Inventory is a necessity in many businesses to enable service performance, but it is also one of the most significant investments many businesses make. Consequently, inventory must be managed effectively. Here we pose 10 questions that you should ask to determine how effective your inventory management really is.
1. Is there a clear inventory strategy?
All finished goods and sub-components should be categorised as ‘Make-to-stock’, ‘Make-to-order’ or ‘Configure-to-order’. Wherever lead time and volume allow, items should be categorised as ‘Make-to-order’ (or ‘Purchase-to-order’ for retail). This ensures inventory is only held for items where demand requirements are not synchronised with supply requirements (see The Basics of Inventory Management Explained for reasons to hold inventory).
2. Are there defined inventory targets for all finished goods and sub-components?
All finished goods and sub-components should have a specific inventory target assigned to them. This may be a specific Reorder Point (ROP) or a minimum and maximum if you are operating to a ‘Min Max’ policy. The inventory target should be justified and minimised using appropriate inventory calculations.
3. Are the defined inventory targets linked to a demand forecast?
Ideally the inventory targets should be calculated from a demand forecast (including the order book), and that demand forecast should be a consensual view driven from your S&OP process. However, many companies do not have a demand forecast at SKU level and in this instance the inventory targets should be linked to demand history.
4. Do the inventory targets account for deviation?
The target inventory for all finished goods and sub-components should factor in forecast error, or when using history, demand deviation. It is common practice to use the Root Mean Squared Error for a demand forecast and the standard deviation for demand history.
5. Are the inventory targets dynamically or periodically updated?
Many ERP systems will have algorithms within their supply chain modules that can dynamically calculate inventory targets. However, this will most often depend on a demand forecast being held in the ERP. Where a forecast is not held, or where the ERP functionality is not used, then there should be a periodic recalculation of inventory targets using spreadsheet models.
6. Do all finished goods have a classification?
All finished goods should be classified according to their commercial importance or criticality. This is often referred to as an ABC classification or ‘runners, repeaters, strangers’. The purpose of the classification is so inventory targets can be modified according to an items importance and consequently working capital can be balanced against that importance.
7. Are service targets set for all finished goods and sub-components?
All items should have a service level set and factored within the inventory target. This service level should be aligned with the products classification i.e. the more important the item, the higher the service level.
8. Are the inventory targets comprised of both cycle stock and safety stock?
Inventory targets should be comprised of two elements: cycle stock, which covers the mean expected demand during the replenishment lead time, and safety stock which covers potential variation to the mean expected demand.
9. Are maximum reorder quantities set?
All items should have a set maximum reorder quantity. Where reorder quantities aren’t set by a supplier, or manufacturing process, then every item should have a reorder quantity that is either derived from an Economic Order Quantity, or set to equal the inventory target.
10. Is there clear responsibility and accountability for inventory targets?
For every area holding inventory there must be responsibility assigned to determine and manage the inventory levels. The person, or persons, responsible for the inventory must also report actual inventory levels against inventory targets and link targets back to service performance metrics.
Here at Paul Trudgian we are experts in inventory policy design and deployment. We have assisted many clients, in both manufacturing and retail environments, to drive down inventory, reduce working capital and improve service. If you would like to discuss your inventory requirements, please contact our consulting team today.
