How efficient and accurate inventory management allows a company to reduce its amount of stock?
With the increasing diversity of the products commercialised by the various industries. For example, food retail or the manufacturing industry, inventory management has taken a core role for an organization’s success. Only an efficient and accurate inventory management allows a company to reduce its amount of stock – thus minimising the necessary investment and the risk of obsolescence and/or deterioration (spoilage) – without jeopardizing the customer service level.
To better clarify the impact of inventory management in these dimensions, it is necessary to explain the diverse relations of cause-consequence in this area, using food retail as an example to illustrate them. It is also fundamental to describe the most present concepts in inventory management, namely, the time intervals used in this area (lead time and review time) and the safety stock.
Stock-out and overstocking consequences
In general, inventory management tries to find the optimal quantity of stock for an efficient process. If the stock in a store diminishes, there is a greater risk of generating a stock-out, which means the store will have no stock, which leads to a loss of sales. Besides, even if a stock-out doesn’t occur, the product may have a stock level low enough so that there’s lack of visibility in the presentation space. This lack of notoriety can equally induce a loss of sales. On the other hand, if the stock in store increases, for the inverse motives, there’s potential for a sales growth. However, there’s also a greater risk of spoilage, since the higher level of stock in the store creates a higher probability of the products expiring before being bought. These products cause a financial loss to the company since they will no longer be sold.
Review and lead time in inventory management
Although there are several inventory management methods, all of them have in common the definition of the moments in which stock is ordered, as well as the quantity to be ordered. Related to the moments in which the stock review and order (if one is necessary) are executed, the time interval that measures two consecutive stock reviews is called review time. After placing an order with a supplier, he takes a certain amount of time to deliver the order. This time interval is called lead time. To ensure that the store doesn’t incur in a stock-out but also doesn’t have stock excess, the ideal would be to guarantee that the quantity received in a certain order is equal to the one to be consumed in the period until the arrival of the next order. To achieve it, the store should, in the ordering moment, compare its stock level with the one corresponding to the protection period (review time + lead time), and then order the difference between the two stock levels. The stock level corresponding to the demand in the protection period is called cycle stock.
As one can deduce, to know the stock level which will be consumed during a review time and a lead time, it would be necessary to know the demand in this period. Given that this quantity is not known a priori, it is necessary to use demand forecasts to better estimate this value. These forecasts are always associated with a forecast error, this is, the real demand may be lower or higher than the one predicted. If the demand is higher than the forecast, the risk of stock-out is aggravated. To preclude this hypothesis, an extra stock quantity is used in the store to reduce the probability of stock-out due to forecasting errors. This stock is called safety stock. The size of the safety stock depends, naturally, on the forecasting error associated with a certain product. The larger the error, the greater the safety stock necessary to assure a certain customer service level. Other constraints of the replenishment process may lead to higher safety stocks (ex: low supplier service level).
As a conclusion, it can be said that the inventory management theme, on the one hand, is structured in a company’s management, since it can have a huge impact on its success potential, and, on the other hand, is covered with a vast complexity, either by the necessity of different data (lead time of upstream processes, review time, presentation stocks, …), as well as by the necessary integration with demand forecasting. Given the clear difficulty of implementing an inventory management method in a company, the big challenge in this area is to be able to improve simultaneously the three key performance indicators: stock level, spoilage and customer service level.