25 Ways to Lower Inventory Costs
July 20, 2011
Inventory policies drive two types of costs: period operating expenses and working capital requirements. The latest “Logistics Cost and Service Report” published by Establish Inc./Herbert W. Davis and Company, indicates that, while total logistics costs as a percent of sales are falling and most individual companies have succeeded in reducing inventory levels; total logistics costs per hundredweight are increasing, and inventory costs as a percent of total logistics cost are increasing.
In many organizations, however, the opportunities to reduce inventory costs are often not addressed at all or are not completely exploited. If your organization needs help taking money out of inventory there are strategies you can employ today that will provide payoff.
Some of these strategies address having less active inventory, others how you acquire active inventory, and still others require transferring inventory or relying on vendors for better inventory management. Regardless of which you choose to explore, proactive inventory management policies will make a difference in your operations. Here are some of the most common techniques for lowering inventory levels.
- Base Cycle Stock on Economics: For purchased products, getting a handle on your acquisition transaction costs will either reduce average inventory or allow for reducing purchasing and receiving labor. For manufactured products, if production equipment changeover costs are in a similar state, getting them in place will either reduce average inventory through shorter runs or allow for reducing changeover and receiving labor through longer runs.
- Reduce Order Transaction Costs: In the office, use the computer to generate purchase orders (POs), EDI for PO transmission, advance shipping notices (ASNs) to reduce expediting, and historical vendor performance to prioritize expediting to lower purchasing costs. In the manufacturing plant, pre-planning; pre-staging of needed parts or materials; use of special tools or equipment; changeover initiation prior to completion of the previous run; teamwork and work-division; maintaining equipment temperatures; and minimizing QA / QC work all reduce cycle stock inventory. In the distribution center (DC), pallet manifest-based receiving processes, counting scales, statistics-based inspection and checking, bar code scanners for data entry, certifying key vendors to eliminate receiving functions, and stocking forward storage locations first and reserve locations second can all reduce purchase transaction costs and cycle stock accordingly. Purchase transaction costs are not normally SKU-specific. However, reflecting any extraordinarily low receiving costs associated with specific SKUs will serve to reduce inventory for them. The opposite, of course, is also true.
- Lower Inventory Holding Costs: Improve space utilization in leased, contract, or public warehouses (or to minimize or delay expansion of owned facilities) through narrow aisle handling equipment, mezzanines, layout, or more appropriate storage modes.
- Base Safety Stock on Customer Service: Prioritizing SKUs consistent with corporate objectives, using the appropriate number of product classes, establishing class sizes that leverage the investment to maximize fill rates, updating safety stock levels dynamically and basing the service levels for each class on the financial goals of the business all serve to either reduce safety stock inventory, reduce out-of-stock situations or increase revenue.
- Forecast Routine Demand Forecasting: Using manually edited, naïve, arithmetic / stochastic forecasting models to reduce forecast error will reduce overstock, backorders, and the need for lateral or reverse logistics, holding inventory levels closest to only that required to support the desired customer service level. Editing history to eliminate non-recurring promotions and to compensate for out-of-stock situations is key.
- Forecast Future One-time Events Based on Past Events: Future promotions and other one-time events can be best forecast from extensive data on similar events from the past. Holding records in a centralized database avoids the issue of the data leaving with the last sales representative. Extending the data format to include not just SKU, retailer, date and lift, but also relative degree of advertizing, duration, price reduction, if any number of locations, or other factors, makes the information infinitely more useful for the future.
- Think Postponement: For parent products from which multiple SKUs can be manufactured, only partially completing manufacturing, placing semi-finished product in inventory, and then completing manufacturing of the final SKUs to order reduces total inventory. In a similar manner, component products from which final SKUs may be assembled can be purchased to inventory and then the final SKUs assembled to order, providing that the time for assembly doesn’t exceed the customer lead time.
- Rationalize SKUs: Removal of inappropriate product from the product line can be a controversy-ridden process, but may reduce inventory significantly if handled in a constructive manner, as follows:
- Develop consensus on the objective of maximizing profit
- Develop activity-based costs for each SKU and separate them into three groups:
1. Those with selling prices that create positive gross margin
2. Those with selling prices that cover their variable cost but do not completely cover their fixed cost
3. Those with selling prices that do not cover their variable cost
- Quantify the sales volume correlations between SKUs, based on the analysis of both individual orders and aggregate order patterns by customer
- Identify the combination of SKUs which maximizes profit on a fully-absorbed basis
Minimize Purchase Minimums: Comparing the total cost of ownership, including inventory holding costs (i.e., not just landed costs) for purchased products’ quoted prices with no order quantity limitations with reduced prices requiring minimum order quantities (MOQs) will help determine if the reduced prices really provide savings. An uninformed purchaser’s interaction:
Purchaser: Can I buy _____ at the same volume but at a lower unit cost?
Sales Representative: Sure, we can reduce your cost by __% if you purchase in minimum order quantities of _______ .
Purchaser: Sure, no problem!
(When the annual holding cost for the increased inventory due to the minimum order quantity more than offsets the annual purchase cost reduction, the higher unit cost with no minimum order requirements has a lower cost.)
There are numerous ways to take better control of inventory and decrease its associated costs. Many of these strategies may seem challenging to implement; however, they have all been used successfully for years. The key to managing inventory successfully is to continuously measure your performance and look for new ways to improve. These 25 strategies should get your organization thinking about what it can do to lower inventory costs.
Ralph Cox, is a director at Tompkins Associates and a recognized authority on improving performance in logistics, warehousing and inventory management.
© Tompkins Associates, Inc., All rights reserved.
|WEBCAST: 10 Proven Ways to Cut Your Inventory Costs|
|Wednesday August 31, 2011 at 2:00 PM EDT|
For supply chain professionals looking for practical tips to lower their inventory costs, this is a "must-attend" event. Ralph Cox from Tompkins Associates will discuss proven procedures, policies, strategies and technology enablers for cutting inventory costs - and improving the bottom line.
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