Contrary to popular belief, Min-Max is still a popular inventory management approach. It accounts for any unforeseen spikes in demand, allows companies to capture opportunistic sales by carrying a safety stock (graph at bottom of post) and amalgamates volumes to reduce pricing and incoming freight costs. While there are inventory holding costs associated with using this supply chain strategy, there are also some inherent benefits as well. For instance, the company is able to avoid the high costs of lost sales cost of inventory. However, the question often becomes: “What criteria should a company use to determine its Min-Max inventory levels?”
Making Min-Max Work
While some companies love the concept of JIT (Just in Time), very few companies have the volume or purchasing power to make JIT work. However, the qualities that make JIT appealing, such as lower inventory holding costs, are qualities that can be achieved within Min-Max, provided the company is able to increase its inventory turnover rates.
To increase inventory turnover rates requires the ability to properly forecast customer demand, decrease sales cycle times, and ensure a high probability of sales by carrying common parts needed by multiple customers. We’ll review these criteria, and address others that companies must look at in order to determine their minimum and maximum inventory levels. Finally, at the end of the article is a video about how to calculate a safety stock - which is essential to defining minimum finished good counts.
1. Assess Sales Cycle Times & Seasonal Demand Patterns
How long does it take a given product to sell? Is the sales cycle time short or long? It’s essential that your company have a solid grasp of your sales cycle times. These times refer to the amount of time it takes to convert potential customers to buying ones. Your inventory turnover rates are simple the rate at which inventory is bought and sold. This is best done by product or product family. Take the time to break down your inventory into its most common parts. Assess the cycle times and inventory turnover rates for each product.
When it comes to addressing seasonal demand patterns, ask yourself if there are busier times of the year when customer volumes spike? Consequently, are there times of the year when customer volumes suddenly drop? It’s essential to assess your customers’, and your market’s, cyclical and seasonal demand patterns. Understanding these spikes in demand is as important as understanding those periods where demand suddenly drops.
Relying upon historical trends is an essential part of capturing cyclical business cycles. In the above graph, the company has tracked its sales volumes from 2010 to 2012 in order to get a more accurate depiction of seasonality. Improved sales forecast accuracy plays a vital role in Min-Max inventory. To read more, please go to: How Do I Improve Our Sales Forecast Accuracy?
2. Accuracy of Sales Forecasts & Vendor Supplied Lead Times
It’s important to remember that having accurate sales forecasts is much easier said than done. There are a myriad of reasons why sales forecasts can become over, or under-estimated. The key is to first start your sales forecasts with those volumes your company is guaranteed to sell. These could be contractual agreements on supply or common blanket orders.
When establishing your minimum inventory, start with these guaranteed volumes first, and then account for those opportunistic sales. Ensure that any sudden changes in sales forecast is immediately accounted for. Make sure to account for your vendor’s lead times. Every inventory management software should track vendor lead times on parts and materials. Stock replenishment must always take into consideration the lead times, or turn around times, from vendors.
3. Manage Inventory Volumes by Quarter
Not all of a company’s products will have a high inventory turnover rate. In some cases, customers know they’ll order product within a quarter, but as for which month that demand falls under, is anyone’s guess. If your company is faced with consistent quarterly sales, but is unsure of which month those products will be purchased, then take the time to adjust your safety (minimum level) inventory accordingly and measure your inventory requirements by quarter. Sure, the holding costs may be higher, but you’ll be able to capture those opportunistic sales.
While there are holding costs in Min-Max, there are fewer cases of lost sales. To read about why lost sales is such a huge cost of inventory, please read: Inventory Carrying Costs vs. Lost Sales: Both Destroy Your Bottom Line
4. Establish Product Grading System
Having as many customers for your products is essential to increasing your inventory turnover rates, protecting against obsolescence, and minimizing the impact of damage to your inventory. Reducing the amount of time your company must hold inventory will ensure damage is less likely to occur. To accomplish this, establish a product grading system based on a product’s popularity. For instance, if a product is purchased by 15 + customers, it could be a tier 1 product, 8-14 customers could be tier 2, and 3-7 customers a tier 3, and so on.
- Tier 1 product = 15+ customers
- Tier 2 product = 8-14 customers
- Tier 3 product = 3-7 customers
Let’s assume a company has a tier 2 product that has consistent quarterly volumes of approximately 10,000 units. As is the case with this product, there are some months within the quarter were sales are higher and other months within the quarter were sales are lower. However, by and large, the company has consistent quarter to quarter sales of approximately 10,000 units.
Within a given quarter, there are customers that buy as little as 300 units and customers that buy as much as 2000 units. The company is also aware that certain quarters have increased demand because of seasonality. In addition, the company knows that its standard vendor lead time is approximately 2 weeks. The company would then answer the following questions to determine their minimum and maximum inventory levels.
- How many customers buy the product within a given quarter?
- What is the average number of units purchased?
- Which quarter has increased demand because of seasonality?
- What impact does the 2 week vendor lead time have?
- What customer volume is covered by contractual agreements?
- How many customers account for the majority of the volume?
Again, far too many companies try to copy strategies employed by larger enterprises, ones who have the market share, the clout and the purchasing power to make Just in Time work. Instead of choosing a strategy that meets their own needs, they go with what they've heard has worked for other companies. Don't make the same mistake.
If you want to read a more recent post about how you can determine your safety stock (graph below) within Min-Max, please read: Determining Safety Stock & its Impact on Inventory Holding Costs
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