More feedback this week from the outstanding letters we received on our First Thoughts' piece Measuring Inventory Performance. This week, we just print a few more of the many we received, including our Feedback of the Week from Joe Witkowski of Dr Pepper Snapple Group, who says inventory quality is a key and underused measure.
You will like that letter, plus two more outstanding contributions below.
Feedback of the Week – On Measuring Inventory Performance:
We use IQR, Inventory Quality Ratio, a dynamic Pareto-analysis based, forward-looking, Best-in-Breed solution. It is, for us, a reporting-only, bolt-on, kind of like an Action or Exception Message laser that prioritizes the most costly or highest opportunity cost decisions and corrections that should be on top of the material planner's or planner-buyer's daily dashboard. Instead of grabbing their morning cup of coffee and facing a random and disjointed list of exception messages, action messages, and potential crises looming deep in the "haystack" of typical lists of ERP exception messages, the planners make the most critical corrections/actions as early as possible with real-time reflections of our ERP supply/demand situations…and even have time to break for lunch!
All costing conversions are "slaved" to the ERP backbone (ours are SAP 4.6 instances in two businesses) so business controls over our ERP change management are extended readily to IQR. The "Quality Ratio" metric of IQR provides a more broad-based, forward-looking metric, but at the same time incorporates the more "sneaky," slower moving inventory buckets that can plague free cash-flow significantly, while the planners are addressing the trivial many or one time events that don't belong remaining on the books in the first place.
Payback times are on the order of weeks to a few months. Very simple, apples & apples, easily implemented and integrated… IQR is what we were looking for and trying to develop in house for a long time… and it was sitting on the toolkit shelf all along… leverage the experience of seasoned materials managers who developed it… for materials managers, by materials managers… don't reinvent the wheel when a can't miss solution is only a phone call or a web address away!
Joe Witkowski, CPIM CSCP
Business Process Development
Dr Pepper Snapple Group
More On Measuring Inventory Performance:
Inventory management is always a huge focus when trying to take cash out of the business. To be effective in getting results quickly, you have to get the right tools in the hands of the people who are actually making the daily decisions on inventory purchases. Instructions from the top down to slash inventory without a proper methodology or rationale for decision making can be a dangerous approach. Most Financial executives drive metrics for inventory turns or days inventory outstanding. IQR is a better metric of inventory performance than either turns or DIO because it is based on future demand, provides a performance measure for each segment of the inventory, and shows you where you can actually take action to reduce excess inventories, free-up working capital, etc.
As Senior Principal of Supply Chain for a Private Equity firm, we have taken a very aggressive approach to mining dollars out of our inventory. To do that, we have engaged IQR at several of our portfolio companies. The results have been phenomenal with payback happening sometimes in the first day. IQR has allowed us to focus on our immediate opportunities to defer purchases and free up cash which is greatly needed, especially in today’s economic environment. It shows us exactly where the potential is and takes the guess work out of decisions.
With the diverse industries in our portfolio and complexity of product offerings, we needed a solution that was quick to implement, easy to use, flexible and, most of all, effective. Using our standard MRP/ERP systems simply wasn’t enough. IQR has been an excellent tool to help our companies navigate through this difficult economy and free up cash to fund the business. It has opened our eyes to better ways of managing one of our largest balance sheet items – Inventory.
Senior Principal of Operations
American Capital, Ltd.
As always, you raise thought-provoking topics. Allow me to comment on three areas that you address in your article. For reference, I have addressed a couple of these in my website, http://www.inventorycurve.com.
1) Supply Chain Management
I would agree that the role of supply chain management is clearly about the efficient and effective movement of inventory, but that it is also about the efficient and effective movement of information. If you can visualize the inventory moving from suppliers to customers along the supply chain, you can also visualize information flowing from customers along the supply chain in the opposite direction to suppliers. The more effective the management of the information flow, the greater the opportunity to effectively manage the inventory flow as well. I've always believed that to be world class in supply chain requires that you be world class in information management.
2) Measuring Inventory Performance
I do not have an issue using inventory turnover as a performance measure, but I use others as well, including the Cash-to-Cash (cash conversion) Cycle and GMROI (Gross Margin Return on Inventory Investment). Each of these can be easily calculated from company financial reports. How these performance measurements balance out in an organization is a function of the business model, the strategy and the execution.
The Cash-to-Cash Cycle measures how well cash is used in an organization for Receivables, Payables and Inventory. Generally, the lower, the better.
GMROI is a concept of inventory profitability that measures the gross profit an organization earns for each dollar carried in inventory and uses both the gross profit and inventory turnover. Generally, the higher the better.
For example, on the webpage, http://www.inventorycurve.com/Tracking_Financials.html, Tracking Financials, I look at inventory turnover, cash-to-cash cycle and GMROI for three companies in the same industry over a five year period. One is better at turnover and GMROI, another is better for cash, and the third is better for gross margin.
In my estimation, all of the metrics are important, but which one carries the greatest weight depends on the organization, its plan and its values.
The complications mentioned in the article include calculation of average inventory along with use of cost-of-goods sold versus sales revenue to calculate turnover. The reality is that there is not a single defined standard method for either of these, so one must be carful in reviewing data to try to understand exactly what is being calculated and how.
That being said, my experience is that many companies actually have multiple ways of calculating turnover. The internal ERP systems can calculate a more accurate average inventory value, which can be the used for the calculation of the internal turnover number, certainly down to weekly or daily levels if so desired. But for the financial reporting, in most cases, average inventories are usually based on the average of quarter end numbers. The result, as noted in the article is that purging inventories at the end of the quarter can reduce the average inventory, thereby showing a higher financial turnover.
If should be noted that when inventory is reduced at period end, either by accelerating shipments or by pushing out receipts, the work disruption and impact on the organization can be substantial and flies in the face of lean concepts.
Principal, Inventory Curve