Supply Chain Management is a key to profitability and survival. The retail channels (online or brick and mortar) will sell things every day. The merchants responsible for product categories in those channels need to hit comp sales growth targets (comparative sales to a previous period, usually the same week or holiday promotion in the past year). They also need to hit gross margin on inventory (or revenue per square foot of floor space) targets. They will sell something, and if your product is not in stock you miss out.
Similarly, when Sua consumer makes up their mind to make a purchase they will most often choose from what is currently available. Often that consumer has an immediate need due to their current product breaking down, an upcoming event, etc. Of course, there is also emotional satisfaction in making many types of purchases, and most people do like instant gratification. If your product is out of stock, they will probably choose something else and move on. As you can see, having your product in stock is essential to top line revenue. It is easy to understand that if you have no revenue, you will have no profit.
On the other hand, too much inventory can cause many problems for a business. First of all, it is a drain on your cash flow when a significant amount of capital is tied up in inventory. In addition to the costs of the goods, there are costs associated with keeping products in a warehouse, etc. To make matters worse, in many industries products lose value over time. This can occur due to seasonality, market trends, and other reasons. Therefore, most large companies have policies in place to force a certain number of inventory turns per year (A “turn” is purchasing and selling a batch of goods. Generally, companies set goals of between 7 and 12 turns of the total inventory they carry per year).
One method of managing inventory turns is to require the dollar value of product purchased to be sold off within 60 days. If that velocity of sales is not maintained, the product needs to be liquidated at a discount. This concept of inventory “aging” can be particularly useful in businesses with life cycle pricing, such as consumer electronics and clothing. Another approach is to manage inventory dollars as a percentage of the sales forecast, to maintain only a total of 30 days of inventory (or 45 days, for an 8 turn target), and to require the majority of the inventory to be purchased to be of the fastest moving skus (stock keeping units, which is another name for a specific model with a unique UPC code). This method works better for high-dollar, slower turning merchandise. The key is to choose the proper method to ensure your inventory does not get too high.
Most companies use some sort of PSI (Purchase, Sales, Inventory) tracking system to manage their supply. Basically, you use your future sales forecast (and actuals, after the fact) to help you decide what to purchase to maintain your inventory targets. The image below is a basic PSI tracker I created in excel for illustrative purposes.
Every week, you consider your beginning on hand inventory, your expected sales and the remaining inventory based on that sales forecast. Inventory days are most often calculated based on an average of between 2 and 4 weeks of future forecasted sales. What makes this interesting and challenging is that a forecast is basically an educated guess that is less accurate the further out in time it goes, and you can’t instantly get new inventory. In fact, overseas factories often require a 120-day forecast from which you can fluctuate + / – 20%; which is not a significant margin for error four months out in time. This is why PSI is managed weekly, so you can continuously refine your near and long-term forecast based on marketplace dynamics.
The time it takes from when you place an order for more inventory, until it arrives in your warehouse is called the “Lead Time”. Most factories make their production schedules at least one week in advance, and shipping time needs to be considered as well. A typical factory in Asia, might take 2 weeks to schedule production (assuming all parts are on hand – managing parts supply at the factory is the reason the 120-day forecast is important and why it is managed to + / – 20%). Let’s assume it takes a week to produce the shipment. The shipment is then sent to port to be loaded into a container on a ship, which can take another week. Generally, it takes 2 weeks for the ship to get to a US West Coast Port (often Tacoma or Long Beach). It can take a week to get a large container ship unloaded and for everything to clear customs (provided all paperwork is in order). Then the product is transported to your warehouse(s). In this scenario, if your warehouse is near the port, your Lead Time is 5 weeks. If your warehouse is on the east coast, add 2 more weeks. Of course, not every city in Asia has ships going directly to the US, adding more time. In fact, it is not unusual to have an 8 or 10-week lead time (Consider the impact to your cash flow since you own the inventory from the time it leaves the factory. Especially since you will likely need to have multiple shipments in transit simultaneously, in addition to your on-hand inventory).
Needless to say, due to long lead times and marketplace dynamics, you will find yourself with either too much or too little inventory from time to time. However, by managing your PSI each week and carefully adjusting your purchases you can be a reliable supplier to your channel partners (or to your customers in your online store), even if you have a 10-week lead time. Here are the key things I’ve found to be essential practices when managing long lead time products:
1. Update your sales forecast and purchase plan every week, based on past results and everything you know or can anticipate about the future state of the market ecosystem. For example, if there is a big holiday selling season coming up or a competitor appears to be faltering, you might want to take some inventory risk, so you can handle the upside sales.
2. Remember that your sales forecast between now (the week you are placing the order) and when the goods arrive (ex. 10 weeks from now, or whatever your lead time is) is a forecast and not absolute reality. A lot of things can happen between now and then, and the impact to your sales can be positive or negative. The same is true for the weeks following the arrival of a particular shipment – even more uncertainty exists then because it is further out in time. Therefore, it is important to carefully manage your purchasing behavior to avoid what is known as “the bullwhip effect” (wild swings in inventory from shortage to glut and back again, caused by trying to correct an inventory problem too quickly).
3. If you have been coming in below sales forecast for a week or more (or the future sales forecast was reduced), and it appears that inventory in the arrival week will be higher than target, never buy 0 units (unless the product is going to be End of Life soon after). Always purchase at least 40% of the arrival week’s sales forecast to avoid overcompensating and thereby causing a future shortage situation.
4. If you have been over-achieving sales forecast (or it suddenly rises due to a change in the market), do not try to purchase the full shortfall in a single week. It is better to more gradually recover to avoid creating a future overstock situation (for example, over a period of 4 purchase weeks). If your company uses an “inventory aging” system to manage turns, never purchase more than 150% of the arrival week’s sales forecast to avoid having to liquidate some of that inventory if the market changes again.
5. If you are launching a product in a brick and mortar sales channel, remember it can take from 4-8 weeks for the store display units to get from the retailer’s warehouse to the store level (the retailer will be able to provide their data). Once your product is on display, it may take another 4-6 weeks before a “run rate” (average sales per store per week) is established.
6. When launching a new product, take some inventory risk in case it is more successful than your forecasting indicates. You can always gradually reduce an overstock situation, but you rarely recover lost sales from being out of stock.
Managing your purchasing habits is the key to maintaining healthy inventory levels, without severe shortages or overstock situations. Healthy inventory levels are the key to maximizing your revenue and profit. Take control of your business’ financial health by careful Supply Chain Management.
