4 key questions to improve inventory efficiency

Did you know that you can get a clear view on how much stock you have and need by answering just 4 questions? Most companies do have either too much or too little stock because of a lack of transparency or knowledge. These outcomes have a huge effect on the company performance, from a financial and a service point of view. Inventory scans can help in defining how good your organization can be or needs to be and provide more insight into the Gross Margin Return on Inventory (GMROI). In this blog we will define the 5 most common stock types and reasons to hold inventory. In addition, we will explain which 4 questions you need to answer to improve your inventory efficiency. 

Lacking a clear view on inventory

It is rather shocking to see how many companies do lack a clear view on how much or what kind of stock they need to be successful. Supply chain disruptions have not really changed this or urged companies to act on it. We often get questions like: “How much stock am I supposed to have? What should be a correct service level ambition given our company strategy?”. In our opinion, a good metric to measure the efficiency (and thus the optimal balance between inventory and gross margin) of your inventory is the Gross Margin Return on Inventory (GMROI).

“The gross margin return on investment (GMROI) is an inventory profitability evaluation ratio that analyzes a company’s ability to turn inventory into cash above the cost of the inventory.” -- Investopedia 

Often supply chain managers are in a catch 22 with no explanation for finance for an unnecessarily high inventory level, while there are challenges in servicing customers, leaving sales unhappy. An inventory scan can create insight by answering 4 basic questions. The scan will support supply chain managers dealing with inventory issues and create more understanding between departments. 

Defining the stock type you need 

Defining what kind of stock you have, or need is a first key step on the path towards more inventory accuracy. There are 5 common types of stock a company can use. Each of them has its own drivers
that are meaningful to the business of an organization.  

5 most common stock types 

1. Cycle stock is linked to the production frequency or order frequency and stems from the need to produce or order in batches. The Economic Order Quantity (EOQ) principle teaches us that it is more economical to produce or source in bigger quantities to reduce changeover costs and receive price advantages. 
   
   
2. Safety stock is a buffer against uncertainty in supply and demand. All products have a lead time in terms of procurement or production, and it is rarely constant. Those uncertainties are typically covered by safety stock, which ensures that you can provide a good service to the next step in the supply chain.  
   
   
3. Anticipation stock is held to absorb foreseen imbalances between supply and demand. If you know that a certain event – such as a tender or a shutdown – will result in a demand peak, you could decide to start producing upfront and to build up inventory in anticipation of that event. 
   
   
4. Work-in-progress or transit stock is inventory which is ‘on the way’. Transit stock is unavoidable in long-distance trading. For example, products sourced in China will have a transit time. Improving the transport routes can reduce the transit stock, while optimizing the production flow can lead to less work-in-progress stock. 
   
   
5. Strategic stock is carried to manage potential risks or to seize certain opportunities. You may decide to build up extra inventory because you expect a market shortage of a key raw material. Alternatively, if you expect to close a big deal, you can start building inventory beforehand to be able to supply a customer immediately.  
   
   

4 Questions paving the path to your success

An inventory scan will provide insight into the how and why of stock levels. By answering just 4 questions organizations can create insight and start acting more accurately.    

1.  How good is your organization? The answer lies in analyzing historical data on GMROI, such as gross margin and inventory turns and inventory value. In addition, you need to analyze aspects like service levels and forecast accuracy to understand the drivers behind a lower GMROI. The answer will show how healthy your company really is.  
   
   
2. How good do you need to be? In which industry is your company operating and how does it want to operate? Which stock levels are required in order to ‘survive’? Again, the GMROI is considered and compared to peers.  
   
   
3. How good do you want to be? Answering this question can be done by surveys that provide understanding about the priority of a company. Different company strategies require different approaches to reach the same gross margin result. Cost leaders and product leaders have different targets when it comes to gross margin and inventory value and therefore different paths towards the most optimal GMROI.
   
   
4.  How good can you be? This question should include an analysis of opportunities, including forecast improvement, optimized segmentation of products/customers and service level differentiation. Lastly, there should be an answer to stock strategy changes, such as MTP, MTS, decoupling points and central or decentralized inventory.  

Theory in practice: F&B example

Analyzing stock data is the key to improve stock accuracy and as a result overall business performance. Recently, a company in the Food & Beverage industry (and a few others in different branches) was open for an inventory scan executed by Solventure. The F&B company was unaware of the ratio between lot sizes of products and the impact of this on both stock positions and risk of expiry. Like many other companies the F&B enterprise had to balance aspects such as offering service towards customers & retailers, reducing manufacturing costs for bigger batches and managing the risk that stock becomes obsolete. By analyzing their data and strategic value proposition, Solventure advised on the ideal batch size that serves both the retailers happy and respects the minimum waste level which results in a healthy GMROI. 

Making strategic changes 

The inventory scan is not just a scan, but a tool that provides insight and forces companies to make choices on what level they want to excel. Having a lot of inventory is not necessarily a bad thing, if it is balanced with a healthy gross margin. Real success in defining which stock levels are needed to serve customers well, even in volatile markets, requires breaking down the walls between departments within a company. Sales hopes for a broader portfolio, production would like to work with bigger batch sizes, supply chain is solving misery and finance would like to improve margins. The only way to improve the company performance is to work together, discuss and make a few strategic changes. Of course, based on data and insights from a proper inventory scan or recurring process.