Mastering the Art of Inventory Management: Techniques of today and views of the future

Inventory management is an essential part of running a successful business. It impacts any company, from the tiny retail shop at the corner of the street to the biggest multinational. It is one of the most import “cash eater” of a company. Inventory is also the easiest to blame for missing sales (who has never heard “we don`t enough stock!!!”) which makes it an emotional topic (who said that supply chain discussion has no emotions!).

Inventory management involves a high level of planning, controlling, network management and finance, and it is directly link to profitability and customer satisfaction increase or decrease.

Though emotions can be involved, inventory is also a “scientific” topic. It must be managed accordingly. Occasionally supply chain professionals tends to forget. This post is to bring the proper methodology required for inventory management) and to start the discussion on what could be the future of that domain

Inventory Management

A proper inventory management required, product classification, safety stock calculation, re-ordering strategy and inventory control. We will go in details for each one of the topics

Product Classification

You can use the ABC/FMR to classify your product. ABC classification will break it down based on the consumption cost and FMR will break it down based on the frequency of consumption

Here are the steps for implementing ABC:

-??????Gather data on inventory items: Collect data on each inventory item, including its annual usage and unit cost.

-??????Calculate the annual usage value: Multiply the annual usage (in units) of each inventory item by its unit cost to calculate the annual usage value for that item.

-??????Rank the items by annual usage value: Sort the items by annual usage value in descending order, from highest to lowest.

-??????Calculate the percentage of total annual usage value: Calculate the percentage of total annual usage value represented by each item by dividing its annual usage value by the total annual usage value of all inventory items.

-??????Classify items into A, B, and C categories: Divide the items into A, B, and C categories based on their percentage of total annual usage value. For example, you may decide that the top 20% of items (with the highest percentage of total annual usage value) will be classified as A items, the next 30% will be classified as B items, and the bottom 50% will be classified as C items.

Here are the steps for implementing FMR:

-??????Gather data on inventory items: Collect data on the frequency of movement for each inventory item (how many time per week, it is going out)

-??????Define the rule: According your business understanding, define what means Frequently moving, Mediumly moving, Rarely moving (for instance, moving more than 10 times per week is F, moving between 3 to 10 times per week is M and moving less than 3 times per week is R)

Once both classifications are done, you will have the matrix which will guide you in managing your stock.

Each category will have his own interpretation. For Instance having a AR in stock is really bad has it is highly expensive and not moving. A focus should be given to get rid of it (except if it is a critical part which then should be managed accordingly)

Different variations of the classification can be done by introducing the criticality of the material, the profit margin, the VEN ranking used for drugs (Vital, Essential and Non Essential) or else to build a multi dimension ranking and define the different ranking. The purpose remain the same, apply pareto principle to classify the items to understand them better. Below is an example:

Safety Stock

Safety stock is the additional inventory that a company holds above its average inventory level to protect against uncertainty in demand or supply. It is intended to ensure that the company can meet customer demand even during periods of unexpectedly high demand or supply disruptions.

Once again, many will use “emotions” to set their safety stock (there are taking every time 3 months to deliver, let s keep 3 months of stock. We missed last big sale, we need to keep x level of stock, etc.…). There are scientific ways of calculating safety stock, for instance the Normal Distribution with uncertainty about the demand (the Greasley method):

There are also several variations to it, like including the supplier reliability factor, taking both parameters either linked or independent, including more demand variability parameter, etc.…

The more important is to understand your product through the classification, then understanding its pattern and then applying the right formula for it

Re-Ordering

In any ordering process, the following point should be addressed:

-??????What should I order

-??????When should I order

-??????How much should I order

The What question is answered through the classification. Let s look at the When and How much.

When to order:

It can be when the stock reaches a certain quantity which is then covering the need to the supply/production lead time until it reaches the safety stock levelè The Reorder Point methods, which can also come with variation depending on how we want to introduce the variability of demand or the forecast or both, which will make a dynamic Reorder point.

It can be a fix date no matter what (take the example of a grocery who is receiving daily basket of fruit and vegetable). One should not forget that by increasing the frequency of ordering we are decreasing the average stock which will have a financial impact

How much to order:

The common wisdom will make everyone use the Economic Order Quantity (Q below)

Where OC is the Ordering Cost and SPC is the Stock Possession Cost

This is a quite simple formula which can be improved by considering volume discount. It can be also modified by introducing constraint like warehousing space, supplier minimum order quantity or supplier rounding value. There can also be some trade off made between Q and transportation cost. Once again for all decisions, let s not bring emotions but bring mathematic

Inventory Control

All the steps above will design our inventory management strategy. Since our world in changing pretty fast which makes the forecasting output inaccurate, the stock policy should be reviewed periodically (to be defined according the business but at least twice a year, not less than that). Proper dashboard should be defined to monitor the stock with KPI like days in inventory, obsolescence. But more important than everything is the have a proper and accurate record of the inventory. Different systems exist to manage it (IM or WMS module of different ERP or on a standalone basis) and it also important to have a solid cycle count process.

Concerning the KPI here is the some of them that you can implement:

-??????Days in Inventory: This KPI measures the number of days on hand. The formula is Inventory on hand/ average COGS for the last 3 months. This can also be based on the last 12 months average or the last 3 months and the forecasted next 3 months. Using the forecast data allow us to find out what will be consume and take further action on slow mover while using the past data gives a snapshot at a given time.

-??????Obsolescence Ratio: This KPI measures the % of inventory above a certain number of days. This KPI needs to go with a proper obsolescence management process especially for perishable good.

-??????Stockout Rate: This KPI measures the percentage of time a business runs out of stock of a particular item. It is calculated by dividing the number of times a business runs out of stock by the total number of times that item was in stock. A high stockout rate can lead to lost sales and dissatisfied customers.

-??????Backorder Rate: This KPI measures the percentage of customer orders that cannot be fulfilled immediately due to out-of-stock inventory. It is calculated by dividing the number of backorders by the total number of orders. A high backorder rate can lead to lost sales and unhappy customers.

-??????Gross Margin Return on Investment (GMROI) : This KPI measures the return on investment for each dollar spent on inventory. It is calculated by dividing gross margin by average inventory. A high GMROI indicates that a business is earning a high return on its investment in inventory.

There are more KPI that can be used to give further details but with the one described above you should have a good start for the overall monitoring. It has to be noted that each KPI can be calculated at a overall company level, at a category level and at an item level.

One should understand that they are many different scientific ways to manage your inventory and what is described above is only a tiny part of it. It can definitely give a good head start but for those are deeply interested into the topic, they are a lot of resources available to go deeper into the topic.

Another element which is important to note is that once you have the understanding, you will have many tool who could do the calculation for you where you will only need to "play" with the parameter and then you can spend your time in added value tasks which are the analyze the results and take decision!

The future of Inventory Management

As technology continues to advance, the future of inventory management looks set to become even more efficient, streamlined, and cost-effective. Here are some of the key trends that are shaping the future of inventory management.

Automation, Machine Learning and AI

One of the most significant changes in inventory management is the increasing use of automation and AI. Automated systems can monitor inventory levels and automatically reorder products when stock levels get low. It then turn to Machine Learning which leads to AI algorithms that can predict future demand patterns It can help companies optimize their inventory levels and avoid stockouts. As AI technology continues to improve, it will become an even more valuable tool for managing inventory.

IoT Sensors

Another important development in inventory management is the use of Internet of Things (IoT) sensors. These sensors can be attached to products or containers to track their location and monitor environmental conditions such as temperature and humidity. This data can help companies improve their supply chain management and reduce the risk of product damage or spoilage. It can also streamline inventory re location defined potential by AI algorithms

Cloud-Based Solutions

Cloud-based inventory management solutions are becoming increasingly popular because they offer greater flexibility and accessibility. With cloud-based inventory management software, companies can access real-time inventory data from anywhere, at any time, which can help them make more informed decisions about inventory levels, ordering, and shipping. The other important benefit is the cost management of the software, as many cloud based solution are on SAAS basis with monthly subscription. It allows the shift from CAPEX to OPEX

Blockchain Technology

Blockchain technology is another emerging trend in inventory management. By using a decentralized, tamper-proof ledger, blockchain can help companies track products throughout the supply chain and verify the authenticity of goods. This can help reduce the risk of counterfeit products and improve supply chain transparency. The food and pharmaceutical industries are already advance on this aspect due the to risk associated with the lack of transparency and counterfeit of their product

Overall, the future of inventory management looks bright, as technology continues to offer new ways to optimize supply chain operations and improve efficiency. Companies that invest in these emerging technologies will be well-positioned to stay competitive and adapt to changing market conditions.

I hope that this post would be useful and don`t hesitate to comment on it