Why are inventories increasing?

The risks in your organisation’s supply network can be reduced in two ways. At the strategic level, supply chains and operational processes can be changed, but to achieve this outcome takes time. The more likely approach is for Logisticians to manage capacity and inventory.

However, in the era of globalisation, the opportunity to manage capacity has decreased. Trade volumes have been influenced by the growth in intra-industry and intra-company movements. Examples are: companies in a country that export high value products and import of lower value products; the import and export of items into countries at different levels of completion and the specialising within a country of a product niche, based on comparative advantage, such as low cost assembly labour or high value R&D skills.

Specialisation in particular items across countries can improve the organisation’s utilisation of assets. This, together with increased levels of outsourcing, reduces the flexibility in capacity planning. To absorb variability and volatility in the demand and supply of items, requires a focus on managing inventory.

Allied with the intra-industry and intra-company cross-border movements, is the increase in stock keeping units (SKUs) in the FMCG (fast moving consumer goods) and CPG (consumer packaged goods) categories. An examples is beverages, with new products such as coconut water and craft beers, plus flavour and packaging extensions of existing product lines. Even though some businesses are attempting to reduce the number of SKUs they carry, the general trend is for an increase, which means increased Uncertainty in supply chains (comprising complexity, variability and constraints).

Together, cross-border movements and increased SKUs can increase your inventories, putting pressure on Logistics to decrease inventory investment:

• Product lines and individual SKUs: the more items = more cycle stock
• Outsourcing: more trade lanes and volatility
  • Nodes in supply chains: more nodes = more inventory
  • Longer trade lanes = more in-transit inventory and safety stock
• Demand shaping programs – more promotions and price specials = more inventory
• Process velocity: longer lead times = more inventory
• Process reliability: more variability = more safety stock
• Demand volatility: more volatility = more safety stock
• Supply volatility: hold ‘safety stock’ inventory of dependent items in the Bill of Material (BOM)

An additional challenge for Logisticians is Demand Amplification through supply chains. This states that a small change in demand at a point in a supply chain can cause a substantial change in upstream demands; due to factors of: demand forecasts; order batching; price fluctuations and rationing. Demand Amplification was discussed in my blog entitled ‘Demand is amplified as it goes through supply chains’ 

Demand management and managing inventories

To better understand the true demand for items and product lines sold by your organisation, implement Demand Management. This approach integrates three techniques:

1. Demand Sensing: analysing the data generated within each sales channel to identify consumer buying trends. As technologies and software are developed, data gathering will be extended from scanned barcode data captured at the point of sale (POS) to include, for example, social media inputs, monthly government statistics and weather bureau data. This is called ‘outside-in’ sensing as opposed to the more common ‘inside-out’ approach of defining demand based only on internal information and judgement
2. Demand Shaping: the promotions designed to increase customer and consumer demand for products. Promotions include: new product releases, current product upgrades, product promotions, price reductions, commercial buyer (or trade) incentives and sales force incentives. Uncoordinated promotions increase uncertainty through the supply chains
3. Demand Planning: builds demand (sales) forecasts from Demand Sensing and Demand Shaping inputs. In addition, Demand Planning incorporates capacity and inventory plans, to establish the best estimate of market demand and profitability for the products on offer. As discussed, limits on capacity flexibility means that inventory management becomes critical. Demand Planning enables improved decisions concerning the form and function of inventory at nodes (locations) in your core supply chains and a better understanding of inventory holdings in the extended supply chains

The ‘inside-out’ approach to forecasting and inventories typically uses the variability of historical demand for products that a company offers. Current inventory planning applications tend to rely on historical data as the basis for recommending future order quantities; Inventory Planners can then accept or alter these recommendations. This is done using their own judgement about future uncertainties and potential disruptions in the supply of items.

But, how good are Logistics professionals at managing inventory within a Demand Management setting? This question is asked, given what appears (from on-line searches) to be minimal learning and training available in university and vocational courses. An article in the Deloitte Review, titled The answer is 9,142 provided an indication of inventory planning capability by logistics professionals and students.

The question for participants was to identify how many units of inventory should be ordered when faced with a possible disruption in supply. The report stated that “Virtually everyone (99.7 percent of subjects) responded sub-optimally, overreacting to low probabilities of disruption and under-reacting to high probabilities. Approximately 15 percent of the individuals in our study responded irrationally, reducing orders in response to potential supply disruptions instead of increasing them. Fully one-third of our subjects altered inventory recommendations for no apparent reason”.

But, are these results really surprising? Behavioural research studies indicate that people frequently make poor choices when faced with uncertainty, so why should Logisticians be any different? The overriding threat to an inventory planner is the loss of their credibility associated with having a medium or low selling item ‘ out of stock’ and the company losing sales. Making a ‘just in case’ upward adjustment to inventory appears to be a reasoned response.  High volume items are less likely to be affected, due to their relatively high inventory levels that are accepted by management, due to their incorrect assumption that high inventories are compatible with high volumes.

The situation concerning the number of items and variable demand is unlikely to change, therefore the pressure on Logisticians will increase. To improve the inventory situation, Logisticians can:

• Implement a risk management regime that incorporates the assessment of high and low risk probabilities and likely impacts and consequences across the organisation’s supply chains. This will identify the inventory risks
• Review the inventory planning processes concerning the role and capabilities of software applications and planners. Identify the scope of acceptable changes to software application suggestions
• Identify training programs in inventory management. Be careful of buying the course if EOQ is identified as a major inventory planning model
• Be aware of developments in software applications and the incorporation of artificial intelligence that may improve decision making in inventory planning