The Inventory Dilemma

What’s the difference between seeing the Loch Ness Monster and achieving perfect inventory balance? One involves a completely unrealistic tale of lore. The other involves a large prehistoric water-dwelling creature with a long neck. Dad jokes aside, the effective management of inventory is a monumental challenge for any business that is involved in manufacturing, moving, storing, or selling physical goods. As a supply chain practitioner for the duration of my career, working with inventory was the source of much of my consternation and my fascination.

Inventory (or the lack there of) is something that touches all our lives. In many ways, Amazon has greatly reduced the impact we experience when inventory is poorly managed. Need something in a day or two? Just find it on Amazon and order away without concern over shipping costs (if you happen to be a ‘Prime’ member). Looking for something at a local store but can’t find it on their shelves? No problem, you can order it from Amazon right on your phone before you even leave the store. Above all else, Amazon is a master of distribution and inventory management. The expert supply chain folks at Amazon have insulated many consumers from the challenges that normally come with needing a particular thing at a particular time. But for manufacturers, wholesalers, distributors, and retailers, the inventory dilemma is very real and very impactful.

The Inventory Dilemma

So, what’s this inventory dilemma all about any way? Having too much inventory means a company’s working capital is tied up, not generating revenue, and likely accruing costs (storage, unnecessary processing, scrappage). Having too little inventory means that customers can’t give the company money in exchange for items they wish to purchase. This quite literally defeats the purpose of being in business in the first place. Unfortunately, many enterprises will face both too much and too little inventory at the same time. It’s a cruel fact of business. Forecasting (or educated guessing) of what future demand will be for a company’s products is really hard; and is almost never accurate at an individual item level

In the early days of the COVID-19 pandemic, hyper efficient supply chains ground to a halt as key participants were impacted by dramatic plant closures and immediate pauses in distribution channels. For example, the auto industry supply, which has been designed to leverage efficient, connected suppliers, was particularly impacted by supply chain disruptions. Ashwani Gupta, Nissan Motor Co.’s chief operating officer highlighted this reality in a recent Wall Street Journal article: “The just-in-time model is designed for supply-chain efficiencies and economies of scale,” he said . “The repercussions of an unprecedented crisis like COVID highlight the fragility of our supply-chain model.” Now, some automakers are stockpiling certain parts in an attempt to avoid especially harmful choke points.

Variability is No Joke

As with many aspects of life, the only thing certain about supply chains is that they face constant uncertainty. All businesses face both demand and supply variability. An individual customer doesn’t have precise knowledge of which products they will order in the future. Nor do they know the quantities or timeframes they’ll want those products for. Forecasts can provide a rough estimate for future orders (product mix, quantity, and timeframe) but still don’t provide an exact answer. Think about your own individual consumption patterns. If you were asked to forecast all of your purchases for next month, could you do it? You could probably come up with something if you had to. But, you likely wouldn’t appreciate being strictly bound to that forecast without any room to purchase in a way that deviated from your prior month’s estimate. Now imagine you’re an enterprise that offers hundreds (if not thousands) of different products to thousands (if not millions) of potential customers. Preparing for the right level of material purchasing, capacity, production starts, storage, and transportation is no small feat!

Speaking of preparing to support customer demand, supply variability is also a daily companion of operations. Even if a perfect demand forecast could be conjured (crystal ball? time travel?), supply chain are faced with events that are clearly not within their control. We need look no further than the COVID pandemic. While predictions of a global pandemic have been present for some time, it would be impossible to know the ways in which this particular global pandemic impacted multiple major facets of society and business. As highlighted above, hyper efficient systems don’t deal well with outlier situations. Per Merriam-Webster, a buffer is “a means or device used as a cushion against the shock of fluctuations in business or financial activity.” Reducing supply chain buffers looks good financially…only if variability is within normal ranges. The pandemic has exposed just how interdependent global supply chains really are. Highly efficient and interdependent supply chains are particularly susceptible to non-normal variability. Stockouts at a manufacturer in Asia can not only impact retail customer sales in Europe but also every stage of the supply chain in-between. Systems without buffers will feel shocks that systems with buffers will not.

What can be done?

So, is the answer to start adding buffers all over the place? Not quite. Maintaining a reasonable level of safety stock (aka buffer stock) is an accepted means of buffering against the variability that occurs in both demand and supply signals in our real world. Hopefully you agree that having too little inventory is bad for enterprises. Stockouts mean that willing and able customers are forced to find what they need elsewhere. Often, customers permanently switch from one enterprise to another when they can’t find what they need – after just a single disappointing experience. On the other hand, maintaining too much inventory can be costly, as it ties up capital that could be used elsewhere and requires storage and space. Holding the “right” level of safety stock allows a company to strike a balance between having enough inventory to meet demand, while avoiding the costs and risks associated with holding too much inventory for too long.

Supply chain conditions have started to flow more freely as the impacts of the pandemic start to subside. At the same time, there are also signs that demand is decreasing in many industries. Companies are starting to face more of the challenges associated with holding too much inventory (working capital locked up as inventory, added storage costs, unnecessary processing, and scrappage). Effectively managing safety stock has never been more important. Enterprises need not feel like they are trapped between a rock and a hard place though. Right Sized Inventory’s patented predictive analytics incorporates all of the required supply chain factors to accurately determine optimal inventory levels. Items are run through over 2,000 simulations to find the inventory level that will most effectively achieve the desired service level without excess.

Insurance Policy

Safety stock inventory is, in a way, an insurance policy. One wouldn’t likely carry a $10M umbrella policy on $1M in actual assets. However, carrying no insurance at all is quite risky because we live in a highly variable world. Variability can’t be eliminated, but it can be modeled and managed via counter measures determined through the simulations including adding safety stock in appropriate quantities and locations based on known market conditions.

Safety stock is a key component of inventory management that helps companies protect against unexpected disruptions, maintain continuity of operations, and reduce the risk of overstocking. By carefully managing their safety stock levels, companies can ensure that they have the inventory they need to meet customer demand and maintain a strong, reliable supply chain without incurring those unnecessary financial risks associated with too much inventory.  And that’s an outcome that is good for all of the bottom lines!

Written by A Reed Reviewed by B Holman