Mastering Inventory Optimization: How to Tackle Mismatched Inventories, Excess Stock Drivers and Shortages Simultaneously
Scope For This Project
Inventory management is a critical component of supply chain management that affects a company’s performance, profitability, and competitiveness. Proper inventory management ensures that companies have the right products in stock, the right amount, and at the right time, enabling them to meet customer demands while minimizing waste and costs.
In this article, we will discuss the significance of inventory in supply chain management and its impact on a company’s overall performance.
Table of Contents
What is inventory?
Inventory refers to the goods or products that a company holds in stock for future sales or production purposes. It includes raw materials, work-in-progress (WIP), finished goods, and packaging materials.
Types of Inventory
The different types of inventory in supply chain management include:
- Raw Materials Inventory: This is the inventory of materials that are used in the production process, such as steel, plastic, and other materials.
- Work-in-Progress (WIP) Inventory: This inventory consists of partially finished products that are in the production process.
- Finished Goods Inventory: This is the inventory of products that are ready for sale.
- Maintenance, Repair and Operating (MRO) Inventory: This inventory includes the materials required for maintenance, repair, and operating purposes, such as cleaning supplies, tools, and equipment.
- Safety Stock Inventory: This is the additional inventory held to protect against the risk of stockouts due to unexpected demand or supply chain disruptions.
Significance of Inventory in Supply Chain Management
Effective inventory management plays a crucial role in ensuring smooth operations within the supply chain. The following are the reasons why inventory management is significant in supply chain management:
- Meeting Customer Demands: Adequate inventory levels ensure that a company can meet customer demands, even during peak seasons, reducing the risk of lost sales due to stockouts.
- Reducing Lead Times: Holding inventory in strategic locations can reduce lead times, enabling companies to deliver products to customers faster, improving customer satisfaction.
- Reducing Costs: Proper inventory management can reduce holding costs, such as warehousing, insurance, and obsolescence, as well as reduce ordering and transportation costs by optimizing order quantities.
- Improving Efficiency: Inventory management can improve production efficiency by ensuring that the right materials are available when needed, reducing downtime and waste.
Managing Risks: Inventory management can help manage risks such as supply chain disruptions, quality issues, and natural disasters by holding safety stock and diversifying suppliers.
Popular Inventory Management Techniques
Inventory management techniques include:
- Just-in-Time (JIT) Inventory: This inventory management technique is used to reduce inventory levels by producing and delivering products just in time when they are required in the production process.
- Economic Order Quantity (EOQ): This is a method used to determine the optimal order quantity that minimizes the total inventory costs, including holding costs and ordering costs.
- ABC Analysis: This inventory management technique is used to classify inventory items based on their value, and prioritize the management of high-value items that contribute to the majority of the inventory costs.
- Vendor Managed Inventory (VMI): This is an inventory management technique in which the supplier manages the inventory levels of the customer by monitoring and restocking inventory as needed.
Challenges in Inventory Management
Effective inventory management faces several challenges, including:
- Forecasting Accuracy: Forecasting demand accurately is crucial for effective inventory management. Inaccurate demand forecasting can lead to overstocking or stockouts, resulting in lost sales and increased holding costs.
- Inventory Visibility: Lack of visibility and control over inventory levels can lead to stockouts or overstocking, resulting in increased costs and lost sales.
- Variability in Demand: Fluctuations in demand can result in overstocking or stockouts, making it challenging to balance inventory levels and maintain a desired service level.
- Obsolescence: Holding inventory for too long can result
Excess inventory
Excess inventory refers to inventory levels that are higher than what is needed to meet current demand. This can result in increased holding costs, reduced cash flow, and the risk of obsolescence. Excess inventory can be caused by various factors, which are commonly known as excess inventory drivers. The following are some of the main drivers of excess inventory:
- Overproduction: Overproduction occurs when a company produces more than what is needed to meet current demand. This can be caused by inaccurate demand forecasting, inefficient production processes, or a desire to take advantage of economies of scale. Overproduction can result in excess inventory levels that are costly to hold and may become obsolete.
- Inaccurate Demand Forecasting: Inaccurate demand forecasting can lead to excess inventory levels if the forecast is significantly higher than the actual demand. This can be caused by a lack of historical data, unexpected changes in consumer behavior, or inaccurate assumptions about market trends.
- Poor Inventory Management: Poor inventory management practices, such as inadequate tracking and reporting, can lead to excess inventory levels. Ineffective inventory management practices can result in stockouts or overstocking, which can drive up holding costs and reduce cash flow.
- Long Lead Times: Long lead times can cause excess inventory levels if a company orders inventory well in advance of when it is needed. This can be caused by slow production times, long shipping times, or customs delays. The longer the lead time, the more inventory a company must hold to meet customer demand, which can lead to excess inventory levels.
- Seasonality: Seasonality can drive excess inventory levels if a company produces or orders inventory in anticipation of a particular season or event but fails to sell all of the inventory before demand drops. This can be caused by unexpected changes in consumer behavior or unanticipated weather patterns.
- Obsolescence: Obsolescence occurs when a company has excess inventory of a product that is no longer in demand. This can be caused by changes in technology, trends, or consumer preferences. Obsolete inventory can become costly to hold and must be sold at a discount or written off as a loss.
Short Inventory
Short inventory, also known as understocking, refers to inventory levels that are lower than what is needed to meet current demand. This can result in lost sales, decreased customer satisfaction, and the risk of losing customers to competitors. Short inventory can be caused by various factors, which are commonly known as short inventory drivers. The following are some of the main drivers of short inventory:
- Inaccurate Demand Forecasting: Inaccurate demand forecasting can lead to short inventory levels if the forecast is significantly lower than the actual demand. This can be caused by a lack of historical data, unexpected changes in consumer behavior, or inaccurate assumptions about market trends.
- Poor Inventory Management: Poor inventory management practices, such as inadequate tracking and reporting, can lead to short inventory levels. Ineffective inventory management practices can result in stockouts, which can drive down sales and reduce customer satisfaction.
- Production Delays: Production delays can cause short inventory levels if a company is unable to produce inventory in time to meet customer demand. This can be caused by equipment failures, labor shortages, or other production disruptions.
- Supply Chain Disruptions: Supply chain disruptions, such as transportation delays or raw material shortages, can cause short inventory levels if a company is unable to receive inventory in time to meet customer demand.
- Seasonality: Seasonality can drive short inventory levels if a company fails to produce or order enough inventory in anticipation of a particular season or event. This can be caused by unexpected changes in consumer behavior or unanticipated weather patterns.
- Unexpected Changes in Demand: Unexpected changes in demand can cause short inventory levels if a company is unable to adjust inventory levels in time to meet the new demand. This can be caused by sudden changes in consumer behavior, trends, or competitor actions.
Inventory Mismatch
Inventory mismatch is a supply chain problem that occurs when the actual inventory levels of a product are different from what was expected or planned. This can happen for various reasons, including inaccurate forecasting, miscommunication between different stakeholders, and unexpected changes in demand or supply. Inventory mismatch can lead to significant disruptions in the supply chain, including stockouts, excess inventory, increased costs, and lost sales.
The following are the common types of inventory mismatch:
- Overstocking: This occurs when a company has more inventory than needed or expected. This can happen when a company overestimates demand or production capacity, leading to increased holding costs, the risk of obsolescence, and reduced cash flow.
- Stockouts: This occurs when a company runs out of stock of a product, resulting in lost sales, decreased customer satisfaction, and the risk of losing customers to competitors. Stockouts can happen due to inaccurate demand forecasting, supply chain disruptions, or unexpected changes in demand.
- Miscommunication: This occurs when there is a lack of clarity or transparency in the communication between different stakeholders in the supply chain, resulting in inaccurate information or assumptions about inventory levels.
- Quality Issues: This occurs when there are quality issues with a product that results in the need to hold additional safety stock. This can result in increased holding costs and reduced profit margins.
- Lead Time Variability: This occurs when the lead time for a product varies significantly from what was expected, leading to delayed shipments or stockouts.
- Seasonality: This occurs when there is a significant difference in demand for a product during different seasons, leading to overstocking or stockouts.
- Product Lifecycle: This occurs when a product reaches the end of its lifecycle and demand declines faster than expected, leading to excess inventory and the risk of obsolescence.
Effective inventory management can help reduce inventory mismatch by optimizing inventory levels, improving demand forecasting accuracy, and reducing lead times. The following are some strategies that can help in reducing inventory mismatch:
- Continuous Monitoring: Regularly monitoring inventory levels and comparing them to planned levels can help identify inventory mismatch early, allowing companies to take corrective action.
- Accurate Forecasting: Accurate forecasting of demand and production capacity can help companies avoid overstocking and stockouts, reducing the risk of inventory mismatch.
- Collaboration and Communication: Collaboration and communication between different stakeholders in the supply chain can help improve visibility and accuracy of inventory levels, reducing the risk of miscommunication and inventory mismatch.
- Safety Stock Optimization: Optimizing safety stock levels can help companies protect against unexpected changes in demand or supply, reducing the risk of stockouts and excess inventory.
- Inventory Visibility: Having real-time visibility of inventory levels across the supply chain can help companies make more informed decisions, reducing the risk of inventory mismatch.
In this project
Our client was facing two major challenges in their warehouse management. On one hand, they were overstocked by 34% of their items, while on the other hand, they had a shortage of 36% of their items. In such a hyper-competitive industry, without proper inventory optimization, our client’s profitability was at stake. To address these issues, we were assigned the task of optimizing their warehouse management to reduce the tied-up opportunity cost associated with excess inventory
Data Analysis
Following a thorough analysis of 30 weeks of data sourced from both their B2C and B2B operations, we compiled a list of inventory-related issues. Excess and short inventory can both have negative impacts on a company’s supply chain performance and profitability. To reduce excess and short inventory, companies can implement the following strategies:
- Accurate Demand Forecasting: Accurate demand forecasting is crucial to maintaining optimal inventory levels. By leveraging historical data, market trends, and other relevant factors, companies can forecast demand more accurately and adjust inventory levels accordingly.
- Inventory Management Software: Implementing inventory management software can help companies track inventory levels in real-time and identify inventory discrepancies more quickly. This can help companies avoid stockouts and overstocking, and optimize their inventory levels.
- Safety Stock Levels: Maintaining safety stock levels can help protect against unexpected changes in demand or supply chain disruptions. By setting safety stock levels based on historical demand and lead time variability, companies can reduce the risk of stockouts while minimizing excess inventory.
- Lean Inventory Management: Lean inventory management involves optimizing inventory levels by reducing waste and inefficiencies. This can be achieved through strategies such as just-in-time inventory, continuous improvement, and reducing lead times.
- Supplier Collaboration: Collaborating with suppliers can help companies better manage inventory levels. By sharing demand forecasts, lead times, and other relevant information, companies and their suppliers can work together to optimize inventory levels and reduce excess and short inventory.
- Sales and Operations Planning (S&OP): Implementing a sales and operations planning process can help companies align their demand and supply planning activities. By coordinating forecasting, production planning, and inventory management, companies can better balance supply and demand and reduce excess and short inventory.
Conclusion
Inventory plays a crucial role in the success of a company’s supply chain management. It involves maintaining optimal levels of stock to meet customer demand while minimizing costs and maximizing profitability. Excess and short inventory can significantly impact a company’s bottom line, with excess inventory leading to increased holding costs and short inventory leading to lost sales and decreased customer satisfaction. To address these challenges, companies can implement various strategies such as accurate demand forecasting, effective inventory management, lean inventory practices, supplier collaboration, safety stock levels, and sales and operations planning. By adopting these best practices, companies can optimize their inventory levels, improve their supply chain efficiency, and enhance their overall profitability.
About the Author
Vivek Sood: Sydney based managing director of Global Supply Chain Group, a strategy consultancy specializing in supply chains. More information on Vivek is available on www.linkedin.com/in/vivek and more information on Global Supply Chain Group is available www.globalscgroup.com
Vivek is the Managing Director of Global Supply Chain Group, a boutique strategy consulting firm specialising in Supply Chain Strategies, and headquartered in Sydney, Australia . He has over 24 years of experience in strategic transformations and operational excellence within global supply chains. Prior to co-founding Global Supply Chain Group in January 2000, Vivek was a management consultant with top-tier strategy consulting firm Booz Allen & Hamilton.
Vivek provides strategic operations and supply chain advice to boards and senior management of global corporations, private equity groups and other stakeholders in a range of industries including FMCG, food, shipping, logistics, manufacturing, chemicals, mining, agribusiness, construction materials, explosives, airlines and electricity utilities.
Vivek has served world-wide corporations in nearly 500 small and large projects on all continents with a variety of clients in many different industries. Most of projects have involved diagnostic, conceptualisation and transformation of supply chains – releasing significant amount of value for the business. His project work in supply chain management has added cumulative value in excess of $500M incorporating projects in major supply chain infrastructure investment decisions, profitable growth driven by global supply chain realignment, supply chain systems, negotiations and all other aspects of global supply chains.
Vivek has written a number of path breaking articles and commentaries that are published in several respected journals and magazines. Vivek has spoken at several supply chain conference, forums and workshops in various parts of the world. He has also conducted several strategic workshops on various aspects of supply chain management. He received his MBA with Distinction from the Australian Graduate School of Management in 1996 and prior to these studies spent 11 years in the Merchant Navy, rising from a Cadet to Master Mariner.
More information on Vivek is available on www.linkedin.com/in/vivek and more information on Global Supply Chain Group is available on www.globalscgroup.com
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