Five Inventory Management Issues That Impact Service Levels and Profitability
Inventory management plays a crucial role in driving a lean yet resilient supply chain while providing the value that today’s customers demand. While companies often focus on fixing downstream inventory-related symptoms such as stockouts, late deliveries, and inefficient warehouses, it is crucial to address the systemic root causes of these issues in order to improve service levels, foster resiliency, and optimize end-to-end costs and the use of working capital.
Inventory management is always difficult. But recent trade wars and pandemic-related disruptions have added additional complexity and underscored the notion that this process is not simply about reducing inventory to the lowest levels possible but ensuring a balanced and robust supply chain with sufficient diversification and safety stock to withstand future disruption.
Challenges may arise in a number of disparate locations and scenarios and may be driven internally or by suppliers. Here are five ways your inventory management process may be impacting service levels, working capital, and overall profitability and what you can do to improve it.
Effective organizations that are able to identify, measure, and execute on inventory management best practices will improve working capital while ensuring customers receive the service they expect and deserve.
1. Limited cross-functional planning and processes
Lack of planning between finance, sales, marketing, and supply chain/operations teams can often cause excess or insufficient inventory. Customer demand, operational performance, raw material availability, new product introductions, general cashflow position, and pricing changes and discontinuation can all impact supply requirements.
Well-designed processes with clearly defined roles and appropriately timed review cadences are the foundation of any effective inventory management program. The alignment of customer needs, business strategy, vendor relationships, efficient delivery, and well-placed inventory requires a consistent understanding and single reference point. Companies should begin by reviewing the various inventory related touchpoints along their supply chain, focusing on those that play a significant role for inventory levels, such as finance, sales, forecasting, demand planning and scheduling, procurement, and distribution. Does each piece have clearly defined procedures and cross-functional coordination mechanisms? Are they tailored to optimize the end-to-end process? Does each process have an assigned owner who is empowered to drive improvement?
2. Underperforming supply base
Suppliers with inconsistent lead times, fill rates, and quality create operational disruptions and ultimately impact customer service levels. This often drives companies to create excessive inventory levels to buffer against variable performance.
Supplier performance management is an essential discipline. Companies should create a supplier scorecard to monitor and report on key metrics, centered around On Time in Full (OTIF), and include order lead times, inventory depth, supply chain diversity, organizational health, and payment terms. As part of this process, it is important to create a dashboard to calculate the costs of poor performance. This may include lost sales, excess inventory holding cost, high damage rate, or frequent returns. Companies may also consider a preferred supply program with criteria and incentives to attain the top supplier-preferred tier. Collaboration to improve sub-par supplier performance and/or identify new sources of supply will provide better total value to the supply chain.
3. Inefficient manufacturing
Product or stock-keeping unit (SKU) proliferation, bill of materials complexity, long changeover times, quality issues, production waste, poor preventive maintenance, and intermittent demand drive increased raw materials, work in process, and finished goods inventory.
Companies should begin with waste reduction as they work to make their manufacturing processes more efficient. This includes leveraging manufacturing process improvement methodologies, such as Lean Six Sigma. Companies should also establish preventive and predictive maintenance, including an equipment investment or upgrade roadmap. It is also important to review the product and customer portfolio to understand SKU level profitability and opportunities to reduce product complexity, particularly around capacity constrained bottlenecks.
4. Network and warehouse shortcomings
Non-optimized distribution networks and poor forecast accuracy by location can result in a need to carry bigger buffers in non-optimal locations. This can lead to higher inventory management and transportation costs. Additionally, poor warehouse practices and lack of a robust warehouse management system can further drive inventory inaccuracy, increased safety stocks, and poor customer service levels.
Companies should assess whether existing plants or warehouse locations are necessary due to customer requirements, balancing inventory, real estate, and staffing costs vs. logistics costs, customer service levels, and supply chain resiliency and risk mitigation. Modifications to a company’s network structure or logistics approach may also be available.
While the planning process and network is important to preventing excess inventory, steps must be taken after inventory is received to ensure it remains productive. Companies should audit warehouse operations for inventory accuracy, core processes performance, and appropriate use of technology and implement a scorecard to track performance and identify improvement opportunities.
5. Technology limitations
Access to accurate data is critical. Some common data challenges include incorrect master data, inability to monitor key metrics, see demand, and track supply and inventory levels throughout the entire supply chain. These data are necessary to use in conjunction with inventory planning software to accurately calculate and refresh inventory plans periodically. Organizations that are unable to share information effectively can no longer compete at scale.
Companies should leverage data from all systems involved in the finance, sales, marketing, and supply chain processes to proactively identify opportunities. Metrics like fill rates, inventory accuracy, turns, and working capital should be monitored constantly to ensure an optimal balance of service and cost. Data must be effectively captured, adequately scrubbed, and periodically audited for accuracy. Master data including vendor information, SKU and location-level item detail, and customer requirements must be aligned to ensure inventory levels remain optimized. Strict controls around capturing and measuring the data should be reviewed and enforced at scheduled interviews. Companies should also consider an end-to-end assessment of technology usage and create a roadmap to implement new technologies. This roadmap should be revisited and refreshed periodically as new requirements or innovations emerge.
Despite these challenges, effective organizations are able to identify, measure, and execute on inventory management best practices will improve working capital while ensuring customers receive the service they expect and deserve. Some improvement initiatives can be implemented rapidly with minimal cost, but it is critical to fully assess the end-to-end cross-functional process to identify, prioritize, and plan the implementation with a cohesive underlying roadmap and timeline.