When the customer’s tolerance time is much lesser than the supply lead time (from production to retail shops), it is imperative to have stocks at the point of sales. Not having availability when the customer comes to buy at the store/ shop leads to lost sales. As retailer does not want to lose customer he will actively sell ‘other’ brands, and if the customer’s experience with the ‘other’ brand is satisfactory, may lead to a long term loss of sales for the company. Usually customers want to justify their purchase and can actively market the ‘other’ brand leading to further loss of sales. Hence even infrequent stockouts at the shops can lead to a significant loss of sales.
Many sales people believe that having huge inventory at the point of sales or at the distributors can avoid unavailability. As a matter of fact, in cases where many SKUs are to be managed, high inventory at distributors and retailers leads to unavailability. A contradiction? Combining the facts that sales forecasts are not accurate as we move towards the retail end and that Sales push available stocks (to meet sales targets) the inventory at the distributor and retailer, though high, is mismatched. Consequently the limited cash of these trading partners is stuck mostly in SKUs that are not going to sell immediately while those selling immediately are stocked out. Either the distributor waits for cash to be unlocked or the company does not supply due to credit limits. In both cases the unavailability is ‘created’ though the company has enough stocks in its warehouses.
Additionally introduction of new items or promos can be delayed due to high stock in the pipeline. Having high stocks is not favoured by the finance people as it leads to increase in costs (warehouse space, carrying costs, damages, writeoffs etc) and requirement of more than desirable capital. Most companies would have more than 4 months of stock in the pipeline from plant to the retailers. This stock in the pipeline is the company’s liability as further sales of the company are restricted by this stock in the pipeline.
To summarise to protect sales i.e. avoid unavailability the company needs to have high stocks, while to control costs the company needs lower stocks. But both ‘control costs‘ and ‘protect sales‘ are critical needs to have a profitable growth.
Management frequently swings between the two actions (high inventory and low inventory) depending on the pressure on the critical needs – protect sales or control costs. In many companies this is the way to manage the situation.
Many would consider this situation very complex. In Theory of Constraints, no system is considered complex. If the cause and effect linkages of all entities in the system are understood then the system becomes simple. Once the cause and effect linkages are known, the solution is usually very simple.
Direction of solution: Obviously keeping high inventories is not a favoured direction due to the damages it generates in terms of inventory carrying costs, capital locked and unavailability. Distribution and Sales want higher inventories to protect sales because they believe that forecasts are not accurate, replenishment times are too long and supply is unreliable. Usually companies try to address this situation by seeking a tool to have more accurate forecasts. Also, managers believe that they cannot reduce the lead times drastically and improve supply reliability without additional investment (additional warehouses and inventory) and a huge effort in the company (as it involves many depts.)