World's Best Practice Inventory Management

In almost every endeavour it is difficult to determine what constitutes ‘best practice’. Businesses around the world spend millions of dollars on software and advisory services and often don’t know whether they are ‘best practice’ or just somewhere in the pack.

Many companies will say, ‘why does it matter just as long as you keep getting better?’ The stark reality is that inventory requires the investment of cash. The items need to be purchased and stored and this ties up cash. This working capital can be a significant burden for many companies and if freed up can provide significant cash resources that can be used for other more productive purposes.

For many companies the key issue is availability and so long as they have an item when it is required they care little about the cash investment. However, this approach will not maximise your ROI and, in almost all cases, cannot be financially justified on any level. This is because the excess inventory investment that this approach generates provides little or no value to your business. The excess is invested in inventory that does not move or becomes obsolete.

World’s best practice inventory management demands that the ‘management system’ is optimised not just the inventory. It is in this field that best practice can be both easily identified and readily achieved.

Each level on the ladder to world’s best practice provides a greater degree of control and management but is only at Level 5 – System Optimization that the management system is optimised. By reaching this level companies can reduce their inventory investment, freeing up cash, AND achieve their desired availability levels.

The five levels to world’s best practice inventory management are:

Level 1 – Ad Hoc: Purchases are made on an ‘as needed’ basis. At this level there is little control necessary as inventory is expensed when purchased and used immediately. While this may seem to reduce the cash investment it may not reduce the total cash expenditure. This approach can only be viable if the items are available ‘instantly’ and the cost of a ‘stock out’ is negligible.

Level 2 – Storage: Inventory is expensed when purchased and stored for use but not strictly controlled. Similar to above except that items are stored because of the cost of a stock out. This approach appears to solve one problem but it raises two others. Firstly, total expenditure is likely to increase as items are purchased in ‘economic quantities’. (See my free e-book ‘5 Myths of Inventory Reduction’) Secondly, without controls there is little opportunity for review and development.

Level 3 – Capitalisation: Inventory is capitalised and subject to some level of control, either manual or software based. This approach is by far the most popular as it appears to provide the required mix of availability and control. Unfortunately, most organizations use their software solely for counting and accounting. There is a strong reliance on human calculation of inventory requirements but often little review of outcomes. The result is likely to be good availability but a significant over investment in inventory and high levels of obsolescence.

Level 4 – Software Optimisation: Inventory is capitalised and stock levels are optimised based on a risk/return algorithm. This is the basis of most software solutions. Most software packages will incorporate the ability to automatically adjust the required stock levels based on the history of demand and supply. Very few companies actually use this feature because they know that they cannot trust the results. This is not due to a software flaw but because the supply and demand may not represent typical usage. (This is explained further in the book Smart Inventory Solutions.)

Level 5 - System Optimisation: Inventory management minimises the overall cash investment without an increase in risk. This is world’s best practice. At this level, all of the factors that influence the actual inventory investment are reviewed on a regular basis. This review is manageable because it is limited to the ‘vital few’ items that have a real impact on the level of investment. Inventory levels are adjusted to take account of changing needs and this minimizes the likelihood of obsolete inventory.

Any company that already has the software required for Level 3 can achieve Level 5 – world’s best practice. What is needed is the know how, policy development, measures and reporting required to take a company to Level 5, not more software. Once these key issues are addressed you are implementing a true management system. Software only goes to level 4, it is the management system that provides the bridge to Level 5.

For more information visit http://www.InitiateAction.com

About The Author

Phillip Slater is the author of the book Smart Inventory Solutions and the developer of the Inventory Cash ReleaseTM System - ICRTM06, a world’s best practice approach to inventory management and reduction.

For more information visit his website at http://www.InitiateAction.com.