Ten keys to inventory reduction

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A-09

Mark K. Williams, CFPIM

Ten Keys to Inventory Reduction
Companies exist to service their customers. The primary service provided by manufacturing and distribution companies is in the form of a raw material or component that the customer then processes into its own product, or a finished goods item that the customer resells. It is therefore critical that each company has a set ofinventory objectives that allow it to provide this service profitably. The main inventory objectives for most companies seem deceptively simple: • Provide the right product • at the right place • in the right quantity • at the right time and • at the right price. If a company does these five things, it will satisfy its customers and become extremely profitable. Although this inventory objective soundssimple, hard and often painful experience tells us that it is not. A forecast of the customer’s demands is based on past history, but if a customer places an item on promotion, the supplier may not have the right quantity. Most of the required product is in the Texas warehouse, and suddenly the demand is heavy in Boston. A company stocks up on a new product that Marketing knows will be a hit, andit turns out to be a dud. Or worse, a new product is suspected of being a dud so very little is stocked, and it turns out to be a hit, leaving Marketing and the customers mad. The days are long gone when customers would routinely accept shipments from suppliers that were 70 percent complete. Many companies will cease doing business with a supplier that cannot maintain a service level of at least98 percent. Of course, a supplier without customers will quickly go out of business. Therefore, if a company experiences fulfillment problems, the solution demanded by the Sales Department and the corner office is usually, “Bring in more inventory and get rid of these stockouts or else!” the product that is in stock. The company has to go back to its bankers repeatedly to borrow money to supportthe higher levels of inventory. At the end of the year they receive a nasty surprise—their taxes have increased! Then the company often has to confront one final problem; their service level has not increased despite the increase in inventory. What does increase is the cost associated with holding the inventory. This is because even though inventory is listed on the books as an asset, increasing theamount of inventory a company holds has an impact on many individual costs not recognized by many companies. When we look at the components of inventory carrying costs (see Figure 1), it becomes clear how increased inventory levels lead to increased costs.1 Our challenge is to reduce our inventory, leading to a reduction in the associated inventory carrying costs. However, we must simultaneouslyincrease our service levels to our customers or risk losing them. Is this possible? Fortunately, yes, it is possible to reduce inventory while increasing service levels. There is no magic bullet, but by working diligently to implement the following 10 keys to inventory reduction, those two vital goals can be achieved.

1. Improve Inventory Accuracy
A rush shipment is being prepared for a keycustomer. According to the figures in the computer, there is enough stock of each item on hand to fulfill the customer needs. Based on this information, the customer is assured that the shipment will be complete. However, when the order is picked, 3 of the 10 items come up short! Now the customer must be given the bad news. In order to make sure this does not happen again, the supplier considersadding more safety stock to its inventory. By simply adding safety stock in hopes of ensuring enough inventory the next time, the core problem is not addressed. After all, according to the computer records, there was enough stock to complete the order. The real problem in this situation is that the inventory on the shelf did not match the inventory figures in the computer. Will increasing safety...
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