First of all, thank you for reading these articles. We’ve already covered a lot of ground on the topic of inventory reduction. I’ve explained the importance of setting a goal, fine-tuning your safety stock strategy, and reducing your high-side forecast bias.
For my next tip, we’ll shift our focus from the strategic to the physical.
What does it take for your company to stock an item in one of your distribution centers? Do these decisions require lengthy discussion? Or is it just a matter of a sales rep promising you that if you keep the item in stock, customers will buy it?
For most companies, it’s the latter. This is understandable. We’re doing business in the era of King Customer. The desire to keep customers happy is one of the biggest motivators for any stocking decision.
If you don’t believe me, take a look at an excess inventory report sometime.
These reports are typically full of items that could have been drop-shipped or built to order—but then a sales rep came along and insisted that they be kept in stock at all times, based on a customer’s vague claim that they were going to buy them.
The problem intensifies when companies not only stock too much of an item, but also keep it in stock in multiple locations. Inventory that is stocked in several warehouses is harder to track—and harder to control. So, if you’re serious about reducing inventory, your next step is to reduce stocking locations.
Why Multiple Stocking Locations Cause Inventory Bloat
You can compute how much your inventory increases when you add new stocking locations. It’s called the Square Root Law of Inventory. According to the Square Root Law of Inventory, your total safety stock will be your total inventory multiplied by the square root of the number of future stocking locations, divided by the current number of stocking locations. Here’s the formula:
X2 = (X1) * √ (n2/n1).
n1 = number of existing facilities
n2 = number of future facilities
X1 = existing inventory
X2 = future inventory
So, suppose your current inventory is 4,000 units, and you’re planning on stocking the product in a third warehouse. Using this formula, your future inventory will be:
(4000) * √ (3/2) = 4000 * 1.2247 = 4,899 units
That’s a 22% growth in inventory as a result of simply stocking the product in three warehouses instead of just two.
How to Determine Your Stocking Policy Criteria
The lesson here is that we should never add stocking locations casually. Each stocking decision should be based on carefully predetermined stocking policy criteria.
How can you develop these criteria? I find it’s helpful to use the concept of inventory picks. To learn more, please download our free white paper, “Five Things You Can Do This Week to Reduce Inventory.”