Some companies know exactly what they’re doing when it comes to managing their inventory. Their entire supply chain is geared towards benefiting from collaborative efforts.
Vendors are managed like partners, inventory strategies are aligned, stock outs and shortages are minimized, freight costs are under control and the company clearly defines its costs of holding inventory relative to the costs of not having inventory. Sounds pretty simple doesn't it? For some companies it is, for others it isn't.
So, why is it that some companies excel at optimizing their supply chain while others continue to fall short? Ultimately, answering this question comes down to avoiding the five don’ts of inventory management.
These simple rule-sets are ones to live by. They will simplify how your company views and manages the inventory you need to win business, while helping you to define all your cost drivers so that you can make more informed decisions.
1. Don’t Misuse or Abuse Vendors
There will always be those corporate buyers and inventory managers who feel the best way to interact with vendors is through aggressive means. These are the buyers who are never their vendor’s number one priority. These are the procurement professionals who move from one vendor to the next, never fully aware of the impact and consequences of their actions.
Vendors should be treated like partners. When you misuse, abuse or otherwise disrespect a vendor, you give them no recourse but to treat you as nothing more than an opportunistic sale – and when they make that sale, you can be assured you’ll pay for it.
It’s often when emergencies or rush orders are needed that buyers suddenly realize the consequences of their actions. However, do you blame the vendor or do you stop and understand that it was your actions and approach to business that forced the vendor's hand? In many instances, it’s not even the salesperson decision to take action, but rather the management they report to that decides how to proceed. The vendor won't forget how you've behaved in the past and management may force the salesperson to gain some measure of revenge when you finally come calling with that all-important emergency.
2. Don’t Run the Wrong Supply Chain Strategy
Sure, we would all love to run Just-in-Time (JIT). We would all love to lower our costs of capital, eliminate issues pertaining to damage and pilferage, avoid obsolescence, lower insurance costs, while also eliminating a plethora of inventory cost drivers. JIT is so alluring because it means we carry just enough inventory to meet our backlog.
JIT minimizes inventory counts, reduces financing and allows companies to better manage payables and receivables. However, few enterprises can make it work the way it’s meant to.
If you have a limited product offering, and substantial sales volumes across that offering, then maybe JIT works for your company. However, customer demand for your products has to be consistent and linear. If you know you'll get an order in a given quarter, but are not sure which week or month you’ll get it, or if you’re sure you’ll get that yearly contract, but aren't sure which quarter it will happen in, then maybe JIT isn't for your company.
Focus on one simple rule to supply chain optimization: Match your inventory strategies to your customers’ needs, your markets business cycles and your product’s sales cycles. If that means running Min-Max, or a demand-driven derivative, then so be it. Just don’t run something you can’t merely because someone else is.
3. Don’t Ignore the Costs of Shortages or Out-of-Stock (OOS) Situations
It’s easy to think that a company is saving money when its inventory counts are low. After all, we aren’t tying up any capital in inventory are we? We aren’t running the risk of encountering obsolete product and or damage? It makes sense, does it not? Well, the fact is, the costs of not having inventory are just as costly as having too much inventory.
Instead of looking at the costs of holding that inventory, think about the risks of not having inventory. First, you won’t make that sale and will therefore lose the profit that sale would have generated. Second, you may just lose a customer, one who would rather deal with your competition. Third, you may lose more than just that one customer, which in the end means you could lose a valuable portion of your market.
However, let’s assume you don’t lose that sale. What are the costs of not letting a stock out impact your business? The answers are simple. First, you’ll have to expedite orders into your warehouse. That’s the first big cost of the stock out. Second, you’ll cover overtime in manufacturing and shipping. Finally, you’ll be suckered into paying for freight for your customer’s late order. In the end, shortages cost money and you must come to understand the costs of out-of-stock situations.
4. Don’t Forget Freight Costs
Isn't it amazing how we look at our projected gross profit margins on sales and then suddenly come face-to-face with the reality that our projected numbers don’t match our actual numbers? It happens all the time and it typically coincides with a company that ignores their costs of freight.
These are the companies that always purchase at the last minute. These are the companies that are afraid to hold inventory so they run so tight and lean that they are always expediting incoming raw materials and finished goods. These are the companies that don’t have a solid idea of the demand emerging from their market. Finally, these are the companies that don’t track their freight costs back to their source.
Instead of defining freight costs for each unit purchased, these companies simply throw that cost into a miscellaneous account. At the end of the month or quarter, they tally up all their so-called profit and then reconcile these hidden costs. It's only afterwards that their profit inexplicably declines.
5. Don’t Cherry Pick Your Cost Drivers
Don’t cherry pick the costs you understand and ignore the ones you don’t. The best enterprise understand that it’s a balancing act, one where they know how much it costs to keep product on their shelves and how much it costs not to have product on their shelves. There are two costs there and they must be understood.
It’s not impossible to track. Understanding your cost drivers for keeping product involves tracking all your individual holding costs. However, tracking shortages and stock outs can be measured by tracking overtime, defining the costs of poor handling due to rush shipments, tracking expedite fees, amalgamating surcharges from vendors for rush orders, and defining freight in and out of the warehouse to fulfill late customer orders.
Every company needs inventory. We may bemoan it when we have too much of it, but we regret it when we don’t have enough. Finding that aforementioned balance involves tracking all costs and then putting someone in the position of inventory asset manager, one who balances out the demands of sales for more inventory, versus the demands of procurement to reduce inventory.
The above video is but a single example of vendor managed inventory
In the end, when companies manage their vendors properly, they are able to reduce a number of cost drivers. They can use multiple vendor managed inventory agreements and contracts to minimize carrying costs and shortage costs.
If they run the right inventory strategy, then they can justify that strategy by defining costs as they actually are – not as they want them to be.
Sometimes the hardest thing is to confront exactly what’s not working and put a plan in motion to make it work.
However, that can’t happen unless you’re willing to truly define all the costs – hidden or otherwise – that are waiting for you in your warehouse.