The Reason Stock is There

When your company buys, makes and sells, stock is there throughout the supply chain and the manufacturing path so that the customer can be served. That’s it. That’s the primary reason why inventory is there.

There are other reasons when there is suddenly no more demand or demand is reduced.

This can be driven by market demand for a product or a market demand for product revisions – engineering changes can be and often are the primary cause for creation of obsolete and / or slow-moving inventory.

Supply Chain as even today a relatively modern division in many companies, understands this perfectly well as coordinating function working between Make Buy and Sell (which were typically functional silos in the past) alongside Finance.

Engineering often doesn’t assess impact on inventory before proposing such changes.

Purchasing, who look for lowest possible price to value often don’t assess the impact on inventory on sourcing decisions.

And yet these decisions impact the capital lockup and cause headwinds to operating cash cycle which Finance and Chief Executives can easily observe.

So this is a game where the referee must be strong, and for the game to go as planned everyone on the pitch should know the rules, right? Yet so often it simply isn’t the case. Why is that?

Well, one of the major factors is that folks simply don’t understand the right reasons to carry inventory, and when they set inventory policy it’s based on some vague logic that is not easily explained. Further to that, it’s probably not based on the demand for the part or other factors that are derived using ERP. Finally, it’s because each area of the factory is set a stock level in a monetary amount in the business plan and as soon as that level is exceeded there can be pressure to reduce the inventory from Finance to the site operations leadership. Yet a lot of the time, when asked how that level is set it’s based on past demand, past performance and, here’s the kicker, much of the obsolete and slow-moving inventory is not correctly categorised as such – meaning if this is x% of the inventory value, the effective command from leadership is to reduce effective inventory to the target – x.

When you hold the right inventory – value, quantity and quality of inventory, the customer is served.

When you hold the right inventory – value and quantity only – the customer service is at risk.

This is an important thing to agree between Supply Chain and Finance because ignoring the factors that would be analysed to propose inventory policy for the desired service is generally a bad idea.

The term ‘Lean’ when not properly understood is often mistaken as the need to reduce inventory – but what the term really implies is that you hold the right level of inventory to keep the key process going at the right rate to optimise the output of the factory and you create flow.

Most companies don’t in fact hold the right quality of inventory.

Many don’t analyse it, or when they do, they might analyse it in a questionable way, and even once analysed they don’t discuss it and agree the right actions. It’s quite common in Manufacturing circles for certain events to result in rather emotional or knee-jerk reactions.?

They load a forecast of questionable accuracy into a requirements calculation that produces a perfectly good theoretical stock requirement and based on the input being ultimately say 50% correct they end up with what is a very bi-modal distribution of inventory onto parts.

To say it without all the consultancy jargon, most companies have “too much of some stuff” and “not enough of other stuff”. There are also other factors, it’s made worse when no requirements calculations are used because if each step of the chain tries to ‘second guess’ what the next step will order, you end up with an amplified bull-whip effect from variation in finished goods signal all the way through the chain, meaning you carry significant levels of raw materials to try to cover the spread – and if this is not based on current demand it could be way over what is really required.

Don’t get me wrong, in many cases, ordering parts to a forecast is the only way to go. Maybe they are on a long lead time, or can only be ordered on a campaign basis once per year or once per quarter. Some parts are so exotic or have so volatile a demand that it doesn’t make sense to have a stock policy. However, this can be measured, and moreover the lesson there is that basically ordering materials using a forecast rather than a pull signal is not a good idea. Stock levels once set will not trigger the next order until there is a shortage and so with this method the on hand inventory has a better chance of remaining within policy.

When you consider the broader picture, if the market is strong and economic conditions are good, there is much more focus on maintaining and increasing growth than on the cash flow – inventory in these conditions is not really the focus, the goal is only to control the operating cash not to liberate locked capital. Inventory is a good investment in these conditions, it’s a way to achieve the growth your company seeks. Quality of inventory is still important, but total value isn’t really the focus.

However, when that economic pendulum starts to swing back the other way, and when cash flow becomes an imperative, there comes much more focus on what inventory is there and how to release the cash tied up in inventory. Yet here’ s the thing – in these conditions, inventory quality is just as if not more important, because even if you do intend to reduce the working capital tied up on stock, you still don’t want to put your customers at a service risk and your revenue / brand / reputation / investors on the back burner just to release a few quid.

And yet, during the downturn of the great economic wheel, cash is important for innovation, new equipment, new processes and so forth. CapEx is very much dependent on the Capital right, no surprises there.

So whether times are good or bad, happy or sad, it’s very important that the inventory you carry is under control and is there for the right reasons.

I’m at a Factory, it’s my first time there, what is the stock position of the goods pertaining to the manufacturing process and to the supply to the customer?

One of the key jobs of Supply Chain Business Consulting is to help Companies understand their position on stock. Stock is probably the easiest aspect of factory management to analyse because it is physically there – you can see it, depending on whether it’s safe too you could (in principle at least) touch it and in many industries, depending on its nature, you can in many cases smell it too.

Yet all that stock in the stores is only there to serve the next part of the manufacturing process, be that input to a production process or to ship to the end customer.

Further to that, there can be many different parts going into a single process typically there are component parts going into a build (a n:1 ratio of components to a finished product).

Automotive, Aerospace and complex Industrial, Electronics and Oil and Gas applications most likely have what can be described as a concentrated inbound supply chain.

We probably instinctively know what this means even if we are outside the function, or the industry let’s say. It effectively means many different parts, in practice often from different vendors from different countries with different shipping rules and with different ways of ordering, come together to single points in the network where production happens.

If you ever took something apart, maybe to try and fix it, you’ll have seen have much stuff goes into the making of it.

As this article is about the stock at the factory I’ll not go too much into outbound supply chains but just to say really quickly, these can either be really simple (e.g. ship directly to customer location) or concentrated outbound where the goods are distributed to many different locations and many separate hops, skips and sometimes jumps to the point of sales (found more commonly in retail but also prevalent in other sectors depending on the nature of the goods).

Anyway, back to the factory. I see a box of parts on the shelf, how do I know if this is good inventory playing a role in serving the customer process? Well, first thing to observe is the condition of the box. Does it look new or is it covered in dust? Does it look like it was moved recently? Are the labels on the box fresh or are they aged? Does the font look like it was from the 1970s? These are of course subjective observations and should be followed up with more questions.

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How is the Part Ordered?

Is the Part Ordered with ad hoc or individual orders?

Or is it ordered based on Reorder or Kanban signal?

What is the Demand for the Part?

What is the Requirement for the Part? How much is needed from demand calculations from the production plan for the next 12 weeks? Or for the next 12 months from the Sales and Operations Plan? You can easily compute the average demand for the planned period.

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What kind of Service Level does the customer process need?

How much is it ok for the next machine or next process to not be running? Is it a bottleneck process that needs to keep going or is it something that runs a couple of small batches per week?

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What is the Demand Variability for the Part?

How much does the demand seem to change in the buckets of the production requirement?

Or how varied or volatile have the goods issues from stores or from WIP been?

This measure is the standard deviation for the same period.

How Often is the Part Ordered?

What is the order frequency? When are the purchase orders or production orders for this part released? Once per week? Daily? Quarterly? Quite often the buyer or the planner will know this, if not it can be measured from order dates in your ERP system.

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What is the Lead Time for the Part?

This is a setting in your ERP system and again the buyer or the planner will most likely know this, if not it can be measured from stock receipt dates vs order dates in your ERP system.

Once you have the answers to those questions you can easily figure out a few important things.

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1 How The Part Could Be Ordered

There is a simple calculation to determine the Coefficient of Variability.

You divide the Standard Deviation by the Average Demand and:

if the result is < 1, you can consider ordering the part through replenishment.

If the result is > 1 or if the lead time is over 60 days or if the value of the goods is high,

you may consider using spike orders / one time ordering from S&OP to avoid capital lockup on inventory.

If you order based on replenishment the next question is to do so based on box quantity or Kanban.

This is a preference based on whether you want to visually manage the stock or if you’re happy for the ERP to do the heavy lifting in the back office.

2 The Stock Policy For Replenished Parts

What my Reorder Point needs to be. What my theoretical maximum stock and safety stock levels ought to be. What this would relate to in terms of numbers of cards for a Kanban system.

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3 The Inventory Quality of Each Part

If the current on-hand inventory is above the theoretical safety stock and below the theoretical maximum stock level, good news this is good quality inventory.

If it’s above the max stock level, bad news is you have too much of the part and are locking up working capital. Good news is you can take action to reduce the level to within policy.

If the stock is below the safety stock level, or at zero, bad news is that this part is contributing to a customer process or even a direct customer service risk. Good news is you can take action to mitigate this risk, not least because you are releasing working capital on other parts above the max stock level.

If a part has Zero / Low Demand (Obsolete and Slow-Moving Inventory) then de facto these parts are over the theoretical maximum stock level even if one is not set.

If a part has no Demand in its current position in the network and Demand elsewhere this is commonly referred to as OOPS (Out of Position Stock) and the action here is to move the inventory to the point in the network where it can serve the customer.

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Key Messages from This Article:

Your inventory is to serve the customer.

The Reorder Points should be set based on good logic.

If inventory and capital lockup are a challenge or if you are experiencing customer service issues that may be related to inventory, RamBase can help you analyse your inventory.

Whether you are an existing RamBase customer or someone who is interested in what we at RamBase can do for you, please contact me here on LinkedIn for more information on this.