Last month, we began a discussion of evaluating your inventory based on the number of day’s supply of inventory you have in stock. That is, how long your current inventory would fulfill anticipated customer demand. The major determinants of day’s supply of inventory are: 1) the lead time or the time it takes to receive a shipment from the primary source of supply, and 2) the order cycle or how often you can place an order with the vendor. This month’s article will focus on the effect of lead time on day’s supply of inventory.
Consider the following scenario. One of our clients imports a lot of products and typically experiences a 16 week lead time. But, they are able to place an order with the vendor each week. The order they place today should arrive 16 weeks from today; the order they place next week should arrive 17 weeks from today, etc. While they consistently have a lot of inventory “in the pipeline” (i.e., on order with the vendor but not yet received), the frequency of delivery results in a relatively low day’s supply of inventory. In fact, if they receive and sell a one week supply every seven days, their average day on-hand of the product would be a three and a half day supply.
However, the reason the above scenario works, is because the vendor enjoys a very consistent lead time of 16 weeks. If lead times vary from 16 weeks to 19 weeks you must maintain some additional inventory or “safety stock” to protect against a stock out in case a replenishment shipment arrives after the expected receipt date. Under normal circumstances (i.e., a 16 week lead time) the safety stock will be on the shelf when a replenishment shipment arrives.
Increasing safety stock significantly increases the day’s supply of inventory that a company must maintain for an item. Let’s say that the company, in order to protect customer service, decided to maintain 3 weeks or 21 days of safety stock for the item in case the shipment comes in at 19 weeks instead of 16 weeks. This 21 days of safety stock must be added to the average three and a half day’s supply of inventory resulting in a 24 ½ day’s supply of inventory. An inconsistent lead time alone caused a rise in day’s supply of inventory from 3 ½ to 24 ½ day’s supply!
There is a common misconception that an item with a long lead time requires one to maintain more day’s supply of inventory than items with a short lead time. Experience has taught us that consistency of lead time is most important, rather than how long or short the lead time is.
In summary:
1) To help minimize day’s supply of inventory, it is important to work with your suppliers to improve the consistency of their lead times. If you can better predict when replenishment shipments will arrive, you can stock less while maintaining a high level of customer service.
2) It is “best practice” to meet with problem vendors and discuss how you can work together to improve the consistency of their deliveries.
Next month we will discuss the other major effect on day’s supply, the order cycle. Our goal is to allow you to maintain the least amount day’s supply of inventory while maintaining a high level of customer service. That is to make your organization as lean as possible.