Two weeks ago I wrote a LinkedIn article about clearing obsolete and slow moving stock before deciding on the need for a bigger warehouse. But inventory that does move, is also worth a closer look. When comparing to my freezer at home, this concerns the “ice cream” in your warehouse. I definitely want to have ice cream in my freezer, but do I need all of these flavours in large quantities? The same goes for your warehouse. Is it necessary to keep your full range of products in stock? Or can you delete a “flavour” from your product assortment or offer it with a delay?
Two important aspects to make the decision whether or not to keep an item in stock, are its demand pattern and the delivery time that your customer is willing to accept
Two important aspects to make the decision whether or not to keep an item in stock, are its demand pattern and the delivery time that your customer is willing to accept. If you have little demand for a product and demand is also very irregular, let’s say only a few orders per year, it is very difficult to always have the right quantities in stock. Don’t you sometimes have the feeling that customers order deliberately one piece more than what you decided to keep in stock? If the customer is willing to wait for the time you need to produce or purchase, you may consider not to keep stock at all. For these products you could apply a make-to-order strategy, so you only produce or buy when there is an order.
Also important to take into account in this decision is the trade-off between inventory costs on the one hand and ordering or set-up costs on the other hand. If you are paying high transport costs for products with a low value, it might be interesting to keep a small amount of stock instead of having to pay for transport cost for every single order, certainly if your customer is not willing to pay for these extra costs.
It is important to make this trade-off for each product in your assortment and it is perfectly possible of course to have a mix of products on stock or not on stock. This decision is certainly not a static one. In general, my recommendation would be to perform this analysis once or twice a year. However, depending on your industry and the speed of changes in market demand, it may make sense to re-evaluate on a shorter time frame.
If you are confronted with limited stock capacity, it is certainly advisable to take a closer look at order sizes
When you have decided which items to keep in stock, you also have to determine how many. What is my ordering strategy? How many will I produce at the same time? If you are confronted with limited stock capacity, it is certainly advisable to take a closer look at order sizes. After all, larger lot sizes are often applied to avoid set-up costs or to limit the number of orders to a supplier. As a rule of thumb, average inventory = safety stock + half of the lot size.
The graph below shows a simulation for a demand pattern varying between 0 and 40 and a safety stock of 20. Order size is the only difference between the two graphs (50 versus 100). Theoretically, average inventory would be 70 = (20 + 100/2) for a lot size of 100 and 45 = (20 + 50/2) when lot sized is reduced to 50. The simulation pretty much confirms this theory with average inventory of 72 and 44. In this example, average inventory was reduced by almost 40% by reducing lot sizes.
Therefore it is certainly worth checking whether we can order from our supplier in smaller quantities. Often this is possible whilst maintaining the same purchase price. For production items, we should evaluate set-up costs on our production line. For those items of which change-over costs are limited, lowering lot sizes could have an important impact on inventory and thus on required warehouse capacity.
Did you like this article? Would you like to discuss whether and how these ideas could apply to your company? Then please contact me at firstname.lastname@example.org and I will be happy to explore this topic further with you.