The phenomenon of “inventory creep”: a constant increase in inventory without a corresponding increase in sales. Management is often puzzled when this occurs, despite having implemented an expensive, state of the art inventory management system.
The most common reason for inventory creep is that buyers and salespeople cannot solely follow replenishment recommendations issued by the computer software. Why? Most automated replenishment systems base purchasing suggestions on past usage history. That is, the theory that what you sold in the past is a good indication of what you will sell in the future (with adjustments for trends, seasonality, etc.). This may work for most items, but most companies have to stock additional products including:
- New inventory items that do not have any actual usage history but possess the potential to generate additional sales
- Vendor offers that provide additional discounts for purchasing a large quantity of a product. That is, an amount that is significantly greater than the computer suggested quantity.
- Non-profitable items that are needed to support customer service for a very profitable customer
There is no question that some inventory, beyond what is suggested by the replenishment system, is necessary to achieve the goal of effective inventory management: “to meet or exceed customers’ expectations of product availability with the amount of each item that will maximize net profits”. But how do you control this additional creep in investment?
We suggest you divide your inventory into two categories: “core” and “speculative” stock:
- Core inventory: comprised of quantities of products suggested by your replenishment system that meet specific volume requirements. For example, one of our clients has specified that in order for a product to be part of the “core” investment, it must have sold in at least three of the past 12 months and at least one sale must have occurred within the past four months. Another distributor has stated that a product must have had sales in at least two of the past 12 months. Most state of the art systems will provide a “target” inventory investment for these core inventory items. That is, the projected inventory value of products that meet the stated stocking criteria.
- Speculative inventory budget: expressed as a percentage of the target inventory value of core items. A common value is 10%. This money may be invested in any product that is not part of the “core” item list or in opportunistic buys of additional quantities of products that are included on the core item list. This budget may be divided between sales and purchasing. Salespeople can invest their portion of the speculative budget as they wish, but they cannot exceed their portion of the speculative budget when requesting new products. If a product on the speculative list sells well enough to meet the company’s stocking requirements, it is transferred to the “core” item list. When this occurs the value of this product is restored to sale’s speculative budget to be invested in other new items. Purchasing will use their part of the speculative budget to take advantage of the most beneficial price breaks offered by vendors.
Implementing a speculative inventory budget helps prevent inventory creep. It allows management to maintain control of what probably is its largest asset. It also avoids common arguments between sales and purchasing over bringing in new items. When requested to bring in a new product a buyer can cheerfully respond, “Sure I will buy that product for you…..if you have the money in your speculative budget.”