This article is an excerpt from the reportThe Right Stuff — Managing Inventory to Enable Agility for Manufacturing and Distribution Companies. A copy of the full report can bedownloaded here.
Challenges and Opportunities of Managing Inventory in Volatile Times
Inventory is the lifeblood of any manufacturer, brand owner, or wholesale distributor. Managing inventory well is the key to success: driving sales, profitability, cash flow, and customer loyalty. When a manufacturing or distribution business is first getting started, it may be able to get away with minimal inventory management systems and processes. The owner can tell how much of an item they have by simply looking or asking a trusted employee, who remembers where they put everything and knows about how many are left.
However, at some point, it becomes too much to remember it all. Inventory may exist in multiple locations: at various suppliers’ sites, on inbound shipments, across various distribution centers, at channel partners’ sites, at customers’ sites, and in transit between all of these. At that point, the lack of systematic processes catches up, causing major problems. If there is extreme volatility in demand and supply on top of that, it can become an existential threat for the company. Putting the right inventory management systems and processes in place is essential for a company to survive in times of disruption and thrive in normal times.
Right Items, Right Place, Right Time, Right Quantity
The core of supply chain management is having the right products, in the right place, at the right time, in the right quantities — and doing it without incurring unnecessary costs, such as excess inventory or transportation expediting costs. When inventory is not right (items, place, time, or quantity), it is usually due to inaccurate forecasting, volatile demand, incorrect inventory counts in the system, disrupted supply, or a combination of these and other factors.
Virtually all manufacturing and distribution businesses experience some amount of imbalance between supply and demand, due to a variety of reasons. As shown in Figure 1 below, your systems may show everything is on track (inventory is sufficient to meet forecasted demand), when in reality, demand may substantially exceed available inventory. In this scenario, it was a combination of 1) having the wrong count of current inventory — the inventory count in system is higher than actual # of items on hand, and 2) actual demand is higher than the forecasted demand. In this hypothetical scenario, a shipment of 3,500 units arrives in week 3, but too late to avoid a stockout in week 2 and again in weeks 4 and 5. Having less inventory than projected can also be caused by supply disruptions and delays to incoming shipments. In any case, the result is undersupply, with potentially serious consequences, including lost sales and possibly losing a customer for life. For a manufacturer, it could cause production stoppages at their plant due to lack of key materials.
Figure 1 – Undersupply: Demand Exceeds Available inventory
Conversely, another common scenario is oversupply, as depicted in Figure 2 below. In this case the initial inventory count in the system (at week 0) is less than what is actually on hand. That error is compounded by actual demand being less than forecasted demand. Since a replenishment order had already been placed, 3,500 units arrive in Week 3, further exacerbating the excess. The result is an oversupply of more than 3,500 units by week 5.
In this case, all the cash used to buy that inventory remains locked up and unavailable to buy more goods or to use for other purposes. There is less cash coming in, due to decreased sales, potentially causing a cash crunch. Beyond the cash tie-up, there are other carrying costs for the inventory — storage costs, handling, insurance, depreciation, and the opportunity costs (what could have been done with that space, money, and resources). Depending on the lifecycle and/or perishability of the products, there may also be a high risk of the inventory becoming obsolete, forcing the business to sell it at a discount or liquidate the inventory altogether.
Figure 2 – Oversupply: Inventory Far Exceeds Demand
Developing Company/Product-Specific Demand Forecasting Knowledge and Expertise
COVID-19 shined a harsh spotlight on how hard it is to anticipate demand when the unexpected happens. The toilet paper shortage was not caused by any change in the underlying rate of consumption, but rather due to panic buying1 (which is notoriously hard to predict) and a dramatic shift in where it was being consumed (at home rather than at work or in public places). Some items, such as hand sanitizers, masks, and gloves, experienced enormous surges in consumption, while many sectors experienced extreme reductions in demand. For example, the mass closure of bars and restaurants hit major food distributors hard, while the inability for consumers to visit auto dealers and test drive vehicles, combined with automotive factory closures, decimated automobile sales.
While COVID-19 is an extreme example of unanticipated disruption, fluctuations in demand happen all the time. Smart manufacturers and distributors learn to monitor key indicators that will influence demand for their specific products. For example, an industrial pipe manufacturer might monitor events in oil-producing countries that influence the price of oil. When oil prices are high, oil companies invest in developing more wells, requiring more pipes. When prices are low, then investments in new wells dries up and demand for pipes goes down. Another example is mosquito repellent manufacturers who monitor long-term weather forecasts; specifically, the amount of rain predicted, which creates standing water that causes more mosquitos to breed. The manufacturer may then share their location-specific demand forecasts with the retailers they sell through. They will send more repellent to certain parts of the country and less to others, based on the weather forecast. It behooves each manufacturer and distributor to become an expert in understanding the key factors that influence demand for their product(s).
Right Items and Quantity — But in the Wrong Place
In today’s fast-paced online world, the location of inventory is of critical importance. Companies invest billions in trying to get the right inventory at the right location in order to rapidly fulfill orders and requests. Without the right tools and processes, it is extremely hard to get the right SKUs, in the right quantities, at the right location. It is common to have the right aggregate amount of inventory across the whole business, but in the wrong places — i.e. oversupply at one location and undersupply at another. In that case, the business is unable to realize the benefit of that inventory without incurring the additional costs and delays of transshipping between locations. In some cases, that may be prohibitively expensive. In all cases, it delays delivery and/or increases expediting costs, and eats into margins. This is why it is so important to have in place the required forecasting capabilities and inventory processes needed to achieve inventory accuracy at a SKU-per-location level.
In Part Two of this series, we discuss the importance of accurate inventory visibility and how to achieve it.
1 Panic buying happens when there is a real or perceived shortage looming, causing large numbers of people or companies to make ‘forward buys’; buying more than they need right now in anticipation of future shortages. In the case of a perceived shortage, the panic buying itself becomes the cause of a real shortage. Panic buying is difficult to forecast as it is often based on predicting human emotional responses, rather than rational assessments by buyers. — Return to article text above
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