In this discussion, we review those critical activities in managing inventory.  We help you decouple the terms and recognize the magnitude of work needed to effectively manage the inventory you invest in.

Theory of Constraints

Businesses today are struggling under the pressure of cash/credit constraints.  Optimizing this constraint will help the business deliver optimal performance.  The science of constraint management is defined by the Theory of Constraints, by Eilyahu Goldratt, who defined that organizations can be measured and controlled by variations on three measures:

  1. Inventory: Defined as the firm’s usage of working capital for goods that they sell.
  2. Operational Expenses: Defined as the firm’s investment in selling the inventory they purchased.
  3. Throughput: Results from the rate of inventory sell through to generate working capital to support the prior defined processes.

Sustaining a firm’s mission (i.e. for profit or non-profit) will be accomplished by managing at least one constraint (e.g. people, policy, culture, equipment, etc.) that is critical to the business performance.  In managing this constraint, the firm will balance the three defined variables to successfully achieve their objective.

To manage a constraint, the theory goes on to explain the use of buffers to “stock pile” products/services to minimize the affect of a constraint.  To optimize the capital performance of a business, therefore, the team must minimize the impact of a constraint.  In terms of inventory, one must invest in inventory that delivers the greatest profit to drive growth.

Inventory Terms 

    1. Inventory Control: The act of physically counting and ensuring the stock ledger and physical values match.  Site controls and physical asset control fall under this term.  Terms such as absolute variance (difference between count and stock ledger regardless of + or -) and shrink are important focus areas.
      1. Stock Take Policies (Annual and Cycle)
      2. Maintaining a Perpetual Inventory System (ERP)
      3. Purchasing Procedures/Triggers (e.g. Kanban)
      4. Stock-Out Management
      5. Dead Stock Management
      6. Age Management
      7. Inventory Stocking Policies and Controls
    2. Inventory Planning: The act of consuming a future demand forecast, the current stock ledger, and lead times to determine when and where to buy goods.  Processes like S&OP fall into this category of tasks.  Terms like Weeks of Supply (WOS), Inventory Turns, and Capital Asset Utilization are often used to manage performance.

      1. Inventory Planning
      2. ABC Classification/Prioritization
      3. Age Reserve Planning
      4. Safety Stock Planning
      5. Supply/Demand Planning
    3. Inventory Management: This is the collective process which incorporates the two processes defined above and ensures the business has what it needs when it needs it.  This process looks across the entire supply chain and defines the right strategy to position inventory where needed to optimize the selling opportunities and reduce the operating cost to serve your customers.
      1. Strategic Stocking Levels
      2. Integrated Business Planning
      3. Inventory Optimization
      4. Strategic Sourcing
      5. Sales & Operations Planning
      6. Inventory Carrying Cost Strategy

    Inventory Indicators

    As one assesses the strength of the inventory management approach, there are critical tiers of inventory that provide insight into how well you have been.  Keeping these types of inventory to a minimum will ensure that you generate maximum long-term profitability and growth.  Effective inventory management requires leaders that are bold and willing to take the right action to remove unproductive burden from the stock ledger.

    1. Avoid Spoilage: Product that cannot be consumed because it will harm the customer.
    2. Avoid Dead Stock: Product that is no longer demanded and is waiting for a “wild hair” customer to purchase.
    3. Manage Aging Stock: Product aging provides an indicator when the current pricing is no longer attractive to your customer.  By providing an aged based price reduction, you entice customer purchasing where the current price does not get it done.
    4. Reduce Unproductive Cash Usage: Look for creative ways to manage inventory where you do not need to carry the burden of the inventory you are selling.  This can be accomplished in several ways.
      1. Drop Shipping: The process where the vendor ships directly to your customer on your behalf.
      2. Consigned Inventory: The process where your suppliers maintains ownership of your goods and does not charge you until they are consumed by your customer.
      3. Cross Dock: The process where inventory arrives at your facility ready for customer delivery and you literally move it from an inbound trailer to an outbound trailer with minimal handling or cost.

Make sure your team is focused on delivering an end inventory strategy that manages those items that detract investment to items that can drive growth.

Are you Managing Your Inventory or Maintaining It?

Delivering optimal performance requires you to have a strategy defining your customer, their requirements, and delivering a distribution strategy to minimize your cost to service them.  Minimizing the inventory, you carry in servicing their needs helps free up working capital to drive growth. 

The final inventory strategy is best defined by starting from the customer and working backward.  Making sure you are solving the real problem versus the perceived internally defined problem is critical to delivering on your customers needs/desires.  Teams should take the time to ensure they listen to the “voice of the customer” and deliver strategies that add value to the experience.

Are you managing your inventory and controlling it?  Is inventory a constraint and considered as part of the strategy development?  Answering these questions will help you determine if your inventory approach is a strategy enabler or a control enabler.

More Resources
Article: Understand the Value of Inventory Management
Video: Creation Competitive Advantage

About the Author
Scott Moon
Scott Moon