Inventory Management: Minimizing Cycle Stock and Safety Stock for Increased Shareholder Value
Capital efficiency can be maximized through effective inventory management, specifically by minimizing inventory working capital while ensuring the required level of customer service.
Inventory working capital has two primary components:
(1) Cycle stock, which cycles regularly through replenishment and consumption cycles; and
(2) Safety stock, a customer service hedge against forecast error, lead-time variability and related issues. The chart below depicts how safety stock can impact desired customer service levels.
Cycle stock is an economic issue. That is, how often do companies need to acquire additional product and what quantities are required? The economics are minimized by balancing the period acquisition transaction costs with the inventory opportunity, risk and storage holding costs for each SKU-stocking location.
Cycle stock is minimized by:
- Stocking only inventory that cannot be economically acquired (manufactured or purchased) after the demand has been received and, then, only in location(s) that are either economically justifiable to minimize transportation expenses or to maintain demand order cycle time requirements;
- Acquiring inventory (that must be stocked) in dynamically determined, economically optimum order quantities;
- Using an SIOP process as a management framework for effectively addressing and resolving conflicting demand/supply issues; and
- Operating an ongoing program of reverse logistics to reposition overstock.
Safety stock is a business philosophy issue – what level of product availability is to be provided? In some cases, the optimum level of customer service can be determined based on economics. In many cases, however, it is a judgment to be made by management across the complete product line.
Safety stock is minimized by:
- Determining the optimum level of customer service for each portion of the product line
- Determining safety stock quantities based on the desired customer service level on an ongoing, dynamic basis
- Reducing acquisition lead times and lead-time variability and increasing the completeness of receipts through an effective Supplier Relationship Management (SRM) program
- Maintaining accurate information on on-hand balances
Above and beyond the specific actions noted, both cycle and safety stock can be minimized by:
- Accurate forecasting of routine demand and one-time demand events.
- An effective business process for new SKU creation, forecasting and determination of initial acquisition quantity.
- An ongoing program of SKU rationalization, supported by an effective SKU discontinuation business process.
- Measuring, reporting, reviewing and continually improving inventory performance results in both financial and customer service areas.
Through management of these two core components of inventory working capital and the issues that arise because of them, costs can be reduced and shareholder value increased.
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