While companies perform well in terms of the financial aspects of working capital requirements (WCR) management (accounts receivable and accounts payable), the reduction of inventory still remains a major issue of economic performance in terms of maximizing cash flow.
Context and challenges
What is the reduction target? Which levers should be used to reduce inventory? We propose an original and efficient approach to help you overcome this challenge.
In addition to their impact on WCR and cash flow, high inventory levels entail multiple costs, such as the cost of destroying obsolete products (out-of-date product configuration, expired shelf-life, etc.) and the physical costs of holding stock (warehouse storage, securing inventory, etc.). Paradoxically, excess inventory is also often synonymous with poor customer service: the products in stock are unsuitable, poorly configured, not in the right location, or the quantity is wrong, etc.
Sectoral developments naturally tend to accentuate this phenomenon, due to the increasing demands of customers in terms of service, abundance of supply, increasing market (and hence product) specificity, and volatility of demand. All this despite the fact shareholders’ demands in terms of cash have risen significantly since the financial crisis.
Imposed by shareholders and/or top management, pressure on WCR drives companies to adopt inventory reduction initiatives, which vary in terms of ambition and aim.
For various reasons, these initiatives are not always successful: unrealistic ambitions, insufficient mobilization of resources, action plans that fall apart over time, and so on.
Implementing a policy of reducing inventory is something that cannot be improvised. The policy’s success depends on certain crucial factors:
- Implementing the project with the support of the company’s top management, which must set an ambitious but realistic pace for achieving the objectives
- Drawing up a roadmap that mobilizes all of the stakeholders, using a normative approach
- Exploring all of the levers, both upstream and downstream, by adopting a collaborative approach within the company: Supply Chain, Manufacturing, Procurement, Sales, and even R&D and Marketing
- Establishing sustainable inventory performance management, to be incorporated into the company’s management routines.
There is generally a great deal at stake: a 15-30% inventory reduction, not to mention collateral benefits (customer service levels, etc.), which may also be significant.
The first and primary task is to identify the potential for reducing inventory and the key levers to achieve these goals.
Only then will the next phase begin, in which the company focuses its efforts on meeting its inventory reduction targets in a rapid and sustainable manner - a whole other challenge!
This is mainly because - beyond identified quick wins, which often represent 10-20% of the overall inventory reduction challenge - extensive work has to be undertaken to optimize the business processes and information systems involved.
How can Argon Consulting help you?
Argon has developed a “normative” approach that has proven very effective for identifying and prioritizing the issues at hand. Based on the notion that inventory is a necessary evil, we establish the inventory model as it should be in the context of the company’s commercial and industrial operations (in terms of quantity, value, and according to location - factories, distribution centers, and affiliates).
The approach distinguishes various inventory components including, but not limited to, the following:
- Safety stock to maintain sales in spite of incorrect sales forecasts, non-performing suppliers, or non-performing production facilities
- Stock resulting from production or procurement campaigns (limited flexibility of factories or suppliers)
- Anticipation stock for various reasons (little upstream flexibility, the seasonal nature of downstream sales, speculative stock, and strategic stock)
- Stock resulting from upstream or downstream logistics (products in transit linked to transportation and administrative timeframes, and rolling stock due to dispatch frequency)
- Work in progress (WIP) directly linked to established manufacturing cycles.
It is important to note that this approach applies to both the make-to-order and make-to-stock industries. However, the various inventory components included in the analysis are different.
The advantage of this approach is that it demonstrates, contrary to popular belief, that inventory management is modeled in a mathematical manner on the basis of an analysis of the company’s historical data and a thorough understanding of its constraints.
This approach provides a realistic vision of ideal inventory levels and a basis for identifying initial short-term initiatives, in particular by focusing on the starkest discrepancies between the inventory in books and actual physical stock; these are high-impact initiatives that focus 20-80 on items showing significant discrepancies as compared with the book inventory. For example, adjusting the levels set for safety stock of finished products in the network can be achieved very quickly, with very short-term implications.