Between sustainability goals, advancing technology, and risk management — to name only a few —inventory management may not be top of mind for supply chain managers on a daily basis. Instead, many companies will address inventory management only when it becomes a problem, urgently creating solutions and strategies either to bring inventory up to meet demand or to reduce inventory when it’s no longer needed.
Other companies might have a proactive inventory strategy in place but oversimplify their goals and challenges, ignoring key details about their inventory breakdowns that could save them time, money, and energy.
In the short term, these strategies can certainly achieve the desired goal. If inventory is too high, stock can be quickly sold off or destroyed for a fee; if it’s too low, the manufacturer may expedite production, though it’s not always as easy as simply speeding up an assembly line. But, as with many short-sighted solutions, there are tradeoffs.
This is why Oliver Wight encourages companies to think bigger about their inventory management strategy, framing the practice as “inventory governance.”
“In many organizations, there is no coordinating mechanism or formal Inventory Governance program, so people will do what they think is best for their function and end up, inadvertently, working at cross purposes,” says Kai Trepte, a business advisor at Oliver Wight. In contrast, he says, the Inventory Governance approach is about getting everybody pulling in the same direction and leveraging the processes the business already has in place, such as integrated business planning, annual financial planning, demand management, and supply planning. Companies need to shift their thinking so that its Inventory Governance programs help interconnect business goals and allow the entire organization to function more effectively.
Defining Inventory
As companies build their Inventory Governance programs, a strong foundation must be laid. According to Leon Dixon, a business advisor at Oliver Wight, it starts with clarifying how each company is defining and segmenting inventory. The best way to look at it, says Dixon, is to focus on the whys behind the inventory as opposed to the whats. Oliver Wight breaks inventory down into the following six categories:
- Cycle Stock: Stock levels that are linked to a regular replenishment cycle.
- Pipeline: Inventory (and the associated timing) that’s committed to an order but has not yet been received.
- Safety: Stock that buffers against operational uncertainty.
- Strategic: Stock that buffers against assumptions, primarily around future events.
- Pre-Build: Stock produced in advance of periods when demand exceeds the supply and,
- Inactive: Slow-moving, obsolete, and non-saleable stock, often called SLOB or SMOG.
Rather than being broken out by SKU or location, each of these categories is based on why that stock exists — and these categories can be mathematically supported. This gives companies a clearer picture of how their inventory is functioning, how the data behind each category can inform the company’s overall strategy, and ultimately how this breakdown can be used to ferret out “root causes” while aligning functional activity.
“Being able to say, ‘It’s just math’ is important”, says Dixon. “This helps remove emotion and replace it with the math behind results. In other words, the root causes and tradeoffs become evident.”
Trepte explains how this breakdown of data can shed light on a company’s challenges. “Often,” he says, “a company will see a bullwhip effect in its inventory levels over time. That means at some point there will be a change that we didn’t expect, and then inventory will either shoot up or shoot down,” he says.“So, the idea behind an Inventory Governance program is to give you the skills and capabilities to manage working capital and blunt the consequences of the bullwhip effect.” Having an Inventory Governance program is crucial to maintaining consistent customer service and efficient supply chain operation because it ensures that the commercial, finance, and supply chain organizations have the same understanding of financial and operational implications when the program is implemented.
By organizing inventory into those six categories and aligning commercial, finance, and operations, companies can make more informed decisions about what types of inventories to invest in based on their business priorities and customer needs. “When we put together an Inventory Governance program,” says Trepte, “we can start to say, ‘What customer segments need shelf stock? What size safety stock buffers are needed, and where are pre-builds required to capture market opportunities?’” While each company makes unique decisions based on its supply chain and competitive strategy, they all need an inventory governance program to ensure implementation. One company, for instance, might decide to drive inventory down and only carry cycle stock for low margins, while another may consistently write off inactive inventory for items that have high margins or support strategic customers.In both cases, the key is that the decision be made intentionally within the governance framework that all stakeholders agreed to.
An Inventory Governance program allows companies to systematically align working capital and inventory with their operating capabilities and strategy to drive positive, sustainable outcomes. “We start to think about where we invest in inventory to drive growth rather than where we cut inventory to contain cost,” says Trepte. “We can use advanced option pricing models to ensure that the investment decisions we make have the greatest chance of paying off; and, while not everyone is ready for such advanced analytics, we see more and more companies bringing advanced math to their inventory governance and policy practices.” The key element to this, says Trepte, is that companies need to ensure that their mathematical models support the planning and coordination with the company’s growth ambitions and business goals.
Creating an Inventory Governance Program
As companies start creating an inventory governance program, it’s important to create a set of policies and principles that lay out the “rules of the road, rather than creating bureaucratic procedures that reduce flexibility and increase friction,” says Trepte. The first step in this process is designating an executive leader to champion the implementation of the Inventory Governance program.
The executive leader can pull together the cross-functional team to make decisions around scope, targets, roles, and responsibilities. Key questions to help drive the team’s activity are:
- 1) How broad will the policy be?
- 2) Will it govern finished goods as well as raw materials and purchased items?
“Our experience,” Trepte says, “is that so long as the focus is on driving business outcomes rather than simply cutting costs, the team will drive an Inventory Governance program that will improve supply chain performance and customer service.”
Building Decision Routines
The next important piece of an Inventory Governance program, says Dixon, is to build routines around the decision-making process. “Do routine things routinely is a standard Oliver Wight teaching,” says Dixon. “Every quarter, companies will be assessing their inventory and making decisions about whether that inventory is too high, too low, or on target,” he says. As such, he urges companies to take a more routine-driven approach to inventory management, likening the process to physical fitness. “We don’t want to come into this process without stretching,” he says. “Every quarter, we want to come into this in a high state of fitness because it’s going to happen every quarter. What we want to do — what we need to do — is make this decision-making process routine.”
One way to do this is by anticipating decisions that will need to be made down the line and creating a plan for how the company will handle that event when it comes. For example, a company needs to decide what to do with its inactive inventory. “Basically, there are two things you can do with inactive inventory. You can sell it for money, or you can pay money to dispose of it,” says Dixon. “There’s a range in there, but we don’t want to have to run a complete business case for each time we do this.” Instead, he says, companies are far better off creating an “if/then” plan that says, if we can’t sell a certain type of item and there’s no demand for it, then this is how we plan to handle that stock. That way, all of the necessary departments have signed off on the plan in advance, and decisions can be made more quickly and strategically.
For all of this to work, it’s crucial that all departments are moving in the same direction. “When we’re working with organizations, everyone feels they’re doing the right things. We need to make sure the right things are also aligned!” says Dixon. Inventory Governance is about getting everybody on the same page, working toward the same goal, and operating under the same strategy with known tactics. “It’s a way to take a look at the organization and see how we, together, can make this into a more structured plan.”
In these ways, building strong Inventory Governance can also be an important first step in diagnosing deeper business issues. Inventory Governance efforts provide early paybacks and important starting points to support more ambitious business improvement efforts.
For Trepte and Dixon, Inventory Governance is a must-have for any company that wants to address its chronic inventory issues. Not only does it get to the root cause of the problem, but it also promotes healthy decision-making habits and company-wide collaboration while increasing sales revenue and market share. “By following these approaches,” says Trepte, “you can really take a lot of the cognitive load out of your business and just fundamentally improve your life.”
Check out our Inventory Governance Course.