We’re all hyper-aware of how erratic demand and long lead times impact profitability. No one wants to be a cost center, but these and other problems force inventory analysts to carry high safety stock — which is one of the most crippling profit stealers of all.
We recently gave the topic of erratic demand its own post: How to Manage Erratic Demand (Profitably). But don’t underestimate a few other culprits that are stealing profits from your business.
Long lead times, high economic buying cycles on slow movers, poor service-level strategies, and a few others are likely sabotaging your inventory optimization efforts. Today we will dive deeper into these areas, offering actionable advice on how to research, find and fix them.
Get a Clearer Picture of Lead Times
As lead times increase, so do safety stocks and inventory expenses. This does not mean that all long lead times are bad. They are often accompanied by great pricing and great margins.
Long Import Lead Times
Retail and wholesale distributors typically buy import items because prices are low and gross margins are high. This typically leads to higher net margins, but today’s inventory planning solutions allow you to do more than assume this success.
Action: Do the analysis. Measure the additional safety stock and inventory cost against the increased margin compared to the domestic source, if there is one. You might find that your expenses are higher than the margin gained and you are better off buying domestically.
Today’s supply chain analytics are rich. Share them with the merchandising team so that together, you can make intelligent buying decisions.
Increased Lead Times from Poor Supplier Performance
Don’t stand by as your supplier struggles and their expected lead times push from 14 days to 17 to 21 days. This increases your safety stock significantly, and guess who pays the price? YOU.
Know your numbers and be prepared to request compensation for the extra inventory required. You are sitting on their safety stock.
Action: Translate your data into financial insights for the organization. How much are you investing with every additional day of safety stock for each supplier? Have these supply chain analytics ready as these situations occur.
For example: ‘For a distributor with service goals set in typical A, B, C fashion, these are the average safety stock needs for the various lead time ranges.’
Erratic Lead Times
We covered this extensively in Part 1, but as a reminder, erratic lead times are the most impactful of profit stealers. There’s a big difference between an average lead time of 10 days that consistently arrives in 9, 10 or 11 days. However, if the item sometimes arrives in 4 or 5 days, but can be as late as 15 or 16 days, you will need safety stock to cover the excessive range of deliveries.
Action: Your supplier needs to understand that your margins are thin, and every extra day of safety stock is another day of lost profit. Work with them to achieve a more consistent delivery experience. Educate them on your costs.
High Economic Buying Cycles on Slow Movers
Some items and some supplier lines just don’t have enough volume to warrant buying frequently. If the economic picture of your carrying costs and buying costs tells you to replenish every 90 days because of the low inventory levels, you should explore the true profit picture. The cost of carrying months of cycle stock is very expensive.
Related: Long Lead Times Bring the Heat
Action: Although an item might be slightly more expensive from another supplier, if that supplier is bought frequently, your lower inventory expense might lead to higher profit. Go beyond gross profit analysis and make decisions on net profit after inventory expense.
High Buying Multiples
One of the most common causes of heavy inventory are required or chosen high buying multiples. If your buying multiples forces you to buy 21, 30, 60, 90 days or more, you should be concerned about the profit that remains.
You have options for every item. For some items your options are: each, case, master case, layer and pallet. For some slow moving items and lines, you simply have to buy in case. However, this requirement should be considered when deciding whether you can afford to stock the item, and if the item should only be stocked centrally or regionally.
Action: ‘Buying Multiple’ decisions are some of the most important decisions you make. Research and align great supply chain analytics to make smart, profitable decisions. Companies have seen dramatic shifts in inventory levels and profits as they have made the buying multiple decision an import factor. Learn more about supply chain analytics solutions.
Unnecessary and Uninformed Service Level Strategies
There is a list of well known companies that have gone out of business because someone decided to be heroic and turned all of their items to a 99% service level. It’s a nice dream, but you simply can’t afford it.
Know the Cost of Safety Stock
The leadership and all team members in retail and wholesale organizations should know the cost of safety stock. The image below reminds us that your safety stock needs double as you move from 80% to 90% service. It doubles again from 90% to 95% and again at 97.5%. It continues up exponentially toward 99.9%
MOVING THE ENTIRE ITEM MIX FROM 95% TO 99% SERVICE WILL TYPICALLY INCREASE INVENTORY ABOUT 40%. SERVICE GOALS SHOULD BE SET INTELLIGENTLY FOR EACH ITEM IN EACH LOCATION.
Action: Service goals should be set intelligently for each item in each location. Set a smart, profitable mix of service goals. What image do you want and what can you afford? Best-in-class supply chain planning systems have automation and AI tools that will help set your smart service mix very quickly. Educate the organization on the cost of safety stock.
Promises of High Service Goals on Less Popular Items
Special mention has to be made that sometimes well-intended Sales minds develop a list of items which they believe can never be out of stock. This is called your ‘never-out’ list. Every company has this list. But the best companies keep their never-out list controlled and small. A large list can become expensive and a source of tension in the company.
Requesting a 99% or 99.9% service goal on slower-moving, erratic items is expensive and could cause the items to live at negative profit. Do your analysis and expose the true cost of your company’s ‘never-out’ list.
Other Profit Stealers
Fixed Cycle Buying
We could devote an entire post to the true, hidden cost of fixed cycle buying. Come to think of it, we probably will very soon. For now, know that when companies can remove this limitation from a supplier’s replenishment process, they typically see a 25% to 30% inventory reduction.
Missed Deal Opportunities
When your focus is solely on keeping inventory at the lowest level possible, you miss out on super-profitable inventory opportunities. Announced and unannounced deals are available and can really boost the bottom line. They require a strategy and a smart solution that puts you in a position to invest in and reap high rewards.
Focusing Only on Inventory Turns
Measuring inventory turns is an old, schoolbook way of analyzing the success of your inventory. It can be found in financial guidance books, and can cause poor inventory buying decisions.
Deals, brackets, tier-pricing, economic buying, smart service goals, and many other factors and decisions can increase inventory and profits, but decrease turns. Tools, resources and education are available now to analyze the true profit picture of inventory.
Final Thoughts
Margins are thin everywhere. However, inventory planning teams have the opportunity and the responsibility to identify item components that are keeping net profits low, and then make smart adjustments.
As an inventory analyst or demand planner in your organization, you are truly an investor of the business. Got a question? Want to learn how easy it is to make smart inventory investment decisions, reduce safety stock and deliver increased profits? Contact us.
