About this time last year I worked with two large distributors that allow their individual branches to completely control the replenishment of the products they stock. Each location’s management, buyers, and/or salespeople could replenish stock whenever they felt it was necessary with either a vendor purchase order or a transfer from another company location. Management at both firms was convinced that this policy allowed for the quickest possible response to customers’ needs and served as the cornerstone of outstanding service.

However neither of these companies was providing great customer service or was meeting profitability goals. They suffered from several, apparently conflicting, inventory problems:

  • Frequent stockouts of critical products.
  • Large quantities (and value) of excess inventory and dead stock.
  • Inaccurate product availability information in the computer system.

Executives at both firms were surprised to learn that the underlying cause of these problems was the strategy they hoped would enhance their ability to effectively serve customers. Let’s look at some of the reasons why their branch replenishment policies were doing more harm than good:

Any available stock could be transferred out of any other branch at any time if it was needed to fulfill an immediate customer need. On the surface this policy may make sense. Why keep four units of a product on the shelf in one location if it can be sold by another branch? Isn’t that what inventory turnover and customer service is all about? But the logic of this policy breaks down when we look at a specific example:

Branch A normally sells 10 pieces of product #A100 per day. The item has a seven-day lead time and the branch manager always issues a replenishment order when there are 90 to 100 pieces in stock (i.e., a nine- to ten-day supply). This provides some safety stock in case of unusual demand or a delay in receiving the replenishment shipment. Branch B isn’t as well organized. They often don’t reorder part #A100 until they experience a stockout. Then they transfer quantities of the item in from other locations (including branch A) to satisfy their customers’ needs. Suppose that one day branch A is awaiting a replenishment order and has only 30 pieces of the product left in inventory. If branch B takes all or part of this stock to fill an existing customer order, branch A may also experience a stockout before the replenishment shipment arrives. The branch that didn’t manage its inventory well looks like a hero to its customers while branch A suffers lost sales and disappoints its clientele. In the future branch A will probably begin to stock defensively – that is, they will plan to stock both the quantity necessary to meet their customer forecast and what they think other branches might pull from their inventory. It is easy to see how this situation can easily get out of hand if any salesperson in any branch can sell any available inventory.

But wouldn’t the practice of defensive stocking actually improve customer service because every branch would be overstocked with critical parts? Not necessarily. We have found that salespeople, when faced with the prospect of other branches taking inventory that might be needed by one of their preferred customers, will go to great lengths to protect this material. One common method is to enter false sales orders to commit material they do not want to be taken by other locations. As a result the available quantity (On Hand – Committed) in the computer system does not accurately reflect the quantity actually available for sale. The falsely committed material cannot be used to fill the needs of other customers in the branch that owns the material. I have even seen situations where the customer for whom specific material was “hidden” fails to receive the secreted product. This happens when the only salesperson who knows about the false orders is out to lunch or on vacation and the salesperson who actually takes the order doesn’t know anything about the material hidden for this particular customer.

Salespeople buy because they know what customers really need. Successful salespeople like to interact with customers, and their compensation is often based on earned commissions. Any replenishment work they must do is often relegated to off hours or times of crisis. The most common cause of one of these crises: a stockout of a popular or critical item.

Effective buyers know that when you buy products is the critical element to achieving a high level of customer service. Replenishment orders must be issued as soon as the net stock quantity or replenishment position of an item [On-Hand – Committed + Currently on Replenishment Order] falls below the reorder point quantity. This reorder point quantity is equal to the anticipated usage during the lead time plus a safety stock quantity to protect against unanticipated demand during the lead time or delays in receiving the replenishment shipment.

Though the salesperson may issue an emergency as soon as the crisis occurs, the results are still often negative:

  • An emergency shipment often doesn’t meet a vendor’s requirement for a “good” or “target” order and the material has to be purchased at a higher unit cost (often with the addition of airfreight), reducing the company’s profits.
  • Customers may not be satisfied with an emergency shipment from the vendor if they expected the material to be in stock and available for immediate delivery.

Branches may overbuy in order to place vendor “target” purchase orders on a regular basis. A target order meets a vendor’s requirements that enable a company to receive the discounts or terms that allow them to competitively sell the vendor’s products. If each branch has to meet the vendor’s target requirement when placing a replenishment order, they may have to purchase more of a popular item than they would if they could split shipments with other branches. They also might have to buy full package quantities of slow-moving products as opposed to “sharing” a package with other company locations.

At these two companies, these problems and others were solved by putting specific buyers in charge of replenishing inventory of specific product lines in all customer locations. These individuals had both customer service and inventory turnover goals they were expected to meet or exceed. In order to do this they:

  • Ensured that replenishment orders were issued as soon as the replenishment position of a product fell below its order point (lead time usage + safety stock or reserve inventory). This avoided customer backorders and crisis replenishment orders.
  • Split replenishment orders between branches and centrally-warehoused slower-moving items. Because the central warehouse serves as the branches’ normal source of supply of these products, they buy enough from the vendor to meet the needs of both their own and the branches’ customers. The result: vendor purchase orders are issued more frequently and several branches can “share” one vendor package of a slow-moving product.
  • Possible unusual usage is identified and analyzed. Salespeople and/or customers are interviewed to determine if an unexpected increase or decrease in usage is the result of sales activity that will probably not reoccur or a new evolving sales trend. Future forecasts are adjusted to reflect the obtained information.
  • Buyers approve all inter-branch transfers. After all, they are responsible for maximizing both customer service (i.e., minimizing stockouts) and inventory turnover. For example, it may be advantageous to move the surplus stock of a popular product from a branch that is a considerable distance from the location that needs the material than a smaller quantity from a closer branch if it will maximize overall corporate profitability.

Both of these companies established central purchasing authorities. All buyers were not necessarily physically located in the same office, but each was responsible for specific product lines throughout their company. As a result we achieved the results that every company desires: a maximization of both customer service and corporate profitability through effective inventory management.