Wednesday, August 13, 2008

10 ways to lower inventory costs

By Ralph Cox
Inventory policies drive two types of costs: operating expenses and working capital requirements. The latest "Logistics Cost and Service Report" by Establish/Herbert W. Davis and Co. indicates that while total logistics costs as a percent of sales are falling, and most individual companies have succeeded in reducing inventory levels; total logistics costs per hundredweight are increasing, as are inventory costs as a percent of total logistics cost.

Many organizations, however, fail to address opportunities to reduce inventory costs. If your company needs help taking money out of inventory, there are a number of strategies you can implement today that will provide payoff:
  1. Base cycle stock on economics. For purchased products, getting a handle on your acquisition transaction costs will either reduce average inventory or allow for reducing purchasing and receiving labor. For manufactured products, if production equipment changeover costs are in a similar state, getting them in place will either reduce average inventory through shorter runs or allow for reducing changeover and receiving labor through longer runs.
  2. Control order transaction costs. In the office, use the computer to generate purchase orders (POs), electronic data interchange (EDI) for PO transmission, advance shipping notices (ASNs) to reduce expediting, and historical vendor performance to prioritize expediting to lower purchasing costs. In the manufacturing plant, preplanning; prestaging of needed parts or materials; use of special tools or equipment; changeover initiation prior to completion of the previous run; teamwork and work division; maintaining equipment temperatures; and minimizing quality assurance/quality control work all reduce cycle stock inventory. In the distribution center, statistics-based inspection and checking; barcode scanning for data entry; certifying key vendors to eliminate receiving functions; and stocking forward storage locations first and reserve locations second can all reduce purchase transaction costs and cycle stock accordingly.
  3. Lower inventory holding costs. Improve space utilization in the DC through narrow aisle handling equipment, mezzanines, layout modifications, or more appropriate storage modes.
  4. Base safety stock on customer service. Using the appropriate number of product classes, setting the dividing lines between each class in the best manner, updating safety stock levels dynamically, and basing the service levels for each class on the financial goals of the business all serve to reduce safety stock inventory or out-of-stock situations and increase revenue.
  5. Use routine demand forecasting. Using manually edited arithmetic forecasting models to reduce forecast error will reduce overstocking, backorders, and DC returns from stores, holding inventory levels closer to only what is required to support the desired customer service level.
  6. Forecast events. If one-time demand clutters the sales history, or if one-time demand events are part of the future, then they need to be taken into account in any forecasting, both in terms of editing them from history and in terms of incorporating future events into the routine demand forecast.
  7. Think postponement. For parent products from which multiple SKUs can be manufactured, only partially completing manufacturing, placing semi-finished product in inventory, and then completing manufacturing of the final SKUs to order reduces total inventory. In a similar manner, component products from which final SKUs may be assembled can be purchased to inventory and then the final SKUs assembled to order, providing that the time for assembly doesn't exceed the customer lead time.
  8. Rationalize SKUs. Removal of inappropriate product from the product line can be a controversy-ridden process, but it may reduce inventory significantly if handled in a constructive manner:
  • Develop consensus on the objective of maximizing profit.
  • Develop activity-based costs for each SKU and separate them into three groups:
o those with selling prices that create positive gross margin
o those with selling prices that cover their variable cost but do not completely cover their fixed cost o those with selling prices that do not cover their variable cost.
  • Quantify the sales volume correlations among SKUs, based on the analysis of both individual orders and aggregate order patterns by customer.
  • * Identify the combination of SKUs that maximizes profit on a fully absorbed basis.

9. Reduce lead times for product acquisition. For both manufactured and purchased product, any reduction in lead time, whether supplier lead time, transportation time, or receiving cycle time, provides a one-time, permanent reduction in cycle stock inventory proportional to the throughput level of the SKU and the degree of lead-time reduction. In a similar manner, reducing lead-time variability and increasing inbound unit, SKU, or order fill rates increases supply reliability and reduces safety stock inventory for a given customer service level.

10. Implement common supplier joint procurement for purchased products. Joint procurement of multiple SKUs from a common supplier serves to effectively reduce unit purchase transaction costs and thereby reduces cycle stock inventory as well as annual purchase transaction expenses. In a similar manner, joint procurement of multiple SKUs from different suppliers located in close physical proximity and consolidation of inbound less-than-truckload (LTL) volume to form full truckloads serves to reduce the incremental transportation cost portion of purchase transaction costs and reduce cycle stock inventory.

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