The most important thing any small business can do is to ensure they run the inventory management approach most suited to their business model and the needs of their customers. Far too often I come across business owners whose biggest mistake is to run an inventory management approach based on something that worked for some other company, or based on something they’ve read is supposed to work. It’s amazing to think that a company would run an inventory system that is completely contradictory to their business model, but it happens far more often than people realize.
Understanding Your Business Model When Choosing a Supply Chain Strategy
We’ll clarify this whole situation by describing two business models and matching those business models to the most appropriate inventory management approach. Now, I’m not assuming that all businesses can be simplified into two distinct models. What I am saying is that for the most part, companies have customers whose order patterns and requirements fall under two criteria: 1) customers who need parts consistently, day after day, week after week etc. & 2) customers whose order patterns are infrequent and cyclical.
We’ll start by reviewing a company whose customers’ volumes, and frequency of orders, are consistent, linear and constant. Afterwards, we'll look at a company that operates in a cyclical market, one marked by infrequent demand from customers and one best defined by multiple highs and lows in business cycles.
The above video is taken from the post: Choose the Right Supply Chain Strategy: Make it an Easy Choice
1. The Business With Linear and Constant Demand
This particular business has a small number of product lines, but large volume sold across those product lines to a customer base whose demand patterns are constant. In this case, the company’s customers need product on a daily, weekly and monthly basis. The company has existing contractual agreements on supply and must meet scheduled deliveries without fail. As such, their part and material requirements needed to support their manufacturing is quite high, and consequently, extremely costly to their inventory. The financial outlay needed to keep inventory running smoothly means the company can’t hold inventory for too long.
The company’s main goal is to get inventory into the warehouse quickly, use it in manufacturing and sell it immediately to meet existing customer orders. The intention is to mitigate the holding costs of inventory by ensuring that what they bring in will immediately be sold. So, what’s the ideal inventory management approach for such a business?
Answer: Just in Time (JIT) and Dell’s Push Pull Inventory Management Approach
I’ve put JIT and Dell’s “Push-Pull” inventory under the same umbrella. JIT is predicated on mitigating the costs of inventory by ensuring that inventory is rarely held for extended periods. In our example above, the company’s customers need parts on a daily, weekly and monthly basis. The customers’ demand patterns specify that the company continually bring inventory in to meet their requirements.
Just in Time is ideally suited to companies who have large volume requirements spread across a small product line. Companies that run JIT would include automotive manufacturers or even some companies in the wireless sector. In the case of the automotive manufacturer, they may have a few models of cars, but their volumes sold across those models are in the millions.
One of the essential ingredients in making JIT work is the volumes required on parts and materials must be substantial. This gives the company the economies of scale they need to make JIT work. In essence, they are their suppliers’ number one priority. When they need product, they get it immediately. Dell’s “Push-Pull” inventory approach is similar in JIT in that it requires inventory to be ready when needed.
In the case of Dell, they partially complete their computers, wait for a customer order, and then pull in the parts needed to complete it. This allows them to provide a custom-made part in a relatively short time frame without having to start from scratch. In essence, Dell completes 70% of the work and then needs very little time to complete the remaining 30%. If you’re interested in reading about how this is done, then read the following post: Supply Chain Management: Running a Better Supply Agreement
The above video is taken from the post: What Are the Costs to Hold Inventory in Just In Time - JIT?
The above video is from the post: Dell Push-Pull: An Order Fulfillment and Supply Chain Strategy
2. The Business with Infrequent & Cyclical Customer Demand
On the other side of the spectrum is a company whose customer demand patterns are cyclical and infrequent. In fact, this particular company has customers who have seasonal demand patterns. Some months the company has too much demand, while in others, they don’t have enough. In every quarter the demand from customers spikes, but as for which month that will happen in, is anyone’s guess. In this case, the company must have inventory available when customers need it.
Unfortunately, this means they’ll have to hold inventory for longer periods. However, they are able to use bulk orders to lower their per-unit purchase price on parts & materials and lower their per-unit freight costs on incoming parts. While their inventory holding costs are a concern, they are able to use their combined volumes to mitigate these costs. So, which inventory method is best suited for this company?
Answer: Min/Max Inventory Management Approach
For whatever reason, Min/Max inventory doesn’t seem as “sexy” or impressive as does JIT or Dell’s “Push-Pull” inventory approaches. Part of this comes from the fact that companies must hold inventory longer in order to capitalize on those opportunistic sales and ultimately, to meet their customers’ infrequent demand patterns. However, the purpose is to match inventory to business model. In the case of a company who has such infrequent order patterns, Min/Max is the only real option. Unfortunately, a number of companies try to avoid running Min/Max and instead opt for JIT.
Most companies don’t have the economies of scale to make JIT work. Companies must be their suppliers’ number one priority for JIT to be successful. Unfortunately, most companies have a grandiose view of their importance. This often doesn’t match the reality of their importance in the eyes of their suppliers. Properly managed, Min/Max can not only work, but can produce significant cost savings over other inventory management approaches.
The above video is from the post: What are the Costs of Holding Inventory in Min-Max Supply Chains?
Min/Max is predicated on maintaining a minimum level and a maximum level of inventory. These inventory levels are matched to the cyclical business nature and order patterns of the company’s customer base. When companies have infrequent customer order patterns, and try to run Just in Time, they are always behind the eight ball by bringing in too much or too little inventory. In addition, because they’re constantly chasing their tales, and because JIT’s premise is to avoid keeping inventory, they’re continually missing those opportunistic sales. In the end, they don’t have the inventory when it’s needed.
Essential Ways to Reduce Freight Costs on Incoming & Outgoing Shipments
Sample Excel Sheet Calculating Inventory Holding Costs
When it comes to small business inventory management, be sure to match inventory to business model. Take the time to review how and when your customers order. Look at your existing product lines. Do you have a small number of product lines with large volume spread across those lines, and customer requirements on a daily and weekly basis? Then JIT might work. Do you have a large number of product lines, small volume across those lines and customer requirements that are infrequent and cyclical? Then Min/Max will work and JIT won’t.
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