How much inventory should I hold? One of the principles of supply of goods to a market
is that companies hold enough stock to satisfy customer demand, without holding too much.
So intuitively, just the right quantities of stock to satisfy demand will minimise cost.
However, when dealing with thousands of stock keeping units, the art of balancing demand
with supply is intricate. It becomes even more complex when multiple storage facilities
are used, and customer service times are short or vary according to the critical nature of
products. The best way to understand how much stock you should have is to determine how
much it costs you. As a guide, inventory costs vary from 2.4 to 16% of sales revenue. You
might like to check your costs before embarking on a cost reduction exercise. In your endeavor
to reduce costs, it’s important to understand what are the typical costs involved. Well
here are areas that you should examine. Facility Costs. These are holding costs which include
rental, mobile and static equipment, utilities, and compliance costs. For example, for dangerous
goods or pharmaceutical products. Human Capital. This is the cost of labour to manage stock.
For example moving it, handling it and counting it. Finance costs. When capital is invested
in inventory, the cost of finance is ‘interest’, or the lost opportunity of vesting capital
elsewhere.Management Costs. These are white collar personnel and information technology
charges. Procurement costs. These relate to the cost of purchasing, including inbound
transport. Inventory turnover. As a rule of thumb, the faster the stock turns over, the
less it will cost you to hold. However, stock turns in some businesses such as spare parts
will be very low, say 1 to 3 times per annum. Whereas stock turns in a a Fast Moving Consumer
Goods business can be as high as 20 to 30 times per year. Regardless, increasing stock
turns for any business to an optimal level is beneficial. Stock Accuracy. If stock records
are wrong, vast amounts of time and expense can be wasted sorting them out. Ideally, stock
accuracy should be 98% or better. This means that 98 times out of 100, the stock ‘on
system’ actually matches the stock in the storage bin. Lower percentages are always
linked to higher operating costs. Pillage and Ullage. Unfortunately, theft occurs as
does unexplained stock losses and damage. The cost of these must be factored in to your
analysis. Service Levels. Too rigid or a single serve level approach can cost dearly. Companies
that will offer goods supplied anywhere, anytime in any quantity, at the fastest delivery time
possible will have higher levels of stock than those who offer a service level specifically
tailored to customer needs. So in all of these, what is the Solution? Know thy customer service
levels well, and note, levels are plural. Smart companies segment their supply to 3
service classes.Critical Goods, these are products that are needed quickly such as for
medical or emergency. Non Critical Goods. These are products needed within a
reasonable time frame but are not necessarily urgent, such as computers, household white
goods, and building materials. Scheduled Delivery. These are goods which can be built or customised
for particular customers and delivered according to agreed delivery times. This applies to
some technology products and also furniture. A further delineation may be made between
retail, wholesale or end user customers. In any case, it pays to start with a good understanding
of customer needs before advancing to the next stage. Now that you know the inventory
cost drivers, what are some of the strategies that can be used to better manage inventory?
Here are just a couple. Firstly, Vendor Managed Inventory. Some companies involved in manufacturing
integration or assembly rely on their vendors to manage their own stock until the goods
are actually used on the production line. Under this arrangement, the manufacturer doesn’t
have to carry any stock and only pays for the stock when used. This strategy can save
the manufacturer money, but can consequently load certain costs upon vendors. This apparent
misalignment of costs between manufacturer and the supplier is beneficial to end customers
as the total cost to supply in fact becomes lower. Another strategy is Postponement Logistics.
This is common to many international manufacturers and is the process of postponing final assembly
of goods until demanded in the off shore market where they will be sold. This enables efficient
storage of a smaller range of goods while offering a fast response time to the designated
market. It has been used in the fashion industry to good effect, and also in industries such
as appliances, computers and gaming. With a large number of companies moving manufacturing
off shore to South and Northeast Asia, postponement is becoming more common and feasible for smaller
markets such as Australia. So, from what I have covered in this session, you will be
aware that inventory management is a challenging and inexact science which should be approached
carefully to ensure full understanding and application of the most appropriate supply
chain strategy. I wish your every success as you scrutinise this important aspect of
your business.