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In today’s marketplace, almost all companies face a major dilemma of supplying the right products in the right quantity at the right location based on the customers’ demand. Inappropriate inventory levels have serious implications on the company’s profitability as well as service levels. Optimizing inventory levels across the entire supply chain has been an area of concern for many companies who manage a variety of Stock Keeping Units (SKUs). Based on my research, I have seen that most industries carry inventory of around 15-20% of their annual sales. Considering an average inventory carrying cost of around 10% (could be higher for many companies), it can be noted that companies spend around 2% of their revenues carrying inventory. This number can be higher for many companies.
The Planning Cycle
A large number of companies, today, follow the depicted planning cycle for Make to Stock (MTS)
It all starts with the finalization of the annual budget/target/forecast which is decided and fixed at the start of the financial year. The forecast is calculated at an all-India level and is sacrosanct. The entire company’s operations revolve around the forecast. Many companies incorporate a Net Forward Coverage (NFC) and target inventory norms for each of their SKUs. The NFC is calculated based on historical sales data (Like-to-Like (LTL)/Trailing Three Months (TTM)/Last Month). The production and procurement plans are based on the forecast as well as the NFC. For example, consider an SKU “ABC.” The all-India forecast (decided and finalized in the beginning of the financial year) for ABC for the month of September is 10000 units. Consider an all-India finished goods inventory (across the entire supply chain) of 6000 units. The TTM average sale is 4000 units and the company’s target NFC is set at 60 days or 2 months. Based on this, the production plan would be released for 2000 units (considering MOQ/batch-size of 1 unit). This would result in 2 scenarios –
1. If the sales team manages to generate sales close to 10000, there would be a shortage of stock due to insufficient saleable quantity. This would lead to stock outs and potential loss of sales
2. Looking at the past trend of sales, if the product has started to de-grow or demand has decreased due to various reasons, the sales team would end up losing their incentives due to low sales. This would happen because of the inviolable annual forecast.
The figure is typically a cause and effect diagram which emphasizes on the most commonly observed effects. The list of effects and implications is endless and can include many other observations from different facets of the organization.
The Way Forward
Having analyzed the effects of carrying inappropriate and ‘wrong’ inventory across the supply chain, let us now analyze at a few possible solutions to better manage and optimize the level of inventory.
1. The inventory levels need to be looked at a holistic perspective across the entire supply chain. The impact that the inventory would have at each level or echelon, upstream and downstream, should be carefully evaluated and analyzed.
2. Organizations need to move to a pull based supply chain, where the procurement, production and distribution of products is based on the consumption and actual market demand, from the traditional push based supply chain, where the products and inventory is pushed towards the consumers, closer to the Points of Sale.
3. An efficient inventory management system coupled with automated, system based replenishment would enable organizations to better track inventory levels as well as prepare for unprecedented events
Companies are evolving every nanosecond and their senior management is focusing on Sales and Operations Planning with an eagle’s eye view on the inventory. There are various areas of supply chain planning that can have an impact on reducing inventory and improving the service levels. Companies should consult and brainstorm internally and optimize these areas in a phased manner to reach the goal of optimizing inventory.