If you’ve known me for longer than five minutes, or if you’ve read more than one or two of my blog articles, you’ve heard me say it before:
Improving the way you manage your supply chain can have a dramatic impact on your working capital.
And let’s face it—what could be more important than enhancing working capital? After all, we’re not in this business just to make our lives easier. We want to improve the bottom line.
If you’re looking for specific ways to enhance your working capital, one of your largest opportunities lies in optimizing your inventory investment. McKinsey’s Ryan Davies and David Merin touched on this topic in a recent article.
Four Inventory Pitfalls to Avoid
In “Uncovering cash and insights from working capital,” Davies and Merin point out several inventory-related pitfalls that manufacturers and distributors should avoid
1. Reducing inventory levels excessively to hit end-of-period targets. It's not always what they want to hear, but companies that invest in our software and engage our team for implementation services will hear about "inventory optimization," not necessarily about "inventory reduction." It’s good to focus on reducing inventory. It’s bad to get so obsessed with reducing inventory that you’re willing to threaten your customer service levels in the process.
2. Not knowing how many days their current inventory will last. An inventory number in a vacuum is virtually meaningless. You might have 2 items, each with $75,000 worth of finished goods inventory. Based on their sales velocity, that $75,000 might represent a 12-day supply for one of the items and a 5-month supply for the other.
According to the authors, “if managers at a manufacturing company can’t quickly determine how many days their current inventory will last at each location and stage of production—raw materials, work in progress, and finished goods—then they can’t be managing it well.” So, this lack of knowledge is both a symptom and a disease. It hampers good decision making, and it portends more significant problems across the supply chain.
3. Creating targets based on gut feel. Many overworked inventory managers fail to calculate stocks based on observed variability, preferring to make an educated guess. They then set unrealistic targets, and have to make unplanned purchases to meet these targets. This can have a devastating effect on working capital. For companies that want to start setting more accurate targets, Davies and Merin advocate using a “clean-sheet” approach in which previous assumptions are tossed out and calculations are made from scratch. Better yet, run Pareto Analysis and vary your inventory targets by ABC Code.
4. Not paying attention after making improvements. According to Davies and Merin, your company can easily backslide if you don’t keep an eye on key areas after making changes. They recommend making periodic audits of inventory to ensure that improvements will last.
Also, it's likely that you'll be either too bold or too conservative in setting your new inventory targets. Evaluate your progress, and tweak your safety stock or safety time settings to consistently improve your inventory performance.
Solutions for Reducing Safety Stock
Your inventory investment is too big a line item to leave to chance. That’s why Demand Solutions delivers solutions that help you optimize this investment in several ways. By letting you measure and improve forecast accuracy, we can help you reduce your safety stock. By enabling you to segment your inventory by ABC Code (according to Cost, Revenue or Margin), we can help you set varied customer service targets by inventory class for further reductions in stock. By improving the management of your supplier network with predictive lead time and other key tools, we can help you shorten lead times and reduce lead time variability.
All of this can help you free up substantial amounts of working capital. To get the details, drop us a line.
Note from the author: I want to thank Bill Whiteside, Principal with Demand Solutions Northeast, for his insightful input for this article.