Inventory management is one of the most important aspects of today’s supply chains. That’s because, as put by Nicolas Vandeput, supply chain and data science specialist, we live in a moment where businesses are made of international networks, the competition on quality and price are more complex and finally, the catalog of products each company offers is ever expanding.
The process of inventory management refers to ordering, storing, using, and selling products that compose a company’s inventory. In other words, in business terms, inventory management means strategic stocking, with the right number of products, in the right place, maximizing profits and cutting costs.
The importance of Inventory Management
Supply chains average life cycles are becoming shorter and demand variability is increasing. In this context, we have international supply chains with longer lead times and more constraints on strategic planning. Because of that, inventory management becomes more critical and decisive for business.
Two questions must be made to start thinking of a more efficient inventory management, they are:
- How much inventory we need?
- Where do we need it?
Those questions will help clarify aspects of purchase such as storage of stock, amount of product for sale, moment for ordering and shortage fulfillment. Of course, all the process includes management of raw materials, components, and finished products. And we mustn’t forget about warehousing and processing of the items.
All of those will vary depending on the types of products your company deals with. But in any case, stocking products makes you supply clients on time and helps with unpredictable conditions.
The advantages of Inventory Management
“Holding inventory disconnects the production process from the sales process.” Nicolas Vandeput
Having a proper inventory management can result in a lot of vantages, but mainly, it reduces the overall cost of the company. Among others, a precise inventory management helps:
- Reduce costs
- Optimize fullfillment
- Provide better customer service
- Prevent loss of stock
However, at the same time, inventory may be a liability if not done right. Vandeput says that “inventory is sleeping cash depreciating over time”. In other words, costs money to store products and every stock has it risks.
For instance, one question you can ask about your stock is: will I be able to sell all these products? Besides that, a large inventory susceptible to spoilage, theft, damage, and changes in demand, that may result in stock break or more difficulty to sell.
Although right inventory is a matter of industries, all of them must be able to decide when to restock, how much to buy, what price to pay and when to sell. It may look simply but those problems are complex decisions involving a lot of data.
To determine how important inventory management is, Nicolas Vandeput, in his book Inventory Optimization, estimates that in United States only in 2018, inventory costs accounted for around $500 billion, which is as much as 2% of the GDP of the country.
Methods of management
We’ve seen that we live in a moment of increasing importance of right inventory management. But how can we do that? How can we achieve a level of efficiency that will not only helps us stay in business but also will maximize profit and cut costs?
There are two main methods of inventory management and optimization: mathematical model and simulation. Each with its own pros and cons and ideal scenarios of use.
The first option is the mathematical model, which has its origin in 1913, when the first model was published by Harris. The professor of Eindhoven University of Technology, Ton de Kok says about mathematical models:
“Inventory models are abstractions that cannot capture all possible actions to balance supply and demand”.
So, we must keep in mind that even the best model won’t be able to foresee every possible scenario. Nevertheless, with a 95% accuracy, the model is enough to bring savings to any supply chain and inventory.
Usually, a most complex model will have more accurate results with fewer costs and more profits. In the other hand, simpler models may be more accessible to users and therefore more understandable.
Simulations have two main functions: test the outcome of a mathematical model and find a good-enough policy when the equations and results of the model aren’t the ideal.
The main problem with simulations, though, is that they have longer computation times and usually gets a more variable result. In the other side, equations aren’t suited to handle the complexity of modern supply chain. Simulations allow business to deal with much more complex situations.
The standard cycle of a model is:
- We arrive at a model
- Try to optimize it
- Apply the model with a defined set of conditions
- We learn with the results
- We incremented the cycle and start again
The goals of inventory management
The process of inventory management aims to understand stock levels and location in warehouses. After that, it follows the tracks of the products from the supplier trough the production and finally at the customer.
We may say that the first main goals of inventory management are keep enough stock to satisfy customers and invest as little as possible earning the most profit without losing material.
Doing that, we can have a better visibility of the whole supply chain process, as in procurement, production, fulfillment, and others. With an efficient and optimized inventory, managers can coordinate to have more strategic supply chains, with better lead times, production, and delivery.
The best way to achieve this level of production is finding a good inventory policy that will help you keep customers satisfied and reduce costs. These policies will determine how you deal with your stock and reflect into your entire supply chain process.
With Delorean, we have already helped large companies improve demand planning accuracy and significantly increase gross margin return on inventory investment.
We have over 450 public databases to improve the accuracy of our models and an automated methodology for supply chain analysis, simulation and diagnostics. This helps us define inventory policies and plan purchases. Want to know more? Let’s talk