Update Planning Processes and Management Discipline to Right Size Inventory and Improve Access to Cash
Ongoing supply chain disruptions, longer lead times, and inconsistent shipping timeframes have put most manufacturers in a reactive state. Good planning, processes, and parameters for managing and maintaining inventory have gone by the wayside as supply chain professionals have found themselves stuck in crisis mode. Buyers are doing whatever it takes to get in materials when they can, sometimes paying suppliers before they get paid, and often without considering shifts in the market profile that are impacting demand.
But if we’re being honest, many manufacturers had less than pristine inventory processes even before the pandemic began. Out-of-date spreadsheets, workarounds, and orders placed outside of business systems have always been more commonplace than they should be. The global crisis simply brought these issues to a head.
Now, more and more companies are finding that their inventory situation is out of control. They have too much of what they don’t need, not enough of what they do need, and a considerable chunk of cash tied up in aging inventory. With the cost of capital on the rise and inventory carrying costs four times more expensive than just a few years ago, the situation is no longer sustainable. It’s time to get serious about right sizing inventory and freeing up working capital that could fuel other critical business initiatives.
Reintroduce inventory management discipline to give your cash flow a major boost.
We recently helped a PE-owned industry-leading aftermarket parts and accessories manufacturer for the outdoor recreation industry reduce the total value of its inventory by 30-40%. Over the course of eight weeks, we were able to assess current state inventory levels, system parameters, and processes related to inventory management; identify and quantify the opportunity; and implement a right-sized inventory management plan. Within a year, the company found itself with an extra $20 million in cash on hand.
Like this company, most manufacturers are sitting on big opportunities to free up cash. And they can often start moving things in the right direction in a matter of weeks.
5 steps to get out of reactive mode and start proactively managing inventory to meet current demand and cash flow needs.
- Get your inventory mix right for right now. It’s an understatement to say that a lot has changed over the past 24 months. But most manufacturers have been too busy responding to crises and demand fluctuations to put any serious consideration into inventory strategy. Now’s the time to rethink your inventory plan at the highest level and get more strategic about what you will and won’t carry based on current market dynamics.
At a minimum, your economic order quantity, which has likely shifted dramatically, needs to be recalculated based on current holding costs, shortage costs, and order costs. Given the current economic situation, most companies cannot afford to overorder or preorder in excessive quantities right now. More frequent orders in smaller batches present a significant cost advantage since cash and storage space are no longer cheap to access.
- Update and document inventory ordering system parameters. Once your mix, order quantity, and order frequency are right, it’s time to define the parameters and enter them into the system. Lead times and shipping times are a lot less predictable than they used to be, so you will want to account for this variability as best you can.
Very often, we find that parameters are either far more complicated than they need to be or grossly out of date and inaccurate. For example, we recently worked with a large company with more than 600 suppliers and 3,000 SKUs. While this company had a long list of parameters, just six were critical to driving MRP. However, for this essential subset, just 17% of the data fields were accurate. Clearly, the company had a significant amount of clean-up work to do to get its system back up to date.
To avoid similar situations, it is important to document methods and processes for establishing the parameters. This will help ensure the parameters can be easily updated and recalculated on a regular basis or as needed. It’s also best practice to identify a process owner. But the most important thing to remember is to trust the system. After the parameters are up to date, the system will help dictate what to order when to rapidly optimize inventory size and your total costs. Respecting the system, however, is sometimes easier said than done.
- Initiate behavioral change if needed. We often find that buyers and other supply chain professionals lack education on inventory ordering systems. Because they don’t know or understand how and why the math and logic work, they may second guess the system’s recommendations. This can often be resolved through training and insight into the system’s results. When buyers can see the impact of the new system parameters on their own work and the company’s bottom line, they will be much more inclined to put their faith in the system’s recommendations.
Of course, there will be times when buyers may still want to override system parameters. This may be done as a safeguard to prevent shortages or as a way to make their own jobs less demanding, as padding orders reduces the need to closely monitor inventory levels and frequently initiate reorders. This is where good process discipline comes into play. Supply chain leaders will need to proactively reinforce the importance of following the rules and tracking the results.
- Enhance visibility, tracking, and oversight. One way to bolster process discipline is to analyze and track ordering behaviors and inventory levels on a daily basis. A simple business intelligence application or a more robust digital manufacturing tool such as Dploy Solutions can provide the visibility supply chain leaders need.
Whatever system you choose to use, real-time exception reporting will be an important feature. Such a tool will alert managers instantly if an order or PO is outside of system parameters, allowing managers to react quickly to investigate the order and make changes if needed.
- Initiate a policy for regular reviews, updates, and sustainment of parameters. While some shortages of critical materials are beginning to diminish and global supply chains are improving in some capacities, the situation is not what anyone would call stable. And if we’ve learned anything over the past two years, it’s that things can and do change rapidly and dramatically.
That said, revisiting inventory strategy and adjusting ordering parameters to ramp up or down as needed is not a one-and-done exercise. It’s a continuous process that should be executed on a regular basis to stay on top of shifts in market, changes in demand, and fluctuating lead times.
Setting a cadence for inventory reviews and system updates is a best practice that, when coupled with analytics and tracking, will help you keep your inventory right sized for the long-term. And when you see the dramatic impact on working capital, cash flow, and the balance sheet, it’s easier to make this process a priority for your business.
Get money out of your warehouse and into your business.
With capital more and more difficult and expensive to access, manufacturers need to look within their own businesses to free up cash. And inventory optimization is a great place to start. An inventory level assessment or diagnostic can quickly quantify the opportunity for your company and pave the way to a much better balance sheet in the months to come.