Inflation is causing weakened demand. Businesses such as Microsoft and Google are preparing for an economic downturn. It is difficult not to react by drastically reducing inventories, and it is hard to determine the right amount of inventory when significant uncertainty exists.
How do companies plan inventory targets? This is usually guided by an overall financial target. Managers must take this target and decide how to allocate the target among the various product groups. Then inventory planners attempt to meet these targets by delaying or decreasing replenishment quantities.
Often, the last two months of the fiscal year are spent trying to reach the fiscal year targets. The items that are reduced are usually the high-moving items because they are the easiest to delay replenishment. Then, at the start of the year, these products are replenished and no real reduction in overall inventory occurs.
From an inventory planner position, the inventory needs to be available when an order comes due to reach on-time delivery goals. However, the planner is often forced to decide between reaching on-time delivery or reaching inventory goals.
What can planners do to reduce inventory and still meet on-time delivery goals?
Review the Product Portfolio
When demand starts to slow down, it is an excellent opportunity to ask sales to rationalize the product portfolio. Sales personnel may be reluctant to rationalize products because when sales decrease, sales goals are more difficult to achieve. Yet even reducing package offerings is extremely helpful in reducing inventory. When companies across the board are preparing for a downturn, they are more likely to be amenable to packaging rationalization.
Increase Customer Minimum Order Quantities
When product rationalization fails, it is often helpful to increase the minimum order quantity on the smaller packaging sizes and low-volume products. Producing these items becomes more profitable by reducing the number of setups each year and increasing the price. However, inventory planners must be aware of these minimums to plan replenishment quantities appropriately.
Increase Lead Times
Another alternative to product rationalization is increasing lead times for slower-moving items. Sometimes inventory holding costs to meet shorter lead times and erratic demand patterns results in no overall benefit for the company. Start by increasing lead times on slow-moving items that have minimal or no inventory and then add other slow-moving items as inventory is sold out. Increasing lead times allows planners to reduce inventory and plan production once orders are placed. This is especially true when capacity is not being fully utilized. This practice will increase setups, but when utilization is low, it is easy to adjust the schedule to plan these items make to order.
If increasing lead times is not possible, it is often prudent to have customer representatives ask the customer to provide a long-term forecast as an alternative. Working with customers and their future needs can help the planner develop optimum replenishment quantities. When this is done, it is important to keep reviewing actual demand versus the forecast to ensure that it remains accurate. Customers tend to respond well to regularly reviewing slow-moving item demand. Remember to advertise the benefits of relationships like this, because it means the company can still provide the same lead times, but inventory will not be sitting around in the warehouse for months, with the potential to be damaged—and for some items, remaining shelf life will be longer.
Review Product Demand Behavior
Inventory planning starts with an ABC analysis, but there are other ways to look at product demand behavior. There is an XYZ analysis. This is used to classify materials based on variability of demand. An item categorized as X has regular demand, and if that item is also an A item, planners can reduce overall safety stocks and replenishment quantities to reduce overall inventory. Since demand is stable period to period, safety stock can be reduced with little risk of a stockout.
Planners need to consider seasonality. Planning inventory based on averages cannot be done with seasonal items. This would include Y and Z items. Planners need to identify seasonality and then develop a supply plan which prevents excess stock during the off-season.
Planners can also classify materials by their lead time to assign appropriate replenishment strategies. Items with longer lead times often have variable lead times, especially imports. These items need to include lead time variability when estimating when they will arrive, not just the stated lead time from the supplier and transit companies. Also, when imports require a container load, review all imported products from this vendor at the same time and build a load for multiple items, instead of ordering each product in full container loads.
Avoid Creating Slow-Moving Inventory
The easiest way to avoid slow-moving inventory is to not produce it, but this is easier said than done. Unfortunately, there will always be items that were purchased regularly, then suddenly stop being ordered. When completing an ABC analysis, it is important to regularly review the ABC assignments, as well as the changes in these assignments. This helps planners target items before they become slow-moving inventory.
Items moving from A to B is a signal of decreasing demands—and that inventory planning needs to change to a reorder point plan, as opposed to a make-to-forecast method. Keep in mind that reorder point planning is only effective when lead time is consistent, and demand is somewhat consistent.
Items that change from B to C need to be reviewed regularly. If possible, also propose to sales that these items should be changed to a make-to-order model. Even if these items are not reclassified as make-to-order, this effort will force sales to review demand with the customer, result in improved communication and create better inventory replenishment strategies.
Inventory planning becomes more difficult when there are major uncertainties in the economy. It is important to change your inventory settings to adapt to what is happening today and tomorrow, not what happened last year. Implement processes that support rapid changes to inventory settings, and then repeat this process regularly. The more often you do this, the less likely there will be slow-moving inventory or stock outs. It is a tedious process to review inventory settings all the time, but once planning develops a standard set of reports and a standard review process, it is easier to repeat.
Jessica L. Cavanagh is a business process design consultant at Uniorg Inc. Jessica has been a continuous improvement consultant for SAP ERP systems implementation and maintenance for the last 5 years, with a 17-year history of working in manufacturing and supply planning.