Why Keeping More Inventory Is a Bad Idea
Three times this past week, I was told by a non-supply chain person that we should have stocked more inventory of whatever the hot product of that particular moment was.
"I knew we should have just made more of that," growled a long-time engineer.
"Why didn't we just have more on hand?" wondered a business development manager.
"Our scrap rate wouldn't matter if we kept more inventory," muttered a manufacturing director.
To which I grit my teeth and try to figure out if these pillars of industry are pulling my leg.
"Making more inventory isn't the way to solve customer supply issues," I sometimes answer, if these inventory building proponents haven't already stomped off.
Sometimes, I repeat, sometimes, building more inventory might be the solution. But I'd never admit that in public. Always, again, always, it shouldn't be the knee-jerk reaction to a missed shipment.
Here's what building more inventory can get you:
- More Product Available to Ship to Your Customers
- A Faster Lead Time When Shipping to Your Customers
- The Ability to Meet Spikes in Customer Demand
So, when you build more inventory, you have more product available to meet customer demand. In fact, in my own oversimplified definition of an optimized supply chain, one should be getting your customers what they want, when they want it, and spending as little money as possible getting that done. Holding more inventory ticks off those first two requirements:
- Get your customers what they want
- When your customers want it
But what about that last requirement:
- Spending as little money as possible getting that done
Not so much.
Those three times this past week, when the long-time engineer, the business development manager and the muttering manufacturing director each campaigned for holding more inventory, I was never tempted to capitulate.
I know what the costs are to holding more inventory are. And what the other potential landmines come with building more inventory. As if I needed another reminder of that, our finance director sent me an email between the long-time engineer's grumbling and the business development manager's exasperation.
The finance director's email read something along the lines of:
"Would you please explain why we're carrying all of this inventory that we'll never sell because the customer discontinued the product this inventory is used for?"
Thousands upon thousands of dollars spent:
- Buying the Raw Materials
- Building and Inspecting The Inventory
- Holding The Inventory
That's not accounting mumbo-jumbo money or theoretical money. That's real money that a material supplier or other provider invoiced your company for, and your company paid.
So, yes, supply chain helps you get your customer what that customer wants when your customer wants it.
But optimized supply chain focuses on the "spending as little money as possible getting that done" part of the definition.
Supply Chains Cost Money
At your company, you spend money on lots of things. Payroll, rent, insurance, and coffee for the break room. But one of the highest cost items is your inventory.
Inventory is what your company spends a good bit of its money on. And, thank goodness, because you probably need that inventory to sell to your customers. There's nothing worse than a stockout.
But those costs need to be managed, and optimized supply chain is how that's done. Any supply chain manager who's been in the job more than five minutes knows that she or he had better watch out for:
- Cost of Goods Management
- Freight and Logistics Costs
- Inventory Control
- Demand Management
Those four areas are the main reason that "keeping more inventory" is a bad idea.
Cost of Goods
Each item that you put into inventory has a cost of goods associated with it. If that cost of goods is $10 for Product X and you put 100 pieces of Product X into inventory, that costs of goods for that 100 pieces of Product X is $1,000.
If you sell Product X for $15 and you sell all 100 pieces of Product X, good for you. That $1,500 you grossed selling all pieces made it all worthwhile.
But if you sell Product X for $15 and you only sell 50 pieces of the 100 pieces you have in inventory, you've only grossed $750 while you spend $1,000. And if your customer no longer orders Product X, the 50 pieces that you have left becomes obsolete.
Finance folks and supply chain folks and management folks do not like obsolete inventory.
Freight and Logistics Costs
The more inventory you make, the more you have to move it across town or country or the oceans of the world. And then you have to warehouse it.
Even if you do sell it, those freight and logistics costs eat into your profit margin. And if you don't sell it, well, you can expect an email from your finance director.
Some companies will carry more inventory and not realize that they're carrying for more than they need. That's because they probably don't have very good inventory control.
Inventory control means that you have 100 percent certainty of what you have on hand. That's not an easy feat and requires cycle counting, physical inventories and meticulous attention to detail.
But inventory control is crucial because, even though you may not know exactly how much inventory you have on hand, you are paying for all of it.
Don't use a lack of inventory control as an excuse to hold more than you need.
What The Answer Is
As I may have mentioned, the point of an optimized supply chain is to deliver what your customers want, when your customers want it, and spend as little money as possible getting that done. Holding more inventory means spending more money. So what's the key to the optimized supply chain?
Using robust demand management will get you on your way there. Work with your customers to understand their demand and also the other factors impacting what they're going to want:
- Customer Orders
- Product End of Life (EOL)
- Competitive Landscape (For Your Customers and You)
- Expiration Dating
- Your Internal Manufacturing and Logistics Lead Times
- Pricing (Increases and Discounts)
By using robust demand management, you can build inventory to suit your customer needs, without building too much. And, yes, robust demand management is difficult, but that's why optimized supply chain is here to help.