through the customer complaints log to see which stock-outs actually caused a problem. If the company does not have this information, then set up an inexpensive online survey through an online surveying service such as Survey Monkey ($20/month for a 1,000-response survey) and ask the customers.
- Call the user – Notice that the header for this point is ‘‘call the user,’’ not ‘‘call the customer’’. There is a specific person within the customer’s organization who is waiting for the company’s service parts to arrive. Find out who it is, and ask her/him how soon she/he needs parts from the company. Not only is this a great way to maintain customer contact and build repeat business, but the company can also obtain an excellent view of precisely how its product is used, and therefore how rapidly its system needs to fulfill any orders for the product. For example, if a service part is needed by the customer on a key piece of manufacturing equipment that will bring down the customer’s entire assembly line, then pre-positioning the part in a nearby warehouse or on-site may be the level of servicing inventory required. Alternatively, if the part is used only on backup equipment that is rarely used, then a week-long delay may be entirely acceptable.
A key point is that not one of the items listed in this toolkit includes the more common metrics, such as fulfillment rates, service levels, demand accuracy, or the percentage of obsolete inventory. The appropriate level of inventory is extremely difficult to determine when using such aggregate measures, because service levels can vary so dramatically by individual product.
The typical warehouse may contain several thousand different products, so conducting an analysis with the preceding toolkit for each individual item would be prohibitively expensive. Instead use these quick simple aggregation steps:
Step-1: Aggregate products by customer to see which ones are used only by low-throughput customers, and then assign them a low level of stocking priority.
Step-2: Aggregate products by type, and determine the level of customer need for each inventory type by using the direct contact or customer complaint tools.
This quick aggregation approach greatly reduces the effort required to determine the correct stocking levels needed for different types of inventory.
The preceding discussion addressed ways to determine inventory levels for individual inventory items. In addition, some general techniques are available for reducing all types of inventory without reducing service levels. They are as follows:
- Consolidate smaller, local warehouses into a single regional warehouse. By doing so, the company needs to maintain safety stock only at one location, rather than once at each warehouse.
- Centralize slow-moving inventory. If an item turns over very slowly, then it may be cost-effective to store it in just one place (not even in a few regional warehouses). The trade-off here is an absolute minimum amount of safety stock versus possibly higher shipping costs.
- Buy in smaller quantities. This may result in more frequent deliveries, so there may be a cost trade-off. At a minimum, avoid any purchasing ‘‘deals’’ where the company buys vast quantities of goods in exchange for a price break.
- Shrink production runs. A major cause of excessive inventory is production runs that greatly exceed the amount of customer orders. If there are no orders, don’t load up the warehouse with extra units. And above all, don’t operate the production equipment just to keep the staff busy. If there is no demand, then do not produce it.
- Shrink the number of product options. Does the company really need to sell a product in blue, green, red, and pink, as well as with an optional confabulator? Though marketing will be annoyed, try to stock only one or two product variations. At a minimum, store only a moderate number of subunits that can be quickly altered at the last minute into a variety of configurations, rather than storing lots of the final configurations.
Another concept that can reduce inventory levels without impacting service levels is “risk pooling”. This is the concept that safety stock levels can be reduced for parts that are used in a large number of products, because fluctuations in the demand levels of parent products will offset each other, resulting in a lower safety stock level. For example: engineers are usually instructed to use common parts in more than one product, so that fewer total parts can be stocked [another inventory reduction technique].
A useful side benefit of this approach is that the fluctuations in the demand levels of a single part by multiple parent products will offset each other. This results in a smaller standard deviation in usage levels for a part having multiple sources of demand, as opposed to the usage deviation for parts with fewer sources of demand.
In order to reduce safety stock levels for parts having multiple sources of demand, use a simple trial-and-error approach of determining the actual stock-out level of these items over a rolling three-month period, and gradually reducing the in-stock balance until the mandated service level is reached. For these items, the safety stock level will likely be substantially below the average corporate safety stock level.
This post has addressed multiple ways to reduce inventory levels without impacting service levels: by the profit level generated, actual customer need, storage centralization, product configuration, purchasing and producing in smaller quantities, and risk pooling. Only by attacking the problem with most of these tools will a company experience a significant decline in its inventory levels while continuing to provide a high level of customer support.