Three (3) Inventory Mistakes that Contribute to Sales & Profit Losses

The primary goal of an enterprise is to serve customers and generate revenues. Inventory is a key instrument in this regard. In this sense, inventory management is the means to profitably serve customer requirements.

Unfortunately, some organizations make three (3) common mistakes when it comes to managing inventories. If you’re in an organization where inventories play a big part in the business, you might want to check these out: 

1. Lack of Uniform Understanding of the Purpose of Inventory

Many executives see inventory straight out as a cost. It is not good for business. It is something to be reduced, if not eliminated. At most, some executives see inventory as a necessary evil; it may be needed to ensure stock availability but as much as possible, the costs for carrying them, such as storage, handling & warehouse management, should be minimized or given the least priority. 

To set the record straight, inventory is not a cost. It is an asset. It is the buffer between supply and demand. Effective management of inventories is crucial in protection from both demand and supply variations. 

When managers see inventory more of as a cost than an asset, it misleads the firm towards overall strategies that would be more detrimental than beneficial. 

For instance, when a major consumer goods corporation rolled out a new hair care product, the management planned everything except for the inventory. Because the managers didn’t want to incur extra expenses, the corporation refused to build inventories and relied instead on just matching production with the sales forecast. 

When consumer demand outstripped the forecast to the surprise of executives, product supply ran out at many stores all over the country. Sales and marketing executives accused supply chain managers for poor sales performance; supply chain managers on the other hand accused sales & marketing departments for poor forecasting accuracy. 

When managers understand that inventories are an instrument for success rather than as a cost, they can consequently see the potential for competitive advantage. 

2. Setting Inventory Targets Uniformly Across All Product Lines

Some company executives would mandate an across-the-board inventory target for all product lines. The root of such a policy is the perception that it is simple to implement and easy to measure. 

The problem is that it is neither. 

Experienced operations managers know that every product line is unique and correspondingly, each depends on a unique manufacturing processes which would make it difficult to meet sweeping inventory targets. One cannot stop the continuous harvest of agricultural products, for example; it would be close to impossible to control the stock level. Measuring inventory actuals versus target on the basis of value is also complicated especially if (and usually it is) products are dependent on commodity market prices.  

Information technology (IT), however, has facilitated the capabilities of firms to manage inventories on an item-to-item basis. Companies can analyze an individual product’s supply and demand in real time and determine volatility with high precision; managers can immediately set higher or lower inventory targets by item. 

3. Mandating Inventory Reduction

When companies face cash-flow issues, executives more often than not would focus on inventory reduction as the swiftest method to solve the problem. Reducing inventories is usually perceived as an opportunity to release tied-up working capital to fund future growth. Arbitrarily cutting inventories, however, may trigger lower sales and more frequent complaints of poor customer service. 

The key to cutting inventories is to determine which items are causing most of the tied-up working capital and analyze the variations in demand and supply of each.  

Products which demonstrate low variations in demand and supply are good candidates for inventory reduction, while products that demonstrate high variations may deserve to have higher inventory levels. 

Inventory Management is and will be a major challenge for firms. As product life cycles become shorter and as more and more new products are introduced at a faster pace, the higher rate of obsolescence coupled with the higher demand for more rapid deliveries and service will necessitate unprecedented sharper management of inventories. 

Firms can no longer ignore the need to clarify inventory policies nor can they afford simplistic sweeping mandates for inventory controls or reductions.  Fortunately there are best practices available in managing inventories, starting with understanding demand and supply variations to tailoring strategies for them.

If your organization manages inventory, you are no exception. 

Mr. Jovy Jader is a Business Consultant and Supply Chain Management practitioner at Prosults Consulting LLP. He has directed and implemented Business Improvement projects both local and international which have resulted to company-wide improvements in revenue, working capital, total cost, and service levels. Mr. Jader was formerly with Procter & Gamble Philippines and Coopers & Lybrand/PricewaterhouseCoopers. Should you have questions or comments, please e-mail at jjjader@prosultsconsulting.com