How do I optimize my inventory?

Many companies struggle to optimize their inventory every day. What is often missing is a targeted and structural approach to the stock. In the article below the most important steps that should be a fixed part of stock optimization.

Number 1: Pareto

Although widely known, a Pareto is often poorly executed. Classification by A-B-C categories [80% -15% -5%] based on value remains a difficult point. Also because the composition of stock changes continuously and so the Pareto has to be redone. And yes, that is exactly what you should do.

Does the A category represent 50% of your stock? If not, you do not have enough stock for these items. A significant portion of the low demand inventory [B-C] can cause problems such as product run-outs and obsolete inventory.

For the second chart, classify the items by volume. Then calculate the sales for each group. Again, does 50% of your sales represent the A category? If not, your inventory is out of balance. Two simple analyzes provide excellent insight into where the problems are in your stock and are the starting point for further analysis and optimization of your stock.

Number 2: Reduce replenishment lead times

This can be important for raw material lead time or lead times between the internal layers of your distribution network. Break this lead time into three components: the reporting period, the production time and transport time.

The reporting period is the time from when the requirement is identified when the order is shipped upstream.
Manufacturing is the time from when the order is shipped until the product is available for shipping.
Transportation is the time from availability until the material is received and available for use at the following location.

Find out how long and how variable these three components are.

Are there any ways to reduce the reporting period? Do you have to wait until the end of the month to place an order? Longer periods can be caused by system limitations; can these limitations be overcome? Can Weekly Cycles Be Reduced To Daily? Often a supplier will demand minimum quantities so that he forces you to group products in this way. Can this minimum be reduced so that the order can be shipped faster and thereby also reduce the possible surplus stock [overorder problem]

The manufacturing time includes your supplier’s period in addition to the actual production time. In general, it is longer than the production time. Can you work with your suppliers to help them reduce their lead times? Do you understand their limitations. Possible solutions are: predetermining future needs, a longer range forecast and fixed cycle replenishment.

For the transport time applies: use faster modes of transport or alleviate bottlenecks during shipping / receipt. Shorter and less variable lead times require less inventory. If you have a safety stock, the cut will be the square root of the reduced time. A 25% lead time reduction equals a 13% safety stock reduction. One day less in the transport is ultimately equal to one day less inventory in the pipeline.

Number 3: Review order cycles / quantities

Translate smaller and more frequent order quantities into less stock. Is there enough capacity to increase changeovers through a higher cycle? Can capacity loss be avoided by producing low demand products less often? Is there a loss of transport efficiency by switching to smaller parties? What does this mean for the workload at the distribution centers? Determining order frequencies is one of the most important variables in your supply chain. It can affect almost every aspect of your supply chain. You must have a thorough understanding of your supply chain costs and capabilities before implementing this strategy, which is based on Goldratt’s ToC.

Options include: reducing setup time and costs, re-evaluating the costs of holding inventory, understanding warehouse storage procedures, understanding labor input, transportation and inventory management costs and associated trade offs. While the goal is to reduce inventory, the opposite may be true; increasing order quantities at some points can yield significant overall savings throughout the chain.

Number 4: Improve your forecasting

Many people don’t like the “F” word. But every organization, big or small, does Forecasting in its own way. Even if your production is the rule; “To make what we sold yesterday” or “Supplement to x,” a forward-looking picture of the question lies in determining how much to buy and how much to keep in stock. While everyone knows that the prognosis will always be wrong, it is possible to be less wrong. Or as the saying goes, “I’d rather be about right than exactly wrong.” Often improvements begin with a simple mathematical forecasting method such as exponential smoothing versus regression versus Winters. That would actually be the last step.

There are 3 important elements:

  • Are the input data relevant drivers of the question? If marketing or sales influence your demand through pricing and promotional activity and you don’t take this into account, then your forecast will be completely wrong. So understand your process and how you influence the question with which actors.
  • The data must be accurate. If you base predictions on shipments, but shipments do not match customer demand and the data (based on unavailability and backorders) is biased, your outcome is not reliable. So garbage in, garbage out.
  • Assess the forecasting method. If you have the correct input and the data is accurate, the forecasting method gives a correct outcome. But this does not have to be a good outcome. If you use linear regressions with a fast and strongly fluctuating demand, you will get behind the facts.


Number 5: Eliminate obsolete stock

How much obsolete stock do you have left in your warehouses? Who takes responsibility for this? Or is it because the company cannot “afford” to write off the obsolete inventory this quarter? Cleaning your warehouses from obsolete stocks is a sensible operational policy and results in a good long-term financial situation. Here, accounting rules can turn out to be bad process rules. If you don’t clean up the obsolete stock now, it will only continue to grow. Outdated inventory becomes an increasingly substantial part of your total inventory and records a financial capital in the books that is incorrect. The longer you wait, the bigger the blow will be. You will not be the first company to run into very serious financial difficulties.

Number 6: Centralize your inventory

In general, many and dispersed warehouses hold more inventory than strictly demanded overall demand. The main reason for this is the safety stock that is held per warehouse. As a rule of thumb: If the number of warehouses increases by a factor of 4, the safety stock increases by a factor of two. {SQR [warehouses}

If centralization is possible, a reduction in order quantities may be possible. By ordering at only one location, you may be able to increase your order frequency, thereby reducing the total order quantity.

You may be able to deposit certain items locally because large-scale centralization is often not possible. Centralization versus distribution is one of the biggest supply chain challenges. It requires an intensive analysis from customer demand to supplier possibilities. However, you often have the option to use centralization, but more on an ad hoc basis. Can you keep security stock centrally and carry out daily replenishment at your local distribution centers? Can spare parts be kept centrally and only be distributed on an urgent basis? Do customers accept different lead times depending on the product and the urgency?

Number 7: lower your service levels

You will be dismissive immediately as I write this. Yet. Let me put it another way. How well do you know your customers and their service needs? Which service do they ask for in a general sense, but also specifically. Especially when it comes to lead times and availability. Does your customer need the shipment completely at once or is partial delivery possible under certain conditions? You can reduce the stock by producing and shipping in parts. Many companies produce complete batches that are stored and only then sent. As a result, there is a significant time difference between the first moment of production and the actual shipping date. This may mean that you have to divide an order into several batches. [Lean Manufacturing]

In many cases lead times are shortened not so much because this is strictly necessary for the customer process, but because you want to outdo the competition. Whatever the reason. Consult with your customer and look for what is critical to their process. You can even decide to share the savings with the customers who participate in your process.

Number 8: decrease SKU number

Do you have customer-specific SKUs? Are identical products packaged and stored differently? You can postpone the customization until the last possible moment. Making products customer-specific up to the very last point [buy effect] can realize significant savings on your inventory. This may mean you have to put the packaging or assembly in the distribution center, but the savings can be worth it. You are then even able to respond faster to changes in customer demand.

Is there substantial part / SKU proliferation? Do you have the 2-count, 4-count, 6-count and 8-count packs in stock? Partnering with sales and marketing on this point can enable you to improve profits by eliminating packages that do not significantly affect the sales of all. Every part reduction will help free up space in the warehouse, simplify production planning and limit inventory.

Number 9: Reduce variability of supply and demand

A difficult task. Let’s look at some ways to reduce the variability of demand. Is it possible to reduce or eliminate inventory that only exists to meet quota? Breaking with ‘the end of their addiction period’ is very painful. Managing the resulting slack in the supply chain is also expensive. This is an extremely difficult habit to break and requires support from the top of your organization.

Are there any other ways to flatten customer orders? Study the biggest peaks in your historical question. What causes them? If you can change these patterns in the future, your volatility will be much less. Or, can you detach them from planning as discrete events?

On the supply side, do you have suppliers who can commit to a tight schedule? A longer average lead time with less variability can be better than an average short lead time with a lot of variability. In general, you should plan for the long term of the spectrum.

Variability is strongly correlated with the lead time; shorter lead times generally have less variability. Identifying volatility and discovering the cause can drastically reduce variability in the supply chain and inventories.

Number 10: Harmonization of indicators

This is a critical and often difficult step. Does your organization have departmental indicators that are at odds with each other? Even ‘good’ indicators can cause sub-optimizations.

For example, the plant manager gets his bonus based on efficiency. The lower the unit cost, the better. The plant manager then directs on long-term batches. The logistics manager receives his bonus based on the stock of finished product. He likes low stocks in the warehouses. And the sales manager wants everything in the warehouse, because his bonus depends on realized turnover.

What happens in our hypothetical organization? The plant manager ignores the short production cycle and therefore produces surplus stock. The logistics manager will not want to accept the goods in the warehouse because he does not want stock of finished products to go up, so it is stored in the factory or other locations. The sales manager puts pressure on production to close his deals, resulting in even more production and surplus stock. The bottom line: Everyone gets their bonus, but the chain is anything but efficient. Watch out for the statistics. What people are paid and rewarded for is exactly what they will do. This efficiency syndrome has been previously described by Goldratt in his famous book “The Goal”.


Finally, your stock is the benchmark for your entire supply chain. It reflects the agility of your supply chain. The only sustainable way to reduce inventory is to improve your supply chain processes. To do this, your organization needs an end-to-end view of the entire chain. You must start by breaking down the “silos” within your supply chain by making them clear and by explaining the supply chain importance to all involved. Start internally at a specific location and then improve the process both upstream and downstream.