Key Metrics to Measure Inventory Management Success
The goal of effective inventory management is to meet or exceed customer’s expectations of product availability with the amount of each item that will maximize your net profits. As they go through the daily process of buying and selling material, many distributors have no idea whether or not they are coming close to achieving this goal. Measurements are needed. In order to be useful, these measurements cannot be overwhelming, hard to understand or time consuming to assemble. Over the next several months, we will discuss several metrics that will allow you to monitor your progress in achieving the goal of effective inventory management. We will begin with the most important measurement: customer service level.
The customer service level measures how often you have the items you’ve committed to stock when your customers want them. Keep in mind that if you don’t have what your customers want, they must look for it elsewhere. Your competitors won’t have to make sales calls… your customers will seek them out! The customer service level is calculated with the following formula:
Number of line items for stocked products shipped complete in one shipment by the promise date
Total number of line items for stocked products ordered
Notice that this metric measures line items shipped complete. That is, when the entire quantity ordered is delivered, in one shipment, on or before the “promise” date listed on the order. If the customer orders ten, and you ship ten, you get credit towards the customer service level. But, if the customer orders 25 and you only ship 24 before the promise date, you get no credit. This is truly a pass-fail test. Why no partial credit for shipping 24 out of 25? Well, if the customer wanted 24, he or she would have ordered 24. They want 25! The customer has to find that last one piece somewhere else, probably at your competitor’s warehouse down the street. They may have to wait (and perhaps delay a project) for you to receive a replenishment shipment.
Why no credit if you deliver the quantity in more than one shipment? Because both parties incur additional costs. Your customer has to process multiple stock receipts, and your firm has to process multiple shipments in order to complete the order.
When calculating your customer service level, only include sales of stocked items that are filled using warehouse inventory. Do not include sales of other kinds of products such as:
Special Order or Non-Stock Items – Items that are not stocked, but are specially ordered to fill a specific customer order.
Direct or “Drop” Shipments – Material sent directly from a vendor to your customer.
Shipments of these types of items do not reflect how well you stock material to meet your customers’ immediate needs. If a company includes special order items and direct shipments when calculating a customer service level, the result will be a falsely high indication of how well they are serving their customers from warehouse inventory.
Best practice is to analyze your customer service level each month using several criteria including:
Rank of Product – It is probably more important to have a high customer service level on “ranked” or designated critical items
Vendor – Is your customer service level for specific vendors’ products unacceptably low? Or, are many of their products out of stock for prolonged periods of time? Can you work with these vendors to provide more consistent deliveries and improved product availability?
Buyer – Some buyers are more talented than others. The customer service level and stock out analysis are good objective measurements of a buyer’s performance.
The customer service level is THE most important inventory metric as it determines how often you are meeting or exceeding your customers’ expectations of product availability.