Most distributors realize the importance of inventory accuracy – that is, having the available quantity of an item in your computer agree with what is actually on the shelf in your warehouse. Management realizes the bad things that happen when inventory accuracy doesn’t exist:
- Wasted Time: If your inside salespeople constantly have to go out to the warehouse to check stock, they’re wasting time. They can’t walk out to the warehouse and answer phone calls at the same time. And, your customers’ time is also wasted as they sit on hold while you dash out to check stock. Do they really enjoy listening to “muzak” or to a ten-minute advertisement describing your commitment to customer service?
- Wasted Money: If inventory is lost in your warehouse, whether through misplacement, theft, or breakage, it must be replaced. Buying replacement material is an expense. And, like payroll, rent, or any other expense, the replacement material must be paid for with part of the distributor’s net profits. For example, if $100 of material is lost per week ($5,200 per year), this $5,200 comes off of your bottom line. If your net profit before taxes is 4%, it takes $130,000 in new sales to make up for this loss ($130,000 x .04 = $5,200)!
- Disappointed Customers: If you promise material to a customer based on what your computer says is in stock, but the material isn’t actually available in your warehouse, the result is often a disappointed customer. You’ll lose your reputation as a reliable supplier. And not being a reliable supplier is the best way to increase your competitor’s sales.
There’s little doubt that management realizes the importance of inventory accuracy. But, how do you convince your employees that inventory accuracy is important? Well, there are two ways:
- Convince them that inventory accuracy is a crucial element for the success of your company – and that their professional futures are dependent on the success of your company.
- Provide economic incentives for maintaining accurate inventory.
What’s Good for the Company Is Good for the Employee
Many distribution employees behave as though they work for the government. Their paychecks are not dependent on how well they perform their jobs. Further, they are convinced that the company’s profits are two, three, or four times what is actually on the bottom line!
It is imperative that all of your employees, from the guy who sweeps the floor on up, realize that your company makes money by buying material at one price and selling it to other companies or individuals at a higher price. Gross profits are the primary source of funds the company has to pay expenses. And, the company is pressured by customers and competition to keep prices low, resulting in small gross profits. One category of expenses is wages, benefits, and salaries. If you buy material, but it’s lost before it can be sold, it doesn’t contribute to gross profits (that pile of money available to pay employees and other expenses). In fact, when material is broken or lost, money must be taken out of the pile to pay for replacement material. If too much material is lost, there won’t be enough money in the pile to meet the payroll. Management does not have the option of printing more cash in the back room (without risking a long, all-expense-paid vacation at a federal government facility)!
At the end of every month, let everyone know what the material lost that month cost the company – how much money was wasted instead of being available to pay salaries, benefits, and other worthwhile expenses.
Rewarding Good Performance
In a perfect world, all of your employees would realize that their future is tied to the success of your company, and they would protect your inventory and other assets as if they were their own. But the world isn’t perfect. And, like it or not, people will tend to do things for which they are rewarded. So, you may be faced with a challenge to develop an incentive program tied to inventory accuracy.
We’ve studied several inventory-accuracy-related compensation programs, and we’ve found that the most successful are tied to the cycle counting. Cycle counting is the process of physically counting part of your inventory every day and comparing the quantity found on the shelf to the on-hand quantity in your computer.
In one instance we implemented a program in which we changed the compensation program for all of a company’s warehouse employees. The distributor involved was loosing one-tenth of his inventory to theft every year. And, we determined that the majority of the pilferage was committed by employees. Because of the transient nature of the local workforce (the company was located in a resort area) we determined that it would be difficult, if not impossible, to convince the employees with words alone that their long-term future was tied to the profitability of the company.
The new compensation plan was radical, to say the least. Instead of paying everyone by the hour, a significant portion of every warehouse employee’s compensation was now dependent on the accuracy of the inventory counts in the warehouse. Management cycle-counted part of the inventory every day. And, employees didn’t know in advance when a particular item would be counted. The inventory accuracy goal was titled the “97-3” rule. If 97% of the counts in a two-week period were within 3% of the quantity that the computer determined should have been in inventory, every employee received an incentive bonus. If the cycle counts fell short of the goal, no employee received the bonus. When the bonus was earned, warehouse employees earned 10% more than they did before the program was implemented. When the goal wasn’t met, they earned 10% less.
The program resulted in every warehouse employee becoming an “inventory watchdog.” They realized that if there was an inventory shortage, the result would be a reduction in their next paycheck. If they saw someone stealing, they viewed that person as stealing from them personally, not from the company. The result was that inventory shortages decreased substantially.
Summary
Most, if not all distributors realize that they must encourage inventory accuracy. If you can convince your employees that their long-term security is directly tied to protecting your assets, great. If not, don’t give up. You must take a different approach. Employees must personally feel the benefit of good inventory accuracy (i.e. a bonus), or the cost of missing material (i.e. a reduction in compensation). In either case, the distributor cannot maximize productivity and profitability unless inventory accuracy is achieved.