10 Commandments of Inventory Management

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10 Commandments of Inventory Management

Inventory management is one of the most important tasks for supply
chain management professionals. However, most inventory control
theories are too complicated or too difficult to apply to real world
situations. Then, this article will show you 10 simple principles that you
can use to streamline your inventory management practices right
away.

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1) Utilize cross-functional team

If you're an inventory controller and you choose to stay in your cubicle for the whole day, it's the
indication that your inventory management practice is a bit falling behind. The reason is that
most people now realize the value of planning practice like Sales and Operations Planning
(S&OP). Inside nutshell, S&OP is different from a Production Meeting in the way that S&OP
focuses on the synergy of cross functional team instead of the separate meetings by each
department. It follows 4-step process as described below,

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(1) Forecaster develops a baseline forecast using statistical methods

(2) Forecast is then adjusted by the sales team to reflect a promotion plan, new product
introduction, special events, current market and economic conditions and so on.
(3) Adjusted forecast is passed to the manufacturing and supply planning team to resolve
potential issues
(4) A meeting among the cross-functional team is arranged to resolve the demand/supply
imbalance and everyone agrees upon the plan
As you can see, S&OP enables an inventory planner to incorporate various factors that
enhance the efficiency of "classic" inventory control theories.
2) Use simple forecasting model
Most inventory management and operations management textbooks tell people to choose a
forecasting model that produces the lowest forecast errors. Then, many people think
sophisticated forecasting models will do a better job. Believe it or not, many fancy forecasting
methods have not been tested extensively in the real-world situations. For example, BoxJenkins model was recently outperformed by a simple forecasting method.
Another thing to consider is that, sophisticated forecasting model only provides the excuse for a
forecaster when the forecast goes wrong. So sticking to simple methods always yield better
results.
3) Forecast at the right level
Standard inventory management textbooks suggested that forecast be done at a product family
level. The reason is that the aggregation of items help to improve the forecast accuracy (it's
referred to as "Law of Large Number or Risk Pooling).
However, modern supply chain management concept encourages information sharing and POS
data has become the gold standard for inter-company demand sharing (but company still
shares demand to trading partners selectively). Then, general guidelines for level of forecast
can be found as below,
- If your customer doesn't share demand forecast with you, use your own historical data to
make a forecast at SKU level
- If you get POS data from customers, use it to make forecast at SKU/store level.
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4) Combine Multiple Methods

Sometime you have multiple sources of forecast data (your own forecast from historical data,
forecast adjusted by sales team, forecast from customer) what you should do in this case?
Some scientific paper suggested you average the forecast from multiple methods/experts
because it can lead to improved forecasting accuracy.
5) Handle unstable time series
In case a time series is very unstable, reducing weight of smoothing constant of the most recent
period (damp trend forecast) will help to reduce the errors because data from the most recent
period may not be very reliable.
6) Obtain reasons for forecast adjustment
A sales team tend to make a forecast adjustment without adequate market information. Asking
for the reasons for forecast adjustment will hold them accountable and a higher level of
accuracy can be improved drastically. However, general guidelines for a forecast adjustment
are as below,
- If demand pattern is pretty stable, forecast adjustment by sales team should be avoided
- Big adjustment is more accurate than small adjustment
- Downward adjustment is more accurate than upward adjustment
7) Measure forecast errors the right way
Many people who adopt S&OP strongly believe that measuring the forecast error is not
necessary because forecast is already validated by human (this is a false perception). The
most appropriate way is to measure the errors of the adjusted forecast, not the forecast from
statistical model. This approach will help you to determine if S&OP meeting help to improve
accuracy or not.
8) Go beyond unit cost
In supplier selection/negotiation process, the first priority for most buyers is to find cheap
suppliers (and other selection criteria are usually ignored). And you know well, cheap suppliers
always make the delayed delivery. To handle this "business as usual" situation, inventory
controllers add the extra lead-time (safety time) into inventory control formula. Would it be nicer
if we don't have to deal with this kind of supplier at all?
Cost of Quality (COQ) is a concept originated in quality management area with the goal to
identify hidden costs associated with manufacturing and delivery of service. COQ consists of 4
elements as below,
(1) Prevention Costs: this includes costs of supplier quality survey and supplier quality training
(2) Appraisal Costs: this includes costs of product/equipment testing
(3) Internal Failure Costs: this includes costs of rework, refurbish, retesting and scrap (from
defective products by suppliers)
(4) External Failure Costs: cost of delay delivery (from suppliers) is in this category. There are a
couple of ways to determine this cost but each method yields totally different result. In reality,
what average people do to solve delayed delivery is to,
- Use expedite delivery (cost of delay is then the difference between Expedited Freight Rate
and Normal Freight Rate)
- Keep extra inventory during a delay (cost of delay is then Inventory Holding Cost x days of
delay)

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In general, we can use COQ concept to evaluate and eliminate suppliers who bring disturbance
into inventory system. What you need to do is to assemble and compare the actual COQ of all
key suppliers every year. Then, remove suppliers with high COQ from Approved Vendor List or
ask them to make a Corrective Action Plan.
9) Use simple scheduling rule
In manufacturing environment, production scheduling has a very strong impact on overall
service level and level of work-in-process inventory. For many decades, researchers try to
improve the efficiency int this area via both optimization and heuristic (rule based) methods.
In real-world scheduling practices, many practitioners prefer rule based method because they
can't deal with many objectives at the same time. Many scientific papers confirms
that scheduling jobs with shortest processing time (SPT) first help to reduce overall lead-time.
10) Streamline warehouse operations
Since the variability of order cycle time is high in some situations, reducing cycle time inside the
warehouse is strategically important. Improvement in this area can be done through a proper
use of storage policy.

Considering 3 warehouse storage policies, the first policy is to store items anywhere. Under this
policy, space can be fully utilized but inventory accuracy will be poor because it's difficult to
maintain the record of storage locations. Imagine an inventory controller reserves the items but
warehouse workers can't find where they are.
Second storage policy is more common where items must be stored in designated shelf/bin.
This kind of storage policy helps a lot with cycle counting and inventory accuracy. However,
order picking time is usually poor because order picker must travel through the aisles which
results in longer traveling distance and traveling time.
In the last type of storage policy, high turnover items are stored near the front part of storage
area. The good point is that workers don't have to walk very far to pick the orders. It also helps
with inventory accuracy and cycle counting because important items are stored in fixed
locations at front.
Conclusion
Inventory management is never about pure theories but it's the interface of various practices in
inventory controllers, sales, production, procurement and warehouse, don't you think so?

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