Closing the Floodgates: Responding to the deluge of inventory filling your warehouse

By Quentin Samelson, Senior Consultant, IBM

 

Over the last year or two, the whole world has become aware of the importance of the supply chain – mostly because it isn’t working in as seamless and uninterrupted a style as people are used to. Most of the talk is still about shortages, but those of us who have worked in supply chain management since the last century (and have seen a few boom/bust cycles already) knew early on that eventually organizations around the world would face the opposite problem: excess.

What has been a bit surprising is that we’re already seeing evidence of severe levels of excess material on hand, even while companies continue to fight shortages of other items. News stories have already popped up on our screens about retailers facing mounds of inventory[1], but there are still empty shelves of some products. Those of us who engage with manufacturers and distributors are hearing the same thing: warehouses are stuffed full of the items that suppliers can ship, but companies are still unable to build some products because key components are not available.[2]

Of course, those two conditions may be related – if your product is made of 500 components and only five of them are difficult to procure, it isn’t hard to end up with a warehouse stuffed with surplus quantities of the 495 easy-to-procure parts. A well-maintained production plan is supposed to avoid that situation, but in unsettled times it isn’t unusual for companies to drive the available parts into inventory, in the hope that they’ll soon be able to source the scarce parts and ramp up production. That strategy does make some sense – it allows your purchasing team to focus all their attention on the hard-to-get parts – but eventually something has to give. That’s the situation that some companies find themselves in – their warehouses are full; they’ve begun to put extra inventory in the aisles or in rented trailers behind the building; and they’ve begun to realize that the situation isn’t going to correct itself anytime soon. So what should they do, when confronted with simultaneous excess and shortage?

The question is especially appropriate if the supply chain organization has been working with clear and emphatic instructions for the last year or so on the order of: “don’t waste time on those other items – focus all your efforts on the shortages.” I suggest replacing those instructions with “keep working on the shortages, but strive for balanced inventory overall.”

What does that mean? It boils down to four actions:

1. Establish target ranges by ABC code. Those ranges don’t need to be overly aggressive at this point, but it is important to understand which items fall below or above the target ranges. (A set of suggested starting points for target ranges, for different inventory strategies, is in Table 1, below.)

	Percent of Annual Demand Value	Aggressive Inventory Management	Moderate Inventory Mgt.	High-Margin Inventory Mgt.
A	(First) 80%	0.5 to 2 weeks on hand	1-4 weeks	4-8 weeks
B	15%	2 to 4 weeks on hand	3-6 weeks	6-12 weeks
C	4%	3 to 6 weeks on hand	4-8 weeks	8-16 weeks
D	(Last) 1%	4 to 8 weeks on hand	8-12 weeks	12-20 weeks

Table 1 – Indicative Target Inventory Ranges for several Inventory Management Strategies
(“A” parts typically represent less than 10% of all part numbers; whereas C and D parts often represent 80% or more of the part numbers.)

 

2. Assess your inventory, by part number, in terms of weeks (or days) on hand.
3. Identify the items with inventory outside their target range. Note that it is useful to use total inventory for this analysis. (In other words, don’t net out safety stock.)
   1. For the items that are in excess, work out the value in excess of the target range. It can also be helpful to assess whether any of those items are taking an excessive amount of warehouse space. This can either be calculated (if reliable volume data is available) or assessed visually.
   2. For the items that are below the target, it’s useful to understand what quantities are needed for the next week’s or month’s production. Even if the item is not one of the items that is currently in an industry-wide shortage, it is still likely to take some time to bring it into the target range.
4. Develop a strategy to draw down inventory levels of the items that are most severely in excess. In most cases, the strategy will focus on two actions:
   1. Cancelling or pushing out any existing purchase orders, to prevent additional receipts of parts that are already in excess.
   2. Allowing production to use up inventory until the excess has been eliminated or substantially reduced.

(Sometimes a review of safety stock settings is also appropriate!)

In most cases, there likely will already be a set of strategies to address the parts that are below the target range – because those are the parts that are in shortage. But this analysis may uncover two other groups of parts that are worth some attention:

• Because they have not (yet) caused a line-down situation, there could be some parts that are actually in a near-shortage condition but haven’t been treated as shortages. This sort of analysis will help to expose those parts and provide the opportunity address them before they cause problems.
• It is not unheard of to encounter a situation where many of the C and D parts are well below their target inventory range, even though they are not likely to cause a shortage at any point. There are usually two possible ways to respond to this:
  1. Reconsider the target inventory ranges. The minimum levels may be set too high.
  2. Retrain the buyer/planners. Sometimes the buyers don’t understand that just because some parts (the A parts) within a particular commodity need to be managed aggressively, it does not follow that other parts (the C and D parts) must be managed the same way. In fact, they may be wasting their time and effort on low-value parts when they should be focused on the A and B parts.

This is pretty logical (better yet – this method actually works!), but inventory strategy can be an unusually emotional topic for many organizations. There can be an odd sort of comfort in a full warehouse. So it’s worth pointing out that excess inventory has both immediate and long-term negative consequences. A few of the most obvious:

• It consumes available working capital. This matters more in low-margin operations, of course… but almost anyone understands that there’s little benefit to an organization to investing in slow-moving inventory. In extreme cases, excess inventory can even make it hard for a company to pay its bills on time.
• It often loses value over the time that is needed to use it up. Items can be lost, damaged, or degraded while the organization is waiting to finally put them in a product. And if it is never used, at some point that excess inventory becomes pure loss on the company’s P&L.
• It can shut down manufacturing just as effectively as shortages. A warehouse that is at 100% capacity (or over its capacity) will struggle to operate efficiently and effectively. With all that extra inventory, it can be hard to access – or even find — the items that are needed on the manufacturing floor.

But it is often also true that demand data is not totally trustworthy, inventory accuracy may not be 100%, and there may be two weeks’ worth of inventory locked up in work-in-process. So it makes sense to proceed with some caution, and be alert to issues that need to be resolved as inventory drops. It’sespecially important to:

• Understand the demand, and identify where demand is relatively steady and predictable vs. spotty and volatile.
• Investigate the S&OP process. There should be a mechanism to provide somewhat steady demand, even as new orders are received from customers.
• Understand the interplay between lead times for those items that must be procured, vs. the lead times quoted to customers and the manufacturing cycle time required to actually build a product.
• Don’t just plan to scrap all the parts where there is inventory but zero demand. Some of these parts may be new parts – identify those & put to a side; and others might still be on active products (albeit active products with no orders or forecast). But any parts that have been on hand for more than a year and have zero demand should be analyzed for possible disposition (scrap, sell, or at least shift to another location).

If your warehouse is already filled to capacity and your CFO has begun making comments about lack of working capital, it’s high time to start working to bring inventory levels back into balance. If that hasn’t happened yet – it’s still a good idea to start this process.

 

[1] See, for instance, https://www.wsj.com/articles/from-walmart-to-gap-which-retailers-have-the-most-excess-inventory-11654776000  and https://www.nbcnews.com/business/business-news/retailers-excess-inventory-mean-big-bargains-shoppers-squeezed-inflati-rcna33750

[2] A review of over 30,000 earnings calls performed by consultants at Avnet Silica revealed that supply chain concerns were discuss in 6% of earnings calls across all industries in early 2022, up from 47% in 2021. The most concern was expressed by companies that rely on semiconductors for their products, with additional concerns from companies in the food and beverage industries. See https://www.avnet.com/wps/portal/silica/resources/article/industries-most-concerned-about-supply-chain-issues/ .

About the author

Quentin is a senior managing consultant in IBM’s Industry Center of Excellence, part of IBM Consulting. Most of his career was spent as a practitioner at several well-known global electronics manufacturers. He has over forty years of domestic and international operations experience in the Global Electronics Industry, and has led numerous Supply Chain process and technology improvement initiatives to improve operational performance and achieve significant cost savings for large multinational organizations.