If these two numbers are good, chances are your company is doing well—quite well, perhaps.
If either of these two KPIs is in a bad state, then there is a good likelihood that your company is doing poorly—perhaps, very poorly. And, there is also a pretty good chance that you’re on a bit of a downhill slide, too.
On the other hand, if your enterprise is like most, chances are these numbers are mediocre. ROI goes up and down a bit, typically reflective of whether you’ve been having good or bad due-date performance over the last several months.
Everybody thinks their inventory is strategic
Ask them why and how they define the strategy that underwrites their investment of $100 million in inventory, and you will almost certainly find them talking in broad generalities about how “without inventory, we just couldn’t do business.”
“Like everyone else in our industry, our supply chains (or manufacturing lead times) are just too long for us to operate as a make-to-order business,” they will say.
And, at the highest level, when painted with the broadest possible brush, these executives are 100 percent correct.
Digging a little deeper
Now, let us imagine a scenario where the inventory investment for a given firm has ranged from $880,937 to $1,263,923 over the last 24 months. This places their average inventory investment at roughly $1.1 million.
Let’s ask the CFO this question: “Since you claim your inventory investment is ‘strategic,’ by what strategy did you arrive at the determination that $1.1 million is the proper amount to be invested in your inventory—on average?”
What do you think he will say?
Here are some possible answers:
- “Well, we didn’t actually arrive at that number by any strategic calculation. That’s just what it happens to be, and we seem to be doing okay.”
- “Actually, we believe the strategically correct investment in inventory should be closer to $750,000, but we can’t seem to get there without suffering huge losses in due-date performance.”
- “Uh. We don’t actually have a strategy by which to calculate the amount of money we should have tied up in inventory; we just know that some level of investment in inventory is necessary for our business to survive.”
Here’s the next test: ask the CEO the same question in the same company. What are the odds, do you think, of his or her giving the same answer as the CFO you just questioned?
Did I hear you say, “Almost zero”?
Okay. Let’s give these executives the benefit of the doubt. We will assume that they actually have some rational answer about their gross inventory average value. They have actually put some thought into the question and they are trying to manage to a strategic inventory value.
Now, let us imagine that we ask them this:
We note that you have had, on average, $D invested in Product 501P over the last 24 months. For the most part, that investment has been pretty steady—not varying by more than seven to ten percent. Tell us: how did you determine that the strategically correct investment in 501P for your inventory was $D?
Be honest with me: what do you think the response will be?
I am betting that in more than 95 percent of companies, no one in the organization will be able to tell us by what strategy they arrived at the $D they presently have invested in Product 501P.
There is a high likelihood that someone picked a quantity at some time in the past and that quantity became the basis for incremental adjustments ever since.
Note that I said someone picked a quantity—not a dollar value. Furthermore, I would be almost certain that the number of dollars invested in that quantity was not strategically balanced against the costs or benefits of carrying that inventory.
If you are picking quantities for inventory with consideration of the dollar-impact of that investment, then I can almost certainly assure you that your investment in the resulting inventory has not strategy behind. There are only the tactics of trying to see to the immediate impacts of day-to-day operations.
We believe that the leading cause for lack of strategic inventory analyses is the lack of good data to support sound strategic decisions about inventory.
Essential data for any strategic inventory calculations
In order to start getting strategic about inventory, certain information must be known (with reasonable accuracy) about your SKUs:
- Average daily usage (actual demand)
- Lead time
- Demand variability
- Supply variability
- Minimum order quantities and multiples, if any
- Relationships between SKUs (e.g., bills of material, kit assembly requirements, product affinities)
- Unit cost
- Customer tolerance time
Inventory is only strategic when it does all three of the following things:
- Absorbs variability (demand, supply or both)
- Decouples lead times
- Provides real (calculable) ROI
We talk more about make your inventory truly strategic in our next article. Stay tuned.
In the meantime, leave your comments here. How would your CEO, CFO and supply chain managers answer the questions we posed above?