25 Ways to Lower Inventory Costs

By Ralph Cox, Principal, Tompkins Associates

Inventory policies drive two types of costs-operating expenses and working capital requirements. The latest "Logistics Cost and Service Report" published by Establish Inc./Herbert W. Davis and Company, indicates that, while total logistics costs as a percent of sales are falling and most individual companies have succeeded in reducing inventory levels; total logistics costs per hundredweight are increasing, and inventory costs as a percent of total logistics cost are increasing.

In many organizations, however, the opportunities to reduce inventory costs are often not addressed at all or are not completely exploited. If your organization needs help taking money out of inventory there are strategies you can employ today that will provide payoff.
Some of these strategies address having less active inventory, others how you purchase active inventory, and still others require transferring inventory or relying on vendors for better inventory management. Regardless of which you choose to explore, proactive inventory management policies will make a difference in your operations. Here are some of the most common techniques for lowering inventory levels.

1. Base Cycle Stock on Economics: For purchased products, getting a handle on your acquisition transaction costs will either reduce average inventory or allow for reducing purchasing and receiving labor. For manufactured products, if production equipment changeover costs are in a similar state, getting them in place will either reduce average inventory through shorter runs or allow for reducing changeover and receiving labor through longer runs.

2. Control Order Transaction Costs: In the office, use the computer to generate purchase orders (POs), EDI for PO transmission, advance shipping notices (ASNs) to reduce expediting, and historical vendor performance to prioritize expediting to lower purchasing costs. In the manufacturing plant, pre-planning; pre-staging of needed parts or materials; use of special tools or equipment; changeover initiation prior to completion of the previous run; teamwork and work-division; maintaining equipment temperatures; and minimizing QA / QC work all reduce cycle stock inventory. In the distribution center (DC), pallet manifest-based receiving processes, counting scales, statistics-based inspection and checking, bar code scanners for data entry, certifying key vendors to eliminate receiving functions, and stocking forward storage locations first and reserve locations second can all reduce purchase transaction costs and cycle stock accordingly.

3. Lower Inventory Holding Costs: Improve space utilization in leased, contract, or public warehouses (or to minimize or delay expansion of owned facilities) through narrow aisle handling equipment, mezzanines, layout, or more appropriate storage modes.

4. Base Safety Stock on Customer Service: Using the appropriate number of product classes, setting the dividing lines between each class in the best manner, updating safety stock levels dynamically, and basing the service levels for each class on the financial goals of the business all serve to either reduce safety stock inventory or reduce out-of-stock situations and increase revenue.

5. Use Routine Demand Forecasting: Using manually edited arithmetic forecasting models to reduce forecast error will reduce overstocking, backorders, and DC returns from stores, holding inventory levels closer to only that required to support the desired customer service level.

6. Forecast Events: If one-time demand clutters the sales history, or if one-time demand events are part of the future, then they need to be taken into account in any forecasting done-both in terms of editing them from history and in terms of incorporating future events into the routine demand forecast.

7. Think Postponement: For parent products from which multiple SKUs can be manufactured, only partially completing manufacturing, placing semi-finished product in inventory, and then completing manufacturing of the final SKUs to order reduces total inventory. In a similar manner, component products from which final SKUs may be assembled can be purchased to inventory and then the final SKUs assembled to order, providing that the time for assembly doesn't exceed the customer lead time.

8. Rationalize SKUs: Removal of inappropriate product from the product line can be a controversy-ridden process, but may reduce inventory significantly if handled in a constructive manner, as follows:

Develop consensus on the objective of maximizing profit

Develop activity-based costs for each SKU and separate them into three groups:

Those with selling prices that create positive gross margin

Those with selling prices that cover their variable cost but do not completely cover their fixed cost

Those with selling prices that do not cover their variable cost

Quantify the sales volume correlations between SKUs, based on the analysis of both individual orders and aggregate order patterns by customer

Identify the combination of SKUs which maximizes profit on a fully-absorbed basis

9. Reduce Lead Times for Product Acquisition: For either manufactured or purchased product, any reduction in lead time, whether supplier lead time, transportation time or receiving cycle time, provides a one-time, permanent reduction in cycle stock inventory proportional to the throughput level of the SKU and the degree of lead time reduction. In a similar manner, reducing lead time variability and increasing inbound unit-, SKU-, or order-fill rates both increase supply reliability and reduce safety stock inventory for a given customer service level.

10. Implement Common Supplier Joint Procurement for Purchased Products: Joint procurement of multiple SKUs from a common supplier serves to effectively reduce unit purchase transaction costs and thereby reduces both cycle stock inventory and annual purchase transaction expenses. In a similar manner, joint procurement of multiple SKUs from different suppliers located in close physical proximity and consolidation of inbound (LTL) volume to form full TLs serves to reduce the incremental transportation cost portion of purchase transaction costs and reduce cycle stock inventory.

11. Purchase Minimums: Compare the total cost of ownership for purchased products as quoted prices with no minimums to reduced prices with minimums to determine if the reduced prices really provide savings.

12. Implement SKU-specific Purchase Transaction Costs: Purchase transaction costs aren't normally SKU-specific. However, reflecting any extraordinarily low receiving costs associated with specific SKUs will serve to reduce inventory for them. The opposite, of course, is also true.

13. Get Demand Plans from Downstream: Hard information on upcoming needs from customers reduces demand variability, thus reducing the safety stock required for a given customer service level.

14. Send Demand Plans Upstream: Sharing demand forecasts with suppliers is more indirect, however, in the long run it will serve to reduce the supplier's finished goods inventory and associated costs and, with effective negotiation, perhaps yield lower prices.

15. Don't Stock It: Manufacturing or purchasing to order when the acquisition and customer lead time relationships and order quantity relationships allow it is a very direct way to reduce inventory, providing that the acquisition capacity exceeds the potential short-term demand rate.

16. Cross-dock Customer Shipments: With effective use of joint replenishment, the potential increases in inbound transportation costs associated with purchasing to order can be mitigated. Cross-docking customer shipments can facilitate purchasing to order even when the order quantity relationship would have otherwise dictated purchasing to inventory. In a similar manner, aggregating purchase requirements for multiple DCs into a single order and cross-docking to multiple DCs effectively reduces purchase transaction costs and reduces cycle stock inventory.

17. Keep In Stock, But Not Everywhere: In multiple DC tier environments, stocking certain SKUs in fewer/upstream facilities as opposed to more/downstream facilities yields obvious benefits. Likewise, within a single tier of DCs, not every SKU deserves to be stocked in every DC.

18. Extend Payment Terms: When negotiating long- term purchase agreements, getting the best payment terms at a given unit price is the most direct way to increase the portion of inventory funded by the vendor. If improving payment terms can be coupled with increased turnover, then the improvement in working capital effectiveness is significant.

19. Take Advantage of Price/Quantity Breaks: Taking price/quantity breaks into account when purchasing for replenishment seems an obvious way to reduce the inventory investment, but seems to be frequently overlooked. Often this is a result of either not quantifying breaks at the time of sourcing or negotiation, not having an effortless way to take them into account, or through lack of understanding of the impact of purchasing larger quantities at reduced unit cost.

20. Transfer Instead of Purchase: When inventory of an overstock SKU in one location needs to be purchased to replenish inventory in another location, transfers are a smart way to reduce inventory. Be careful that additional warehousing and transportation expenses aren't unnecessarily incurred so the reduction in holding cost does not exceed the cost to transfer.

21. Consider Liquidation: Although there will always be a short-term price to pay on the P&L and the balance sheet, when it is absolutely clear that the value to be gained through liquidation-whether through sale at reduced price, sale as distressed product, salvage, or charitable donation-is greater than the most optimistic estimate of future gross margin from conventional product sales, then liquidation is the best decision.

22. Try Merge-In-Transit: The concept of in-transit product merging-where, for example, two things are shipped from different locations and then married in transit so that they reach the customer as a single shipment-can be seen as a technique for reducing inventory if the need for the customer to simultaneously receive multiple SKUs is taken as a requirement. If the need for simultaneous receipt is a given, then the concept eliminates the need for inventorying the individual SKUs together. To some extent, merge-in-transit represents an extension of postponement beyond the distribution center walls.

23. Get Help From Friends: Collaborative Planning and Replenishment (CPFR) is an open set of pre-defined business processes and IT/communications standards created to facilitate collaboration between supply chain partners. CPFR can reduce inventories through inventory balance, forecast, demand and other data visibility and associated collaboration in the planning area.

24. Use Vendor-managed Inventory (VMI): With the appropriate incentives, allowing suppliers to assume the responsibility for replenishment of your inventory, because of their visibility into both their own inventory and production schedule and your demand data, can almost always reduce your inventory.

25. Implement Vendor Stocking Programs (VSP): Used primarily for maintenance inventories but applicable to all, VSPs require a supplier to commit to an extremely high service level for delivery of specific SKUs within a fixed time at a pre-defined mark-up over cost. VSPs can reduce or eliminate inventories for slow-moving products.

There are numerous ways to take better control of inventory and decrease its associated costs. The key to managing inventory successfully is to continuously measure your performance and look for new ways to improve. These 25 strategies should get your organization thinking about what it can do to lower inventory costs. Many of these strategies may seem challenging to implement. This is when it is wise to seek outside help for insight on how to put these strategies to work for you.

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