Lean Inventory – Exactly, How Lean is Lean?

Lean is the flavour of the decade. With the global economic recession fairly widespread and margins under pressure, manufacturers are increasingly looking towards cost cutting as a tool for improving profits. And where else to cut costs than that biggest of all culprits – that elephantine mammoth INVENTORY!

It goes without saying Inventory is a necessary evil. In fact a bundle of evils, including:

  • Space Eater:
    The more the Inventory, the more Space it gobbles up
  • Capital Blocker:
    Sigh! All that investment in inventory lying idle for realization
  • Earnings Killer:
    Not to forget those Write-Offs of Non Moving Dead Stock, Pilfered & Damaged Inventory – all directly deducted as “Stock Adjustments” from the Company’s Bottom Line
  • Productivity Loser:
    Double the Inventory you hold and reduce your Productivity by Half. Well, not exactly, but I guess you get the idea!

And so, in this season when “Lean is In”, how LEAN is actually LEAN? Am I already lean?

Going lean is not an end in itself – striking the right balance is the key to losing flab without your business failing to deliver. Going Lean cannot be an excuse for failed deliveries. Without an effective strategy in place, you will be playing blind in this gamble of going lean.

Defining a Coherent Stocking Policy

Lean Inventory comes with its own set of risks towards realization of Order Fulfilment Ratio. A successful model balances both these concerns and helps in reducing inventory without affecting the Effective Service Rate or Order Fulfilment Ratio adversely. Critical to success of any lean inventory endeavour is effective Demand Forecasting. So if you have not invested in necessary forecasting tools, do the same before you embark on this route.

Even with an effective forecasting in place, there are a number of outliers to the rules and these must be normalized. It must be remembered that all Demand Projections come with an inherent risk of being wrong. Recognizing the common factors for such a failure and fine-tuning the forecasts can mitigate the risks significantly.

Some of the common type of exceptions you must be on the lookout for are:

  • Fluctuating Demand
    Make a judgment towards what is the acceptable fluctuation in your type of industry. Fluctuation may be measured as:fluctuating-demand
    Fluctuating Parts may be the single most potent disturbance in all your efforts to bring down inventory levels. Look at fluctuation in conjunction with ABC classification of your parts and define a clear Stocking Policy.A Sample Stocking Policy is shown below which indicates which type of Parts should be stocked and which should not.

    fluctuation-table
    In the above sample “Very Fast Moving A-Class Parts” are stocked irrespective of their fluctuation. Not stocking such parts can hurt the business interests adver sely.However in the case of “B-Class Parts”, Very High fluctuating SKUs are not included in the stocking policy. Likewise we gradually taper down the list of parts we will stock under each category and finally when we come to the “Non-Moving E Class Parts”, there is a clear direction that no such parts will be stocked in the warehouse. A Back Order situation is acceptable for such parts.This way we try balancing our Service Rates with Inventory Reduction. However please note there is no one single Stocking Policy that is correct for all. You will need to do the hard work to arrive at the relevant measurements and thereby a meaningful Stocking Policy for your specific business requirements.
  • Frequency of Demand
    Frequency of Demand is the measure of how many different customers is the Demand sourced from. It is an indicator of the actual spread of the demand of an SKU. A high demand from a few customers runs the risk of disappearing suddenly when such customers stop ordering the SKUs, leaving you with a pile of non-moving inventory.Similar to fluctuation, frequency of demand is also a pointer of the risk that this demand projection carries. The lower the frequency of Demand, the higher the risk of inventory turning bad in the coming days. Like fluctuation, form an internal standard towards what is an acceptable frequency for your specific business. Define a stocking policy towards Demand & Frequency and validate all Demand forecasts against this stocking policy.A sample Stocking Policy is indicated below.fluctuation-table
  • Campaign & Seasonality related spikes
    Demand forecasts can go awry if there are spikes in demand due to extraneous factors like Campaigns and Seasonality. A forecasting model not tuned to the above realities, will adjust Demands on the higher side after the spike has occurred, leaving you with loads of redundant inventory. When in fact what is required is exactly the opposite. Spikes due to campaigns & onset of seasons, must be recognized early and demand must be adjusted to the higher side before the spike is felt in the system. And once the event has passed, demands need to be adjusted to the lower side to prepare for the lower demand periods now coming in.

An intelligent Forecasting model can help take into account this and various other factors for inventory forecasts and safeguard your path to Lean Inventory.

Measuring the Forecasting Accuracy:

If you are already on the Forecasting bandwagon, then do not forget to take your efforts one step beyond. Make sure you are monitoring the effectiveness of Forecasting, especially Demand Forecasting which is the Achilles’ heel of the entire process. Compare the Actual Demand with the Forecast predicted and monitor for Top 5% variances (both Up & Down variances).

Some of the metrics that can help you judge the efficiency of the forecasting model are indicated below:

  • Root Mean Squared Error (RMSE) measurements can ensure positive variances are not offset by the negative ones, thereby providing better insight into the effectiveness of the forecasting model employed.
    formula1
  • Mean Percentage Error (MPE) measurement indicates the direction of the forecast bias i.e. over-forecasting / under-forecasting.
    formula2
    In conjunction with RMSE values, MPE provides a fair assessment of the forecasting efficiency in the organization.

Summary:

Journey towards Lean Inventory management is fraught with risks and wrong steps can result in significant loss in business. Applying scientific models, using tools etc., can help to a certain extent. However over and above the same, it is necessary to establish internal standards for acceptable fluctuation and frequency of orders. A well-defined stocking policy is critical to the success of such initiatives. Make sure the forecast is constantly monitored and relevant metrics are regularly presented and discussed. Look out for the top 5% wrong forecasts and carry out a root cause analysis for the same. This will give you surprising insights into what needs to be corrected in your business in this noble path of lean inventory.

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