Whose Inventory Is It Anyway?

This is one of the most contentious questions that is often raised in review meetings especially during months of high inventory. We’ve all been there - where all the inventory indicators are in red, warehouses are overflowing with stuff, several leaning Towers of Pisa in the DCs are a common sight and trucks are waiting for hours to unload their stuff. The supply chain VP’s phone is ringing non-stop and when it seems that nothing can go worse, you suddenly realize that you have an S&OP meeting to attend to.

As you expected, the meeting is a bloodbath - S&OP chair, with deep burrows on his face, points finger at supply chain, others join in. Supply chain, on the other hand, blames faulty forecasting numbers. Demand planning, in turn, blames the inputs especially the sales projections; and when confronted, sales talks about their top-down targets and narrate in vivid detail how they didn’t receive right marketing support and how Supply Chain didn’t ensure that inventory was at the right place at the right time, thus completing the full circle of shrugging the responsibility of inventory ownership.

To muddy the waters even further, that one person from finance mumbles how “Inventory” is on the asset side of the balance sheet1 but still recommending to reduce it as the cost of borrowing is getting higher.

So, who is responsible for the inventory after all?

As the norm has become with this blog, the answer is – “Well, it’s more complicated than that.”

You see, inventory is not a single homogenous bloc that can be assigned or attributed to a single department or function, but a culmination of several direct and indirect causes across the organization.

In fact, Harold S. Geneen, has famously said, apart from his many other famous quotes,

All the problems of business end up in inventory

 

That’s true. Isn’t it?

Bad forecasting accuracy? – you’ll end up with unsold stock in inventory

Quality problems? – you’ll end up with returns in inventory

Bad roads? – you’ll end with damaged stock in inventory

Failed new product launch? – you’ll end with dead stock in inventory

Bad customer service? – you’ll end with canceled orders and... you guessed it, inventory

Very high customer service? – you’ll need to maintain high safety stock which is...inventory

So, are we doomed to live with this inventory mess forever without figuring out the real culprits? Is there no one who can save us from this impending inventory apocalypse?

Cool down, cut down on dramatics and dial a supply chain detective.

The solution to this mess is actually quite simple. A quick word of advice for SCZs out there – whenever you come across what seems like an insurmountable problem and you are unable to make a headway, start breaking the problem into its individual pieces, trace them back to their source and treat them individually. Once you solve the pieces, put them back together and voila – you have a solution.

For inventory ownership, the problem may look unassailable but let’s start breaking it. The good news is that we already know some of the inventory components. See! The moment we said inventory components, you’d know what is about to come already.

Cycle Stock

The first and often the biggest component of inventory is Cycle stock. It is the inventory that is needed to fulfill the average customer demand between the orders. Simply put, it is all the stock that is meant for selling before you receive the next inbound.

Cycle stock is dependent on two factors = Annual Demand and Inventory turns2.

While annual demand is an independent variable, inventory turns (the ability to churn your inventory) is something that is inherent in organizational strategy which in turn impact supply chain design and policies3 around it.

Let’s take an example –imagine there are two organizations named SavingPrivatePenny Inc (SPP) and FastAndFurious (FAF) Inc. SPP focuses a lot on cost efficiencies while FAF tries to be more responsive to their customers. With these different high-level strategies, SPP has a supply chain policy that prohibits less than 80% FTL load to be shipped. FAF Inc. Doesn’t have such policies and their trucks often go half unutilized.

In this example, SPP will have lower inventory turns vs FAF Inc. By extension – SPP will have higher cycle stock than FAF due to a. Organizational Strategy b. Supply Chain design.

[Some professionals blindly assume that SPP is a better organization than FAF. We’ll discuss this in another article why it’s a wrong pre-assumption without proper assessment.]

In a nutshell, cycle stock seems to be the responsibility of SCM function. However, supply chain design which has set a lower bound on cycle stock, also depends on financial constraints and overall organizational strategy.

Safety Stock

Demand-supply fluctuations are the name of the game and safety stock is the secret weapon in the arsenal of the organization that can help maintain the desired service level despite these fluctuations. However, this weapon comes at a cost. And that cost is inventory in form of safety stock. Higher the target service level, higher is the safety stock you need that may or may not be used that leads to higher inventory. In fact, the service level is the only deciding factor in determining the safety stock.4  

So who owns the safety stock?

Simple. Whoever decides on the service levels. In most cases, this is something that is defined by Strategy (since they define the market positioning of the organization) and Sales (as they back-feed the strategy on customer requirements). But it varies widely from organization to organization.

Hence, safety stock inventory component is something that should be owned by strategy or sales. (Or whosoever is taking call on the service level).

Other Miscellaneous Inventory

You’ll notice that even after accounting for cycle stock and safety stock, you’re left with unaccounted inventory. This is something that is often reported as “Excess Inventory”. It is a curious mix of different types of stock that ends up in excess inventory bucket.

Unsaleable Stock: This one is my personal favorite. It consists of all kinds of expired, damaged or otherwise unsaleable stock. The reason this is my favorite is that more often than not this represents a good percentage of overall inventory. And it’s relatively easy to get rid of – you have to simply write it off.

The expired products are due to over-forecasting, and that ownership needs to be shared between the businesses and the demand planning. Damages fall right on SCM and should hit their KPIs.

Interestingly, most of the organizations are aware of this bucket but they don’t want to do the write-offs. Why? Remember when we said at the beginning that inventory is treated like an asset on the balance sheet. Well, write-offs of this inventory, that could be valued millions of dollars on the balance sheet, forces the company to take a huge one-time loss that could be detrimental to its share prices.

This hesitation is natural since no CEO wants to take this dent on the share prices and on his/her bonuses. But keeping this bad stock not only reduces its salvage value but also eats up valuable warehousing space. So, a good SCD must always push for continuously identifying and reducing this unsaleable stock from their supply chains.

This problem was quite visible in the banking industry (Surprise! You can apply SCM concepts to the banking industry too!) in 2008-09 where banking behemoths refused to identify their own toxic assets leading to the biggest global meltdown the world had ever seen since the great depression.

Bonus question: What is “inventory” in banking context? Does EOQ formula hold any significance in such context? What does ‘quantity’ in Economic Order Quantity refers to?

QC Stock: The stock under quality check can be quite significant especially for high-value items or high-tech industry where the quality process can take several days. The ownership of this stock is with Quality, Manufacturing or procurement depending upon your organization. Being in QC doesn’t mean that this inventory can not be reduced. We’ll have an entire post detailing inventory reduction

Promotional Stock: Remember that promotion scheme when you gave out Boyfriend Pillow to your customers for free – when your customers looked long and hard at you wondering if they should be seen in the vicinity of your products; and where, even after six-months of trying to push it down the throat of unsuspecting customers, dealers, wholesalers and mortal enemies, there are still mountains of this abomination lying somewhere in the corner of your warehouse.Yeah, that one.

Dispose it off and put it on marketing’s account. Done.

Blocked Stock: All ERP systems offer stock blocking to prevent multiple sales commitments on the same stock. Once the stock is “blocked” it is unavailable for committing to another customer. However, this functionality is sometimes used to game the system to hoard the stock even for tentative sales. We’ll see various means by which this can be reduced but one thing is clear that the ownership of this inventory lies with the sales.

 

In conclusion, I want to reiterate that high inventory can be a real big pain for the organizations as it locks up capital, occupies valuable warehousing space and chokes us the free movement of stock though the supply chain. Identification of its ownership goes a long way towards taking the corrective action because if you don’t know who owns it, you will never know how to fix it.

This ownership should be built directly into the KPIs to ensure that right action is taken at the right time.

Do you have something to ask or say about inventory ownership? Please let us know through your comments.


Footnotes:

1 It is important to note that balance sheet inventory also includes raw material and WIP inventory. However, in the current article, we are focusing on FG inventory.

2 Hardcore SCDs might argue that the equation is other way round, where inventory turns is calculated from average inventory and COGS. Secondly, average inventory and cycle stock are two different things as former also includes safety stock and other misc inventory like returns, damaged good etc.

While these arguments are correct, in this article’s context we are looking at inventory turns more from a network capability viewpoint and not as a performance metric.

3 If your policies aren’t centered around overall supply chain design and organizational strategy, your supply chain goals will always be in conflict with the organizational goals. For e.g. If you claim to be a super-responsive pizza delivery chain, then your supply chain’s goal can’t be vehicle utilization. You’d have to be prepared for small orders that need to be delivered in 30 mins even if it means carrying one pizza in one van.

4 All other variables in safety stock calculation are not directly controllable e.g. demand variability, Lead Time etc.

1 Comment on “Whose Inventory Is It Anyway?

Leave a Reply