A recently released research report titled “Retailers and the Ghost Economy: $1.75 Trillion Reasons to be Afraid”, produced by the IHL Group and commissioned by OrderDynamics, a Big Data prescriptive analytics software company, calls to mind the reason most companies are so focused on inventory: “Retailers Lose $1.75Tr in Revenue Worldwide Due to Overstocks, Out-of-Stocks and Returns.”
Inventory level, and the direct losses clearly associated with inventory issues can be huge factors in the company’s financial results. Inventory is a very visible item on the balance sheet and inventory-related factors like stock outs and the resultant lost sales show up quickly on the income statement.
You can download your own copy of the free report, but the title and abstract sum it up – inventory can be an indicator of underlying problems, and companies should be concerned when inventory performance illustrates the existence of inventory control challenges.
Even though the report is focused on retailers, the points apply to manufacturers as well. Companies hold inventory for a purpose – several purposes, actually – but the most important is to be able to satisfy customer demand. Ideally, there should be just enough inventory to meet demand and not a single unit more. We all know that this simple sounding objective is nearly impossible to achieve because of variability in both demand and supply. At best, operations and supply chain professionals try to find the best balance between having enough inventory to be able to deliver an acceptable service level while minimizing the inventory investment as much as practical.
As experienced operations professionals we also know that there will be excess inventory and there will be shortages – at the same time – because this balancing act applies to each and every item at every location where it is held. So the real challenge is to have the right amount of the right inventory (at the right time). So, the simple objective (just enough and not too much) gets a lot more complicated.
The above referenced report attributes the reported losses to returns (37%), out-of-stocks (shortages) 36%, and overstocks (27%). In other words, 63% of the losses or more than 1 trillion dollars’ worth are from having too much or too little inventory.
Understandably, inventory is the main focus of manufacturing management. Nearly all investments in ERP and related systems are justified (in projected ROI calculations) by inventory reductions. In fact, Material Requirement Planning itself — and just about all the ERP systems in use today contain some type of MRP engine — is designed to calculate the minimum amount of inventory needed to achieve service objectives (minimize shortages). Sales & Operations Planning (S&OP) is also inventory planning – they actually call it SO&IP in Europe. Inventory is central to operations management, supply chain management, MRP/ERP, and the financial health of the business.
The good news is that we, as operations managers, are in the unique position of having control of inventory through the way we schedule and manage purchasing, production and supporting activities. We implement management policies by how we set up our ERP systems (safety stock, shrinkage factors, lot sizing rules, etc.) and we apply our knowledge and experience in the way we use these systems to direct activities and respond to system recommendations. Our participation in S&OP activities, Lean Manufacturing and Six Sigma efforts, risk management strategies collaboration initiatives and other process improvement programs are aimed at reducing variability which, in turn, helps us deliver better service with lower inventory.
Operations management and supply chain management are at the focal point of inventory management because inventory performance is the most visible indicator of overall management success. It’s an important job, often not appreciated as it should be. Nevertheless, it is potentially the most important and most fulfilling career in manufacturing.
