You’ve set an inventory target but operations don’t seem confident about achieving it.
The new ERP system was supposed to solve the problem – that’s why the investment was approved. But so far you still not seeing the ROI.
You’ve told the operations director to reduce the inventory by 10% and shown what a massive positive impact this will have on profitablity, but so far there are no tangible results.
Why is that? What are they doing over there in operations? They just keep telling you it’s not that simple …
A company that made car washing equipment suffered the threat of having to close down its car washes when there was a drought.
They therefore took the decision to buy a number of 35-gallon water butts that would allow the car washes to stay in business.
By the time they’d ordered the water butts, got them delivered and into the central warehouse, it had started to rain and so the need for the water butts disappeared.
Although they weren’t used, they ended up staying on the inventory.
When we were asked to analyse the inventory with the aim of reducing it, we discovered that the water butts were the top inventory item.
As such a large proportion of the inventory was not being used, it was difficult to make better use of the active inventory.
So we helped this client by introducing them to the two terms – active and inactive inventory – and advising that operations can only be measured against the active inventory.
The inactive inventory was there because of a strategic decision taken in the past. As long as that decision remained valid, then it was still relevant to hold it, but it needed to be identified and managed accordingly.
In another example, an aerospace company were making specialised air speed sensing equipment that used a particular type of metal.
There was only one supplier that cast this metal and he only cast it in 50 tonne ingots. And they used about 3 ounces of it at a time.
When we analysed the inventory, a massive proportion of it was this particular metal.
When such a picture is shown to senior managers, they are able to clearly see the inactive inventory that is held for genuine business reasons.
Otherwise when the Financial Director looks at total inventory and he sees £2.5 million, reducing it by 10% seems a reasonable request.
But when it is broken out in the analysis he sees that, for example, 0.5 million is there for non-operational reasons and that this part cannot be reduced.
So he then understands that they have to separate the inactive from the active inventory.
What’s interesting is that inactive inventory is very common – it’s not just about special or big products brought in for strategic reasons – and is a key problem in managing inventory.
Take a supermarket selling garden furniture.
In April, they start selling garden furniture. Come September they’ve got furniture they don’t want any more.
So, do they hang on to it thinking that in another 8 months time people will want to buy it again and incur the cost of holding and managing it over the dead period – or do they try to sell it off cheaply and get new stock in the following year?
Likewise many businesses constantly have the problem of old then obsolete inventory. But at what point do you get rid of it?
Often they don’t want to write off the inventory because they don’t want to write it off the books.
But the auditors are saying that that inventory is now old and therefore you can’t keep it on your inventory as part of the financial benefit of the business, so you have to devalue it.
If you want to scrap material it ends up being shown as a write off and therefore affects reduces profitability.
So the finance department doesn’t really want to write off materials. What they should be doing is writing off a little bit all the time so they never significantly affect the profit.
But what often happens in practice is that they hang on to the material because they think you might use it.
Eventually they realise they can’t use it, but that slug of inventory is now too big a chunk of money to get out of the process.
Again this is a strategic issue because at that point the decision has to be taken to either take a hit on profitability or leave the inventory there in the hope of finding a market for it in, say, the next 6 months.
Read more case studies in ‘Inventory Management: Advanced Methods’ (Kogan Page, July 2015) written by Geoff & Catherine. Exclusive discount available through this site.