The conflicting objectives of inventory management

The ninth profit driver we look at for opportunities is inventory. Inventory reduction tends to go straight to the top of every production executive’s priority list when interest rates are high. Even when interest rates, and corresponding carrying costs are as low as they have been for a number of years, inventory is often still a significant asset on the balance sheet so continues to draw its share of management attention.

The key for managing inventory is getting the mix and levels right. This is harder than it seems because usually no one person is responsible for understanding and managing all the integrated aspects of inventory control. Marketing forecasts and production plans drive purchasing actions. Purchasing feeds raw materials inventory levels, which supply production, which in turn drives finished goods levels. Warehousing and distribution costs are a result of the primary inventory decisions already assumed. Inventory managers must decide what the most appropriate inventory levels and inventory mix should be, trading off the risk of being out of stock when an item is required, versus the cost of having too many items in stock. Not a very easy thing to manage and particularly because it’s dynamic.

To uncover opportunity in this area we find the best approach is to first try to quantify what the ideal inventory level should be. Again not so easy but a fair approximation can be derived through some form of ABC classification based on usage-value, and marrying up current levels against forecast requirements. Once a reasonable level is established you can determine how much is excess. The cause of excess inventory can be roughly split between the planning parameters and people’s behaviors. The planning parameters (e.g. forecasting, lead times, service levels, safety stock levels, accuracy, and order quantities) require technical analysis and all can yield opportunities. The behaviors (e.g. purchasing, product engineering, scheduling, and warehousing) are often driven by organizational policies. How people are measured and what affects their compensation can introduce conflicts in trying to optimize inventory levels. The simplest opportunities are often to identify slow or obsolete stock. Even this however can be problematic because eliminating stock can upset finance (e.g. the impact of write-offs on the company financials) and sales (e.g. the impact of eliminating items that just might be needed for older products or past customers).

Even from these simple examples you can see that while inventory is often ripe for finding opportunity, it can be something of hornet’s nest to try to manage the levels down in a sustainable manner.