Inventory Management (4) - Source of inventory

In the world of commerce, efficient inventory management is the backbone of a successful business. Whether you're a small retailer or a large multinational corporation, having a well-organized and optimized inventory system is crucial for maintaining a competitive edge (Improves cash flow), minimizing costs, meeting customer demands (Reduces stockouts), Reducing wasted inventory, and increasing customer satisfaction. In this article, we will explore the importance of inventory management and provide practical tips to excel in this essential aspect of business operations.

Unlike most of the inventory-introducing articles, I categorize inventory into three types: 1. Cycle inventory: It is the inventory used for the day-to-day business to meet the “Regular” demand. It can be in the form of raw materials, WIP, and Finished goods. A simplified Supply Chain requires 6 weeks to obtain the longest-LT components (The raw material cycle inventory is 6 WOS), 4 weeks in production (The cycle inventory required is 4 WOS), and 2 weeks for transportation to the customer (The required cycle inventory is 2 WOS). Therefore, the total cycle inventory is 12WOS (=6+4+2). The source of cycle inventory is the total cycle time of each Supply Chain node, which means cycle inventory reduction can only result from the reduction of total cycle time. Product standardization, common platform design, product modularization, lean production, and supply chain route optimization contribute to the reduction of cycle inventory. 2. Safety stock: It is the inventory to meet the fluctuations in demand AND supply. The nature of forecast is uncertainty; that’s what we know for a long time. However, by 2021, we see a serious critical component supply shortage and production line lockdown (No matter if it is caused by a pandemic or power restriction). The source of safety stock is uncertainty. Only reducing the uncertainty can result in lower inventory. 3. Excess inventory: It can be the result of an inaccurate forecast, orders canceled, MOQ, or the economical scale of production, and it can also be strategic procurement for key components, such as display panels and IC. In most of cases, this type of inventory is caused by people’s behavior introduced by processes and organizations. Inaccurate forecasts, problematic engineering change processes, and purchasing more to drive the lower buy price can be the result of this type of inventory. If we’d like to drive better inventory management for these inventories, we will need to drive the change from people, processes, and organizations. The primary goal of inventory management is to strike a balance between supply and demand while minimizing costs and maximizing profitability. A well-managed inventory system ensures that a company has the right products, in the right quantities, at the right time, and in the right place.

Strategic approaches to drive inventory reduction

I will use three paragraphs to explain how to manage those three types of inventory.?

A traditional mechanical vendor in Aisa. They buy raw materials from China and ship them from China to Vietnam (Sea transportation time+production: 1 week) for machining. Then, ship to Mexico (Sea transportation time+production: 8 weeks) for modular assembly. Ship the modular from Mexico to North America (NA) for system integration (Transportation+production: 1 week). The vendor buys the material based on the forecast given by customers and increases its own buffer based on its own judgment of the market and/or better cost deal with higher order quantity. Once the order is received from the customer, they will trigger the production in Vietnam and all the way from WIP to FG (Build to order). The total order lead time (LT) of the Supply Chain is 9 weeks. They only keep raw material inventory in Vietnam and FG inventory in NA. As usual, the inaccurate forecast results in both high FG inventory and raw material inventory. The higher service level agreed upon becomes higher inventory and heavier working capital. It becomes a nightmare for executives.????

Is there a way to reduce the order cycle time, and reduce the inventory without sacrificing service level? Yes, let’s change the push&pull point from Vietnam to Mexico. The production of Mexico and NA are built to order (BTO). When the actual order is received from customers, the Mexico production line pulls the WIP inventory from its domestic warehouse and starts production. The order cycle time/customer waiting time after placing an order can be reduced from 9 weeks to less than 2 weeks and the cycle inventory for FG is reduced from the level of 9 weeks of supply (WOS) to less than 3 WOS. Even though we need to build the WIP inventory in Mexico, the cost of WIP compared with FG is only 50%. The total amount of inventory in the Supply Chain pipeline is reduced.?

More ideas offering:??

1. Can we reduce the node of the supply chain, such as combining Vietnam production with Mexico production? Usually, reducing the node in Supply Chain means reducing the? complexity and light working capital and lowering the management efforts. The location of the combined production is the key factor. The first question one needs to ask is what will this impact customers and the business model. What is the target goal of change and how to measure it? More details can be found in my prior article- “How Supply Chain shape looks like now and future” ( https://www.dhirubhai.net/pulse/how-supply-chain-shape-looks-like-now-future-rob-chang ). I provide some guidelines for the supply base selection and Supply Chain optimization.?
2. More adjustments for Push&pull point: This point can be changed based on different products, and/or different customers for different levels of service agreement. It all depends on how flexible your supply chain is and how agile your factory and vendors can replan the supply.?
3. Local optimum v.s. Global optimum: Some companies like Dell, AWS, Lenovo, have commodity GSM (Global Supply Manager) and system-level GSM. If commodity GSM doesn’t have the view of the whole Supply Chain, in most cases, he/she won’t agree to increase the commodity inventory because it is a conflict with their department KPI. Also, for system-level GSM, their daily KPI is no shortage. Even though some may argue that aging inventory and E&O are also important. Nonetheless, compared with sufficient supply, the way they deal with aging inventory is more passive and lacks automation. An experienced manager?
4. Common part v.s. Customization: Unique design, unique ID, and unique production (Such as COWOS from TSMC) can be sometimes hard to avoid. However, it doesn’t mean that we don’t manage the complexity BOM materials. On the contrary, the Supply Chain manager needs to assure the design team has considered the manufacturability and supply capability before out of control.
5. Lean? SMED (Single Minute Exchange of Die)? The key factor to reduce cycle inventory is the cycle time. Kanban limits the buildup of excess inventory at the production line. and TPS aims to eliminate all the waste in the production line. SMED converts a manufacturing process from one product to another in the soonest manner.?
6. Long approval process? It generally represents the contract, new price of the new product/service, engineering change (EC), purchase order, new forecast, etc. All the data, analysis, and documents are only usable for the moment they are generated but are no more valid for the future. Optimized business processes and good infrastructure setup can reduce the processing time significantly.?
7. VMI? The concept of VMI is to let your vendor maintain a certain level of component inventory in the vendor’s warehouses. By sharing the “Actual” consumption with the vendor, VMI reduces the waste caused by the independent forecasts between customer and vendor and reduced the total cost of the Supply Chain. The more details are in my prior article: https://www.dhirubhai.net/pulse/inventory-management-2-vmi-lo-ping-chang/ ????

?After the discussion of managing cycle inventory, let’s deal with the safety stock in this session. The source of the uncertainty comes from two causes: 1. Unwilling to share the information, 2. Incapable to share the information. The first lesson of business negotiation is not to share your bottom line. Therefore, most companies don’t want to share information because sharing the information means sharing your weakness and taking accountability (Liability). This behavior can be true when you are dealing with someone who is easy to be replaced (Low switching cost) and/or you are in a buyer's market. Nonetheless, most people underestimate the cost of changing vendor/partner and the market can be changed from buyer’s market to seller’s market (Look what we have experienced in 2021 and 2022, shortages!!). That’s why we see the game played by salesman and procurement on a daily base. Following is the example happened:

Salesman: Who is willing to share? Is the information I obtain correct? I need to verify further! Why can’t the procurement manager write a mail to honor what he/she said? What should I communicate internally to secure the resource in such unclear information given by the customer?

Procurement: a. New product will be launched soon. BOM is not updated or incorrect and the qualification test is not yet passed. I am not sure what component needs to be buffered ahead by the vendor and how many will be required, but I still need to ask the vendor to prepare. How can I deliver the information to the vendor? b. The forecast is higher than the actual pull again. Is the demand really exist? Does it make sense to roll out the unfulfilled demand to the next version of the forecast? Do I need to ask the vendor to expedite? How will this impact the unit price? c. How I can get a better price in a new deal while the unpaid liability is getting higher??

Image the information delivery from the salesman to the demand planning manager, from the demand planning manager to the supply planning manager, from the supply planning manager to the commodity supply planning manager, and from the commodity supply planning manager to vendors, all the information was delivered by email with Excel spreadsheet. The long communication time and the quality of data can be easily damaged during the process. It is one of the incapable to share the information examples. A capable procurement manager can provide trustful information/data and honor what he/she said and write. The information remains the same within the organization. Accountability needs to be a business culture from the top-down.???

More ideas offering:?

1. Collaborative Forecasting and Planning: To tackle demand uncertainty, companies can collaborate closely with customers and use advanced forecasting techniques. By sharing information and insights with key stakeholders, businesses can gain a clearer understanding of demand patterns, seasonal variations, and upcoming market trends. Leveraging data analytics and machine learning models can improve forecast accuracy, enabling companies to optimize inventory levels and production schedules accordingly.
2. Agile and Flexible Operations: Adopting agile supply chain practices enables businesses to swiftly respond to changing conditions. Flexible manufacturing processes allow companies to adjust production schedules and product configurations based on real-time demand signals. Emphasizing lean principles can also reduce lead times and minimize waste, making the supply chain more adaptable to fluctuations.
3. Enhanced Communication and Visibility: Effective communication within the supply chain ecosystem is crucial for managing uncertainties. Employing collaborative technologies and cloud-based platforms can improve real-time visibility across the entire supply chain, allowing for better coordination, proactive issue resolution, and informed decision-making.
4. Contingency Planning: Developing comprehensive contingency plans is essential for dealing with unexpected disruptions. These plans should outline step-by-step procedures to address various scenarios, such as supplier failures, natural disasters, or geopolitical instability. Regularly testing and updating these plans ensure their effectiveness when a crisis arises.
5. Diversified Supplier Base: To mitigate supply uncertainty, businesses should establish a diverse supplier base. Relying on multiple suppliers, preferably from different geographical regions, reduces the risk of disruptions caused by a single supplier's issues. Companies can also evaluate suppliers based on their risk management strategies, financial stability, and responsiveness to unforeseen events.

Larry Lapide published an article on May 8, 2014, https://www.supplychain247.com/article/navigating_a_course_with_planning_forecasting/bristlecone . Supply planning starts from demand planning. From his article, demand forecasting is so critical and the major driver for the following activities which are S&OP, inventory planning, and supply planning. The demand side (Including the regional rep, and demand planning manager) and supply side (Supply manager, planner, and procurement manager) need to work together to come out with the financial performance goal.??

Excess inventory refers to an overabundance of products beyond what is necessary to fulfill immediate demand. It ties up valuable resources, incurs carrying costs, and can negatively impact a company's bottom line. We will explore the root causes of excess inventory and delve? into effective strategies to manage this challenge.

Root Causes of Excess Inventory:?

1. Forecast Failure: One of the primary reasons for excess inventory is inaccurate demand forecasting. When businesses fail to predict customer preferences and market trends correctly, they may either overestimate demand and produce more than required or underestimate it, leading to stockouts and subsequently panicked over-ordering.?
2. Order Cancellation: Canceled orders by customers or abrupt changes in demand can leave businesses with excess inventory. Factors such as external events, supply chain disruptions, or customer-specific issues can lead to order cancellations, leaving companies with products they can no longer sell as planned.
3. Minimum Order Quantity (MOQ): Suppliers often impose minimum order quantities on businesses to ensure cost-effectiveness in production. Companies may be compelled to place larger orders than needed to meet the MOQ requirements, leading to excess inventory if the demand does not match the order quantity.
4. Economic Scale: Achieving economies of scale is an essential objective for cost-effective production. However, when businesses produce goods in bulk to benefit from lower per-unit costs, they risk holding excess inventory if the actual demand falls short of expectations.
5. Strategic Inventory: Maintaining safety stocks or strategic inventory is a common practice to safeguard against supply chain uncertainties or sudden spikes in demand. However, if not managed judiciously, strategic inventory can turn into a major contributor to excess inventory levels.

Dealing with excess inventory requires a systematic approach and a combination of strategies tailored to the specific circumstances of each business. Here are some effective ways to manage excess inventory:

1. Analyze and Identify the Causes: Start by conducting a thorough analysis of the inventory data to pinpoint the root causes of excess inventory. Understanding why it happened is essential to prevent similar occurrences in the future.
2. Improve Forecasting Accuracy: Invest in advanced forecasting methods, such as data analytics and machine learning algorithms, to enhance demand forecasting accuracy. Regularly update and refine forecasts based on changing market dynamics and customer behavior. For those who are interested in forecast, you can refer to my prior articles:

Forecast (1): Statistical analysis:? https://www.dhirubhai.net/pulse/forecast-1-statistical-analysis-lo-ping-chang/

Forecast (2): Professional judgment:?

https://www.dhirubhai.net/pulse/forecast2-professional-judgement-lo-ping-chang/

Forecast (3): Strategy:?

https://www.dhirubhai.net/pulse/forecast-3-strategy-lo-ping-chang/

Forecast (4): Demand planning:

https://www.dhirubhai.net/pulse/forecast-4-demand-planning-robin-chang/

1. Strengthen Communication with Suppliers: Work closely with suppliers to negotiate flexible agreements that allow for smaller, more frequent orders. Reducing MOQs or implementing just-in-time inventory practices can help mitigate excess inventory resulting from supplier-imposed limitations.
2. Implement Agile Production Techniques: Embrace agile manufacturing practices that enable companies to adjust production levels rapidly in response to changing demand. This approach ensures that production stays aligned with actual market requirements.
3. Offer Incentives for Order Fulfillment: Encourage customers to follow through with orders by providing incentives, such as discounts or rewards, which can reduce the likelihood of order cancellations and related excess inventory issues.
4. Optimize Inventory Levels: Continuously monitor inventory levels and adjust safety stocks based on demand patterns and supplier performance. Employ inventory optimization tools and techniques to strike the right balance between avoiding stockouts and minimizing excess inventory.
5. Sales and Marketing Strategies: Develop effective sales and marketing strategies to promote slow-moving or excess stock. Bundling products, offering promotions, or discounts can help clear excess inventory while attracting new customers.
6. Reverse Logistics: Implement efficient reverse logistics processes to manage returns and unsold inventory. This approach can recover some value from returned items or expired products and reduce the overall burden of excess inventory.

Mastering inventory management is a fundamental aspect of running a successful business. It empowers companies to deliver exceptional customer service, optimize costs, and streamline their supply chains. By implementing the tips outlined in this article and maintaining a proactive and data-driven approach, businesses can achieve excellent inventory management, leading to greater success and sustainable growth in the long run.

Appendix A: Tips for Excellent Inventory Management:

1. Invest in Inventory Tracking Systems: Implementing a robust inventory tracking system, such as a barcode or RFID system, helps you maintain accurate stock records, track inventory movements, and identify discrepancies promptly.
2. ABC Analysis: Categorize your inventory into groups based on their value and significance. The ABC analysis typically involves classifying items into A (high-value, low-frequency), B (moderate-value, moderate-frequency), and C (low-value, high-frequency) categories. This allows you to prioritize your efforts and resources accordingly.
3. Just-In-Time (JIT) Inventory: Consider adopting a Just-In-Time inventory approach, where you receive goods only as they are needed in the production process or for customer orders. JIT reduces storage costs, minimizes the risk of obsolescence, and improves efficiency.
4. Supplier Relationship Management: Cultivate strong relationships with your suppliers to ensure timely deliveries and favorable terms. Reliable suppliers are instrumental in maintaining a steady supply chain and reducing the risk of stockouts.
5. Safety Stock and Reorder Points: Establish safety stock levels to act as a buffer against unexpected demand spikes or supply disruptions. Determine reorder points based on lead times and sales patterns to replenish inventory before it runs out.
6. Regular Audits and Cycle Counts: Conduct routine audits and cycle counts to verify the accuracy of your inventory records. Identifying and rectifying discrepancies promptly will prevent inventory issues from spiraling out of control.
7. Data Analytics and Forecasting: Leverage data analytics and forecasting tools to gain insights into customer behavior, demand trends, and seasonality. This information will enable you to make data-driven decisions and plan your inventory accordingly.
8. Continuous Improvement: Treat inventory management as an ongoing process of improvement. Regularly review and refine your strategies, taking into account feedback from customers, employees, and suppliers.