Inventory Optimization Techniques – cycle stock | safety stock | inventory
Inventory Optimization Techniques
Whether you work in retail, wholesale or manufacturing there’s only one thing worse than having too much inventory and that’s not having enough. When you run out of inventory you’re missing out on sales or you’re shutting down a production line. In this video I’ll show you two different ways to think about how much inventory you really need.
The first way to use inventory is called cycle stock inventory. And it’s really about decoupling steps in your supply chain. For example, let’s say that a store gets a discount if they buy 10 widgets from their wholesaler. But their customers only buy one widget per day. The store can use cycle stock inventory to decouple these steps. If they order a new shipment once every 10 days, then they should always have one widget in stock to sell to their customers. The amount of money you spend on cycle stock inventory depends on the amount of product you buy at one time. As long as your timing is perfect then the average cycle stock is one half of the order size. So to reduce the cost of cycle stock inventory, all you need to do is reduce your order sizes. But be careful, when you reduce the order sizes, you’ll need to order inventory more often. And that’ll increase your transportation cost. Cycle stock is fairly easy to manage when you have steady levels of supply and demand. But real world supply chains are unpredictable. For example, what happens to the widget store if a shipment is delayed? Or if a customer buys three widgets instead of one?
To handle this uncertainty you can use a second kind of inventory called safety stock. Safety stock inventory is a buffer that protects you from variations in supply and demand. The more variability there is in a supply chain, the more safety stock you need. Remember the benefit of having inventory is that you have products available to sell to your customers or to feed a manufacturing line. But the more inventory you have, the more working capital you’re tying up and the harder it is for your business to be profitable. So you need to balance the benefits of inventory against the costs.
One way to find this balance is by selecting a target service level. Basically that means you decide how often you’re willing to run out of a product. Many companies choose a 95% service level as their target, meaning that 95 times out of 100 they wanna have the items their customers want in stock.
A higher service level will increase sales and customer loyalty, but it’ll also increase inventory costs. A lower service level will save money, but it could mean they run out so often that they drive customers away. Once you choose a service level there are mathematical formulas that tell you how much inventory you should have. You can do these calculations by hand, but most companies use inventory management software to do it automatically.
Managing inventory effectively is a critical part of keeping costs down while still meeting your customers’ needs. And when you optimize cycle stock and safety stock levels, you can have a big impact on the profitability and the performance of your entire supply chain.