Vendor-Managed Inventory

Many firms are trying to concentrate on the "core competences." They want to outsource minor tasks and activities when it is cost effective to do so. For a distributor, an example of one of these tasks is the replenishment of less-expensive products. For a manufacturer, it may be the procurement of MRO (maintenance, repairs, and operations) inventory. A popular way to outsource these procurement activities is a vendor-managed inventory (VMI) agreement. Under a VMI agreement, a supplier takes full responsibility for maintaining stock of its products at a customer's facility. VMI agreements differ from traditional consignment agreements in that the customer is billed for material when it is delivered, not when it is consumed or issued. When establishing a VMI agreement, the supplier and customer must agree on:
* The specific products that will be covered under the VMI agreement.* "Acceptable availability" of these products at the customer's site and the corresponding investment required by the customer. Usually the supplier and customer will agree on a "service level," which is the percentage of orders for a product that can be completely filled out of the VMI stock inventory. The higher the agreed-upon service level, the more the customer will have to invest in the supplier's products.
* How often the stock of these products will be replenished.
* The automatic return of material that is no longer needed by the customer.
Potential advantages for a customer participating in a VMI program include:
* Eliminating the cost of managing replenishment parameters and issuing purchase orders.
* Establishing an extremely reliable source of supply for products that are very important to its operations but represent a relatively small investment.
Advantages to the supplier include:
* Securing all of a customer's business for the types of products it supplies.
* The ability to better plan its own inventory replenishment needs because the supplier's buyers can monitor the actual sales or use of its products at the customer's site.

How much to stock?

How do you know if you have too much, too little, or just the right amount of stock inventory? One way is to compare the value of your current inventory to an "ideal inventory investment." In this article we will discuss how to calculate the value of this "right" amount of inventory. As with many of our other inventory analysis tools, calculating the ideal inventory investment requires that we first separate those inventory items with recurring demand from those items with sporadic usage.

Recurring Usage Items
Recurring usage products are sold or used on a regular basis. Typically these items:
* Have had usage in at least eight of the last twelve months.
* Have had usage in at least four continuous months in the last twelve months (this second condition identifies seasonal items that are only sold during certain times of the year).

Replenishment of these items is normally based on safety stock quantities, order points, line points, and standard order quantities:
* Safety Stock Quantity: The "insurance" inventory maintained in stock to protect you from stock outs resulting from unexpected customer demand or vendor shipment delays.
* Order Point: The Safety Stock Quantity plus predicted demand during the anticipated lead time.
* Line Point: The Order Point plus predicted demand during the supplier review or order cycle; the normal length of time between typical replenishment orders with the supplier.

Cycle counting

Cycle counting is the process of verifying the on-hand quantity of a specific number of stock products every day. In previous articles, I have described how to set up and maintain an effective cycle counting program and why this process is usually better than a full physical inventory for maintaining an accurate perpetual inventory in your computer system. But verifying on-hand quantities is only one of the advantages of cycle counting. The other benefit of a cycle counting program is to improve your business processes, including:
* Making sure that all material movement is properly recorded.
* Ensuring that stock receipts are put away in the proper location.
* Verifying that the right quantity of the right item is shipped on outgoing orders or is pulled from stock for an assembly.
* Preventing shrinkage from theft and the mishandling of stocked items.
Absolute Value of (Quantity Counted – Current Stock Level)] ÷ Current Stock Level
Process improvement results from carefully analyzing significant stock discrepancies.
Including the "absolute value" of "Quantity Counted – Current Stock Level" in this equation signifies that a discrepancy should be analyzed if significantly more or less inventory is found during the cycle counting process.
It is impossible to achieve effective inventory management without accurate stock levels in your computer system. A comprehensive cycle counting program is a valuable tool for ensuring that the quantities in your computer system agree with what is physically in the warehouse. But to be certain that stock levels remain accurate over time, you must investigate significant stock discrepancies and take corrective action to prevent similar problems from reoccurring in the future – that is, you must utilize cycle counting to improve the way you run your business!

Weekly forecasting

The order point is a "minimum" quantity for the product, and is equal to anticipated demand during the lead time plus a safety stock quantity. Safety stock is insurance inventory to protect customer service from unusually large usage or shipment delays during the time it takes to replenish inventory. When the stock level falls below the order point of 150 pieces, a replenishment shipment would be issued to the vendor.

Each new order point becomes effective at a date equal to the first business day of the week minus the lead time.
So, four business days before the start of week one, if the stock level of the product was less than 497 pieces, a replenishment order would be issued. If the stock level was equal to or greater than 497 pieces, the buyer would leave the item alone because he has plenty of stock available to see him through the first week of the month. The result: The distributor will have this critical item available when their customers want it. Also notice that the order point drops during the period of the month with less usage activity. We are not ordering the material far in advance of when it will be needed. This will help improve the inventory turnover and overall profitability of the distributor.

How Much of Each Item Should be Maintained in Inventory

You can separate your MRO inventory into three categories:
* Continual-Use Items – These are maintenance items and other products that are continually used.
* Specific-Need Inventory – Though not continually used, these items are used on a regularly scheduled basis.
* Emergency-Repair Parts – These are parts whose use sporadic usage cannot be predicted.

Every one of your MRO stocked products should be assigned to one of these categories. Continual-use items are just like the recurring stock products we address in other articles and our books. Please refer to these resources to determine how to calculate a forecast of future demand and other purchasing parameters for these items. Most organizations have too much money invested in the other two types of MRO inventory. Specific-need inventory products are required for scheduled maintenance operations. Unless these are very inexpensive items (i.e., they don't cost much to carry in stock), most companies are best off acquiring just what they need before each scheduled task. Emergency-repair parts are a different story. Since you don't know when each of them will be required, how can you determine how many of each one to stock?
For very critical parts that can completely shut down operations, we will keep one normal-use quantity of each item in inventory even though we can get a replacement part in less than a day. And if the lead time of a very critical part is greater than a week, we will probably want to keep three normal-use quantities on the shelf in our parts room. The cost of this "insurance" is the annual cost of carrying inventory (normally 20% to 25% of the inventory value of the target stock level). You must weigh this expense against the cost of shutting down operations. Notice that we are not even considering maintaining an inventory of a non-critical part unless it has an extended lead time.

The average-use quantity suggestions in this table are not "cast in stone" and should be adjusted for your organization's specific needs. However, if you must reduce the value of your spare-parts inventory, we strongly suggest you discontinue or reduce your stock of non-critical and somewhat critical parts before reducing the target stock level of any of the very critical items. After all, these products support the lifeblood of your vital operations.
With proper management of MRO inventory, an organization can maintain an outstanding level of productivity at the lowest possible overall cost. But like any other process, it cannot be accomplished without a logical, methodical action plan

Effective inventory management and inventory investment

Many companies try to capture all unfulfilled customer requests and add them to the actual usage recorded for a specific inventory period. They believe that by including these lost sales in usage history, future demand forecasts will be adequate to cover the unfulfilled sales or usage experienced during the current inventory period.As part of a comprehensive customer relationship management (CRM) program, it is important to capture lost sales in order to see what customers are not being adequately served. Indeed, your sales manager probably wants to know if your most important customer requested an out-of-stock product five days in a row. But as we've seen, adding lost sale quantities to actual usage may not truly reflect the quantities of a product actually needed. The adjusted figures may distort future demand forecasts and result in either additional lost sales or excess inventory.

We've found that there is a better way to adjust actual usage for lost sales. This method does not require sales people to accurately record customer requests and protects you from capturing phantom demand. As with other aspects of our inventory management philosophy, we have different recommendations for items with recurring activity (i.e. those that are sold or used on a regular basis) and those with sporadic usage.

Recurring Items are sold on a regular basis. As these are the products customers request most often, it is important to correct for out-of-stock situations in order to ensure a high level of customer service.
1. Specify whether each of these inventory items will or will not accumulate backorders. If an item will accumulate backorders, customers will wait for you to receive the product. As a result, these items tend not to experience lost sales. If the product will not accumulate backorders, customers will go elsewhere to obtain the item. These are the items that will probably experience lost sales.
2. At the end of each inventory period (i.e. week, month, four-week period, etc.), record the number of days each product was out of stock.
3. For items that will not accumulate backorders, multiply the days out-of-stock by the forecast demand/day and adjust monthly usage by this quantity.

Sporadic Items are not sold on a regular basis and whose replenishment parameters are based on the normal quantity sold or used in one transaction as opposed to the forecast demand for an upcoming inventory period.
1. Record the number of times a product is out of stock (or its available quantity drops below the normal or average sales quantity).
2. If the product is out of stock more than one or two times in a six month period, automatically increase the minimum quantity for the product by the normal quantity sold or used in one transaction.
Note that to avoid an unrealistically large inventory investment, most organizations will tolerate a certain number of stock-outs of non-critical sporadic-usage items. That is why we normally will wait for several stock-outs to occur over a certain period before making the adjustment. However, this rule is not "cast in stone," and should be adapted to each company's specific situation and needs.A good forecast is the foundation of an effective inventory management program. The better the prediction of future demand of a product, the easier it will be to provide a superior level of customer service while minimizing your overall inventory investment. Correcting actual usage for lost sales opportunities is an essential part of the forecasting process. But to be effective, these corrections must predict, as accurately as possible, what would have been sold or used had the item continuously been in stock.

When the stock level of an item falls below the minimum quantity, it is time to reorder the product, right? But there are instances where it is difficult to maintain accurate stock levels because it is impractical to record each individual material disbursement. These are usually very inexpensive products that are taken from stock as needed by the user. But most of these items do have significant usage. And in many cases, a company would suffer a hardship in the event of a stock-out. After all, a product does not have to be expensive in order to shut down production or to be deemed important by customers.
How do you maintain effective inventory management of these items without accurately recording every material disbursement?We change our focus and don't concentrate on what people are using or buying. We track the rate at which we have to replenish the "open stock" available to consumers or other users of the product. The on-hand quantity in the computer system reflects the total quantity in unopened containers (boxes, cartons, gallon bottles, etc.) in "bulk storage" that have not yet been released for sale or use. Note that bulk storage could be a locked cabinet, a high shelf, or a bin location in the back room or warehouse. It just has to be a location that is not accessible by end users of the product. This bulk storage inventory is used to replenish the "open stock" of the item (i.e., the stock available to consumers). As a container is taken from bulk storage and made available to workers or customers, the on-hand quantity is reduced by the container quantity. Therefore the on-hand quantity in the computer reflects an accurate count of the quantity in bulk storage. When the on-hand quantity drops below the minimum stock level or order point, the product should be reordered. Usage history of the product reflects the number of containers of the product that were released from bulk storage in a day, week, month, or other significant inventory period. This usage history can be utilized to forecast future demand for each bulk-storage item. Unexpected increases in replenishment from bulk storage should be reported to management as it might reflect pilferage or some other problem that should be investigated.

From an accounting point of view, we are "consuming" the entire quantity when it is released to consumers. That is, the total inventory value is being reduced by the value of the container, though the product is still in your facility in an "open" bin. Is this a "perfect" solution to maintaining an accurate inventory? Even though the on-hand quantity of open-stock items is not reduced when an individual piece is sold or consumed, customers or projects often must still be charged for the items. This can be accomplished in several ways including:

Issuing a special charge based on the average amount of open-stock material consumed on each order or in the course of a month. Most consumers are now used to their automobile dealers adding a line item on repair or maintenance invoices for "fluids and other consumable maintenance items." And many companies charge each department for a share of the total office supplies consumed in a month based on the number of people in that department.

Utilize a special type of inventory item in the computer system for open-stock products. These items can be billed out to a customer on an invoice (i.e., nails being purchased in bulk at a hardware store), but an individual sale does not reduce the on-hand quantity of the item.

Because they are usually small, inexpensive, and/or hard to count, open-stock items have proved to be a nightmare for many manufacturers, distributors, and retailers. Unfortunately they are often necessary elements in a manufacturing process or crucial in maintaining a high level of customer service. Our goal should be to maintain an adequate inventory of each of these products with the least amount of effort.

Effective Inventory Management and Demand Forecasting

It is no secret that an accurate forecast of the future demand of a product is crucial in achieving the four "rights" of effective inventory management: that is, getting the right quantity of the right item to the right location at the right time. As we've discussed in previous articles, products with different patterns of usage require different forecasting methods. The forecast for items with recurring usage is usually based on four elements:
* Some sort of average of past usage.
* A trend derived from past usage.
* Future anticipated usage that is not revealed in past usage or trends.
* A forecast horizon reflecting when material ordered today can be received and the length of time for which inventory must be purchased.

If an item has recurring usage (that is, it is sold or used on a regular basis) we can test various formulas that apply different factors to each of the four elements to determine the best method of forecasting future demand of each item. But applying these elements to an item with sporadic activity (i.e. one that is not sold on a regular basis) produces strange results
It's easy to see that forecasting future usage of an item using an incorrect formula will result in stocking the wrong quantity of the wrong item in the wrong location at the wrong time. To achieve effective inventory management, it is essential to be able to differentiate between items with sporadic sales and those with recurring usage activity.

Stock counting, cycle counting

Cycle counting and the process of counting some stock items or warehouse locations every day are a valuable tools in ensuring the accuracy of your perpetual inventory. We've seen numerous cases in which organizations, after implementing a comprehensive cycle counting program, have had a much more accurate perpetual inventory than they had when they performed full physical inventories. Because accurate on-hand quantities are vital to both providing outstanding customer service and maximizing inventory turnover, it is not surprising that more and more distributors and manufacturers are implementing cycle counting programs.

But cycle counting programs can be difficult to maintain over a long period of time. Many firms become frustrated with the "coordination" problems inherent in cycle counting that are usually not found in a full physical inventory. When companies conduct a full physical inventory, they temporarily halt all normal material movement – that is, they stop filling orders, putting away stock receipts, shipping material, etc. Before this is done, a special effort is made to ship as many orders as possible and put away all stock receipts. During the actual counting process the business is virtually closed down. Counters do not have to worry about someone doing something that will affect the quantity in stock during the full physical inventory process.

Extensive preparation is necessary for a full physical inventory. It is not practical to complete this preparation before each daily cycle count. It is equally difficult to conduct cycle counts only when a business is closed and there is no material movement. After all, cycle counting should be performed every day. Even if a company counts before or after normal working hours when there is little or no material movement, paperwork involving items being counted can be "floating" somewhere in the warehouse or office. For example, a quantity of an item may have been pulled from the shelf but not yet shipped. Or a stock receipt for a product may have been put away but not yet entered into the computer system.
This simple process has the potential to dramatically cut the time necessary to perform daily cycle counting. No longer will people roam around your facility trying to determine if a particular order was picked or put away before or after a product was cycle counted. The result: More accurate inventories with less effort and frustration, a winning combination for any organization. This method could turn out to be a very valuable tool in your quest to achieve effective inventory management!

inventory carrying costs calculation

The specific cost of carrying a specific product or group of products in inventory is calculating by totaling the five components:
* Insurance, Taxes, and Opportunity Cost: Multiply the ITO factor (calculated above) by the average inventory investment of the item or group of items.
* Shrinkage Cost: Multiply the calculated shrinkage factor by the average inventory investment. If history is any indication, this portion of the average inventory value will eventually be lost, stolen, misplaced, or broken.
* Obsolescence Cost: Multiply the calculated obsolescence factor by the average inventory investment. Again, if history is any indication, this portion of the average inventory value will eventually be classified as obsolete inventory.
* Cost of Counting: Add the annual cost of counting the item.
* Cost of Rent, Utilities, and Moving Material: Add the calculated annual cost that was based on the cubic volume of space required to store the item.

Divide the sum by the average inventory investment for the item to determine the product's specific carrying cost percentage.

Is this a lot of work? Of course. But if significantly different amounts of effort are necessary to maintain individual inventory items in your facility, the exercise may be worthwhile. Remember that the cost of carrying inventory is one of the keys to effective inventory management, and that accurate information usually leads to outstanding results!

Inventory mangement and Sporadic Sales

A lot of firms stocked big amounts of unique products in each of several warehouses. Their buyers seemed overwhelmed with the task of maintaining an adequate inventory of each of these items, most of which were not sold on a regular basis. At each company we worked to "tame the replenishment beast".
The replenishment of these popular products should be micro-managed to maximize inventory turnover (i.e., the number of opportunities to earn a profit) while retaining a high level of customer service. Indeed most books and articles on inventory management (including ours) focus on maximizing the profitability of these items that customers request most often. Most if not all of the methods described in these publications involve a prediction of future demand based, at least in part, on a calculated average of past usage. Although the specific calculation may differ from method to method, most rely on the average or weighted average of the quantity sold or used over a specific period of time.
We could apply other forecast demand formulas, but the results will probably be the same. The demand forecast will be less than the normal sales quantity of 10 pieces, and as a result there will not be enough inventory on-hand to meet the customer's needs.An item experiences sporadic sales if its normal sales quantity is greater than the average quantity sold or used per month.
The average sale quantity often reflects the normal sale quantity. However its accuracy may be influenced by one or two unusual sales. A more accurate method of determining the normal sales quantity is to search transaction history for the mode in the transaction history of the product – that is, the quantity that is most often sold or used.
Although items with sporadic sales or usage do not (or should not) usually represent a large portion of your total inventory investment, stocking these items correctly is crucial to providing a high level of customer service. It does not make sense to stock these products unless you maintain the most commonly requested quantity in your warehouse.

Inventory management and vendors

How well your vendors are helping you achieve the goal of effective inventory management and which of these methods produces the best results.
Qualifying each vendor's inconsistency in lead times is very important. In order to maintain superior customer service, you must maintain more safety stock (i.e. reserve inventory) to compensate for greater inconsistencies in vendor lead times. This additional safety stock raises the average value of stock inventory and results in decreased corporate profitability.
Determine if the problems:
* Had a negative effect on the service you provided to your customers.
* Caused you to maintain additional inventory to maintain a satisfactory customer service level.
* Increased your operating costs.
The best way to improve your operations, reduce your operating costs, and improve customer service is to closely monitor the problems produced by your current operations. Applying the vendor satisfaction analysis to supplier shipments is a good way to identify ways to improve your replenishment process.

Collaborative forecasting

There is another form of electronic commerce that promises to greatly increase the efficiency of the supply chain. It is called Collaborative Planning Forecasting & Replenishment (CPFR). CPFR involves a customer regularly notifying a supplier of his/her expected future needs of certain products.
Collaborative forecasting works to solve two of the greatest challenges faced by buyers and inventory managers:

* Stock outs of critical products
* Unneeded safety stock sitting on the shelf gathering dust

Of course there are many instances in which customers cannot predict their future product needs – but whenever they can, collaborative forecasting promises to increase productivity and profitability throughout the supply chain. Let's work to replace inventory with information.

manage dead inventory

Dead and excess inventory – that is, your stocked products that haven't sold for a certain length of time (usually a year).
turning excess inventory into cash is good. But before you put considerable effort into a dead stock liquidation program, be sure that you are currently "buying right" – that is, be sure you are ordering the right quantities, of the right items, at the right time.To show you how "buying right" does more for your profitability than liquidating dead stock, we'll look at an example. We ranked the items for one of our distributors. The ranking process identifies those products that provide the most opportunity for your company to earn a profit. We begin the process by sorting all stocked products in a warehouse in descending order, based on cost of goods sold (COGS) during the past 12 months.
Sure, liquidating dead stock is important. But it probably won't contribute as much to your overall profitability as the process of ensuring that you are buying the right quantities of fast-moving products at the right time. This distributor has a long way to go to achieve his inventory-related goals, but he's off to a good start.

"Free" inventory

The same as there is no such thing as a free lunch, there is no such thing as free inventory. Just because the vendor issues a credit for any unsold material at the end of a season doesn't mean that the distributor doesn't incur costs in carrying the stock in their warehouse for the remainder of the year. These are the costs the distributor will experience in carrying this stock:
* Moving material from the receiving dock to the proper bin location and shifting it to other warehouse locations as necessary (such as to bulk storage at the end of the season and back to the picking area at the start of the next season).
* Insurance on the inventory. If it is in your warehouse, you are probably responsible for it.
* Rent and utilities for the portion of your warehouse used to store material. The material takes up space that could be used to store other products, sublet to another business, or not rented in the first place.
* The cost of physical inventory and cycle counting. If you don't buy it, you don't have to count it.
* The cost of inventory shrinkage. If it is in your warehouse, someone may steal it or it may be broken.
* Opportunity cost of the money invested in inventory – that is, how much could you make if the money tied up in inventory was invested in a relatively safe, income-producing investment. Or, if you finance your inventory purchases, the amount of interest that you pay the bank. Note that the distributor will only experience the opportunity cost during the popular season, as they will get their money back for any unsold material when the season ends.

The one typical cost of carrying inventory that this firm won't experience is product obsolescence. They won't have to sell some of the material below cost, or throw it out, because it has exceeded its expiration date or fallen out of fashion.
Yes, because of the vendor's special credit policies, the distributor should purchase more inventory. But, they should be careful not to get carried away and fill up their warehouse with material that won't contribute to the company's bottom line. There is, after all, no such thing as free inventory. Remember this to make you inventory management effective!

How to avoid inventory shrinkage

Here are several policies that will help to solve the inventory shrinkage problems faced by many distributors.

1. Limit access to the warehouse
2. Pay your employees well. We've seen great results when the accuracy of on-hand quantities affects the compensation of all employees that have access to warehouse inventory. These employees are motivated to treat your inventory as if it was their own. It's like having management constantly watching over your warehouse operations.
3. If someone is caught stealing, get rid of him.

Inventory accuracy is a necessary element in any effective replenishment system. If your buyers don't know how much of a product is in your warehouse and available for sale, there is no way they can accurately determine when to replenish stock and how much to order. You'll end up with a "lose-lose" inventory: shortages of products your customers expect you to have in stock, and excess quantities of slow-moving items/ Thia is a key to effective inventory management!

Inventory shrinkage

by by Jon Schreibfeder
Many employees don't realize the value of your stock inventory and may "borrow" products or take samples
for their personal use. Unfortunately, there is another reason why material disappears: theft. Many distributors find it hard to believe that their employees or customers would steal. But unfortunately stealing, especially petty theft, is a very common reason for "inventory shrinkage." And a distributor who doesn't admit that theft is a problem, or a potential problem, is just burying his or her head in the sand.

Employee theft is not a new phenomenon. Nearly a hundred years ago, my great-grandfather owned a clothing store in Weston, West Virginia. He occasionally commented that he'd been in business for 30 years and had never sold a single handkerchief to an employee (these were the days before Kleenex).

Did the employees think they were stealing? Probably not. These were good people who never would have thought of taking money out of the cash register. But they didn't appreciate the true value of inventory. They didn't see the direct relationship between the inventory in the store, turning that inventory into cash by selling it to customers, and using that cash to pay employees and other expenses. As we stressed in the article mentioned above, employees must see all inventory shrinkage as an expense that reduces the amount of money available to pay wages and benefits. It takes money out of their pockets.

There are, of course, some people who are truly thieves. And sometimes a distributor inadvertently hires one. Thieves usually don't see their long-term security tied to the success of the firm that employs them. Most often these individuals have a short-term goal: that is, getting as much material as possible out of the warehouse (without being caught).

Some distributors install security cameras and other theft-deterrent devices. While they are important tools in a retail environment, the effectiveness of these "hi-tech" solutions in a distribution warehouse is questionable. True, they may be a deterrent to some theft, but employees who are also thieves usually put considerable thought and effort into getting around these systems and continue to steal. At the same time, honest employees often feel intimidated and resentful as "big brother" continually watches their every move. These feelings often discourage good and loyal employees from giving their all for the company.

A better way to discourage theft is for management to create an atmosphere that encourages effective inventory management.

Safety stock and effective inventory management

Theoretically, it should be easy to determine when to reorder a stocked item from a supplier. If you know that customers will order ten pieces of the product each day, and you know that it will take seven days to get the shipment from the vendor, you should reorder the product when there are seventy pieces on the shelf.
This quantity is appropriately called the "order point." But the order point formula contains one more element: safety stock. Safety stock provides protection against running out of stock during the time it takes to replenish inventory. Why is this protection necessary?
* Demand is a prediction based on past history, trend factor(s), and/or known future usage of a product. The item's actual usage will probably be more or less than this quantity. Safety stock is needed for those occasions when actual usage exceeds forecasted demand. It is "insurance" to help ensure that you can fulfill customer requests for a product during the time necessary to replenish inventory.
* The anticipated lead time is also a prediction, usually based on the lead times from the last several stock receipts. Sometimes the actual lead time will be greater than what was projected. Safety stock provides protection from stock outs when the time it takes to receive a replenishment shipment exceeds the projected lead time.
The safety stock quantity allows you to satisfy customer demand for the product until the replenishment shipment arrives from the supplier
How Much Safety Stock Do You Need?
When a replenishment shipment arrives, the available quantity is usually somewhere in the shaded area of the graph. Notice that the safety stock quantity is in the middle of the shaded area. Half the time you will use some or all of the safety stock before the replenishment shipment arrives. The other 50% of stock receipts will arrive before you use any of the safety stock. On average, the full safety stock quantity is always on the shelf when the replenishment shipment arrives. It is, on average, "non-moving" inventory.

A distributor puts inventory in her warehouse to sell it to customers. Profits from these sales are necessary to pay the distributor's expenses and provide a return on her investment. With this thought in mind, it seems as though it would not be a good idea for a distributor to intentionally have non-moving inventory in stock.

On the other hand, keep in mind the goal of effective inventory management:"Effective inventory management allows a distributor to meet or exceed his (or her) customers' expectations of product availability with the amount of each item that will maximize the distributor's net profits."
Safety stock is, in reality, an expense of doing business. But it is necessary to ensure good customer service. To maximize profits, we must carefully control all expenses, including safety stock. Therefore, we want to achieve our customer service goals with the least possible amount of safety stock.

Ordering process and inventory position

Ordering policy describes how ordering takes place in response to demand.
Ideally, we would like a policy which is optimal in some sense. However, usually such policies are quite complex. Instead, we shall settle for a simple ordering policy which is "nearly optimal". To define the policy, however, we need to introduce a new concept - inventory position.
At first glance, it might seem our ordering decision should be driven by the on-hand inventory level,
alone. However, as in life, in inventory management it pays to think ahead - in this case we need to think
one lead-time ahead. The reason is that future inventory levels are affected by both the on-hand inventory
and the orders in the pipeline that are due to arrive.
Inventory position captures this idea. Inventory position is the total amount on-hand plus the total amount on-order.
Keeping a careful eye on the inventory position reduces the nasty tendency to overshoot and undershoot
the inventory that lead times typically engender. An important fact to recognize is that we can regulate
the inventory position by simply placing an order or by holding back orders. In other words, the inventory
position is controllable.

Effective inventory management -more tips

Following items are almost sure to sell.
New Items with a Firm Customer Commitment – that is, a signed customer purchase order to buy the entire quantity that you must bring into inventory. Yes, there is a chance that the customer will go out of business, cancel the order, or return the material for credit, but most customers who are willing to sign a purchase order are intent on using the product.

Non-Stock Products with Recurring Sales. These are non-stock products that are continually sold to one or more customers. After you've ordered them several times in one year to fill existing customer orders, you may decide that it would be more economical for you, and more convenient for your customer, to keep several pieces in stock.

To reduce the chance of these items becoming dead inventory, sales should be analyzed at least twice a year to ensure that your customers are continuing to buy these products. If you notice a drop in usage one month, immediately contact the customer to determine the reason for the decrease in demand. Perhaps they are experiencing a temporary drop in usage – or, for some reason they've determined that your service is unsatisfactory, or their needs have changed. Quickly identifying the reason for the decrease in sales allows you to fix the problem or to liquidate your remaining inventory before it becomes dead stock.
There is a greater chance that these new stock items will eventually become dead inventory. Salesperson and customer "suggestions" represent the most common type of moderate risk item.
To reduce the chance of these items becoming dead inventory, you must continually remind the salespeople of the sales and current stock position of all new stock items. Print and distribute a report containing the following new product information to each salesperson each week, or at a minimum each month, until the product has been in inventory for five to six months:

* Product number and description.
* Current month sales (in units).
* Sales projection for the current month (provided by the salesperson before the item was added to inventory).
* Total sales (in units) of the item to date.
* Total sales projection to date (provided by the salesperson before the item was added to inventory).
* Current on-hand quantity.
* Manually set minimum stock level of the item.
* Manually set maximum stock level of the item.
* Name of salesperson who requested that the item be stocked.
* Reason why the item was added to stock.Note that because we don't have enough usage history to accurately forecast future demand of new products, they are normally maintained with manually set minimum and maximum stock quantities