By Scott Bernier, Consultant, ProcurePro Consulting
In today’s challenging times where revenues are flattening or disappearing, it is imperative that organizations free up cash flow as much as possible to see them through these difficult times. One source of potential cash flow is in optimizing your inventory, often resulting in millions of dollars in savings for reinvestment in your business.
1. Conduct an ABC Analysis
A great way to reduce inventory is to review the mix of products your company is carrying, and using the 80/20 rule, to reduce unnecessary products and focus on the most important. Why have 20 inventory turns of low dollar value items, when you may have some really big-ticket items collecting dust? If you have the wrong inventory mix, this is costing your company money.
The rule of thumb is that the top 20-25% of your inventory, equals 75-80% of your inventory value. These items need to be managed closely by your warehouse, purchasing and inventory management teams. By reducing inventory in these few products, you have the greatest impact to inventory reduction.
As a new Inventory Manager, I was tasked to review my company’s inventory, valued at approximately $6.4M. After conducting an ABC analysis and modifying the order parameters to closely align with ABC rules, my company’s inventory reduced by over $2M and customer deliveries improved from under 80% to 97%. This $2M in increased cashflow was used to hire additional sales force and subsequently, sales increased from ~ $30M to over $50M in 4 years.
Action – Analysis of your ABC inventory and modification of your inventory parameters, should be conducted at least once per year. Many companies don’t do this often enough and find that the product mix has significantly changed. It is a quick, low cost analysis that can help improve your overall inventory optimization strategy.
2. Reduce Your Order Sizes
This is an important part of any good inventory optimization strategy. Many suppliers try to force customers into large order lot sizes. This will significantly hamper a company’s ability to reduce inventory. Work closely with your manufactures, distributors and wholesalers to reduce the order quantities to align with your ABC classifications.
For example, if your current order sizing is eight weeks supply at $1M inventory for six turns per year and you’re able to reduce this to 4 weeks, you can increase your turns to twelve per year and your inventory can be reduced by $500,000.
Action – Work with your top 5 product suppliers to change order sizes based on ABC classifications. The goal is to order 1-2-week planning horizon every 1-2 weeks. Once these suppliers achieve this, work on the next five, 2-3-week horizon every 2-3 weeks etc.
3. Reduce Supplier/Supply Chain Lead-time
One of the main drivers for how much inventory your company has is the total time (lead-time) it takes your company to source and receive the purchased goods. A 1-week reduction of total lead-time can create a significant reduction in your inventory. If you are carrying $10M for eight weeks worth of inventory (six turns per year), a 1-week reduction in inventory increases your cash flow by $1,250,000 ($10M/8). Instead of carrying $10M you can now carry $8.75M. Think of the things your company can do with an extra $1.25M? If the value of money is at 3% (Many companies don’t get 3% for interest and many have to pay a much higher rate then 3% for loans so it could be significantly higher), this is realized savings of $37,500 annually.
Ordering product, manufacturing, transportation, customs or receiving, all have an affect on the overall lead-time and increase the need to carry more inventory. As you reduce these times, you are able to put this money to better use. Keep in mind, in the case of critical items, rather than holding contingency stock in your inventory, negotiate with suppliers for them to hold contingency stock specifically for your organization. This avoids a shortage of critical items when fluctuations in supply and demand occur.
Action – Find your top 50 products (by spend) and set a goal to optimize lead-time reduction from your supply chain. Once this has been achieved, work on the next 50 products.
4. Conduct Cycle Counting
Cycle Counting has become a very common practice in many companies. However, it is usually followed by adjusting the inventory up or down, ordering new product or deferring orders. This should be a continuous cycle.
Cycle counting is an important step but not in and of itself. The key to an effective cycle counting strategy is to conduct root cause corrective action. Once an error is identified, it needs to be investigated to determine why it is happening:
- Was the product received incorrectly?
- Was it the wrong quantity?
- Was it put away in the wrong location?
- Was it picked for the wrong job?
- Was the wrong quantity picked?
- Was the wrong product picked for the job?
- Was the product picked but not transacted?
- Was there a quality issue such as damaged or expired and then not properly transacted?
By identifying the root cause of the error and then working as a team to reduce and eliminate future errors, you will be able to reduce the instances and improve your inventory accuracy. With better inventory accuracy, you can reduce the inventory you are carrying without the concern of missing a shipment to your customer.
At a former company I worked at, they had an 80% accuracy number, this was a major concern as their external auditors would not sign off on their financial statements without trusting the inventory numbers.
I reviewed the cycle counting procedures and was able to identify some common inventory errors due to removing expired product without the proper transactions. This error changed their accuracy from ~ 80% to over 90% and the auditors were able to approve their inventory.
If a company has 3% variation in their inventory valued at $1M, this is $30,000 +/- (lost inventory or extra inventory both can cause financial problems). If you believe you have more inventory than you actually do, the customer is impacted, orders are not fulfilled, and your customers may find another supplier. If you believe you have less inventory than you actually do, you are ordering more to refill your stock, suppliers are being pressured and it is costing your company money.
Action – Develop a cycle counting procedure for your company’s warehouse team. Have dedicated people conduct the count, perform a root-cause analysis and implement corrective actions to prevent future errors.
5. Improve Customer & Supplier Relationships
I was recently tasked with improving delivery and reducing inventory. This was a no-win task, as my customers distrusted the old Supply Chain team, their Key Performance Indicator (KPI) and the overall goals of the team. The first thing I did was peel back the onion and discovered the “real” delivery numbers. They were horrible. Customers were not getting what they ordered, when they asked for it. To compensate for this, they started hording product and over ordering for each of their jobs.
Suppliers were constantly being pushed and pulled because they were asked to expedite orders and then the very next month, orders were pushed out or canceled.
By working closely with the internal customers and suppliers, I was able to identify the root cause of the problem (poor warehouse management of orders), focus on solving the trust issue with the internal customers and help solve the supplier’s concerns.
Over a one year period, I was able to align the inventory to better meet customer demand and reduce the inventory on product not needed, provided smooth orders for the supplier and reduce inventory by 5% on $60M ($3M inventory reduction).
At the same company, I was a part of the team which developed the supplier scorecard. It was a balanced scorecard which included cost, lead-time, pricing, delivery, engineering support, quality and sustainability measurements. With a balanced approach, the supply chain team was able to evaluate the performance of the top suppliers and work closely with them to continually improve.
Action – Implement a Supplier Relationship Management (SRM). Meet with your top customers and suppliers regularly at a minimum, these should be annual meetings. Provide clear measurable KPI data on your performance to customers and your suppliers performance to you. This will help solve both customer and supplier issues.
6. Product Consolidation
As a new manager, along with conducting ABC analysis, I worked closely with the engineers to review what products were similar, had alternatives, or were even identical in some circumstances. My task was to eliminate products not needed. With over 16,000 product offerings, it was easy to see why. Customers had too many choices. This created several “specials” and while innovation is vital for a company to grow and prosper, many innovations were just not selling.
With the help of the engineers, I was able to identify 4,000 products which could be eliminated and suggested alternatives which met the needs of the customers.
A 5% product reduction can reduce a $10M inventory by $500,000, without impacting customer service while improving on-time and in full delivery (OTIF) because you are focusing your inventory on what product is selling. The more customers you can have pulling from the same product(s), the more reliable you will be as a supplier.
Action – Develop a cross-functional product committee at your company with a mandate to evaluate requests for new products, changes to existing products and removal of products. A cross functional team with input from quality, engineering, sales & marketing, operations, finance and supply chain, can help focus your product offering to ensure it is best in class.
7. Provide Your Supplier an Accurate Forecast
Sales & Operations Planning (S&OP) receives a lot of attention and it is extremely important for manufacturers and distributors to provide the best possible lead-times to get the product to you when you need. The more accurate the forecast, the lower the variability and risk.
Early in my career, I worked closely with a manufacturer to develop a tool which provided them a manufacturing window (8 weeks) of firm commitment and a 6-month window of fluid commitment. They placed their shop orders based on the 8-week window and their raw material commitments based on the 6-month window. This changed based on the customer demand for product and inventory at the company, but because we were able to provide 8 weeks firm commitment, this allowed them room in their production to help if things needed to be expedited. This also allowed them to pull on their raw material suppliers if they needed because of the 6-month commitment.
I was transparent with everyone on the purpose and goal of the forecast, including the buyers and we ensured we followed the forecast commitments. We were over 80% accurate within 1 month of placing an order.
My supplier’s costs were reduced, and they passed through to us product savings of 10% ($2M annually in spend or $200,000 in savings) and reduced lead-time from 6 weeks to 2 weeks ($166,000 in inventory reduction). A combined annual savings of $366,000.
Action – Even if it isn’t 100% accurate, start working closely with your sales and marketing team to develop a monthly forecast and provide this to your top suppliers. Provide feedback to the team regularly on the accuracy of the forecast to refine the process.
8. Review your Slow-moving & Obsolete Inventory
It is important to look at what is in your inventory that isn’t selling and being used. This inventory is pure waste and is costing your company serious money. It is taking up valuable shelf space, it is being cycle counted, and it is tying up cash that should be used for reinvestment in your company.
One of my global suppliers was having difficulty with end of line product not being used. Efficiencies in their line actually created obsolete inventory for them. I was able to work with my company’s team to reuse $400,000 worth of this product on a less efficient line. Efficiency does not always mean the best use of resources.
Another company I worked with had a 5-year shelf life on their product and was at risk of writing off over $1M in inventory. By offering key customers some discounts, they were able to reduce the write-offs to less than $200,000, saving over $800,000.
Action – Review your product that is greater than 30, 60, 90 days supply and determine strategies for eliminating or reducing your company’s risk. Sell at a discount, reuse or repurpose the product, sell at auction, or sell to a liquidator. You may need to destroy or dispose of the product (as a last resort) but this will at least free up shelf space and reduce the need to cycle count obsolete inventory.
9. Measure your Buyer/Planner Separately
“What gets measured gets done”. I have used this quote for over 20 years, but it still holds true. By measuring each person on your team individually, they take ownership of their own numbers. Some common measurements include, too much inventory, not enough inventory, late ordering, and poor supplier reviews. It is best to conduct a brainstorming session with your team to determine what needs to be measured on an individual level. Company wide measurements, such as on time in full (OTIF) to customer, are how the customers on a whole, view the performance of the department, however these numbers may not reflect an individual customers’ reality.
I developed a Business Intelligence (BI) tool that measured Supply Chain Services. This included delivery performance OTIF, days worth of inventory (inventory turns), value of inventory, late purchase order (supplier performance) and orders late (buyer performance). Each buyer/planner had their own measurements they were responsible for. Once this was adopted, OTIF improved by over 10%, and inventory reduced by over $1M ($56M to $55M).
Buyers and Planners are looking to tools to better manage their inventory, suppliers and purchases. Even a 1% improvement on a $10M inventory is $100,000 in improved cashflow annually.
Action – Work with your buyers and planners to develop the tools to measure individual performance.
10. Fundamental Supply Chain & Inventory Training for your Supply Chain Team
During my career, I’ve had the privilege to work for some amazing companies in several different industries. During this time, I have amassed a wealth of knowledge. I have also had the opportunity to go back to my local college and teach. This was an extremely valuable experience. It has led me to understand and have a much greater appreciation for inventory, purchasing, warehousing, and several other functional areas within supply chain.
By providing a foundation for your entire team you, will ensure everyone is on the same page, speaking the same language and drumming to the same beat.
Nothing shuts down innovation, continuous improvement and improved moral than having change shut down because the team isn’t clear on the direction, doesn’t understand why changes are happening and being part of the solution. Foundational training is a key element in this transition.
Action – Invest in your supply chain team, from the C-suite to the warehouse clerk. Everyone on the team needs to be speaking the same language. I have found it extremely beneficial to bring an expert in-house and include representation from customer service, IT and other functional areas that support the overall supply chain.
You can expect to see anywhere between 2x to 10x Return on this Investment (ROI).
These inventory strategies and others will significantly help your company reduce unnecessary inventory and build critical inventory to maximize profits.
I look forward to your feedback. What strategies are you doing at your company to make it best in class? Need help with managing your inventory or providing training for your team? We’ve got you covered. Contact me today for a free, no obligation consultation at Scott.Bernier@procurepro.ca, or for more information on ProcurePro Consulting checkout our website procurepro.ca
Scott is a seasoned operational and supply chain expert with over 20 years of Operations Management, Warehousing, Inventory Management, Procurement and Strategic Sourcing experience.
Scott Bernier, SCMP