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6 Vital Inventory Reduction Tips

Author Zilvinas Lapacinskas  Zilvinas
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– The average reading time for this post is 5 minutes –

When talking about inventory optimization, most readers are interested first by the inventory reduction criterion. Despite the fact that overstock is a very common problem, to think about inventory reduction alone is not a very good idea, because pushing too hard on inventory reduction can strike at your service level. It should be emphasized here that stock-outs are more harmful for the bottom line than overstock, because of lost sales, poor client satisfaction level, and the overall image of the company as being an unreliable supplier. In this article I will suggest some of the most efficient measures for inventory reduction, while at the same time reminding you where you should be careful to put effort in order to maintain a high service level.

1.     Switch to MTO (Make To Order)

It is obvious that the best way to optimize inventory is to find the possibility to run sales or production without inventory. However implementation of this concept in a real-life environment is not so easy and requires rethinking the entire sales, supply and production process. On the other hand, almost every company has at least a few items that could be switched to MTO. The main criterion here is the so-called client-waiting time. Clients always wait for their items; even in retail self-service superstores it is necessary to wait a few minutes in a queue near the cash desk. In other cases, the client-waiting time is even longer. So how long can you make your client wait without losing him? Your task here is to find some items in your assortment whose sales possibility is not so sensitive to waiting time, for example some luxury items, specialized equipment etc. The second task is to minimize the lead-time for these items in order to fit into a waiting time that is less painful for the client, and then you can run sales without inventory.

If talking about raw material inventory,  there is always some waiting time between production plan approval and the release of raw materials. The main task here is to synchronize supply in such a way that the lead-time fits into the production order waiting time. This is exactly what is called JIT (Just In Time).

2.     Aggregate inventory as much as possible

The main reasons why an aggregated inventory is more efficient are that it reduces uncertainty and makes demand more predictable, thus requiring less safety stock.

Item aggregation

Let’s consider the example of 3 items with hardly predictable sales, where the only difference between them is the language of description on the label. Despite the similarity of these items, they cannot be substituted and must be in stock in order to provide a high service level. Illustration 1.

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Illustration 1

As shown in Illustration 2, the total inventory of these items (Inventory of items 1+2+3) is much higher than if we were to replace the labels with one multilingual label thus aggregating the items. The concept of aggregation is a very powerful feature, and you have probably noticed multilingual labels everywhere.

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Illustration 2

But it is not only a question of labels. Production companies aggregate inventory by keeping stock of unfinished products just before the production stage after which one product falls into many different items, for example by being painted in different colors, packaged into different packages, cut into different lengths, assembled with different accessories. They consider that the final stages are fast enough to fit into client-waiting time.

Place aggregation

It is not only items that can be aggregated, but also places (shops, warehouses). How many distribution centers do you need for a specific region? 1, 2 or 3? In some cases, the idea of having distribution centers every 100 km seems brilliant in terms of client service quality, but is reducing delivery time by one hour a significant improvement in client-waiting time and worth the additional inventory investment? Just after the beginning of the 2008 crisis, we noticed here in Europe that big international companies closed a lot of smaller regional logistics centers in order to have a more aggregated inventory, especially in regions where sales are more difficult to predict.

3.     Increase replenishment frequency

Probably there is no other inventory management parameter that has such a significant impact on inventory level and efficiency than the replenishment frequency. If you ask yourself how much inventory has to be in stock, the conservative answer is “enough to cover consumption (sales, production) until the next shipment arrives”. So the shorter the period until the next shipment, the less inventory you need in stock. For fast-moving items, this relation is almost linear: increase replenishment frequency twice, and you will need twice as less inventory.

The example in Illustration 3 shows how dramatically inventory could be decreased by switching from monthly replenishment to weekly.

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Illustration 3

Shorter periods between replenishments also shorten the duration of stock-outs if some appear. This explains why increased replenishment frequency helps not only to lower inventory level, but also to increase service level, especially for items where sales (consumption) are hardly predictable.

The only downside of increased replenishment frequency is the probability that purchase-order processing and operation costs related to the acceptance of shipments will increase. You can read about the techniques for choosing an optimal replenishment frequency in our article “How to determine efficient replenishment frequency when managing your inventories“.

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Use our Profit Calculator and find out your how much you can profit using Inventory Management software based on Pull approach!

4.     Be careful with the EOQ (Economical Order Quantity) model

The purpose of the EOQ model is to determine the order quantities for every item in every order where total inventory related costs are minimal. Theoretically, it must be a bullet-proof method in terms of efficiency and the best option for calculating purchase or production quantities.

formuleWhere:

D – demand

S – reordering costs

H – holding costs

 

While reordering (S) and holding (H) costs can be calculated with the required precision, demand (D) can only be predicted in some cases, with some deviation from the actual demand. The main disadvantage of this method is that it does not evaluate the risk of unpredicted demand changes, especially demand decrease, creating costly overstock.

Another issue with the EOQ-based replenishment process is that it is difficult to run efficiently if many items have to be collected in batches for purchase order or production. For example, if you order a large number of items from one vendor, you will probably want to carry them all in one shipment, but quantities calculated by the EOQ model cover different sales periods for different items depending on their costs, thus the next time you try to calculate an order there is a big probability that while one item is near stock out, the others still have a high inventory.

In conclusion, I should say that in real life the EOQ model falls far short of its theoretical concept in terms of efficiency, and if you cannot predict demand near 100%, and must collect items in batches for ordering, then better stay out of the EOQ concept.

5.     Smaller batches

Ordering in big batches sometimes seems like very cost efficient way to manage inventory. Additional discounts from vendors and efficiently used transport or production equipment is strong motivation to follow this strategy. While this article is about inventory reduction, I must stress here that big batches are the main enemies in the effort to lower inventory. O course, it would not be clever to ignore the possibilities for saving on additional discounts, so when dealing with batches it is more important to see the big picture and evaluate batching impact on bottom-line profit. The EOQ model can help here by overall evaluation of batch size, but at the same time the risk of unpredicted demand change should also be evaluated.

6.     A correctly chosen inventory management system always helps

By inventory management system, I mean the methods and tools that are used for inventory planning. This can be a simple scrap of paper, one’s head and a pencil, or a sophisticated ERP system; in all cases it determines how efficient (and low) the inventory can be. If you have a few hundred items in stock, manual calculation may be enough, because it is possible to focus on every item and evaluate various factors while calculating order quantities. In cases where tens, or even hundreds, of thousands of items have to be managed in many different locations, some automation tools are required. Different tools require different approaches and processes. In our experience, Dynamic buffer based automation tools like SOFT4Inventory are very efficient, especially when there is a possibility of frequent replenishment. For items with long lead times, Soft4Inventory forecast (which is also a standard feature) may work better than the dynamic buffer option. In all cases, the main purpose of an inventory management system is to help to reduce inventory by minimizing the number of errors in the calculation process.

Of course there is no single recipe for every case, but the above ideas are quite fundamental and can help you achieve lower inventory levels. But do not forget that focusing on inventory reduction alone is not a correct way of thinking, because your clients are probably still interested in purchasing something from your stock

SOFT4, as a provider of software solution for efficient inventory management, is constantly releasing blog articles about how to meet and cope with the trends, tendencies, and challenges, and give suggestions as to how to react to the changing environment in order to stay competitive.

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