Managing Inventory for Optimal Advantage10 Common Inventory Mistakes and How to Correct Them

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A Management Series White Paper Compliments of Demand Solutions

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Inventory Management: The Objective

Each company that attempts to reduce inventory and its associated costs brings its own unique advantages and challenges to the battle. Managing for optimal inventory levels is a critical objective that requires diligent attention and daily action to maintain hard-fought advantage. The results, however, measured through improved customer service, increased sales, reduced costs and ultimately more profitability are worth the effort.

For more than 24 years, Demand Solutions has helped thousands of customers manage for optimal inventory levels. During that time, we have encountered frequent misconceptions about inventory planning based on outdated practices, short-sighted thinking, or simply inexperience. In this white paper, we identify the 10 most common mistakes we have encountered and list their “symptoms” to make each error easier to diagnose. We then offer practical solutions to help companies solve these problems to begin reducing inventory-associated costs and their performance-sapping consequences.

The 10 Most Common Inventory Mistakes

Using a Narrow Measurement Performance1.

Having Unqualified Employees Manage Inventory2.

Forecast Management Without a Disciplined Process3.

Not Communicating Internally4.

Not Talking to Customers5.

Forcing the Budget6.

Using Reorder Points to Manage Inventory7.

Having Too Many SKUs in Too Many Places8.

Managing All Items the Same Way9.

Never Trying New Things10.

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Mistake No. 1: Using a Narrow Measurement of Performance

Preoccupation with forecast within the execution timeframe: Typically, companies begin altering their forecast management processes when addressing supply chain performance. But this is unwise without understanding the nature of your demand and the root causes of forecast errors. When forecast accuracy is overemphasized, fill rates and inventory turns don’t improve even when forecast accuracy does.

No measure of customer service or inventory turns: Customers must be satisfied on an ongoing basis in order for a company to achieve long-term sustainability. Yet, inventory managers often have no idea how well customers’ needs are being met. Similarly, without knowing how quickly inventory moves through the value-creation-and-delivery system, a company won’t be able to manage inventory levels.

Daily planning is based on a backorder report: This is an entirely reactive model. Today’s fast-paced marketplace requires proactive inventory planning to meet current demand. Customers will switch to a competitor if their needs are consistently unmet in the timeframe they dictate.

Mandatory tracking of fill rate and inventory turns for all product lines: Product managers should know these measures at all times. Fill rate should be measured daily, while inventory-turn measures will vary based on sales and production cycles. The important thing is that managers are both tracking and working to improve these rates.

Develop realistic forecast-error measures: Developing realistic measures for how much forecast error you can tolerate without a SKU stock-out is essential. Typically, companies estimate plus or minus 10% for this measure, which equals about two days worth of inventory-a miniscule amount considering that companies often have weeks or months worth of inventory. Effective forecast management and inventory planning require accurate data, so accurate forecast error measures are a must.

Symptoms

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A sentiment that “our business is different because (fill in the blank)”: Every company has inventory planning challenges, such as variable demand. No business is so different that it would not benefit from strategic inventory management.

Decentralized inventory management. If warehouse managers, office clerks, and other employees without specific inventory-management training are making inventory-management decisions, then it is certain that wasteful inventory is piling up throughout the system. Usually, this model reflects a company with no clear goals or strategy for inventory planning.

Lack of formal training program or professional peer interaction: Inventory management is a professional skill that requires upfront and ongoing education. Emphasizing “buying” over planning: Buyers make purchases, but planners make strategic decisions to meet goals. Thinking of inventory planning from a purely “buying” point of view means opportunities for improvement and financial benefits will be overlooked — daily.

Mistake No. 2: Having Unqualified Employees Manage Inventory

Symptoms

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Recognize that inventory management requires professional job skills; and hire and train accordingly: Just as a company with hundreds of thousands of free dollars on its balance sheet would hire professional investment advisers, a company with hundreds of thousands of dollars in inventory should have professional inventory managers.

Assign accountability for inventory management: Often, companies can’t answer the question, “Who is in charge of making sure inventory levels support strategic goals?” If no one is, then these inventory planning goals will never be met.

Centralize inventory planning where possible. This improves standardization of processes and makes inventory more visible and easier to manage consistently.

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No one “owns” the forecast management process, but everyone blames the forecast: As with inventory management, without someone being responsible for forecast accuracy, an organization will never have an accurate forecast.

Excessive forecast overrides and/or inaccurate forecasts: Often this reflects a lack of collaboration and input (internal and external) on the forecast management process. Without accurate information as an input, a forecast will not be accurate.

Managing inventory by forecast adjustment: A natural response to having too much inventory often is to cut the forecast so that the system uses up the excess inventory. Among other problems, this disconnects inventory planning from customer demand and, therefore, puts customer satisfaction in jeopardy by risking the ability to fill orders.

Make forecast management a full-time job: If not assigned to one person, assign to one or two people with the understanding that the forecasting process is a collaborative endeavor.

Have a monthly forecast collaboration meeting before the sales-and-operations-planning (S&OP) meeting: During this meeting, company executives should review, adjust (if needed), and approve the monthly sales forecast, preferably at the product-family level.

Override the forecast only if you know something the planning system doesn’t: Often, companies override the forecast for the wrong reasons, such as “gut feel” or to “make the numbers come out right.” This is planning without regard for true customer demand.

Implement forecast accuracy measures: This injects accountability into the job of maintaining an accurate forecast and is a prerequisite to continuous forecast management and inventory planning improvement.

Mistake No. 3: Forecast Management Without a Disciplined Process

Symptoms

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Surprises — i.e., promotions and new-product information is not reaching all pertinent departments: In order for all functions to support strategic inventory-management goals, managers in those functions must have up-to-date information for forecast management and inventory planning. If this is lacking, then it is likely there is no S&OP process, or the S&OP process is ineffective.

“One-button” sales forecasting: Sometimes, companies make the mistake of having complete trust in their forecast management software system and think they don’t need to review data or make adjustments. Be cautious of this. Demand changes, so the forecast should.

Lack of coordinated input/multiple sets of numbers: This occurs when a company is operating in silos, and managers are not planning together. For instance, those responsible for inventory replenishment will have their own forecast, and this is different from what the sales team is using. Meanwhile, finance is using yet another forecast.

Implement a “real” S&OP process: Have meetings with the goal of reaching consensus on planning for the month, both on the demand side (Sales and Operations) and supply side (Production, Purchasing).

Establish accountability in the company business plan: Ensure that all actions in these plans align with the overall strategic goals of the company.

Mistake No. 4: Not Communicating Internally

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Scrambling to service key customers: We often see this in companies that serve mass merchandisers. Everyone awaits these key orders and then begins planning work. The irony is that overall customer satisfaction suffers from this haphazard planning.

Surprise “killer” purchase orders: These are orders no one sees coming that put stress on the system. Using unplanned resources (i.e., overtime, expediting) frequently kills the profit margin of these unexpected sales.

Lumpy ordering patterns: Although variability of demand is expected, this should not be the case with a company’s best customers. Similarly, a supplier should know its best customers’ promotion schedules and be planning accordingly for the spikes.

Regularly talk with and visit customers: Supplier inventory planners should be meeting with customers regularly to find out what is driving their replenishment; and then create internal processes that match the cadence of this replenishment.

Implement collaborative forecasting and/or replenishment programs with key customers: For instance, Collaborative Planning/Forecasting/Replenishment (CPFR) in the consumer goods business, which is a technique of replenishment based on a consolidated inventory plan or forecast. Another common program is Vendor-Managed Inventory (VMI), where a supplier takes over responsibility for managing a customers’ inventory.

Mistake No. 5: Not Talking to Customers

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Company-wide preoccupation with “the budget”: A large amount of resources (time and energy) is put into planning and updating the annual budget; and the budget drives decision-making. Often this mentality is driven from the top down.

Reluctance to get hands dirty with SKU-level forecasts: This usually accompanies a preoccupation with the budget. Companies think they are planning properly by overlaying the budget on top of the sales forecast for product families. This “pseudo-S&OP” process often makes for exceptionally inaccurate inventory planning.

Measure the gap between the budget and rolling sales forecast: This gap is inevitable. The most beneficial action is to manage the gap with inventory-planning techniques instead of forcing the budget to determine SKU-level forecasts. If the gap is too big, change the budget, not the forecast. The forecast likely is closer to reality than the budget.

Mistake No. 6: Forcing the Budget

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Using a spreadsheet program to manage inventory and/or using Economic Order Point/Economic Order Quantity (EOP/EOQ): These methods do not provide visibility into customer demand, a key piece of information for leveling the forecast; this lack of visibility inevitably causes excessive inventory and weak customer responsiveness.

Manufacturing and Distribution use different numbers: This reflects that distribution inventory is not linked to the production schedule.

No information given to suppliers: This represents another missed opportunity to reduce costs and increase performance with strategic inventory planning. Generally, suppliers and customers share the benefits of collaborative inventory management.

Implement time-phased inventory planning: Use information from planning and distribution information systems to begin long-term planning. A company should know not only what is needed today in terms of inventory, but also what will be needed weeks in advance. With this information, a company can manage delivery timelines, truckload quantities, and other variables for minimum cost and maximum customer responsiveness.

Time-phase master scheduling for manufactured items: This is the same concept, but the future-focused information is provided to suppliers.

Mistake No. 7: Using Reorder Points to Manage Inventory

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Scrambling to fill orders for C (low-volume) items; or the 80/20 rule no longer applies: SKU proliferation occurs naturally over time and needs to be minimized. Sure signs that SKU proliferation has become problematic are that filling lower-volume items always causes a scramble; and/or, no longer does 20% of items account for 80% of sales.

No stocking policy: A stocking policy requires a process-control-focused justification for stocking an item in a specific distribution center.

Buying versus planning mentality: When buying is emphasized over planning, no one tracks SKU levels. An inventory planning mentality would require a reason for stocking an item.

High number of SLOBs (slow-moving, obsolete items) and inventory-reduction campaigns: Both represent an excess of inventory.

Use ABC analysis: This will segregate inventory according to volume. Stocking according to this commonality will improve efficiency.

Establish a stocking policy based on velocity: This ties stocking decisions solely to inventory planning and prevents arbitrary stocking-location decisions.

SKU-rationalization project: Use these projects regularly to tamp down SKU proliferation, both the number of SKUs and the number of stocking locations.

Centralize C items in one distribution center if possible: Consolidating this inventory in one location will allow for more effective customer service and response because the inventory can be managed based on commonalities.

Mistake No. 8: Having Too Many SKUs in Too Many Places

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It’s just as bad to stock-out of a C item as an A item: This mentality will result in either having too much C inventory or not enough A inventory because they require different handling to meet efficiency requirements.

Same inventory goal for all items: This presumes that all items are consumed in the same quantity at the same rate, which of course, is never true. Using this goal, companies will spend significant time expediting C items.

Using fixed safety stock quantities: Again, this assumes that all inventory is consumed in the same amount at the same rate, which makes for inefficient inventory planning.

Use ABC analysis; and manage As differently than Bs and Cs: As stated previously, this ties stoking decisions to true customer demand.

Use safety time rather than safety stock: Safety time automatically increases safety stock in response to anticipated demand, whereas safety stock is a stagnant quantity that must be set manually and does not account for changes in demand.

Mistake No. 9: Managing All Items the Same Way

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Still trying to implement EDI: New technology provides better capability for ongoing, collaborative improvement in the areas of forecast management and inventory planning.

No new initiatives to electronically link with customers/suppliers: Such collaboration is becoming mandatory to remain competitive. Customers are expecting it.

No one is attending professional association meetings and little emphasis on training: Without motivation for individual improvement, employees will not be receptive to change.

Develop a “tinker” attitude — try new things: Emphasize ongoing improvement rather than constantly seeking ROI for new and different ideas. Allowing low-cost/low-risk trials will demonstrate to employees that you value their input and ideas and will not punish failure during trial-and-error.

Collaborate with key customers: New technology makes customer-level sales forecasting much easier than in previous years. This improves forecast management and inventory planning accuracy.

Share purchase schedules with key suppliers: Gone are the days when companies have suppliers they can’t trust. True collaboration requires open communication.

While these 10 mistakes are the most common ones we have helped customers reverse, the biggest mistake we have encountered is a reluctance to address inventory planning with a holistic and strategic approach. If your company is “fighting fires” daily to meet customer demand, then you are already losing customers and missing new sales. Today, business is conducted in real time, a reality that requires flexibility and responsiveness, and it is these two attributes — along with reduced costs — that are the most beneficial fruits of managing for optimal inventory levels. We hope that this white paper will begin or further efforts within your company to plan and manage inventory for long-term sustainability rather than short-term survival.

For the past 24 years, Demand Solutions has been empowering small and midsized enterprises to reduce costs and increase profits through effective inventory management. Its solutions address the full spectrum of inventory planning, including demand forecasting, sales force collaboration, inventory replenishment, sales and operations planning (S&OP), retail point-of-sale (POS) planning and manufacturing planning. More than 2,000 customers in 74 countries rely on Demand Solutions to turn supply chain insight into competitive advantage. Learn more at www.demandsolutions.com.

Mistake No. 10: Never Trying New Things

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Conclusion: Managing for Optimal Inventory Levels is Profitable

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