Chaouki M. Eid | Managing Director
28th January, 2015
Effective inventory management is aimed at finding the optimum between the high availability of inventory items (driven by customer service objectives) and the tied capital in order to reduce expenses (a financial objective); definitely two conflicting objectives. As a result, “Supply Chain” professionals are under constant pressure to reduce inventory and there are many reasons why. We have all heard of dead, slow moving, duplicate and overly stocked items sitting in warehouses where the cash could have been utilized somewhere else in the company to deliver profit instead of incurring carrying cost. While I must say a lot of progress has been made on this, keep in mind though that if at any point in the process the maintenance or production departments are unable to meet their schedules due to lack of operational/maintenance parts or production material then all hell breaks loose. As such, “Supply Chain” professionals and more specifically “Inventory Control” in-charge are faced with this constant puzzle/dilemma: “How to maintain effective Customer Service with the lowest Inventory Levels possible”; easier said than done. Hence what can be done?
Before looking at solutions, we need to examine the following issues prior to taking any decision regarding when and how much to order:
Once we have had clear answers to the above, we need to scientifically calculate the ROP (Re-Order Point) for each Stock Keeping Unit (SKU) and strategize how to order. The ROP inventory replenishment technique considers forecasted demand over the replenishment lead time period, plus an allowance for safety stock. The ROP can be scientifically calculated depending on the situation. There are four distinct situations for calculating and setting the ROP, as follows:
When the inventory level of an item goes down to a pre-specified minimum level (ROP), an “Economic Order Quantity” (EOQ) is ordered to replenish the system. This EOQ is intended to be a balanced quantity that optimizes both the purchasing cost and the carrying cost for the inventory hence keeping the total inventory cost to a minimum.
The EOQ model finds the optimal order quantity keeping the above two constraints in mind. However, the EOQ model is not the best solution for all items. For very expensive items, the strategy could be to order the exact amount needed, while for cheap consumable items, buying in bulk makes more sense. On the other hand companies that employ a JIT (Just-In-Time) approach consider the EOQ as a waste since the purchased quantities ordered should only be the ones required for the next immediate schedule. Then you also have the blanket agreement option.
Each of the above strategies has its own pros and cons depending on the situation and unfortunately there is no one single solution that fits all scenarios. As such, it becomes imperative that the right strategy be used for the corresponding situation. Last but not least, the inventory specialists should be accountable for the two most important and conflicting inventory KPIs (Key Performance Indicators) which are:
Chaouki Eid, Deputy Managing Director, Meirc Training & Consulting. Chaouki is a subject matter expert on strategy, supply chain management, project management, maintenance planning and management.