NEED SOME EXTRA MONEY THIS YEAR?
Take a look in your warehouse. See those pallets in the racks? What about all the cases on those shelves? What you are really looking at is this: cash. And since that cash is sitting there in your warehouse, it isn’t moving into your bank account. The other thing you see is risk — with that static inventory, there is a higher risk that obsolescence and damage will occur.
To get that inventory (cash) moving requires taking decisive steps toward increasing its speed. Inventory velocity is typically measured by inventory turns, as shown in the following formula: Inventory turns = (Cost of goods sold) / (Average inventory for the period)
The cost of goods sold, which is found on the income statement, is the amount spent to manufacture, create, and sell the inventory. The inventory amounts, which are found on the balance sheet, are the end-of-period value.
To look at a real example, Coca-Cola had a cost of goods sold of $6.2 billion in 2000. The inventory values were $1.07 billion in 1999 and $1.06 billion in 2000, for an average of $1.065 billion. The inventory turn is calculated as $6.2 billion/$1.065 billion = 5.82. This means that Coca-Cola sells its inventory 5.82 times each year.
TAKING TURNS
Intuitively, it would appear that a company with higher turns would be able to enjoy some competitive advantage over a company with slower turns. But how do you measure the advantage? The answer can be found in figure 1 (p. 40). XYZ Company has $1 billion in sales, holding $308 million in average inventory, with turns of 2.5 times per year. Hypothetically, if turns increase 20%, to 3 per year, there is a reduction in the average inventory to $256 million, assuming the cost of goods sold remains constant. The impact: a bottom-line savings of $52 million of on-hand inventory. In addition, more money in the bank comes from reduced carrying charges, reduced storage space and facility costs, and better operator productivity.
The elements of inventory velocity, from a total supply chain perspective, can be identified as the elapsed time it takes for product to travel the entire length of the supply chain. Specifically, these can be further identified as the time taken to source from suppliers, manufacture the products, distribute them, process the order, and deliver the products to the customer. There are specific strategies for improving inventory velocity in each of these time elements. For warehouse operations and order fulfillment, the most significant approaches to improving inventory velocity are based on inventory management practices designed to improve operator productivity. This allows the operation to respond rapidly to customer orders.
HIGH PROFILE
One of the first measures to remove time from the supply chain is to know your inventory, to the item level. “Inventory accuracy is critical to all aspects of supply chain management,” says Jon Chorley, senior director of inventory and warehouse management at Redwood Shores, CA-based Oracle Corp. “Supply chain visibility is compromised with inaccurate inventory.”
What characteristics are important? Knowing annual volumes is not enough. The most important to understand are the line item quantities, typical pick quantities for each reach to the pick face, seasonality, propinquity or affinity to other products, relative order frequency compared to other inventory, and accurate cube/weight of the item and case.
One way to derive movement characteristics is through an order analysis. Examining the orders over a historical period of time gives a baseline view of how the item was stored, picked, packed, and shipped. Of course, in the world of fulfillment operations, the only thing that is constant is change. The analysis also needs to consider SKU rotation — the obsolescence of old items and introduction of new items, projected growth rates in sales, and the resulting implications for on-hand inventory changes.
Using this inventory profile allows accurate and more productive assignment of the item to the picking location and storage type — what is known as product slotting. For small parcel operations, there are typically three types of picking. As shown in figure 2 (left), items can be picked from shelves (slow movers), caseflow racks (medium movers), or pallet positions (very fast movers). The decision on item placement for each pick type depends on the velocity of the item, assuming the item can physically be placed in the location.
By correctly slotting product, you increase inventory velocity because inventory is placed in the pick type that best corresponds to its movement. Fill rates are improved, operators spend less time traveling and more time picking, and warehouse space is better utilized — all factors that incite velocity.
Other techniques to improve SKU velocity include task interleaving, improved cycle counting for higher inventory accuracy, and use of more productive picking technologies (such as pick-to-light, voice, or radio frequency, where appropriate) linked to a warehouse management system.
INTEGRATE FOR IMPACT
For all of the operational improvements within the warehouse, the impact on velocity (as measured by inventory turns) remains limited. When inventory turns slowly, there is a tremendous amount of stock available. For example, six inventory turns give you an average of two months of inventory on hand. The time saved on the order fulfillment is small when compared to the amount of time the inventory sits and waits for the order. While warehouse improvements may have a large impact on productivity, the impact on overall inventory turns is somewhat minimal.
To really drive down average inventory and increase turns requires an integrated approach to the supply chain. And that means collaboration between supply chain partners.
In the best-case scenario, inventory is a temporary resident in the warehouse. Through cross-docking, inventory is received and transported directly to an outbound staging area or fluid-loaded to a waiting trailer. By using advance shipping notices, inventory can be pre-allocated to customers even before it arrives at the warehouse. A recent implementation by a northeast retailer touted a seven-minute transfer time for cross-docked inventory.
To get to that level of integration with suppliers, however, requires a level of trust and collaboration that is emerging as a critical success factor in supply chain management. On the inbound side, sharing forecasts, agreeing on order frequency, and employing merge-in-transit to reduce shipping costs for all parties are the major techniques. Where manufacturing or assembly is involved, immediate purchase and delivery of components from suppliers, direct work-order scheduling, and swift work-order release are necessary. On the outbound side, zone skipping and creating backhauls with partners are effective. Together, the overall levels of inventory can be dramatically reduced — resulting in staggering increases in inventory turns.
VELOCITY IN REAL LIFE
In a presentation to the Institute for Supply Management conference in November 2003, Mike Gray, senior manager of global supply chain strategies for Round Rock, TX-based Dell Corp., provided the insights on the Dell business model shown on page 39.
The results? Overall inventory turns were 91.25; in the factory the turns were over 500. Inventory is constantly in motion at Dell. This is achieved by a direct connection between the customer order, the supplier, and the Dell manufacturing and distribution operations. Each customer order triggers inventory delivery from suppliers and a work-order release to the Dell factory floor. High-velocity make-to-order is the business rule at Dell.
Another prominent example of supply chain velocity in action comes from Seattle, WA-based Amazon.com. According to CFO Tom Szkutak, speaking at a Credit Suisse First Boston technology conference in December 2003, Amazon.com reported inventory turns of 19. The Amazon.com business model fundamentally relies on leveraging transaction speed (via the Internet) and inventory velocity. While inventory is received and stored in the warehouse an average of 19 days until shipped to the customer, the customer payments are received only three days later through credit card purchases. The original supplier of the inventory is typically paid 28 days after the product has already shipped to the customer!
The net result is that Amazon.com is able to ship product, get the money from customers, and earn interest, all before having to pay the supplier. While the products and industries are different, Amazon.com shares its approach to and reliance on supply chain collaboration and inventory velocity with Dell. If Amazon.com and Dell did not have the supply chain collaboration to receive merchandise as needed (demanded by the customer), their business model would fail.
UNLIMITED VISIBILITY
The challenges in warehousing and distribution today are enormous. As profit margins are continually squeezed, improving inventory velocity can be a vital way to improve cash flow. To make dramatic changes in inventory velocity and turns requires end-to-end visibility of the supply chain and an examination of possible changes.
“To increase inventory velocity, a holistic approach is necessary,” advises Oracle’s Chorley. “There are a lot of interrelated components — from the basics of inventory management to the sophistication of inventory redeployment and collaboration. Every company has a set of options that will work best in their industry and circumstances.”
Excellence in supply chain management is now a crucial component of business success. As you understand more about your supply chain, you will be able to contribute greatly to its efficiency by adding velocity to your SKUs. The benefits are indeed like money in the bank!
Jeff Zeiler is a senior consultant with York Consulting Group Inc. (YCGi), a York, PA-based firm that focuses on supply chain analysis, material and process flow, and information technology. Zeiler can be reached at [email protected].
Dell’s supply chain formula
- SCM is the entire enterprise.
- Manufacturing reports to sales.
- Procurement does not own pay terms.
- Inventory does not equal service.
- It’s all about supply and demand.
Source: Dell Presentation to ISM (11/03)
| Annual sales | $1,000 million |
|---|---|
| Gross margin | 30% |
| Cost of goods sold | $769 million |
| Average inventory | $308 million |
| Inventory turns | 2.5 |
| Turns increase | 20% (turns = 3) |
| New average inventory | $256 million |
| Inventory Savings | $52 million |
| Source: York Consulting Group | |