Inventory and supply chain management methods are a major component of business strategy and profitability. Without them, companies cannot manage their inventory effectively and can incur additional costs.
The increase in costs can be incurred with increased warehousing requirements or lost revenues due to dead stock. Human and financial resources dedicated to inventory management can also represent a significant expense.
Poor inventory and supply chain management can hurt a company's profitability through the strain that inefficient inventory puts on its cash flow.
It can also lead to dissatisfied customers, who may seek alternative suppliers as a result of the continual unavailability of certain products.
Adopting an optimal inventory management strategy designed for your specific challenges is essential in reducing costs and risk, and more importantly, ensuring the long term future of your business.
Good inventory management will allow you make better decisions. It will also give you the ability to be more responsive to customer demand and ever changing market needs.
In this article, we will demonstrate the different inventory and supply chain management methods available, to ensure you optimise your logistics and improve the profitability of your business!
I - Inventory and supply management : definitions
First of all, it is important to get to know some of the key terms and definitions
1 - Inventory management strategies
To choose the best inventory and supply chain management method, there are two options available:
an empirical strategy
a forecast strategy
An empirical inventory management strategy is based on sales history. By establishing the average sales of each unit, their frequency of removal from stock and any consumption peaks, it is possible to anticipate the future requirements. An empirical strategy is based on what has happened in the past.
A forecast strategy also takes into account sales history, but includes macro influences – those that take place outside of the company: things like market and sector trends, changes in consumer behaviour, etc.
This type of strategy is essential to manage the stock of products that are highly susceptible to seasonality or whose sale is typically irregular. For this to be useful, it requires the availability of reliable market information and indicators.
One solution is to engage with a company specialising in logistics management.
2 - Inventory and supply management - what is it?
Inventory management refers to the methods and practices used to determine the quantities and frequency of purchases of a company's products.
The aim of this set of measures is to establish the best compromise between storage and delivery costs, in order to be able to meet market demand.
To be effective, inventory management involves documented tracking of products (quantity, location, condition, etc.).
Supply is what keeps the chain moving. It can be anything from providing the company with the raw materials and/or goods in order to guarantee products are made, to the movement of products through the various phases of distribution.
Supply can occur in different places: the warehouse, a manufacturing plant or even at point of sale.
II - Why optimise the inventory and supply management method?
Choosing an effective inventory and supply management method is vital in avoiding two costly situations - product overstocking or out of stock scenarios.
1 - To avoid overstocking
Overstock is dormant products that don't bring any profit to a business and cost a business money (through warehousing costs).
These products are effectively tied up capital that cannot be mobilised to create value, and in turn increase costs which is a real disaster!
A company must try to avoid overstocking at all costs, because the negative effect it places on cash flow, increases the Working Capital Requirement (WCR) and reduces its margin of safety.
In addition, if products are difficult to sell and/or they are perishable, a company will be forced to sell them at a discount or loss, which leads to a decrease in the company profits.
In the worst case senario, overstocked product can eventually become dead stock, outdated or obsolete items that can no longer be sold, a net loss for the company.
2 - Avoiding low stock and out of stock
If you have insufficient products to meet the potential demand of your customers, the risk of out of stock is increased.
This is a situation that must be avoided, because it means a temporary halt to your business.
If stock shortages are chronic, a business will run the risk of upsetting its customers and maybe even saying goodbye to them forever. A store that no longer receives your products and is forced to have empty shelves on a regular basis will quickly turn to a competitor for resupply.
III - 7 methods of inventory and supply chain management
Now that you know why it's important to find the most efficient way to manage your inventory, here are the most popular methods used by businesses today.
1 - The ABC analysis of stock
The ABC analysis of stock is a method of separating your products into 3 classes to determine their importance.
Class A: 10 to 20% of products representing 80% of the total revenues. These are the most important products. Breakage is not an option and inventory monitoring must be rigorous and regular.
Class B: 30 to 40% of the products which represent 15% of the total revenues. These are intermediate products and it is advisable to monitor these regularly, to always ensure a products are available.
Class C: 50% of products that represent 5% of the total revenues. These products require less frequent replenishment. Replenishment is only needed when all the stock has been sold, in order to minimise storage costs.
2 - Calendar replenishment
Calendar replenishment is an easy-to-implement inventory management method. Orders to suppliers are determined in advance and deliveries are made on fixed dates.
This method is relevant for items sold regularly over time.
It has the advantage of requiring limited administrative management since everything is planned in advance.
This method of supply management can also significantly reduce costs. Since the supplier can organise deliveries well in advance as part of its activity is guaranteed in the future, this makes the supplier more open to negotiation.
3 - The replenishment method
This method consists of placing a regular restocking order, by defining a stock level status of products. The quantity that constitutes the difference between the current stock and the optimal stock level is defined beforehand.
This inventory and supply management method is particularly useful for expensive and/or perishable products sold on a regular basis, such as food products.
It can cause problems if consumption does not follow sales forecasts and may result in the company finding itself at the mercy of shortages or overstocking.
4 - The reorder point method or just-in-time (JIT)
The reorder point method, or “just-in-time” method, is a supply chain management method that requires defining a minimum stock level in advance.
As soon as this level is reached, a replenishment order is triggered. The timing of the order is determined by stock levels and delivery times.
This method is particularly relevant for products whose frequency of sales is difficult to anticipate. It is also used for products whose storage costs are high and must be optimised wherever possible.
In theory, this method has a number of advantages. It makes it possible to only hold the optimum quantity and minimise storage costs. It also offers several automation opportunities to reduce the time spent on inventory management.
Not all suppliers accept it because of the random nature of each order (quantity and date). It also requires a lot of organisation to get right!
An example of the reorder point method
Maximum sales per day: 18
Average sales per day: 6
Maximum delivery times: 14
Average delivery times: 8
1 - We start by calculating the safety stock with the following formula:
Safety stock = (Maximum Sale x Maximum Delay) – (Average Sale x Average Delay)
In our example, the safety stock is 204 units. Below this quantity we risk running out of stock.
2 - We then calculate the control point with the formula:
Order Point = Safety Stock + Average Sale x Average Lead Time
In our example, the reorder point is 252 units.
So, as soon as the stock reaches this quantity (252), it must be replenished. By the time the new stock is delivered, you will have just reached the safety stock quantity (204).
5 - Replenishment on order
Restocking to order is advisable when it is not possible to know when or how many products the company will sell. It makes it impossible to establish accurate sales forecasts.
This method consists of restocking products when the low stock number is reached. It is used when the risk of stock shortage is better than overstocking.
By ordering variable quantities on variable dates, this method is responsive to changes in consumption. It is vital to have a good grasp of what is in stock at all times.
This method can result in high delivery costs, due to the random nature of orders to suppliers.
6 - Dropshipping
Dropshipping is a simple inventory management method, because there is no inventory.
An economic model that has been in fashion for several years on the web, dropshipping consists of selling stock that you do not yet own.
The seller promotes the products, collects the payment and maintains the relationship with the customer, but does not undertake the shipping or the logistics.
A model particularly suited to e-commerce, dropshipping nevertheless presents potentially high levels of dissatisfaction on the part of customer, risking out of stock situations or long delivery times.
7 - “First In, First Out” or FIFO inventory management method
The FIFO method consists of selling the oldest stock first in order to avoid the expiry dates of the products. It is widely used for logistics management in the food sector. However, it is not strictly limited to food and can apply to all types of items that may deteriorate over time.
This method is often used by stores that highlight the oldest stock on fresh shelves.
The FIFO method requires rigorous monitoring of stock, as well as good organisation of warehousing and shelf space.
Note: the reverse of this inventory management method is the LIFO (“Last In, First Out”) method. It is based on the opposite idea - that newer stock is more valuable than the old stock. However, it is rarely used.
You now know the methods of inventory management and replenishment!
If you want support in optimising your supply chain, contact us to discover our supply chain management solutions and services!