Achieving Customer Service Success with Lower Total Inventory Costs, Part 1

In this part 1 of our 2 part series on better inventory control in the supply chain, we give guidance on successful inventory management. Today, we explore how firms handle inventories, tomorrow, we conclude the series with best practices and tips to control inventory costs.

Changing Inventory Control Practices and Supply Chain Technology

The formation of Efficient Consumer Response and its adoption by companies came about from an increasing focus on cost controls and supply chain processes.  Competition ramped up to please buyers and inventory methods changed. Firms now hold inventory primarily for cost reduction or buyer satisfaction levels. Having just the right amount of inventory level is the goal and these levels differ across industries.

Supply chain management’s inventory reductions often translate to cost savings.  Since 1982, these costs dropped around 60%, along with 20% lower transportation costs. As result, businesses pursue inventory-reduction strategies within their supply chains. Effective logistics strategies are attained through knowledge of the supply chain functions, unit demand, and cost of inventory.

Companies choose one of three basic inventory management approaches:

  1. Retailer inventory levels monitoring by item for inventory control.
  2. Manufacturer focus on production scheduling for inventory using flow management.
  3. Companies, particularly those in extractive industries or raw materials processing, passively vs. actively manage inventories.

Many manufacturing firms hold large inventories. While they don’t ignore inventory levels, they also do not actively manage them. This is because production, procurement, or transportation cost-induced reductions out-weigh basic reduction efforts.  Economies of size often cause longer productions runs that generate inventory accumulations.

Seasonal inventory buildups of key inputs and outputs happen simultaneously and economies in forward buying, quantity and bulk shipping discounts during procurement also up inventory numbers. Companies must be attuned to changing conditions and responsive by employing more exact levels as necessary. This comes into play when their industry has production proliferation. Preservation of identity during market growth, unit labeling, or safety concerns will require precision in how many company units to stock.

Inventory Control and Demand

Inventory is affected by independent or derived demand. Independent demand comes with a demand for end products, which are found throughout a firm’s supply chain. Managing uncertainty is the key to reducing inventory levels while meeting customer expectations. Supply chain coordination can decrease intermediate product demand costs caused by uncertainty and inventory levels.

A derived demand arises from the production of another product. When a car is ordered, for example, a manufacturer can estimate what parts are needed. These calculations are part of flow management for deliveries for inputs scheduling as well as inventory and capacity management. Since the 1960s, flow management software has become more complex than simple Materials Requirements Planning (or MRP) with the Enterprise Resource Planning (or ERP) of today. A flow management system is set in motion by the demand for end products.

Inventory Control and Customer Service

Unit availability fulfills customer expectations. Item Fill Rate (IFR) gauges each product’s availability and units are tracked by the stock keeping unit (SKU) as well. IFR is the percentage of time customers are able to get the unit they order. This metric for customer service can be set to a percentage such as 95% by a firm. For example, a 95% buyer service order policy would mean 95% of the time, buyer orders are fulfilled from held inventory.

In reality, customer orders can hit snags like damage, expiration, incorrect unit fulfillment, or inaccurate forecasts causing an item to be out of stock. Poor tracking can also cause problems.

inventory control inventory costs by order sizeBalance is key. Businesses carry extra safety stock units to prevent stockouts or shortfalls. Sales can be expected to increase as service levels rise, however, logistical costs then rise exponentially. Not to mention too much inventory stock could cause low turnover in units or disguise operational issues like late delivery times by suppliers.

Product Life Cycles, Uncertain Demand, and Inventory Stocks

The structure of independent demand and logistical requirements vary by stage in the product life cycle (introduction, growth, maturity, and decline). During introduction, logistics must support the business plan for product launch and prepare for potential rapid growth and need for quick distribution expansion. At market maturity, the logistical emphasis becomes cost driven. In the decline stage, cash management, inventory control, and abandonment timing are vital. Over-abundance of products in the late maturity or decline stage will ultimately result in obsolete products.

The life cycle strategy typically involves getting to profitability quickly recuperating startup costs, then sustaining high profits for as long as possible, and finally, acting decisively for products in decline to minimize losses. Understanding this life cycle can help you select logistical tactics, inventory levels and supply chain designs.

Product managers face substantial uncertainty in prediction during the introduction and growth stages, relative stability during maturity, and increasing uncertainty in decline. This uncertainty drives forecasting accuracy and the levels of required safety stock to best meet customer expectations for service.

inventory control staeg of life cycleThe coefficient of variation (CV) measures the stability of a product’s demand, comparing the variability in demand to the size of the average demand. The introductory stage’s high demand variability make it difficult or even impossible to forecast demand. Meeting minimal buyer service levels requires high levels of inventory stock. In contrast, lower variability during maturity means that demand forecasts are quite accurate. In addition to product life cycle stage vagaries, demand varies widely as well as lead time variability.

Product demand forecasting was simpler in the past. Items remained in the mature product life cycle phase for a long time so it is harder to forecast sales now. This is caused by product proliferation wherein product line extensions add more products that often cannibalize product sales and shorten their life cycles. Sales trends show that more sales take place in the erratic earlier stages of a product’s life instead of the mature stage.

To learn more, check out Part 2 of this series on inventory control in the supply chain.