Manufacturers Need To Manage Inventories in a Changing Economy

[DHowardell]

During the current economic downturn many manufacturing and distribution companies are discovering that a small drop in sales can result in a much larger drop in inventory turns. As planners, buyers and managers whose performance is often measured by inventory turns, we need to understand why this happens and what we can do to avoid it.

First, most companies will admit that they had too much inventory to begin with and that they din’t react to changes quickly enough. But even when we do react well to a drop in demand, our systems are typically using the same replenishment parameters that they were programmed with months or even years before.

Using one popular measure of inventory performance, IQR, confirms this fact. The IQR for most of the over 400 companies we have surveyed is in the 30% to 45% range. The Inventory Quality Ratio is the ratio of the active inventory dollars to total inventory dollars. In a theoretically perfect situation (i.e., with no excess, slow moving or no moving inventories), the IQR would be 100%. So an IQR in the range revealed in the survey means that approximately 60% of inventory dollars are tied up in excess, slow or no moving items.

The major reasons that inventories go up in a down economy are:
• Our inventory systems and metrics, like turns and Days Inventory Outstanding, are backward looking.
• Our ABC classifications are out of date.
• Our order quantities and safety stock levels are based on past usage.
• We are still planning part quantities rather than managing inventory dollars.

To manage inventories effectively – in any economy, but particularly with changing demand – we need systems that are dynamically demand driven and that provide a dollar focus. Forward-looking demand-driven ABC classifications are needed to revise our order quantities and safety stock levels. Most importantly, we need to focus on the value of the inventory so that planners and buyers can be more effective in choosing the most important issues to work on first. Since we have limited time to work the issues, we need to make it easy to identify the ones with the biggest dollar returns.

Here again, many companies have found IQR helpful. The Inventory Quality Ratio methodology provides an effective way to manage inventory dollars and improve inventory performance. The IQR technique and tools help; to prioritize improvement opportunities, to set meaningful inventory targets, and to revise safety stocks and order quantities consistent with current demand, all of which make the planners’ and buyers’ jobs easier.

Whatever tools we use, in any economy we can do a better job of managing inventory levels and working capital by using demand-driven inventory logic and having a dollar focus. This will allow us to respond more quickly and effectively in dealing with the inevitable changes in demand for raw materials, purchased parts and our finished goods.