When the customer’s tolerance time is much shorter than the supply lead time (from production to retail shops), it is imperative to have stocks at the point of sale; otherwise, product unavailability when the customer comes to buy at the store/shop leads to lost sales. As the retailer does not want to lose the customer, they will actively sell ‘other’ brands. If the customer’s experience with the ‘other’ brand is satisfactory, it may lead to a long-term loss of sales for the consumer goods 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 shops can lead to a significant loss of sales.  Many salespeople believe that having a lot of inventory at the point of sale or with distributors can prevent stockouts. As a matter of fact, when 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 mostly tied up in SKUs that will not sell immediately, while those that do sell 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 consumer goods company has enough stocks in its warehouses.Additionally, the introduction of new items or promotions can be delayed due to high stock levels in the pipeline. Having high stock levels is not favoured by finance people, as it increases costs (warehouse space, carrying costs, damage, write-offs, etc.) and require more capital than desirable. Most consumer goods companies would have more than four months of stock in the pipeline from the plant to the retailers. This stock in the pipeline is the company’s liability, as further sales are restricted by it.  To summarise, to protect sales (i.e. avoid unavailability), the company needs to have high stock levels, while to control costs, it needs lower stock levels. But both ‘control costs’ and ‘protect sales’ are critical for 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 consumer goods companies, this is how they manage the situation.Many would consider this situation very complex. However, 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 fairly straightforward.   <h2>Direction of solution:</h2>Obviously, keeping high inventories is not a favoured direction due to the damage it causes in terms of inventory carrying costs, locked capital and unavailability. Distribution and Sales want higher inventory levels to protect sales because they believe forecasts are inaccurate, replenishment time is 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 they cannot reduce lead times drastically or improve supply reliability without additional investments and a significant effort within the company (as it involves many departments).As it is impossible to have accurate forecasts (one cannot control or predict external factors such as competition activity, weather, supply unreliability, etc.), we will not try to improve them. Instead, we will try to reduce replenishment lead time and supply reliability while releasing investment (reducing inventory). Let’s see how. <h2>Elements of the solution:</h2>If the replenishment of the next stocking point (regional warehouse, distributors, retailers, etc.) is based only on what is sold, the stocking point can have nearly 100% availability. But if the initial inventory of the SKUs at the stocking points is inadequate (to cater to any demand in the supply lead time), then this replenishment cannot guarantee 100% availability at this stocking point.  As forecasts are never accurate and demand fluctuates, there is no point in undertaking extensive research to determine the optimal inventory level for each SKU at each stocking point. If a reliable mechanism exists to adjust stock levels in response to demand trends or changes in supply conditions, then a good enough starting stock is sufficient. This good enough stock level is determined by:Good enough starting stock level at a stocking point = Average dispatch (or sales) per day x Total Replenishment Time x A factor of safety (to account for variability in demand and supply).Total Replenishment Time (TRT) is the time taken from the time the SKU is sold until it is refilled at the point of sale.  Consider the case of a regional warehouse (which could be a regional Carrying and Forwarding Agent). By the above formula, to have high availability, the inventory to be carried would be very high, in the range of more than 45 days, as the TRT is above 40 days. Due to the monthly planning horizon and the fact that the plants produce in large batches (aiming for the highest efficiency and utilisation), SKUs are generally produced 2-3 times a month. So, a regional warehouse could receive material 2-3 times a month. So, from the time the monthly order is placed until the material is received, the elapsed time is above 30 days. Add to this extra inventory to account for variability in demand and supply reliability; the safe inventory will be more than 45 days.  Using a TRT of 45 days does not reduce inventory. Since average demand is an external factor, the only parameter to be reduced to have lower inventories is TRT. The key to reducing TRT is to understand its composition. TRT is made up of: <ul><li>Order Lead Time (OLT): Time taken to place the next order an SKU since the last sale</li><li>Production Lead Time (PLT): Time taken to manufacture a product</li><li>Transportation Lead Time (TLT): Accounts for the actual transportation time and the time for waiting for full truck batches </li></ul><h5>Order Lead Time (OLT):</h5>Interestingly, if regional warehouses or distributors place an order for an SKU once a month, the OLT is 30 days. The graph below illustrates the inventory level of the regional warehouse, which orders once a month from the plant. This is also the case of a distributor ordering directly from the plant. <figure class="image"><img style="aspect-ratio:3334/3334;" src="https://new-stage-be.vectorconsulting.in/storage/editor_uploads//cg-article-10-fig-1_1711622238.jpg" width="3334" height="3334"></figure>If the regional warehouse orders every day, the OLT will be reduced to one day, a huge reduction! With today’s IT capabilities, this data can be easily transferred to the earlier delivery point. <h5>Production Lead Time (PLT):</h5>If the supplies to the regional warehouse take place from a plant warehouse that has 100% availability, the Production Lead Time (PLT) can be eliminated from TRT.  <h5>Transportation Lead Time (TLT):</h5>Suppose the plant warehouse receives daily sales data from the regional warehouse and has a near 100% availability of all SKUs. In that case, it can fill up trucks with an assortment of SKUs for a full load, rather than, as in the existing system with no plant warehouse, wait for the large batch to be produced. This system of daily replenishment increases the frequency of trucks leaving the plant warehouse (and not the number of trucks), thus reducing the TLT by more than half. <h5>To summarise the TRT reduction:</h5>The OLT is reduced from around 30 days to 1 day, PLT is reduced from the normal 15-30 days to zero, and TLT is reduced to less than half. The effect of these reductions on the inventory levels and availability is illustrated below:  <figure class="image"><img style="aspect-ratio:3334/3334;" src="https://new-stage-be.vectorconsulting.in/storage/editor_uploads//cg-article-10-fig-2_1711622276.jpg" width="3334" height="3334"></figure>The safe inventory to be kept at the stocking points reduces to about 10-15 days from 45 days earlier.However, the concern with the above solution is that the addition of the plant warehouse, which did not exist before and is supposed to maintain 100% availability to cater to the demand of the whole country, will increase the inventory in the distribution pipeline substantially - currently, the plant supplies directly to the regional warehouses.  Not so! The inventory to be maintained at the central warehouse/plant warehouse = average daily demand X production lead time X factor for the plant’s unreliability.  The plant warehouse (or central warehouse) is an aggregation point where statistical fluctuations even out. Not all regional warehouses will have peak demands at the same time. By the principle of aggregation, maintaining half the average demand of all the regional warehouses at the central warehouse is sufficient to guarantee availability.  These solutions reduce production lead times by half. So, for the plant warehouse, we have reduced the daily demand by nearly half and production lead time is also reduced by half, ensuring that the inventory required at the plant warehouse is not more than 15 days. Incidentally, having a plant warehouse decouples the plant from market demand fluctuations, thereby reducing emergency orders on the plant and further reducing production lead time and unreliability. Hence, the factor accounting for unreliability is also low.  Accounting for the already reduced inventory at the regional warehouses (15 days) and the reduced requirement at the plant warehouse, the total inventory in the system up to the regional warehouses, despite the addition of a central warehouse, has reduced from 45-60 days to 30 days.  Usually, most distributors are just 1-2 days away from the regional warehouses. With the model described above, they can have nearly 100% availability of the full range with an inventory of about 10-15 days. Their inventory turns will increase to 24 from the earlier six. For a distributor with a 4% margin, this will mean a Return on Capital Invested of above 50%! Currently, they have to be satisfied with about 12%-16%.  This is all fine, but demand is influenced by many external factors such as competitive activity or inactivity, seasons, festivals, and events, and can change significantly. In such cases, the original stock levels will be insufficient to cater to the growing demand. What can one do in such a scenario?The Buffer Management System manages these changes effectively.  <h2>Buffer Management System:</h2>The initial stock level is designated into three colours: red, yellow and green, each with a 33% band. Stock at less than 66% of the designated stock level will be in red.  <figure class="image"><img style="aspect-ratio:1080/1080;" src="https://new-stage-be.vectorconsulting.in/storage/editor_uploads//2_1712573677.png" width="1080" height="1080"></figure>With an increasing demand trend, the stock level will remain in the red, as supply is insufficient to meet the rising demand. If the stock remains in the red for a period equal to the replenishment time to that stocking point, the stock level is increased by 33%, i.e., one colour band. Any further change in stock level is carried out only after observing the stock levels after the arrival of additional (33%) material at the stocking point. Similarly, for a decreasing demand trend, the stock level is reduced by 33% if the stock is always in green. For steep changes in demand, such as an event (Diwali) or a season (air conditioners), the levels will have to be changed manually and later managed by Buffer Management during the season. As the supply is only according to what is sold in the next stocking point (distributor or retailer), and Buffer Management manages the upward and downward demand trends effectively, there is obviously no need for a short-term forecast! Long-term forecasts are required to manage only long-lead-time raw materials, such as imports.  The model described above provides a near 100% availability at all stocking points while reducing the inventory in the system to nearly half. The improved availability increases sales, while the distributors and retailers experience a significant increase in ROI. A win-win for all partners in the chain.  So, the magic mantra: Stop forecasting, hold back inventory rather than pushing down the chain, and supply according to consumption.This comprehensive solution, with all its elements, has been implemented in quite a few distribution companies (companies in consumer goods, automotive parts, fashion goods, etc.) in India by Vector Consulting Group’s consulting services.  The results: Above 30% sales growth at half the inventory levels in a year.

Key Takeaways

Navigating the tension between maintaining high stocks for sales security and minimising them for cost control is a perpetual challenge. A new approach that is not dependent on forecasts improves product availability and slashes overall inventory, creating a mutually beneficial outcome throughout the supply chain.

100% availability with less than half the inventory

When the customer’s tolerance time is much shorter than the supply lead time (from production to retail shops), it is imperative to have stocks at the point of sale; otherwise, product unavailability when the customer comes to buy at the store/shop leads to lost sales. As the retailer does not want to lose the customer, they will actively sell ‘other’ brands. If the customer’s experience with the ‘other’ brand is satisfactory, it may lead to a long-term loss of sales for the consumer goods 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 shops can lead to a significant loss of sales.  Many salespeople believe that having a lot of inventory at the point of sale or with distributors can prevent stockouts. As a matter of fact, when 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 mostly tied up in SKUs that will not sell immediately, while those that do sell 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 consumer goods company has enough stocks in its warehouses.Additionally, the introduction of new items or promotions can be delayed due to high stock levels in the pipeline. Having high stock levels is not favoured by finance people, as it increases costs (warehouse space, carrying costs, damage, write-offs, etc.) and require more capital than desirable. Most consumer goods companies would have more than four months of stock in the pipeline from the plant to the retailers. This stock in the pipeline is the company’s liability, as further sales are restricted by it.  To summarise, to protect sales (i.e. avoid unavailability), the company needs to have high stock levels, while to control costs, it needs lower stock levels. But both ‘control costs’ and ‘protect sales’ are critical for 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 consumer goods companies, this is how they manage the situation.Many would consider this situation very complex. However, 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 fairly straightforward.   <h2>Direction of solution:</h2>Obviously, keeping high inventories is not a favoured direction due to the damage it causes in terms of inventory carrying costs, locked capital and unavailability. Distribution and Sales want higher inventory levels to protect sales because they believe forecasts are inaccurate, replenishment time is 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 they cannot reduce lead times drastically or improve supply reliability without additional investments and a significant effort within the company (as it involves many departments).As it is impossible to have accurate forecasts (one cannot control or predict external factors such as competition activity, weather, supply unreliability, etc.), we will not try to improve them. Instead, we will try to reduce replenishment lead time and supply reliability while releasing investment (reducing inventory). Let’s see how. <h2>Elements of the solution:</h2>If the replenishment of the next stocking point (regional warehouse, distributors, retailers, etc.) is based only on what is sold, the stocking point can have nearly 100% availability. But if the initial inventory of the SKUs at the stocking points is inadequate (to cater to any demand in the supply lead time), then this replenishment cannot guarantee 100% availability at this stocking point.  As forecasts are never accurate and demand fluctuates, there is no point in undertaking extensive research to determine the optimal inventory level for each SKU at each stocking point. If a reliable mechanism exists to adjust stock levels in response to demand trends or changes in supply conditions, then a good enough starting stock is sufficient. This good enough stock level is determined by:Good enough starting stock level at a stocking point = Average dispatch (or sales) per day x Total Replenishment Time x A factor of safety (to account for variability in demand and supply).Total Replenishment Time (TRT) is the time taken from the time the SKU is sold until it is refilled at the point of sale.  Consider the case of a regional warehouse (which could be a regional Carrying and Forwarding Agent). By the above formula, to have high availability, the inventory to be carried would be very high, in the range of more than 45 days, as the TRT is above 40 days. Due to the monthly planning horizon and the fact that the plants produce in large batches (aiming for the highest efficiency and utilisation), SKUs are generally produced 2-3 times a month. So, a regional warehouse could receive material 2-3 times a month. So, from the time the monthly order is placed until the material is received, the elapsed time is above 30 days. Add to this extra inventory to account for variability in demand and supply reliability; the safe inventory will be more than 45 days.  Using a TRT of 45 days does not reduce inventory. Since average demand is an external factor, the only parameter to be reduced to have lower inventories is TRT. The key to reducing TRT is to understand its composition. TRT is made up of: <ul><li>Order Lead Time (OLT): Time taken to place the next order an SKU since the last sale</li><li>Production Lead Time (PLT): Time taken to manufacture a product</li><li>Transportation Lead Time (TLT): Accounts for the actual transportation time and the time for waiting for full truck batches </li></ul><h5>Order Lead Time (OLT):</h5>Interestingly, if regional warehouses or distributors place an order for an SKU once a month, the OLT is 30 days. The graph below illustrates the inventory level of the regional warehouse, which orders once a month from the plant. This is also the case of a distributor ordering directly from the plant. <figure class="image"><img style="aspect-ratio:3331/1445;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//olt-1_1777467431.jpg" width="3331" height="1445"></figure> If the regional warehouse orders every day, the OLT will be reduced to one day, a huge reduction! With today’s IT capabilities, this data can be easily transferred to the earlier delivery point. <h5>Production Lead Time (PLT):</h5>If the supplies to the regional warehouse take place from a plant warehouse that has 100% availability, the Production Lead Time (PLT) can be eliminated from TRT.  <h5>Transportation Lead Time (TLT):</h5>Suppose the plant warehouse receives daily sales data from the regional warehouse and has a near 100% availability of all SKUs. In that case, it can fill up trucks with an assortment of SKUs for a full load, rather than, as in the existing system with no plant warehouse, wait for the large batch to be produced. This system of daily replenishment increases the frequency of trucks leaving the plant warehouse (and not the number of trucks), thus reducing the TLT by more than half. <h5>To summarise the TRT reduction:</h5>The OLT is reduced from around 30 days to 1 day, PLT is reduced from the normal 15-30 days to zero, and TLT is reduced to less than half. The effect of these reductions on the inventory levels and availability is illustrated below:  <figure class="image"><img style="aspect-ratio:3331/1506;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//olt-2_1777467581.jpg" width="3331" height="1506"></figure> The safe inventory to be kept at the stocking points reduces to about 10-15 days from 45 days earlier.However, the concern with the above solution is that the addition of the plant warehouse, which did not exist before and is supposed to maintain 100% availability to cater to the demand of the whole country, will increase the inventory in the distribution pipeline substantially - currently, the plant supplies directly to the regional warehouses.  Not so! The inventory to be maintained at the central warehouse/plant warehouse = average daily demand X production lead time X factor for the plant’s unreliability.  The plant warehouse (or central warehouse) is an aggregation point where statistical fluctuations even out. Not all regional warehouses will have peak demands at the same time. By the principle of aggregation, maintaining half the average demand of all the regional warehouses at the central warehouse is sufficient to guarantee availability.  These solutions reduce production lead times by half. So, for the plant warehouse, we have reduced the daily demand by nearly half and production lead time is also reduced by half, ensuring that the inventory required at the plant warehouse is not more than 15 days. Incidentally, having a plant warehouse decouples the plant from market demand fluctuations, thereby reducing emergency orders on the plant and further reducing production lead time and unreliability. Hence, the factor accounting for unreliability is also low.  Accounting for the already reduced inventory at the regional warehouses (15 days) and the reduced requirement at the plant warehouse, the total inventory in the system up to the regional warehouses, despite the addition of a central warehouse, has reduced from 45-60 days to 30 days.  Usually, most distributors are just 1-2 days away from the regional warehouses. With the model described above, they can have nearly 100% availability of the full range with an inventory of about 10-15 days. Their inventory turns will increase to 24 from the earlier six. For a distributor with a 4% margin, this will mean a Return on Capital Invested of above 50%! Currently, they have to be satisfied with about 12%-16%.  This is all fine, but demand is influenced by many external factors such as competitive activity or inactivity, seasons, festivals, and events, and can change significantly. In such cases, the original stock levels will be insufficient to cater to the growing demand. What can one do in such a scenario?The Buffer Management System manages these changes effectively.  <h2>Buffer Management System:</h2>The initial stock level is designated into three colours: red, yellow and green, each with a 33% band. Stock at less than 66% of the designated stock level will be in red.  <figure class="image"><img style="aspect-ratio:1078/671;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//olt-3_1777467703.png" width="1078" height="671"></figure><p class="MsoNormal" style="-webkit-text-stroke-width:0px;caret-color:rgb(0, 0, 0);color:rgb(0, 0, 0);font-family:"Times New Roman", serif;font-size:medium;font-style:normal;font-variant-caps:normal;font-weight:400;letter-spacing:normal;margin:0cm;orphans:2;text-align:start;text-decoration-line:none;text-decoration-style:solid;text-decoration-thickness:auto;text-indent:0px;text-transform:none;white-space:normal;widows:2;word-spacing:0px;"><o:p></o:p> <h5>The stock level in red gets first priority followed by yellow and then green. </h5> With an increasing demand trend, the stock level will remain in the red, as supply is insufficient to meet the rising demand. If the stock remains in the red for a period equal to the replenishment time to that stocking point, the stock level is increased by 33%, i.e., one colour band. Any further change in stock level is carried out only after observing the stock levels after the arrival of additional (33%) material at the stocking point. Similarly, for a decreasing demand trend, the stock level is reduced by 33% if the stock is always in green. For steep changes in demand, such as an event (Diwali) or a season (air conditioners), the levels will have to be changed manually and later managed by Buffer Management during the season. As the supply is only according to what is sold in the next stocking point (distributor or retailer), and Buffer Management manages the upward and downward demand trends effectively, there is obviously no need for a short-term forecast! Long-term forecasts are required to manage only long-lead-time raw materials, such as imports.  The model described above provides a near 100% availability at all stocking points while reducing the inventory in the system to nearly half. The improved availability increases sales, while the distributors and retailers experience a significant increase in ROI. A win-win for all partners in the chain.  So, the magic mantra: Stop forecasting, hold back inventory rather than pushing down the chain, and supply according to consumption.This comprehensive solution, with all its elements, has been implemented in quite a few distribution companies (companies in consumer goods, automotive parts, fashion goods, etc.) in India by Vector Consulting Group’s consulting services.  The results: Above 30% sales growth at half the inventory levels in a year.

<h4>100% availability with less than half the inventory</h4>

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Vector Consulting Group - Research and Publications: How holding back inventory, lead to an increase in sales? Know more.