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Session Preview: Jon Schreibfeder: Does Your Inventory System Work for You

Or do you work for your inventory system?

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WHEN AND WHERE: STAFDA inventory consultant Jon Schreibfeder, president of Effective Inventory Management, will discuss “Effective Purchasing & Inventory Management” from 1:00 to 2:30 p.m., and again from 3:00 to 4:30 on Monday, Nov. 11.

We have worked with hundreds of distributors throughout the world. These firms have distributed nearly every type of product imaginable. Despite the variety of locations and industries, we’ve found when we start to work these distributors, they typically have very similar inventory-related problems:

• They have too much of some products. This excess inventory and dead stock leads to decreased turnover and profitability.
• They experience stock outs of other products. This results in back orders, lost sales and an overall decrease in customer service.
• They don’t know what is in stock. The on-hand quantity in their computer system does not agree with what is actually on the shelf in their warehouse.
• They can’t find material in their warehouse. They know the material is “out there somewhere,” but they don’t know exactly where it is located.

As a result, many distributors don’t have control of their inventory; their inventory is controlling them! Yet they have purchased expensive software that promised to alleviate all of these issues. Why aren’t they getting the promised results? Often they have purchased inappropriate computer software for their business. In this article, we will look at the
capabilities of a “best practice” system.

Today there are literally hundreds of inventory
management systems available to distributors. Some are incorporated into enterprise resource planning (ERP) systems that include sales, replenishment, general ledger, warehousing and other modules that can be used to process all of a distributor’s transactions. Other packages are “bolt-on” solutions that provide an inventory management tool set which is seamlessly connected to the distributor’s ERP system.

Bolt-on packages are utilized when a distributor is generally happy with his or her ERP system but would like more inventory and replenishment functionality.

Here is a list of capabilities that most distributors should look for in an inventory system:

1. The ability to identify and correct for unusual sales or usage activity that probably will not reoccur in the future. Unusual activity includes:

• Stockouts
• Unusually large one-time sales or usage quantities
• The start of a new trend

Future forecasts of product demand are based on this “adjusted” usage. After all, you want to base your forecast on what would have happened under “normal” circumstances not situations that probably won’t reoccur in the future.

2. Separate items with sporadic sales/usage from those products with recurring sales or activity. Items with sporadic usage are not sold or used on a regular, predictable basis. Items with sporadic usage should be maintained based on a multiple of the normal quantity sold or used in one transaction.

In other words, you don’t know when you will sell or need the item, but when you do you want enough to fill an average sale or usage quantity, not the “average” quantity you would sell per month. This “normal usage quantity” number for an item is usually based on four factors:

A. How often the item has been sold or used during the past 12 months. We don’t know when an item with sporadic activity will be sold, but we probably want to keep more of an item that has had six sales in the past year than an item that has only been sold once.

B. The lead time for the item. If it takes longer to replenish stock, you might want to keep an extra normal usage quantity on hand.

C. The cost of a normal usage quantity. Maintaining larger inventories of less expensive items allows you to achieve a higher level of customer service with a relatively low investment.

D. The critical nature of the item. You don’t want to run out of product that will cause a good customer to have to shut down his/her operations.

Note that more than 50 percent of the items stocked by most distributors experience sporadic usage.

3. For items with recurring usage (i.e., products that are sold or used on a regular basis), the ability to utilize different forecasting methods for items with different patterns of sales/usage. Not all of your items are sold or used at the same rate. When evaluating different software solutions, be sure to include items with:

• Sporadic usage
• Seasonal usage
• Increasing or decreasing usage
• Other unique situations (e.g. high usage every other month) faced by your company

4. For items with recurring usage, report the actual forecast error over the past several weeks or months using the error forecasting method. To calculate the forecast error we use the formula:

Absolute Value of (Forecast – Usage)
÷ Smaller of Forecast or Usage

Superior inventory systems will determine which replenishment method results in the lowest forecast error for each item and use this formula to forecast future demand for that product.

5. Direct the buyer to the product line or items that need the most attention. Most buyers are responsible for thousands of inventory items. They cannot effectively function if they are buried in data and paper. Good systems continually evaluate the stock position of each item and let the buyer know when situations occur that require their attention.

6. If a company has lead times greater than 21 days, the ability to calculate forecasts and other replenishment parameters for future months and predict when inventory will need to be ordered and received in order to meet this future demand. This capability is commonly referred to as distribution requirements planning (DRP).

7. The ability to incorporate collaborative information from sales, customers and other sources into the demand forecast. Afterward, assess the accuracy of the information from each source.

8. Maintain safety stock quantities based on the average deviation between the forecast versus actual sales/usage and anticipated lead times versus actual lead times recorded over the past several months. Safety stock is reserve or “insurance” inventory maintained to protect customer service in the event of unusual usage or delays in receiving a replenishment shipment.

Superior systems allow the user to adjust the safety stock quantity for each item to achieve a desired level of customer service. Typically distributors want to achieve an overall service level of at least 95 percent. That means that 95 out of 100 requests for products can be completely filled in one shipment from stock inventory. Items deemed to be “critical image items” should have a 99 percent or greater customer service level.

9. If needed, a program to assemble “kits” from other stocked items. Superior kitting systems allow a distributor to:

• Pre-assemble kits to sell as finished goods.
• Create and customize “build to order” kits as needed.
• Create kitted items by “disassembling” a product, for example, filling 55 one-gallon containers of a product from one 55-gallon drum.

Note that if a distributor has a multi-step manufacturing or assembly process, they should examine systems that include comprehensive manufacturing requirements
planning (MRP) and bill of material (BOM) modules.

10. The ability to evaluate vendor price breaks, free-freight requirements and other considerations to determine “best buy” purchase opportunities.

11. The ability to effectively replenish branch warehouse stock from a central warehouse or distribution center. Superior systems will guide buyers as to whether it is more advantageous to replenish a specific product with a purchase order from a vendor, transfer inventory  as needed from another warehouse or assemble the product in-house.

12. Comprehensive inventory analysis including:

• Multiple ranking of products in each warehouse based on cost of goods sold, activity (i.e., number of sales) and profitability.
• Customer service level. This is the percentage of line items on customer orders filled completely in one shipment by the promise date.
• Inventory turnover. Turnover is calculated by dividing the cost of goods sold recorded over the previous 12 months by the average inventory value over the same period. Inventory turnover measures the number of opportunities you have to earn a profit for every dollar you have invested in inventory.
• A target inventory investment necessary to achieve a desired level of customer service.
• Gross Margin Return on Investment (GMROI), or the Turn/Earn Index. These are profitability measurements. GMROI is calculated by dividing annual gross profit dollars by the average inventory value. The Turn/Earn Index is calculated by multiplying your average gross margin by the inventory turnover. These are equally good metrics that measure profitability on different scales. As a result, a GMROI will always be higher than an equivalent Turn/Earn Index. When setting goals, consider the following results from our user base of distributors:

• Percentage of excess inventory. This is the percentage of your current inventory in excess of a certain number of day’s or month’s supply. Most distributors strive to have no more than five to ten percent of their inventory dollars invested in more than a one-year supply of a product.

There are many good “best practice” inventory management systems marketed today. Look for the one with the user interface and features that best meet your organization’s specific needs. Be sure to have the representatives of each potential system load all of the items from at least one of your locations into their system. Have your buyers and
salespeople review the results.

Are the calculated replenishment parameters reasonable? Are the reports and inquiries easy to use? Get everyone’s input as to which system “feels right” and produces the best results. Selecting software is a lot like getting married, you want to choose the right
partner to live with! CS

STAFDA consultant Jon Schreibfeder discusses key areas of his newly published book, STAFDA’s Effective Inventory Management Manual, with an emphasis on smarter purchasing habits, avoiding excess inventory and working better with vendors. Learn more at www.effectiveinventory.com