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Materials management is the sumo arena the company’s other departments wrestle in. Each of these departments; sales & marketing, production and finance will have different ideas on how the company is to prosper and make a profit. Sales and marketing want a seemingly endless supply of finished goods and replacement parts to maintain sales without a single stock out, production wants an endless supply of raw materials and WIP so they can meet all the production requirements of sales and marketing and finance want to keep just enough material on hand to satisfy customer orders without any material left over. Materials management must balance these often conflicting objectives while maintaining high levels of customer service.
You must remember that every dollar not spent is a dollar of profit.
To maintain the proper level of inventory you need to understand the demand for your products. You’ll need to understand your company’s:
· Sales trends
· Any sales seasonality
· Demand for replacement parts
· Any variations in your demand whether they are random or cyclical. (Random is any fluctuation that doesn’t follow a pattern while cyclical fluctuations follow a pattern.)
When you do encounter fluctuations in the demand you will need to record the reason for the fluctuations. This understanding will help provide more accurate inventory levels and forecasts. (More on that later…)
The focus this week is on finding some “low lying fruit” or those items that obviously have excessive levels of inventory. You’ll need to begin by tracking your usage or demand. The time frame will depend on your business needs and model but the most widely used is weekly average demand. You can use daily average demand but that will require a larger commitment as you will need to track demand more frequently.
Then determine the “Mean Absolute Deviation” of the data you’ve collected. The “MAD” is the average of the absolute value of the difference between the demand and the weekly average of the data being collected. As an example, if the data for a fore week period is 5, 15, 15 and 5 your weekly average would be 10. The absolute value of the difference between each data point and that average is 5. Add the MAD to the weekly average to arrive at the proper inventory level. In this case 10 + 5 or 15. Below is an example:
| Period | 1 | 2 | 3 | 4 | Avg. | Inventory |
| Demand | 5 | 15 | 15 | 5 | 10 | Level |
| Weekly Avg. | 10 | 10 | 10 | 10 | MAD | 15 |
| Absolute Difference | 5 | 5 | 5 | 5 | 5 |
If you’re a manufacturer you will need to blow this down through your bill of materials to ensure there is sufficient stock of your subassemblies and raw materials.
Now track your average on hand inventory. To keep this simple just take the beginning inventory level and the ending inventory level for the period being tracked and use the average of the two. Make sure you didn’t have a last minute receipt or reduction in inventory that would give a false average.
Also review your demand to make sure there isn’t a recurring spike in demand that isn’t captured within the MAD plus average. That would be an example of cyclical variation. You don’t want to reduce your inventory so this demand is backordered or otherwise unfilled. Depending on the type and frequency of the high demand and your material lead times it is possible to lower your inventory while meeting this demand. But, for now, let’s stay focused on the low lying fruit. Below is an example:
You’ll need to inform and work with your suppliers and production team as they may need to reduce the flow of product to make the reduction a reality.
This all sounds overly simplistic and it is. As I mentioned earlier we are looking for the low lying fruit. There are more complicated methods for inventory tracking and reduction but every company I have ever worked for was able to track demand for a short time, measure the inventory levels, make immediate reductions and save cash. I wanted to provide you with the means to achieve a quick win so you can reap early benefits and see the value of these methods.
-David