Excess stock ties up capital and costs money
by Dr. Götz-Andreas Kemmner
Inventories tie up capital, a lot of capital: on average, companies in the manufacturing sector can reduce their liabilities to banks by 27% or use this capital to finance growth by reducing their inventories by 20%!
Inventories cost money, a lot of money: if you add up all the costs of warehousing, the annual expenses for warehousing often amount to 19% to 30% of the inventory value!
2 € = 2,70 € ?
A 20% reduction in inventories increases cash and cash equivalents by an average of 55%!
Fortunately, you will say, stocks at least create readiness for delivery. This would be correct if the customer just wanted something. Unfortunately, most customers are quite narrow-minded and expect very specific items, materials and products, so you are no different to my wife with our muesli stocks at home: always trying to keep all the types of muesli that children’s hearts desire, the stock shelves almost collapse. But the only two types of muesli my children have ever eaten since this week, the only ones that make them happy and are good for breakfast before school, are of course missing… Let’s be clear: excess stock costs a lot of unnecessary money and does not improve delivery readiness. But how can you avoid overstocking? We all regularly “bludgeon” our stocks down, but as soon as we look away, they grow again like weeds in the garden. Inventory management is a tragedy in many companies. And the failure of the tragic hero (=disponent) is inevitable. Reducing stocks and keeping them sustainably low is not easy, but it can be done and – the good news for you – tragic failure can be avoided if a number of tips are followed. In most tragedies, this way out is open to the heroes, but they don’t take it…!
On average, companies in the manufacturing sector can reduce their liabilities to banks by 27% and increase their liquidity by 55% by reducing their inventories by 20%.
TIP No. 1: Evaluate your excess stock
How large are the overstocks in your company for raw materials, semi-finished goods and finished goods? Have I perhaps caught you on the left foot? Never mind; take your time and provide me with the figures later. However, before you continue with tip 2, you need to be clear about how much excess stock you have. If you don’t know where you’re going, you can’t know when you’ve arrived. If you do not know which item has excess stock, you cannot know which item you can reduce stock of.
Very few companies are aware of the extent of their excess stock. You do not have to turn this question into a scientific paper in the first step. Since you have enough money, otherwise you would probably not be so generous with your holdings, you can also have this question clarified by an advisor. After €20,000 to €30,000 in project costs, or one or two more zeros before the decimal point for large companies, you will know exactly how much stock you have too much of, but you still won’t know how to systematically get rid of it.
From many years of experience, we have developed a very pragmatic yet accurate method for estimating excess inventory1 , which we make available to companies free of charge for initial analyses.
You will only be able to use “on-board resources” for a portion of the overstock identified, as a rule of thumb 10% to 20%. But at least you have gained the liquidity to be able to afford the advice of a rescuer (see tragedy) for the rest of the way.
Tip no. 2: Recognize your inventory drivers
Once you know where the excess stock is, you can ask the essential magic question in the next step: “Why…?”. Every overstock has its stories and some are even true. But even fairy tales can teach us life lessons. Systematically go through the items with the highest overstocks and ask why five times for each story. After some time, you will have a catalog of inventory-causing parameters, which we call “inventory drivers”. Some of the stock drivers represent evil witches who are not so easy to burn. However, there are usually also some inventory drivers that can be solved more easily and quickly.
As with diets, there are three directions that must be tackled together so that the new figure can be maintained in the long term. Sometimes it is still quite easy to organize processes properly (= healthy cooking). Is it essential that customers are allowed to leave finished products, which have previously been bludgeoned through on schedule with overtime, standing around for four weeks without picking them up and paying for them?
It can be quite difficult to plan properly (= eat in moderation). Most existing diets fail to change the lifestyle of a company, its planning and management principle. But think positively and take advantage of the following tips:
Tip no. 3: Ensure sufficient data quality
Admittedly, this is not a very original suggestion. It may be more fun to randomly select replenishment times, batch sizes, minimum order quantities and other logistical parameters instead of measuring or coordinating them correctly and storing them in the master data. Even with simple overstock analyses, we often hear the saying: “We still have to adjust the replenishment times before we can provide the data”. Banks are – thank goodness – a little less imaginative and don’t mess up their customers’ master and credit data like some account managers and purchasers mess up their company’s master data.
Systematic planning can only be based on clean data. Even if the dispatchers supposedly have all the important master data in their heads, you will find that simply cleaning up the material master data will melt away some excess stock. Without sufficient data quality in the ERP system, you can skip the next tip directly.
Tip no. 4: Give your ERP system a chance
Even if nobody wants it to be today, at some point someone bought your ERP system for a lot of money. Instead of using the system as a golden typewriter or a luxury card box, you should give it another chance. We often find that companies hardly use the possibly limited, but nevertheless existing possibilities of their ERP system in the area of material planning and scheduling. “In the past,” a logistics manager once said to me, “we used to plan manually, now we use our ERP system. The results are mediocre, … but at least they’re no longer mediocre.” Follow this lady’s example and trust your ERP system a little more. Although many ERP, PPS or merchandise management systems do surprisingly little in the area of demand planning and scheduling, you could live with the results if you just left the systems alone once and didn’t constantly override them.
An ERP system offers two decisive advantages over requirements planning and materials planning: On the one hand, it is emotion-free and on the other, it makes mistakes systematically. Systematic errors are easier to eliminate than involuntary errors made by hand.
Tip no. 5: Accept stock-outs and reasonable delivery readiness levels
No matter what you do, and no matter who demands it: there are no “never-out-of-stock items”. At best, there are “as-never-out-of-stock articles”. The availability of every item in the entire universe is statistically less than 100%. It is therefore quite correct that items are occasionally out of stock. 98% readiness to deliver means that I can neither deliver nor want to deliver exactly 2%. If you achieve 99% readiness to deliver at 98%, you are not doing well, you are wasting capital on excess stock. The more irregularly an item is in demand, the more the necessary stock explodes with each additional percentage of availability. In almost every company, there are items for which 99% readiness for delivery would require double the stock compared to 98% readiness for delivery. For this reason, you should be clear about exactly what delivery readiness you need for which items and your stocks will drop again – perhaps even by a considerable amount.
Tip no. 6: Schedule according to reach
Do you also like to discuss cost-optimized order quantities in your company? Dissertations and theses on this subject have long been measured only in tons. It is such a beautiful, systematic game with formulas and influencing variables and yet so beautifully systematically wrong. Firstly, you can’t correctly determine all significant cost influences anyway. Secondly, there are other constraints that limit you in your choice of batch size regardless of the cost optimum. Thirdly, the costs change by less than 5% between half and double the optimum batch size for most items. These are lost in the measurement inaccuracy of the calculation and cost recording.
Instead, look at the expected future requirements at the end of the replacement period and summarize them for a reasonable period of time. For items in large quantities and in regular demand, a period of one to two weeks may be reasonable; in some sectors it may be a matter of hours. In the case of rarely requested, low-cost items, it may even be six months. If the expected demand increases, you automatically order more with this procedure, if the demand decreases, you order less. This means that your order quantity adapts to your requirements. Consider the determination of the cost-optimized order size as the last tuning step in the inventory process and leave it to the professionals.
If you currently plan items with reorder points and fixed batch sizes, you can usually reduce your stock significantly in this way.
Tip no. 7: Qualify your dispatchers
Employees are neither born to be dispatchers, nor do they fall from the sky. Nevertheless, many companies treat their employees like the U.S. Navy treated its pilots at the beginning of the 20th century after it received its first airplanes. The pilots were asked to teach themselves how to fly. The Navy quickly abandoned this idea because the material costs – surprisingly, there were hardly any personal injuries – were considerable. When weighing up the costs, the U.S. Navy quickly decided in favor of the lower training costs instead of the higher material costs. Does this sound familiar to you? In most companies, dispatchers still have to teach themselves how to fly or are trained by their colleagues.
Try the training strategy. You will see that the stocks slide a little lower again. In our projects, in which we automatically provide theoretical and practical training to the dispatchers involved, stocks are also melting away in product areas that we have not yet even dealt with.
Tip no. 8: Straighten out your planning processes
You have now come a long way. Some large overstock rocks still lie ahead of you. To clear these away, you need increasingly in-depth knowledge and possibly also heavier equipment and external support.
Imagine you are in Berlin and want to go to Milan. Once you have boarded the right plane, you have already completed a significant part of the journey. The route from the airport to the cathedral may be hard to find, but at least you’ll be close once. It would be more difficult if you had to ask yourself after landing why everyone is suddenly speaking Swedish. Believe me, this even happens when you fly and there, firstly, you know where you have to go and, secondly, many people make sure that you get on the right plane. If you cannot simply determine your material requirements on an order-related basis because the customer is patient enough, you face the same problem, but in a more serious way.
If you are already heading in the wrong direction at the start of the planning process (when forecasting requirements), the precision of the subsequent planning steps will be of no use to you. A reliable forecasting process is therefore an essential prerequisite for avoiding the majority of excess stocks in the future and giving existing excess stocks a chance to be reduced more or less quickly.
Again, I don’t want to advise you against listening to the forecasts of your ERP system from time to time, if it is able to create demand forecasts at all. But please note:
Firstly, virtually all forecasting methods available in our standard ERP systems are statistically incorrect2. Secondly, a demand planning process is not particularly good if the forecast matches the later reality as closely as possible, as is usually assumed, but if the required delivery readiness is achieved with the lowest possible average stock level at the end of the demand planning process. A supposedly good forecast in conjunction with incorrectly determined safety stocks and, depending on the scheduling method used, can lead to inadequate delivery readiness and excessive stocks. Can you see why I am subtly pointing out the possible need for external support? An expert can help you check whether your ERP system’s forecasts are good enough or whether you should use an external system, which is the subject of my next tip.
Tip no. 9: Only introduce external forecast optimization systems when your planning organization is right
Let’s get straight to the point: External forecasting optimization systems are not a frippery but often necessary and helpful. However, they are not tools, but weapons, and anyone without a firearms license can easily shoot themselves in the foot.
You wouldn’t believe how many of our projects already have forecasting optimization systems in place without customers being able to reduce their inventories. Just as powerful weapons systems rot in some Third World countries because nobody can operate and maintain them properly, these add-on systems rot in some companies. It’s not enough to buy a great system with as many functions as possible; it’s also not enough if training is also provided. Rather, you need to have aligned your entire planning processes with the use of the forecasting system and you need someone who can competently monitor and regularly maintain the basic settings of the entire “weapon system”.
If you proceed in this way, your investment will not rust out, but will bring the stocks down significantly.
Tip no. 10: Review your company’s planning and control principle
There are two basic planning and management principles that your company can follow. These planning and control principles can be understood as the lifestyles of a company: You can drive your production orders through the company towards the assembly and shipping ramp like cowboys drive their cattle to St. Louis; this is known as the push principle.
On the other hand, there is the pull principle, which works like last week’s shopping trip to the supermarket: empty shelves are replenished again and again by the previous stage of the value chain. The pull principle has become popular here, particularly in its Japanese Kanban system form.
At the moment, push systems are considered uncool and in many companies, they are used for all they’re worth. Everyone wants to be involved and everyone does Kanban, even if the possibilities and knowledge are only sufficient for a small “bimbo Kanban” between the central warehouse and the assembly line.
Experience shows that pull systems, provided the logistical and production-related conditions allow their use, manage with significantly lower circulating stocks than push systems. Theoretically, push systems should be able to work more precisely and with less inventory than pull systems. Generally speaking, however, production is a process that cannot be planned in detail. Push systems react much more sensitively to these planning uncertainties than pull systems, which results in higher circulating stocks in practice.
However, it would be fundamentally wrong to conclude from this that pull systems are always the right solution, as some advocates of Japanese production organization do, because if you look closely, there are very few pure push or pure pull systems.
If you produce in series to some extent, the products or materials flow fairly evenly and the development department is not constantly nagging you with technical changes, then you may want to switch to pull control in these areas. If you implement the principle properly and size it correctly, your circulating stocks in these areas can shrink by more than 30%.
Tip 11: Position your production correctly
Do you still occasionally make coffee the conventional way, with the coffee funnel on the pot and pouring by hand? This used to be called “brewing coffee”. Haven’t you ever had a coffee overflow? The coffee flows slowly and comfortably out of the funnel below, as if it didn’t care about the waiting guests. So you eagerly pour in water and keep the funnel as full as possible to the brim. We know for sure that hardly any more will flow out at the bottom just because we fill the coffee funnel to the top. Somehow, however, the full funnel is appropriate to the drama of the situation, and before we know it, the coffee is dripping out of the pot, but the funnel is still half full and the swearing starts.
If the orders are pressing because the workload is good, we tend to brew coffee. We cram as much as possible into production, which usually consists of a whole range of coffee brewing funnels, and just like coffee at home, stocks are overflowing in production. Only sensible “brewing behavior” helps to get the circulating stocks down. If you pour fewer production orders into production at the front, the stocks at the various hoppers in production can flow out again, the circulating stocks fall again and you reduce some stocks again.
I know you already had this wise insight. So why is production so full? If you keep up your brewing behavior for longer, and there are said to be companies where this has already happened, all production orders will slowly turn red. No one knows what needs to be produced first, the current stocks continue to rise and yet less and less comes out of the assembly line. This behavior is referred to as the production control error loop. There is only one solution if you cannot or do not want to increase production capacity, and that is to put fewer orders into production. Anyone who beats you up for this has not understood the context. Even if orders that are due for production are burning brightly, it is no use pouring them into production if the production hopper is already full. There would only be more production orders on fire. In this situation, it is better for a customer order to burn up before production than to ignite a wildfire during production.
The amount of circulating stock required for production can be determined using operating characteristics, the explanation of which would go too far here3. As field surgery measures, you can firstly try to place orders with approximately the same work content in production and secondly, carefully reduce the inflow of orders into production until you have the feeling that the order backlog at the bottleneck capacities is becoming too low. This will not only significantly reduce work in progress in production, but will also help production and assembly to reduce throughput times and better meet completion deadlines.
Now you know the route you have to take and I don’t want to keep you any longer. Once you have worked your way through to tip no. 11, a significant proportion of your surplus stock will have largely disappeared, except of course for those that can only be scrapped. Good luck!
