The global marketplace is constantly evolving due to political, economic, technological and social factors. As small- and mid-sized businesses (SMBs) try to remain competitive, many are coming up against inventory management challenges. In this three-part blog series we’re looking at three of the most common inventory management issues faced by stock holding companies. So far we’ve discussed the following:
1. Complex supply chains as businesses rely on a vast network of manufacturers, distributors and retailers
2. Growing product portfolios as businesses continue to expand and customers demand ‘more choice’
In our final post we’re looking at how businesses can ensure stock availability without investing too much capital into their inventory.
Many businesses fear stockouts – and rightly so. Ten years ago it might have been OK to ask your customer to wait a few weeks until you got their product in stock, but today you’re likely to lose that customer to another supplier if you aren’t able to deliver. After all, your competitor is just a click away.
Faced with the risk of stockouts, a damaged reputation and reduced profits, some businesses will resort to stocking high quantities of every SKU to meet demand. This is a very bad idea for three reasons:
1. It will negatively impact your inventory turnover ratio
2. It will tie up working capital and increase carrying costs
3. It will increase the risk of excess and obsolete inventory
Instead you need to find ways to fulfill orders without maxing out on stock. This is where inventory optimization comes in. Introducing inventory optimization methods to your inventory management practices ensures that supply and demand volatility is considered when setting your demand forecasts, stock levels and replenishment parameters.
The first stage of inventory optimization is to set accurate demand forecasts so you only carry the products you need to meet demand. Read our blog on demand forecasting or download our whitepaper for more information.
The next stage is to optimize your stock levels. There’s no point carrying high volumes of every item in your warehouse – this will be a drain on your working capital. Instead you need to identify the most important inventory items to your business and prioritize those over those less valuable. One way to do this is to use an inventory classification model. ABC analysis is a simple way to segment your stock based on its value to the business. The aim is to stock more category ‘A’ products that have a good profit margin, versus ‘B’ that are less valuable and finally ‘C’ products that you may choose not to stock, as they are the least important.
For more sophisticated stocking policies you can turn to inventory planning software, such as EazyStock. EazyStock will analyze every SKU based on a number of variables including demand type, demand volatility, pick frequency and cost to sell (or profitability). It then recommends what to stock based on these (and other) parameters. For example it often makes no sense to carry large numbers of expensive items which have a volatile demand when investment in cheaper, fast-moving goods will help ensure stock availability and keep inventory turnover high.
The next step to ensuring stock availability is to set target service levels. Service levels measure whether an inventory item was in stock when it was requested for delivery, leading to a completely fulfilled order; that is, whether demand (or sales orders) could be met from the inventory on-hand.
The target service level you set for each item in your warehouse should be based on its forecasted demand and demand type. So if you have fast moving products where demand is consistently high, then you might set a high service level of 98% or above. Whereas for slower moving products with intermittent demand you may set lower service levels, such as 90%.
Your service levels are therefore a measure of stock availability.
With your service levels set, you can then determine stocking policies, such as minimum order quantities and safety stock levels, so you lower your inventory to free up capital and space but still ensure availability.
Monitoring your service level as an inventory management KPI helps you ensure you can completely fulfill every order and prevent stockouts.
Inventory replenishment planning is also critical to ensuring stock availability without over-ordering. Determining your order frequencies and order quantities to take account of demand and supply variables meansyou can reduce stock but still achieve high target service levels.
However, basic replenishment models (often found in spreadsheets or used by ERP systems) are very one-dimensional. Reorder times are based on a fixed order cycle or when stock hits a certain trigger point. Reorder quantities are either the same amount every time or based on filling up to a min/max warehouse capacity.
The Economic Order Quantity methodology is more advanced, taking carrying and ordering costs into account. But none of these methods consider supply and demand variables.
With inventory optimization software you can go one step further and factor in:
Many inventory management issues are a result of not accounting for supply and demand volatility. Stock availability is certainly one of those challenges.
If you can stock the right goods in the right amounts to meet demand, you’ll maximize your stock turnover rate. As goods move quickly in and out of the warehouse you can keep cash flowing and prevent excess and obsolete stock. At the same time, you’ll have optimized stock levels that are set to ensure high service levels and product availability targets.
Contact us for more information on EazyStock.