Inventory is low hanging fruit for most turnarounds. After eradicating obsolete and slow moving inventory, the company needs to determine the right product mix that preserves a strong balance sheet while servicing customer demands. Without spending capital on 3rd party software that takes months to implement, executive leadership should consider ‘min / max’.
How does your portfolio company prevent inventory stock outs?
Companies that rely on ‘tribal knowledge’ to prevent inventory stock outs from occurring should re-consider how they monitor and control inventory levels. A sound, mathematical approach to inventory will not only justify the required inventory levels to business leaders, but also balance conflicting goals of maximizing customer service and minimizing inventory cost. Many factors impact how inventory is managed including seasonality, customer demands and lead times. Developing a robust systematic approach that key stakeholders agree upon is essential.
Min Max Approach
There are different systematic ways to approach inventory including weeks-of-supply (WOS), make-to-order (MTO), finish-to-order (FTO) production environment. However, these are suited for customers willing to accept longer lead times. An alternative way that has proven to be successful leverages historical data and customer service levels to calculate minimum (min) and maximum (max) inventory levels. Min or ‘reorder point’ represents the level of inventory at which a replenishment order is triggered. This value is the total sum of Safety Stock and Cycle Stock consumed during the acquisition lead time. Max or ‘reorder quantity’ is the recommended quantity when a reorder is triggered. In manufacturing, this approach balances changeover cost and inventory carrying cost. Depending on the desired service level, these values are pushed through to purchasing so that the company will have raw materials available without holding up production.
What is Cycle Stock & Safety Stock?
Cycle Stock is the amount of inventory a business needs to meet customer demand between receipt of more inventory from suppliers. A company goes through its cycle stock inventory as it sells products and restocks inventory. Safety Stock calculates inventory held as a buffer variation in demand, supply, and unforeseen emergencies. In other words, safety stock is used to mitigate stock outs. Cycle stock and safety stock enable a company to maintain targeted service levels at the least possible cost despite unpredictable variations in demand and supply. For example, 98% service level would result in fewer stock outs but require significantly more safety stock. Creating a balance between inventory costs and customer service is essential. By using min max methods, companies can find cycle stock and safety stock levels to achieve a desired customer service level.
One key component to a successful portfolio company is the ability to service customers by having the right products at the right time. ‘Min Max’ is an effective way to mitigate demand uncertainty and lead time variability while still providing high service levels to customers. Before proceeding with a plan, key stakeholders must understand how to determine appropriate levels of safety stock and what degree of protection they provide. Having a systematic approach and steering clear of ‘tribal knowledge’ can free up cashflow and improve EBITDA.
Contact Jeff Vogelsang @ (312) 925-9972 firstname.lastname@example.org for more information on how to implement a min max program.