CHAPTER 6 WAYS TO LOWER INVENTORY COSTS

Objectives:

Learn different ways to lower inventory cost.

Identify whether it is useful or not.
Understand about the future on inventory management control.

25 Ways to Lower Inventory Costs:

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.
MODULE INVENTORY MANAGEMENT AND CONTROL

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-

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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:

o Those with selling prices that create positive gross margin

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

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MODULE INVENTORY MANAGEMENT AND CONTROL

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.

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MODULE INVENTORY MANAGEMENT AND CONTROL

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.

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MODULE INVENTORY MANAGEMENT AND CONTROL

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.

THE FUTURE OF INVENTORY MANAGEMENT AND CONTROL

The advent, through altruism or legislation, of environmental management has added a new
dimension to inventory management-reverse supply chain logistics. Environmental management
has expanded the number of inventory types that firms have to coordinate. In addition to raw
materials, work-in-process, finished goods, and MRO goods, firms now have to deal with post
consumer items such as scrap, returned goods, reusable or recyclable containers, and any
number of items that require repair, reuse, recycling, or secondary use in another product.
Retailers have the same type problems dealing with inventory that has been returned due to
defective material or manufacture, poor fit, finish, or color, or outright "I changed my mind"
responses from customers.

Finally, supply chain management has had a considerable impact on inventory management.
Instead of managing one's inventory to maximize profit and minimize cost for the individual firm,
today's firm has to make inventory decisions that benefit the entire supply chain.

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MODULE INVENTORY MANAGEMENT AND CONTROL

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