Hey guys. Long time, no blog -- I know. But just wanted to get a shout out to Tip'd - Financial News, which just launched version 1.0 of their website today. Tip'd is a social media site, similar to Digg and Reddit, but focused more on business and finance. Not a whole lot of inventory management tips on there yet, but everything business and entrepreneurship related. They also have some good looking financial and investment news up there.
As I cover in many of my posts, the number one problem I experience with inventory management is "what difference does it make if I have too much inventory, I'm going to sell it eventually anyway, right?"
Typically, this question comes into play in terms of over ordering stock that really does sell, but not fast enough to warrant such large orders. Many posts on this site cover this the issue of how much to order and the true cost of carrying excess stock.
Another problem I haven't really addressed is what happens when inventory sells so slowly and costs so much to carry that it's not only not worth it to order more, but it's actually worth it to destroy that which you do have.
I recently came across this example while studying the inventory at a book publisher that noticed they were spending thousands a month on excess inventory charges. While my example uses the book industry, these principles can be applied to other goods.
The typical storage cost per book is generally right round a penny per year. While this doesn't seem like much, it adds up pretty quickly to $5000/mo when you have 500,000 books in stock.
The question quickly becomes, is the $5000/month worth it to store all the goods. In order to adequately determine this, what needs to be examined is the lifetime cost of storing the goods until they're sold and comparing this to how much it costs to store relative to destroying and then reproducing.
Start with the monthly sales/inventory. This will help you to get a feel for how fast the book is selling. Once this is determined, you can determine how long until the book will sell out.
The next thing to look at is the cost of the book. This will help determine how how long you should keep the book.
Once you have this information, here is how you can apply it:
Taking the monthly sales to inventory ratio, you can determine how long it will take to sell the book out completely. Let's assume we discover that based on historical evidence, we believe the title will sell out in 6 months. This means that if sales remain steady, it will cost an a maximum of six cents (a penny per month) for storage. Assuming the cost of the book is roughly $1, you're better off storing the books than destroying now and reprinting later.
This is a fairly typical example of a good that is still selling well and certainly shouldn't be destroyed.
But let's take a look at an example that should be destroyed.
The monthly sales to inventory ratio shows that it will take 400 months to sell the remaining 8,000 copies of a certain title that is sitting in the warehouse (assuming it ever sells). While this sounds excessive, I can assure you, I've seen it.
At 400 months, it will cost the last of those books that is sold $4 in storage over the next 400 months. Assuming the cost to print the book is $1, a $3 loss is incurred by storing the book as opposed to printing again in the future. At $1 to reprint, the recommendation for this title would be to keep 100 months of inventory. 100 is chosen because this is the point at which it becomes no longer worth it to store rather than to reprint.
That is, you should keep the amount of inventory that is cheaper to store than to reproduce.
While this model is very simple, it serves as a useful starting point for determining how much inventory to hold. There truly is a point at which destroying now and reproducing later becomes a worthwhile investment. However, the goal is to avoid this altogether. To properly order in the first place and to not hold excess inventory is a much more desirable achievement.
This should serve as a starting point, although there are certainly other things to look at, including the funds that can be acquired through remaindering goods, and the likelihood that sales will increase, rather than remain steady or decrease.
Normally, I just delete spam comments and continue on with my day, but this one, although merely an attempt to put a link from inventory management was at least related to the subject at hand. So I thought, what the hell, I'll write an article about it.
The comment I'm referring to is in response to my most recent article and reads as follows:
The above formula applies only for the reorder point - order quantity system. The mathematical problem is to find the correct reorder point for a discrete time axis and often non-normal and dynamic demand. Many textbook formulas are wrong. See the new textbook [link deleted]
Although it's spam, it raises an interesting point; are the formulas on this page the most reliable?
In short, not always, but by and large, yes.
The comment aptly points out that there are, for certain inventory issues, better formulas than what is layed out on this site. One of my articles details the implementation of the more optimal models. The problem is that these models are often more trouble that they're worth.
In other words, it's not always worth it to spend one millions dollars in order to save half a million dollars.
What this site offers are inventory management tactics that should be a starting point. Ideas to think about and in many cases, very worthwhile formulas capable of acheiving serious savings for your firm.
In other cases, more robust formulas and algorythms can and possible should be applied. My honest advice if this advice applies to you is to hire a consultant if you do not already have the infrastructure to achieve better than average models.
And, if you're right on the edge of needing a consultant and doing well without one, my advice is to check out your industry competition and see how your inventory turns stack up to your rivals. If you're doing well, then good, if not, maybe it's time to improve. Look forward to more on checking out the competition.
Quick little not on a comment I received on my post on Safety Stock.
Reader, Anish, said:
How could we calculate the safety stock exactly? The available equation
safety stock =reorder point -lead time demand
Well, what Anish did here was rearrange the SS formula and pointed out a way to figure out safety stock if you know re-order point and lead time demand.
This may be useful if you know your re-order point, and know your average demand but never calculated what your ROP should be and just want to see how much safety stock you hold. By the way, I used the word average demand, which Anish did not.
Remember, if you know your actual demand, you don't need safety stock. Chances are, you know you have a decent idea of what your average demand is, and with the knowledge of the standard deviation of that average, you can determine safety stock...which is the second term in the ROP formula, which my article on safety stock covers.
Good question by Anish, and yes, that is a way to determine what the safety stock you've been using is, not what it SHOULD be.
Not so recently - sorry for the delay! - I received the following question in response to one of my articles:
We have over 2000 parts in inventory. Rather than calculcating the EOQ with the formula, which I do not have time to do, I want to use the "rough estimate." What are the factors that go into the material's "actual value per year?
Dave brings up an interesting point - What to do when there are so many SKUs?
So many parts, so little time, eh Dave? EOQ 2000 times in a row...blah! I mean seriously, is it even worth the effort?
Is it worth the effort?
This is the question you need to ask yourself. Unfortunately, finding the answer to this question may be harder than just doing the damn work, so now what are you supposed to do?
To answer this, I have 3 suggested solutions:
1. Maybe it is worth it.
Possibly, there are enough savings that can be found in reducing holding costs for each individual part that performing EOQ calculations for each part is actually worth the trouble. I mean, on a case by case basis, you'll probably become quite good at evaluating the holding costs and from there, it's a simple matter of plugging the variables into the equation. The result could be cost savings of 10% per year. Maybe it is worth it to repeat 1999 times.
Maybe not. Also, if it worth those savings, maybe buying a software package or hiring a consultant is a better option.
2. Rough estimate may be more your style.
Chances are, holding costs are similar for certain types of products. My suggestion (if you really want to cut corners) is to group products that your gut feeling tells you have similar holding costs properties and similar ordering costs. Hopefully, they even have similar in demand. Build an Excel spreadsheet and make the program do most of the work for you.
But...rough estimates are a waste of time if you ask me. Either it's worth it to get a decent idea of what EOQ should be or it's not worth it. Currently I'm in a situation where it's not worth it...lucky me.
As for what factors go into a material's actual value per year, it varies. Luckily I wrote a whole article on what goes into holding costs.
3. Pay someone to do it.
Like I said earlier, get a software suite and a consultant to implement it. If you have 2000 products, you're probably big enough to warrant the help.
Similar to what you're doing now (although reading this is a much smaller scale compared to what's out there for purchase), stand on the shoulders of giants and buy your way into the vast quantities of inventory management resources and gurus.