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Measuring Inventory Performance
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Expert Insight - Managing SCM Performance: Inventory Metrics, Part 3: Shrinkage - - Into Thin Air
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April 16, 2009 - Supply Chain Digest Newsletter

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Measuring Inventory Performance

I have been working hard trying to better understand inventory management, supply chain “finance,” and the bottom-line value of the supply chain.

I’ve been working on this for several years, actually, and I got good at the basics soon enough. But I am finding that getting to the deeper levels is a bit harder – and I consider myself pretty good on the numbers side.

Why this column now? In part, because of what’s going on in the economy, and how it has brought inventory management skills to the forefront.

As I noted in a recent contribution for our friends over at the RetailWire, I believe the imperative to reduce inventories in this recession, in many cases, has gone overboard and cost retailers and consumer goods companies sales revenue. I am less sure in other industries, since inventory decisions are less visible, but it is likely the same in many of those too.

Gilmore Says:  

I believe the imperative to reduce inventories in this recession, in many cases, has gone overboard and cost retailers and consumer goods companies sales revenue."

What do you say?

Send us your Feedback here


As my friend Joe Shamir of ToolsGroup recently noted, this is not uncommon, as in periods of slowing demand, companies are often late picking up the signals, resulting in excess inventories. When the drop in demand later becomes apparent, they throw on the brakes too hard in the other direction, resulting in stock outs. I would argue the penalty for those stock outs is even greater in these times, as most companies really need every sales dollar they can get.

In a real sense, I think supply chain management, at its core, is about the efficient and effective management of inventory. Logistics is about processes and skills in moving inventory; supply chain is about optimally managing supply and demand across the full plan, buy, make, move, deliver and return processes, but in the end, those processes and the skill with which they are executed largely involves having the right level of inventory where its needed – at lowest total cost.

Since I started my career, however, I think the focus on inventory has become even greater, especially for public companies. I trace this, in part, to the incredible 2001 announcement by network equipment giant Cisco that it was going to take a charge of $2.25 billion (with a B) for the third quarter of that year for excess inventories. That caught the Wall Street analysts completely by surprise, and ever since, most have paid a lot more attention to a company’s inventory levels than they used to.

That’s especially true in any industry with rapid product lifecycles, such as the high tech and fashion sectors, although the reality is that today that includes an increasing number of industries and companies. Even if Clorox had been caught with as much excess inventory versus demand as Cisco did in 2001 (as the Internet bubble burst), it would not have had to take that type of write down. Why? Because, to the best of my knowledge, the bleach and other products Clorox sells don’t quickly become obsoleted by the next round of new product development introductions, as they do to companies like Cisco or Liz Claiborne. Time puts a more severe inventory penalty on Cisco than it does Clorox.

Measuring Inventory Performance

So, just how do we measure our inventory performance?

The traditional approach for most of us has been “inventory turns.” According to the CSCMO glossary of terms maintained by our columnist Kate Vitasek, the inventory turn metric “Measures how many times a company’s inventory has been sold (turned over) during a period of time.” It equals “the cost of goods sold, divided by the average inventory level of inventory on hand.”

So, if a company has cost of goods sold of $1 billion, and average inventory levels of $100 million, it has 10 turns of that inventory per year.

But as usual, there are complications.

First, just how is the “average inventory level” determined? Most commonly, in my experience, you take the starting and ending inventory levels for some period, add them together, and divide by two. In some cases, companies simply use the end of the period number. In either case, it can lead to issues with companies purging inventory at the end of a period, either due to sales patterns or tax efficiencies. If so, it may somewhat muddy the turn numbers.

Today WMS and ERP systems can give you a true average inventory number for a period, but I am not sure how many companies use that in their turn metrics.

Some companies may determine inventory turns using sales revenue and retail price to value inventory. I could even argue that there is merit in using “units” as the correct unit of measure, as it would remove some of the noise that can creep in as financial adjustments are made to inventory levels by the accountants. For example, back to the Cisco scenario, its current inventory level would have suddenly been reduced by $2.25 billion on the books after the write down occurred.

A related metric is “Days Inventory Outstanding” or DIO. This is the number CFO magazine uses each year in its annual Working Capital study that we generally summarize on these pages (See latest summary here: Interesting Inventory Times).

You calculate DIO by taking a company’s inventory levels for a period, dividing by total revenue, and then multiplying by the number of days in the period. This measures how many days of sales a company on average holds in inventory. Finance types like DIO because it is the cousin of such metrics as “Days Receivables Outstanding” (DRO) that measures how effective a company is in collecting on its invoices.

So, for example, if a company has $2 billion in sales for the year, and average inventory levels of $100 million, then $100 million in inventory, divided by $2 billion in sales, times 365 days in a year, equals average DIO of 18.5.

This is, in a sense (though not completely), the opposite of inventory turns. A company with a high level of turns will have a low DIO, and vice-versa.

One thing I don’t like about DIO, however, is that it mixes, in a sense, units of measures – cost for inventory and actual revenues for sales. This means that the effectiveness of the purchasing and/or manufacturing organization comes into play. If that same company was able to reduce the cost of what it paid for its goods or to make them more efficiently, its DIO would go down, not because of improved inventory management, but simply because the numerator of the equation was pushed lower by cost efficiencies.

But what none of these metrics really gets to is the real impact of inventory performance on working capital, the bottom line, and free cash flow. That discussion is coming on these pages soon.

There is growing recognition that supply chain professionals need to get better at “supply chain finance.” Let’s take some of that journey together.

What do you think is the best way to measure inventory performance? How do you calculate “average” inventory levels. Do most of us need to get better at Supply Chain Finance? Let us know your thoughts at the Feedback button below.

Let us know your thoughts.

Web Page/Printable Version of Column

***Upcoming Videocasts***

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April 28, 2009

Part 4: Taking the Food
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April 29, 2009

Why Leading Firms are
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May 6, 2009

Part 1: Reviewing the Data

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This Week's Supply Chain News Bites Only from SCDigest

Supply Chain Graphic of the Week: Attaining S&OP Leadership

This Week's Supply Chain by the Numbers - Intra-Company Global Trade, TWIC Program, Oil Demand, Shipper's Disconnect with Government


The upswing on Wall Street (however slight) continued last week.  With very few exceptions, our Supply Chain and Logistics stock index had a refreshingly stable week.
In the software group, Descartes climbed 6.1%, followed by Ariba (up 5.3%) and now the only stock in our index in positive territory for the year (up 5%).  In the hardware group, Intermec was up another 4.9% and Zebra was down only a slight 0.9%.  In the transportation and logistics group, Expeditors’ International had a good week (up 4%); however, Yellow Roadway and Ryder lost all and more of last week’s gains (down 25.1% and 19.2%, respectively).   

See full stock report.

Each Week:

-Global Supply Chain
-Distribution/Material Handling
-Trends and Issues

Weekly On-Target Newsletter
April 14, 2009 Edition

Guest Column by
Mike Gregory,
Kurt Salmon Associates

Creating a Performance Culture in Supply Chain and Logistics

Companies Need to Continually look Beyond Costs to the Multiple Factors that Drive a Dynamic Work Environment

Managing SCM Performance
by Kate Vitasek, Supply Chain Visions

Inventory Metrics, Part 3: Shrinkage -- Into Thin Air

Just where does that Missing Inventory Go? Here is the List of Most Common Culprits

THIS WEEK ON Distribution Digest


HolsteHolste's Blog:

A Consultant Might Just Help you Save your Automation Project

What is the Relationship between Material Handling System Performance and Actual ROI?

>> Top Stories: Gainsharing Your Way to Productivity Gains in Distribution
>> The 10 Indicators You May Need a Multi-Carrier Shipping System

Why should SCM professionals remember a man named Keith Oliver?

A. Click to find the answer below

Have supply chain or logistics-related questions you need answered?
Ask our panel of experts. Share your insight!

Featured Question and Answer:

How to Calculate Discount for Customer Freight Pick-Up?

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We received a few good letters on our piece on Getting a Handle on Expedited Freight, which said many companies don’t really look at the root causes of the need for this expensive transport.

That includes our Feedback of the Week on the topic from Maureen Miller of Garlock Sealing Technologies, who agrees that there are real opportunities to save freight costs.

We also print more letters this week on whether on-demand TMS implementations inherently are less expensive. Greg Aimi of AMR Research and Jay Friedman of Agistix weigh in with thoughtful responses.

Feedback of the Week - On Expedited Freight:

I believe that expedited freight is a major issue; too many times the right questions aren't asked and decisions are made, which, as your article states, cost big money.

Most people inside a company do not see the real freight costs until someone brings it to their attention; usually after the fact!

Everyone wants to satisfy their customer, but what if sending the order out overnight as instructed is going to cost them $900? That makes them think about it, lots of times they change their mind. Perhaps it wasn't such a hot order after all.

The real emergency or problem gets taken care of no matter what the costs. I have seen this cost companies two to three times the product cost to make things right for the customer.

It goes both ways, sometimes the company eats the freight, and, other times, the customer pays for this expedited service.

Paying attention to this spend is crucial! But I strongly agree, logistics people see and know the high costs - it is our job to educate, share the costs and let others KNOW -- FAST -- that it is NOT free!

Maureen Miller
Logistics Manager
Garlock Sealing Technologies

More on Expedited Freight:

Expedited freight is sometimes a problem in manufacturing concerns, but a company should be well prepared for such an unplanned event.

Logistics should be preplanned for an unplanned event, meaning a back-up plan should be prepared in advance in event of an expedited freight. Suppose we have to move fabrics from
Shanghai by sea, but due to the suppliers delay, now we have to move by air; hence, taking in all uncertainties, a company should be prepared by getting the cheapest rates for sea or air.

Hence, all contingency plans should be made for any unexpected events.


On On-Demand TMS Implementation Costs:

The connectivity of the carrier base is quite an issue that is time consuming and fraught with difficulty, so that is one area of simplicity from on-demand. In addition, the system is already up and running, so that on day 1 you are starting to load the following:

  • TL rates
  • At least your discounts for LTL
  • Consignees
  • Shipping facilities

The active (execution) data is the orders, which have to hold data such as from, to, weight, cube, pieces, and freight class, at a minimum.

You know part of the problem, I think, is what people call 'using a TMS.'

If you remember from the days, doing broadcast tendering, acceptance, and tracking with 214s were what people were doing and calling it TMS. Then, the next step might be to actually get freight payment automated!!!

I do not think there is any way to get a large company's implementation of what they would call a TMS done in weeks/months.

So, I really think its probably a matter of scope, and so many companies still don't have even basic TMS execution capabilities that it seems like a big deal to them to get that incremental benefit.

Greg Aimi
AMR Research

More On On-Demand TMS Implementation Costs:

The only way an on-demand implementation is 'dumbed down' is if a customer 'dumbs down' their expectations in scoping the project.

A better way to look at this is a customer buying what they need when they need it and adding more functionality or services at a time they believe is appropriate.

On-demand applications allow this approach where the typical deployment does not. Remember the issue being addressed in the article is cost of 'implementation.'

On-demand implementations do not require much of the start-up costs of the traditional deployment: no special hardware, no software installations, very little customization, relatively minor start-up consulting.

The need for, and the internal cost of, the customer's IT resources is also substantially less. And, as mentioned indirectly in the article, economies of scale play to the on-demand providers' benefit, rather than the typical upfront costs of the traditional play.

As a result, not only are on-demand implementations faster and less costly, but benefits are delivered much sooner. So, yes, on-demand TMS implementations are easier and cost less. That's not to say there isn't some effort and cost involved, just less of it, and in most cases, much less.

Jay Friedman
Director of Business Development
Agistix, Inc.


Q. Why should SCM professionals remember a man named Keith Oliver?

A. As consultant at Booz Allen, he is generally (though not universally) credited with being the first to use the term Supply Chain Management, in a published article in 1982.

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