Inventory Optimisation
Inventory optimisation is the art of balancing service level goals with inventory investment constraints over a large range of stock keeping units (SKUs). This is done by forecasting demand and managing supply variables, whilst dynamically adjusting stock rules and inventory parameters. Inventory optimisation techniques allow businesses to ensure product availability, while reducing inventory costs and minimising the risk of excess stock.
Put simply, inventory optimisation is a way of ensuring the right supply of inventory to meet your target service levels, while tying up a minimum amount of capital. To achieve this, you need to account for volatility of both supply and demand variables.
Don’t confuse inventory optimisation with basic inventory management. Whilst inventory management involves ordering, managing, storing and moving inventory, inventory optimisation focuses on ordering the right products, in the right quantities to meet demand – as cost-effectively as possible.
Optimising your inventory will make you more competitive
Digitalization, globalisation and security threats are just a few of the macro trends that are affecting suppliers worldwide. In addition, consumer behaviors and habits are changing more rapidly than anyone thought possible, while new technology is making it easier than ever to source cheaper and better products from all over the world. As a consequence, businesses are faced with complex supply chains and a new threat around every corner.
To manage these turbulent times, businesses need comprehensive IT systems to automate processes and improve efficiency. Many large businesses, like Amazon, Walmart and Tesco are already on this journey, with advanced supply chain systems that allow them to source products from all over the world and deliver in record time.
The advantages of inventory optimisation
Unfortunately many businesses are still playing catch up when it comes to system automation – especially inventory optimisation solutions. Those with enterprise resource planning (ERP) or warehouse management systems (WMS) are one step ahead, with advanced capabilities to manage their stock. But even these companies will struggle to forecast accurately or calculate optimum order quantities, safety stock levels and reorder points, often resorting to spreadsheets to carry out these tasks.
A lack of inventory optimisation solutions can have substantial consequences across your entire business. For example, inaccurate demand forecasting can lead to stockouts and missed sales opportunities, estimated replenishment can result in capital being tied up in excess stock and manual order processing is inefficient and resource intensive.
By optimising your inventory you can determine exactly how much stock to order and when to order it, so you’re always able to serve your customers. You’ll consider demand variables, such as seasonality and campaigns, as well as supplier lead times and schedules. This way you’ll always have the right products in the right warehouse to fulfil demand, without tying up too much capital in inventory.
Inventory optimisation techniques
There are three key inventory optimisation techniques:
1. Demand forecasting
2. Inventory policy
3. Replenishment
Let’s discuss each in turn and link to resources that will give you more details:
1. Demand forecasting
When it comes to demand forecasting, some businesses will simply ask their sales team or copy last year’s numbers. Whilst this can work for items with steady, predictable demand, these methods can be entirely inadequate when demand gets more uncertain. Here’s why:
Every product has a lifecycle. For example, when a product is first introduced to the market it will have no historical demand at all. Then it will likely move into to a positive trend as demand constantly grows, until it becomes a stable and fast moving good. From there, demand might get more irregular and then move into a negative trend before becoming a dying and then obsolete product.
In order to ensure demand forecasting accuracy you need to keep track of where each SKU sits in the product lifecycle.
Demand forecasting also needs to consider seasonality. It’s important to know when you’ll get seasonal peaks and troughs in demand, so you don’t miss out on extra sales or be left with excess stock at the end of a season. Identifying seasonal demandis key for forecasting accuracy. For example, there’s no point forecasting demand for a product that only sells in the summer (e.g sunscreen) based on the previous quarter’s sales.
2. Inventory policy
The next step is to set your inventory policy, which means determining which products to stock and how much to keep of each unit.
ABC analysis is a common method of inventory classification. This is where you classify your inventory into A, B and C classes depending on their annual consumption value. You can read all about ABC analysis in our blog post. ABC analysis helps you to determine which items to stock and which items can be ordered on demand.
Part of setting your inventory policy involves establishing sufficient safety stock levels. With the right amount of safety stock you can cover sudden demand peaks, supplier disruptions or other unforeseen happenings. You can read more about safety stock calculations here.
Finally, if you have more than one warehouse, it doesn’t matter how well you optimise your inventory levels, if you store these items in the wrong locations, you’re missing a trick. Multi-location inventory optimisation is about distributing your inventory across your warehouses, in the right quantities at the right times. You can then move items from regions where demand is low, to those where it’s higher. Products are then available to ship to local customers as quickly and cost effectively as possible.
3. Replenishment
Last but certainly not least is stock replenishment. This involves calculating accurate reorder points and cost-effective order quantities and turning them into actual orders.
To help optimise your purchasing activity you should always consider:
a. Supplier reliability: Supplier lead times have a big effect on stock availability and service levels. For example, the Chinese New Year, when many Chinese manufacturers shut down production, often causes big supply disruptions for many western distributors because they fail to account for it in their replenishment planning. Knowing the lead times and production cycles for every SKU and its supplier is critical to effective replenishment.
b. Goods in transit: When setting accurate reorder quantities, it’s not enough to simply know what you currently have in stock. For a complete overview of your stock levels, you also need to know what’s on the way to your warehouse from your suppliers. This may seem obvious, but most ERPs and other systems don’t have this information available in a way that’s easy to retrieve.
