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Inventory Management:
Making the Jump from
Reactive to Predictive
First Published in Operations & Fulfillment
How important is
inventory management? It can be the determining factor in a companys
long term success or failure; it can raise customer service to new heights
or send it plummeting; and it can increase profitability or losses. But
wait, theres more! The implementation of an inventory management system
will improve cash flow, streamline order fulfillment, and provide a
competitive edge. So, how does a smart company move from reactive
inventory purchasing to predictive inventory management?
One method is to
purchase an inventory management package and either modify it to meet your
needs or adjust your needs to conform to the package. While this can be
effective, without a complete understanding of your product flow and
inventory processing costs, choosing the best package for your needs is
impossible. Another method is to develop an inventory management system
in-house. This can be as complicated as hiring a team of programmers or
as simple as utilizing a spreadsheet. The best method is the one that
fits your corporate structure and objectives. Either way, an
understanding of the product flow and processing costs are required to
determine the most effective solution.
Simple inventory
management techniques can be applied to purchasing decisions without the
implementation of high-ticket software or the hiring of a team of
statisticians. It is as simple as analyzing historical data, developing
an initial sales forecast, converting the forecast into a buy plan and
executing the plan. While the implementation of a sophisticated inventory
system can maximize the benefits, a simple plan will generate benefits and
help define the requirements for the best system.
Inventory
management begins with historical analysis of sales and costs. Begin the
sales analysis by determining the sales curves for each product class and
by campaign. Individual items within the product class may follow a
different curve, but the product class curve is usually representative of
all items. The steps for sales analysis are:
·
Group similar curves
together to reduce the number of curves within a campaign.
·
Identify specific product
class curves that follow the circulation sales curve.
·
Determine if sales curves
vary from campaign to campaign.
·
Identify any item that
varies greatly from the product class curve.
This analysis
determines the curve(s) that products follow throughout a campaign.
Standard stock items can be expected to follow seasonal curves comparable
to previous seasonal campaigns. New items can be expected to follow
curves for similar items.
Most companies
consider only product costs when analyzing inventory. If the hidden costs
of inventory purchasing decisions are ignored, unprofitable products may
be retained with an adverse impact on the future of the company. The
hidden purchasing costs include purchasing staff, quality control,
inventory carrying costs, backorder costs, training, incoming freight, and
related administrative costs. When these costs are calculated into the
overall product cost, a previously profitable product can become very
unprofitable. For example, a best selling item requires extensive
haggling with the vendor for each order. Then, twenty-five percent of the
shipment is either damaged or inferior. Backorders are constant, because
of poor service from the vendor, quality issues, and a lack of accurate
forecasting. Once all of the related costs are added to the product cost,
this item is unprofitable. The next step is to determine whether to
replace the item or resolve the issues. If the item is replaced, training
is required to educate customer service and fulfillment personnel about
the new item. Whatever the final outcome, replacement or resolution, the
decision will be made based on realistic analysis if an inventory
management system is utilized.
The next step of
inventory management is to develop an initial sales forecast. The sales
forecast is a dollar based forecast that must balance with the circulation
projected sales dollars. The steps of initial sales forecast development
are:
·
Determine the total
projected sales by week
·
Develop an initial forecast
by product class group utilizing historical analysis and projected sales.
·
Balance the product class
group forecast with the total projected sales dollars.
·
Review with merchandising to
see if any product classes are expected to change in performance.
·
Adjust projections
accordingly.
·
Develop an initial forecast
by specific product class.
·
Balance the specific product
class forecast with the grouped product class and the total projected
sales dollars.
·
Develop an initial forecast
for each inventory item.
·
Reconcile item forecast with
product class, grouped product class, and the total projected sales
dollars.
The initial
sales forecast is a forecast based on historical analysis and the
presumption that an item will perform as previously indicated. The
weighting of item by placement in catalog, trends, or intuition is part of
the next step.
Developing and
executing a buy plan is the final step of implementation. The buy plan
includes weighting of items, planning specific order quantities, and
management of incoming orders. Specifically, the steps for this stage
are:
·
Convert item forecast from
dollars to units.
·
Review item projections with
merchandising to determine variance in performance (weight items
accordingly for placement, trends, etc.)
·
Reconcile item forecast with
product class, grouped product class, and the total projected sales
dollars (if one item is increased because it is the cover shot, other
items must be decreased so the forecast will balance with the sales).
·
Plan specific purchase
orders based on projections, current inventory, lead times, risk, economic
order quantity, and vendor reliability.
·
Place orders with vendors.
·
Monitor incoming sales for
variances from projections.
·
Adjust projections
accordingly, always balancing forecast with the total sales projections.
·
Place re-buy orders to
accommodate actual and projected demand.
·
Continuously monitor
merchandise delivery, overstocks and backorders.
Implementation of
these steps will generate the benefits of an inventory management system.
While on the surface the steps are simple they are extremely time
consuming and can be overwhelming. If your company needs an inventory
management system, but does not have the resources to begin a full scale
implementation, begin with the top twenty percent of the items.
The reliable
80-20 rule (80% of the sales are generated by 20% of the customers) is
also applicable to inventory management. While focusing on only 20% of
the products will not maximize the efficiencies and benefits, it will
serve to substantially reduce costs and improve service. In addition to
the overall management of products and costs there are some key trends
that must be monitored:
Backorders -
The percentage of items unshippable because of inventory outages.
Shipments per
Order - The average number of
shipments per order. Customers pay for one shipment per order; lost
profits pay for all other shipments.
Average Length of
Time to Fill Backorders - The
higher the number the greater the adverse impact on future sales.
Inventory Turns
per Year - The total number of
units sold divided by the average on hand quantity. The higher the turns,
the less cash is tied up by slow moving inventory. It is important to
make sure that backorders are not increased by the higher turnover.
Gross Margin
- Staple products can have gradual increases in costs that merchandising
may want to delay passing on to customers. Monitoring the overall gross
margin will provide early warning that selling prices may need to be
increased.
Controlling
costs associated with purchasing will strengthen your competitive edge and
increase profits. Here are ten ideas for reducing the purchasing
overhead:
1.
Eliminate unprofitable products unless they have intangible
benefits such as generating publicity or upsales and cross sales.
2. Reduce the number of vendors. This with reduce the administrative
costs and increase your bargaining power with the remaining vendors.
3. Concentrate on the high volume items (top 20%). There should be a
portion of your inventory that are considered never-outs and the
appropriate attention should be focused on these items.
4. Bundle orders together to gain vendor discounts and free freight.
Analyze these decisions carefully. Sometimes the carrying costs and
financial risk exceed the savings.
5. Re-negotiate with vendors on a regular basis. Often a small or
mid-size catalog will not realize that their purchasing volume with a
specific vendor has substantially increased. They may have become the
largest customer with that specific vendor and have the opportunity for
reduced costs and/or increased service.
6. Ask your vendors to provide training materials and/or training for
operations personnel on new or updated products.
7. Negotiate advertising dollars. One caution: if the product
required extensive merchandising to locate or develop, do not disclose
vendor information in exchange for advertising dollars.
8. Treat your vendors as partners and build long term relationships.
Vendor turnover is expensive and a vendor/partner has a vested interest in
helping you to increase sales and reduce costs. Ask your vendors to refer
their retail requests to your catalog.
9. Keep it simple. The more sophisticated a system or procedure the
higher the costs in implementation.
10.
Negotiate for cash discounts. They can reduce costs and increase
service. Small vendors are constantly facing critical cash flow issues.
In addition to providing a cash discount, they will probably fill your
order before the companies that take 30 - 90 days to pay them.
Now is the time
to take the inventory management basics and apply them to your business.
They will improve cash flow, streamline order fulfillment, and provide a
competitive edge. Hurry, orders are standing by. . . .
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