Inventory, whether it be in the form of Raw Material, Work in Progress (WIP) or Finished Goods, has the potential to significantly impact a company’s operational and financial performance. Whether that impact is positive or negative depends on a number of factors.
When managed effectively, inventory can provide a company with a strategic advantage over its competitors. Reduced lead times, improved order fill rates, less stock-outs, reduced administrative cost and the ability to meet unforeseen changes in demand can lead to increased levels of customer service, improved customer retention rates and growth in market share and profitability. In some cases, companies can even charge a price premium for items they can supply ex stock rather than the customer having to order the item and wait for the standard manufacturing or supply lead time to pass.
Conversely, inventory holdings represent an investment in working capital that ties up cash that would be otherwise available to invest in the business. Inventory holdings can also lead to additional financial exposure in the form of increased storage and holding costs and obsolescence risk.
The challenge for any business is determining the optimal level of inventory to meet desired customer service levels while managing the various risks associated with holding stock, which leads me to the Good, the Bad and the Ugly from an inventory perspective.
First for the Good. Good inventory is inventory that is held in optimal quantities and provides a competitive advantage to the business. The investment in inventory is more than offset by the benefits the company derives from carrying the inventory. Good inventory typically has some if not all of the following characteristics; high inventory turns, predictable demand patterns, low obsolescence risk, low holding costs, etc.
Now for the Bad. Bad inventory is inventory that is held in quantities that are excess to requirements or is approaching the end of its product life cycle and is often the result of poor inventory management processes, a lack of effective planning or in response to poor supplier delivery performance. It ties up valuable working capital that could be used elsewhere in the business to fund more profitable activities and growth. Bad inventory typically has some if not all of the following characteristics; low inventory turns, unpredictable demand patterns, high obsolescence risk, significant storage and holding costs, etc.
And finally, the Ugly. This is inventory that no longer has a use in the business, it has become obsolete and future sales are highly unlikely. Opportunities to deal with obsolete inventory are fewer, but still may exist. Investigate alternatives to re-engineer or modify the product so it can be used in new or alternate product applications and markets. Review existing equipment populations and determine whether there is potential, albeit at reduced prices, to offload the inventory to support ageing equipment in the existing field populations. And finally, as a last resort, scrap the inventory to realise any scrap value and free up warehouse space. Decisions not to deal with obsolete inventory, which in many cases are financially driven because it is still recorded on the company’s balance sheet at its original cost, are mostly counterproductive. Continuing to hold obsolete stock adds to the financial burden through ongoing warehousing and storage costs as well and hindering a change in culture to support effective inventory management as employees see the obsolete inventory as an accepted and necessary part of doing business rather than waste that should be managed and avoided.
The key is to address Bad inventory before it becomes Ugly and implement inventory management strategies and processes that eliminates Bad inventory or transitions it into Good inventory. This is not a once off exercise, but rather an ongoing process that continually analyses and responds to changing market conditions and product life-cycle requirements. Effective demand planning, supplier management, production scheduling, data accuracy, management reporting and use of ERP & MRP tools all play a part in achieving this goal as does the alignment of employees to company objectives through effective goal setting and performance management systems. Understanding why particular categories of inventory are held also assists in developing optimal inventory management strategies and processes.
Talk to Procuremax to find out how we can help you sort the Good from the Bad and the Ugly.