Optimize your inventory and unlock or free-up your working capital

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One of those rare enigmas that a supply chain expert is still trying to resolve is that how to have correct inventory in the warehouse so that the stock-outs are zero, on-time delivery is 100% and yet there is no over stocking or obsolescence.

There are multiple questions that bother the supply chain professionals and some of them are:

• Where to stock inventory – at the finished goods level or raw material level?
• How to address demand volatility?
• How to balance supplier lead times with cost & quality of item procurement?
• How frequently one should revise the inventory targets?
• What is more beneficial – Are bulk purchases at low cost really beneficial as they increase inventory?

Few months back, I came across a scenario of a typical manufacturing company where one of my friends who is part of senior management, was struggling to optimize the inventory. Their inventory carrying costs wetoo high and yet they lost sales because of stock outs. A big piece of the working capital was blocked in carrying the inventory. When we both did the drill down in an informal discussion, we found that following were the major reasons of their unbalanced inventory:

• The forecast is done in spreadsheets which impacts the accuracy, consolidation and low connect with past demand history – This makes the forecast more disjointed, less realistic and hence the procurement process that depends on this most important piece of supply chain, becomes skewed
• Though the company used to stock inventory in raw material form so that they had the flexibility to switch to different product variants looking at the demand, this process took a backstage after they started optimizing their inventory – this had a cyclic effect on supply chain as more often than not, the assemblies could not be completed as there was one or other part missing – This led to rise in unfinished and non usable inventory
• Production slowed after they took a decision that only if all material is available, only then the production of a model will start. Production department started crying foul as they lost production incentives for no fault of theirs. Voices heard about a possible worker strike and they were caught between devil and deep sea
• They thought over and switched to a process, where the production was given a plan as per the stock of raw material available and not as per the foreseen demand. They did this meticulously for those models that were always in demand so moving them out of shelf was not a problem – But all their plans failed when they saw that their most popular model too started fading in market due to competition prices. They tried to reduce the prices after negotiation with suppliers on raw material – started buying large quantities at lower rates but now they had another problem – huge stockpiles of finished inventory

The action plan that came out from our brainstorming and then later, the exercise done by their staff was:

• Start the process for moving to an ERP to improve and automate the forecast process as soon as possible
• Go back to stock inventory at raw material level instead of finished goods level as it has lesser shelf life and usage flexibility
• Collaborate with suppliers to work in a partnership mode (this is another story that I will take up in another post) so that they have visibility to their production plans and inventory levels and accordingly come closer to replenish the stock
• Balance the large quantity purchases with respect to foreseeable demand and accord more weightage to demand than raw material price
• Plan for day after tomorrow and as per demand – Till now they used to plan for tomorrow’s production and the production faltered if the raw material was not available. Assuming that one day in between will act as a buffer for procurement of unavailable components
• Reduce obsolescence of low shelf life material by optimizing their stocks and visibility
• Revisit the inventory targets every quarter in first year and as soon as the selected ERP is deployed, move to revising inventory targets every month
• Introduce category for critical and flexible components to utilize them to the fullest level
• Plan a strategy to improve inventory turns per annum
• Make efforts (after stabilizing forecasting) to move towards build to order scenario rather make to stock scenario

Today, more than 4 months have passed after our discussion and when we met last week, he was a much happier person with some actions started bearing fruits. They finalized SAP (even started the requirement gathering phase) as the preferred ERP. They started re-engineering the processes, automating them and nailing down the bottlenecks. The inventory turns per annum they calculated just last week improved to 3 from 1.8, six months back thus freeing up working capital. The list is long but it is a live example that just by optimizing inventory, which is a major driver for manufacturing companies, you can unlock your working capital that can be deployed at doing more useful activities.