Wholesale & Distribution International - Fall 2017 - 53
Imagine a water tank with two valves: one lets water
out at the bottom, the other refills the tank from the
top. If we let too much water in, the tank overflows;
if we don't keep up with the rate of consumption, we
end up with too little (or none). Many organizations
manage inventory by manually draining and refilling
their "tank'" at will.
The problem with this is that they can
only hope to hit the optimal level of inventory by accident. The result is stockouts - the water in the tank goes to zero
- or cash that is tied up in excess inventory. Like water in a tank becoming stagnant, inventory ages. Given enough time,
the inventory becomes obsolete and that
cash has gone down the drain.
What we really need is an automated
method for refilling each item as it reaches a critical threshold, much like the float
valve in a water heater. Any good warehouse management system (WMS) has
this capability built in, but the math is
pretty basic and can be done in a spreadsheet, if that's all you have.
First, we need to find out the average
turnover of each item - how long we
held it in stock. Of course, there were
times we turned the item more frequently, so the average alone is not terrifically
useful; we want to capture those deviations from the norm - in fact, we use two
For those of you who break into a sweat
when you hear statistical terms, "standard deviations" are just bands on either
side of the average that capture a certain
percentage of fluctuations. If the average
is the middle lane on a highway, the standard deviations would be like the lanes on
either side. You don't always stay in the
middle lane; sometimes you go into the
fast lane, sometimes the slow.
The more standard deviations you
consider, the more variation you capture.
Working with two standard deviations is
more comparable to the shoulders on a
highway - it's rare to veer off into them,
but not entirely unknown.
Two standard deviations will capture
roughly 70 percent of fluctuations - it's
really just a way of saying that we hope to
have the right level of stock about 70 percent of the time.
There is one important caveat to bear
in mind when using this method: it will
sometimes tell you that you don't need to
keep certain items in stock. This is fine if
the item is obsolete, slow-moving and of
low importance - but if it is critical to
your core business, you may want to have
at least one unit on hand at all times.
The supplier's lead times should also
be considered here - if it takes them
six months to get you a replacement
and you need one every three months,
you'd be better off keeping a couple on
hand. Of course, no method works for
everybody in every situation. That being
the case, we're also going to discuss the
THE "ABC" TECHNIQUE
The first step in this method is to gather
data about your total spend on inventory. You'll usually find that 80 percent of
your sales is going to a surprisingly small
number of items - somewhere between
10 percent to 20 percent of the SKU's is
typical. These form your "A" list. Just like
in Hollywood, your "A" list items are the
fast movers - you'll probably want to
keep them close to point of use.
The next category is the "B" list. These
items take up roughly the next 10 percent of your sales. Unexpectedly, though
you're spending less money, there will
typically be more items in the "B" category than in "A." This is also where you can
start to save serious money, given that
you'll often have reorder points that are
set too high, and probably the wrong mix
of vendors to boot.
The final category is "C" - the last 10
percent of your sales. As long as you give
careful thought to how long it takes for
your supplier to get the item to you, and
whether its lack would cause a major
problem, you can often get rid of these
items entirely. They're likely obsolete, or
easily replaced as and when the need arises. Why would you want to tie your cash
up in stuff you don't need yet? q
Tony Donofrio, head of Argo Consulting's
supply chain practice, has more than 30
years of supply chain experience. He has a
reputation for taking on tough challenges,
creating growth opportunities and outperforming the competition. Stephen Francis,
senior consultant, co-created the Argo Integrated Management System (AIMS). He develops and implements tools that drive deep
and rapid change for Argo's clients. Jim
Shepherd is a director with Argo Consulting.
He has led teams that launched satellites,
returned manufacturers to profitability, and
consistently delivered multi-million dollar
savings for clients.
Fall 2017 www.wdimagazine.com