How to Solve Inventory Pileup?
Regardless of the industry, too much inventory is piling up, robbing companies of working capital and profit. There's a better way.
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Inventory pileup has been in the news lately, in industries including automotive, pharmaceuticals, retail, high-tech, military and others. In 2016, retail inventory pileup led to drops in rail, truck and sea shipments, and a significant increase in warehouses across America. Hanjin and a few other shipping companies went bankrupt. Production gluts in crude oil led to floating oil on tankers across the world.
Increases in inventory is not good for many reasons. It not only occupies valuable warehouse space but also represents locked-up cash that is unavailable for revenue generation. To sell this inventory, companies may have to take substantial markdowns. For many, products have a shelf life and once a product expires they have to scrap the inventory. That reflects poorly on profit.
Why does inventory pile-up?
Given that most companies have invested heavily in supply chain technology, and inventory continues to be part of leadership focus, you have to wonder why this is still an issue. We think there are two primary reasons. The first is channel stuffing by management to meet quarterly revenue and profit targets, and the second is planning based on a forecast. Let’s look at both.
Problem 1 - channel stuffing
The problem of channel stuffing exists in all industries when consumers or retailers are lured by sales promotions to buy and store inventory when there is no consumption. It’s a big problem in industries where end-users are serviced by middle men such as dealers or distributors – and not by the company producing the finished products. To meet its targets, the producing company’s sales team forces products that hasn’t been ordered onto distributors who, in turn, push them onto retailers. There is no actual consumption, but it is an artificial way to make the book look good.
Problem 2 – planning based on forecast
Companies forecast market demand based on historical information to ship or replenish products to distributors and retailers. Projections based on historical data are never going to be accurate because history is not a good predictor of future events. Forecast accuracies are consistently low across industries. Things change—competitive action, consumer taste or preference and changes in disposable income can have an impact on consumer demand. In the case of the automotive industry, consumers are buying more trucks and SUVs instead of sedans due to falling oil prices, but auto companies continue to forecast demand and produce sedans.
Avoid a pileup
How do you avoid an inventory pileup? It starts with changing the company policy towards sales promotion and incentives, ditching forecasts and using pull-based replenishment for shipment and debottlenecking the supply chain.
Solution 1 – change sales promotion policy and incentives
Research has shown that sales promotions do not have long term impact on sales and dilute brand value while creating havoc for the supply chain. Procter & Gamble stopped sales promotions on its products a long time back. Wall Street and investors should stop rewarding management for achieving sales and profit numbers via inventory manipulations.
Incentives within a company have to change as well. Organizations should be rewarded for actual sales and not for inventory adjustments. If incentives are aligned appropriately, then metrics will change the behavior of sales and supply chain organizations. Instead of pointing fingers, they will collaborate and focus on fixing problems.
Solution 2 – ditch the forecast and use pull-based replenishment for shipments
Real-time sales information provides better insight into customer demand and can be used for shipment planning. This is true even when customer demand data is not readily available. Companies can ask their customers to provide future demand/orders. If that is not possible, then firms can estimate the demand based on a customer’s production plans and inventory levels. For selling to consumers, companies can use actual order information as a trigger for shipment and production instead of using forecasts. As demand information becomes more reliable, inventory can be reduced.
A leading consumer goods company ditched forecasts and implemented pull-based replenishment (when a product is produced and shipped only when it is actually sold). Inventory in the system shrank from 115 days to 60 days. Perfect orders— meaning orders where the right quantity is delivered at the right time, with the right billing—rose from 40% to 90%.
Solution 3 – debottleneck supply chain
Inventory hides many problems in the supply chain. To sustain inventory reduction, companies will have to debottleneck their supply chains by simplifying all the processes. That process begins with reducing non-moving inventory, streamlining network and simplifying ordering, delivery, new product introduction, organization alignment and engaging with suppliers.
For the above consumer goods company, the debottlenecking effort led to an increase in profitability by 100% for the same products. How is that possible? When you reduce inventory, you start taking cost out of the system. Transportation is more efficient, with a higher percentage of shipments being dispatched in full truckloads. Container utilization increases. Factories are better able to streamline their processes, reducing the amount of rejected items. Last—but not least—people simply do a better job when they do not have to rush from one task to another.
Suman Sarkar is a Partner with Three S Consulting and the author of The Supply Chain Revolution.
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