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The effective use of a manufacturer’s inventory investment is an important determinant of the company’s success. Excess and obsolete inventory is a drain on resources, as is excessive safety stock. Stockouts affect customer satisfaction and revenue, and the frequent need to expedite orders adds to costs and highlights problems lurking in the system.

Managing an Inventory Investment

Inventory effectiveness measures the process that delivers the right part to the right place at the right time, while minimizing investment and meeting customer requirements. Managing inventory effectively is a delicate balancing act, affected by lead times, supply chain efficiency, demand variability, product complexity, product life cycles, warehouse space and practices, among other variables.

It is critical to monitor inventory effectiveness using five key metrics: Expedited orders, inventory turns, obsolete inventory, safety stock and stockouts. We already covered stockouts and backorders in a previous post, so in this post we’ll focus on the remaining four.

  • Expedited Orders: This represents the number of orders expedited in a given period. Whether you measure purchase orders or customer orders—and you should do both—high numbers indicate problems in your inventory planning and flow.
  • Inventory Turns: This represents the number of times a company sells and replaces its stock of goods during a given period. Calculate it by dividing the cost of goods sold by the average inventory value. Many organizations publish turns data by industry or SIC code to help gauge where you stand against others in your industry.
  • Obsolete Inventory: The value of obsolete, inactive or slow-moving inventory. It can be measured either as a dollar value or a percent of total inventory. 
  • Safety Stock: This is an extra level of inventory held to reduce the risk of stockouts. Many companies just estimate safety stock levels, which may or may not be effective. There are numerous formulas for calculating safety stock depending on an item’s usage pattern, but the simplest one is to multiply the average daily demand by average lead time.

Using Metrics to Measure the Health of the Business

Companies use these metrics to minimize their investment in inventory without adversely affecting customer service levels. The absolute measure is less informative than the trend in the metrics.

For example, rising obsolete inventory may point to problems in managing new product introductions and the retirement of old products. Failure to balance the intro date of new products against the inventory on hand and usage for components that will no longer be needed shows that the new product introduction process may need refinement. 

A company may choose to introduce a new product while old stock and components are still high, but the company should be aware of the cost of this decision and balance that against the benefits of early market entry. Obsolete inventory may also indicate poor electronic communication network (ECN) and corrective action and preventive action (CAPA) processes, so if the number is trending upward, investigate both areas before changing any process.

The number of expedited orders is also an important trend that can indicate emerging business issues. The rise may be because of a deterioration in forecast accuracy, a problem in the supply chain or an internal order process issue. Watch the trends and dig deep to find the causes.

Inventory turns can identify whether changes in inventory management processes are effective, but they also serve as an important benchmark against competitors and similar companies. Never just choose a number arbitrarily as a target, since optimum levels vary between industries. Look at what the best companies in your industry achieve and then shoot for something similar. 

By definition, safety stock is inventory you never plan to use, so it makes sense to minimize it as much as possible without compromising customer service levels. Safety stock can be minimal for items that are easy to acquire but may be higher for sole-sourced or custom items. Anything critical to your brand reputation or production process may require higher levels of safety stock. You may want to keep safety stock for extremely high-cost items low. The point is, one size doesn’t fit all when it comes to safety stock.

Best Practices for Inventory Effectiveness

  • Monitor forecast accuracy and work to improve accuracy wherever possible
  • Use consignment inventory or vendor managed inventory for critical items
  • Cycle count to identify any stockroom or warehouse process problems
  • Use safety stock optimization techniques to minimize the investment
  • Use bar coding or RF devices to improve inventory transaction accuracy
  • Use available-to-promise (ATP) to ensure promise dates are realistic on customer orders
  • Monitor supplier performance to ensure purchased item deliveries are consistent
  • Implement cross docking procedures 
  • Design products and processes to enable postponement of the point when inventory must be committed
  • Use lean manufacturing and Just in Time to reduce inventory
  • Use effective CAPA and Engineering Change procedures to minimize obsolete inventory

Tracking, Managing, and Choosing Metrics

Using these metrics will help to minimize the investment in obsolete inventory, freeing up capital for investment in more productive endeavors without adversely affecting customer service levels or stock outs. The simplest way to track and manage these metrics is with the Action Centers found in QAD Adaptive ERP: Operations Action Center, Maintenance Manager Action Center or QAD Enterprise Asset Management.

What challenges are you finding most significant when it comes to inventory effectiveness? Let us know in the comments section below.

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