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Beyond Mean and Lean

The specter of interruption demands new ways to manage inventory.
Cathy Lazere, CFO Magazine
November 1, 1997

The recent UPS strike has challenged the mantra of just-in-time (JIT) inventory. Shelves empty of raw materials left some companies wondering if operating mean and lean is worth putting the bottom line in jeopardy.

"You have to be lean all along. It doesn't do any good to be overly prepared for what you can't predict," says Anders H. Herlitz, chairman and chief executive officer of E3 Associates Ltd., an Atlanta-based software and consulting firm specializing in supply-chain management. "You can't afford to be ready. There's always a little hype after a UPS strike or a Hurricane Hugo. The more disciplined, the more prepared you are from a management point of view to recover, the better off you are," he adds. Herlitz has been crusading for 30 years for more scientific inventory management, through seminars and his Inventory Management Institute.

Contrary to what many assume, turning anorexic inventories doesn't automatically yield more profits. Treasurers focus too frequently on accelerating receivables and the best way to float payables. They take a more passive view of inventory management, leaving it to the province of sales and marketing, where turns take precedence. Such thinking is shortsighted.

In the competitive world most firms now face, turns are not enough. "In almost all wholesale and retail businesses, top management tends to be sales oriented," says Herlitz. "If sales are down or if the economy is in recession, people try to sell more. Selling cures all, they think. Selling generates revenue, but profit is the important part. If you're not profitable, you won't be around too long."

Managing inventory mean and lean has been the trend over the past 20 years. In 1982, the ratio of inventory to sales was 1.67; in July 1997, it was 1.36. "One of the biggest factors for keeping inventory down is low inflation," says Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., in Chicago. High real interest rates have also contributed to low inventories. But have those lower inventories been managed efficiently?

A LONG WAY TO GO
Competition has forced companies in some industries, such as the major food, drug, and consumer-goods retailers, to pay greater attention to sophisticated inventory management and distribution systems. Thanks to the pressure, they're way ahead of their counterparts in Japan and the EU. Companies with short product life cycles, such as those in the computer industry, have also managed well. And the automotive industry is known for being a pioneer in JIT. But most companies have a long way to go. "EDI [electronic data interchange] and electronic commerce are complex programs to implement and measure," says Steven Gold, partner-in-charge of the Supply Chain Strategy Practice at KPMG Peat Marwick LLP. "The great majority of companies have not done it and are not close to it."

To profit from potential efficiencies in the supply chain, companies need to revisit and analyze customer demand and turns, vendor lead time, transportation costs, and service levels. Scanners and detailed databases help. "If we can't get next year right, at least we ought to know where we are now," says economist Wesbury. But the goal of inventory management doesn't stop there; better forecasting is critical.

The need for good forecasting is clear. "Safety stock is based on customer demand; the more variation in demand, the higher your safety stock. That's costly. Most CFOs understand that," says Tom Loos, vice president of corporate operations for C&H Distributors Inc., a Milwaukee-based business- to-business catalog distributor specializing in materials handling, storage, and safety products.

But what some might not understand is that it sometimes makes sense to stock up when the price is right. If you can get a big discount and you're reasonably sure the product won't become obsolete, then it may be more profitable to stock up. "The biggest reason not to focus on turns is if you have special discounts and promotional support from suppliers," says Herlitz.

"Turns are nothing but a financial statistic," says Joseph Dillhoff, president of OKI Bering Inc., a Cincinnati-based wholesaler of welding, safety, and industrial products, with annual sales of $115 million. "They're great for a controller to quote, but they tell you nothing about how you really run your business."

Rita Kahle, who has been a CFO and is now a senior vice president, wholesale, at Ace Hardware Corp., in Oak Brook, Illinois, agrees. "When I first got involved in the CFO role," she says, "it was easy to say, 'Increase inventory turns.' CFOs have working capital on their minds and the effect on interest expense. But there are offsetting factors. There's competition, and margins are being hit. You can improve margins based on efficiencies that include inventory efficiencies."

Toward this end, many companies diligently monitor customer demand and turns. But they neglect vendor lead-time forecasting. "Vendor lead time is probably the concept in inventory management that gets the least attention," says Loos. "If you can't predict when that product is going to come in, you'll have to ratchet up the safety stock. We spend a great deal of time working with our vendors."

Economies of scale at large companies facilitate added control over transportation and distribution, especially in crises. "We're taking control of inbound freight," says Ace's Kahle. "We've had our own fleet for a number of years. When something like the UPS strike happens, the more you control your own freight, the better off you are."


MANY HURDLES
Outsourcing often makes similar economies of scale available to smaller companies. "Transportation is the biggest outsourced resource in the whole supply chain. With deregulation, it's now price and service competitive," says KPMG Peat Marwick's Gold.

Finance executives who still focus on the traditional bird's-eye view of inventory tend to miss opportunities for tighter inventory management, whether internally or externally driven. These days, good management requires many handles on inventory--a handle on every detail, from the supplier to the customer. "CFOs are the gatekeeper of costs," says Gold. "If they take time to look at total delivered costs from point of vendor to manufactured process to customer, they can raise the right flags and start thinking about supply-chain costs. It's an operations- management and performance-metric concern."

7 TIPS ON MANAGING INVENTORY
Companies that manage inventory properly don't have to learn about mistakes the hard way. Instead of in procedures that are counterintuitive or highly sophisticated, the means to better inventory management lie chiefly in rigorous application of good sense across corporate disciplines. Here are seven steps familiar to finance executives who squeeze the most profits from inventory.

  1. Finance, marketing, and inventory control work together and form a common language. "A strict functional view of an organization doesn't work anymore," says Rita Kahle, senior vice president, wholesale, at Ace Hardware Corp. "Finance should be provided with the right facts, such as multiple-year history at a product category level," says Sports Authority's vice president of merchandise control, Tom Souza. "If you have the numbers and understand what they mean, everybody will understand reality," he adds.
  2. Key the level of inventory to the level of service, not the other way around. "Determine the service levels you need first," says Joseph Dillhoff, president of OKI Bering Inc. "Sometimes, you might have to accept a little lower service level. The sales department might want a 99.9 percent service level, but there's a quickly escalating cost to that."
  3. Take advantage of forward buying opportunities. Losing customers for lack of inventory could have more impact on the bottom line than carrying some extra inventory. "The customer is smarter today than ever before," says Souza. "You can no longer take him for granted." There's no such thing as loyalty anymore.
  4. Cultivate links to buyers and vendors to aid forecasting and cut lead times. "Purchasing people should spend time doing other things--looking at trends, working closely with manufacturers," says Dillhoff. The days when buyers could concentrate solely on replenishment are long gone. "We have a whole expediting department, and all they do is work with vendors," says Tom Loos, vice president of corporate operations for C&H Distributors Inc. "We have EDI, fax servers, but sometimes it's just a matter of picking up the phone."
  5. Review the sales incentive system, which often drives overemphasis on inventory turns. "If a buyer regards turns as incentives, he will forego any type of speculative or investment buying," says Anders H. Herlitz, chairman and CEO of E3 Associates Ltd. "If buyers have incentives based on customer service and profitability, they will be working for the same cause as the shareholders."
  6. Keep inventory systems up to date with costs and pricing structures. "No matter which system you have, maintenance is important. We spend a great deal of time updating the system to make sure costs are correct," says Loos.
  7. Reevaluate distribution systems. "We are migrating from DSD [direct store delivery] to RDC [regional distribution centers]," says Souza. Regional distribution centers will give Sports Authority the freedom to consolidate orders and save time and costs. "At the regional centers, we value-add to the products with ticketing, tagging, and hanging. Today, goods average five days in the backroom. Tomorrow, they'll go right to the floor," he adds.

Above all, companies cannot afford to be complacent about inventory amid fierce global competition and shareholders' expectations. "Unless CFOs and CEOs take advantage of efficiencies," warns Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., "they are costing the shareholders money."




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