August 24, 2016

Logistics News : Calculating Inventory Levels Complicated By Shorter Product Life Cycles

Shippers Searching for a Better Inventory Management Tool

Editors Note: The following was originally published in Supply Chain Digest August 8, 2012. In response to the ongoing high interest in inventory management mythologies, we are republishing the article including a few minor editorial updates.

In today’s uncertain economy, product stability has become a causality of extreme market fluctuation and consumer caution. What was a trendy fast mover 3 months ago may be dead now. New products are launched, old ones are removed and demand for products change with the seasons. Shippers are therefore challenged to maintain an on-hand inventory of active products to satisfy fluctuating sales demand but, at the same time, not too much so as to keep total inventory from rising too high. The key question is “how much safety stock is needed”?

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In his book, “Inventory Management for Small and Medium-sized Businesses”, published in 2009, Mr. Jyrki Salmivuori, of Salmivuori Consulting (www.salmivuori.fi) points out that the trend toward shorter product life cycle applies not only to mobile phones and digital cameras, but also to nearly all traditional business fields. Therefore, when considering inventory optimization, the safety stock of rising trend products (that might be at the introduction stage or growth stage of their life cycle) can be maximized, whereas the safety stock of products that are approaching the end of their life cycle can be minimized.

How can this be carried out in practice? The answer, according to Mr. Salmivuori, is product categorization as follows:

In a traditional ABC categorization, products are divided into A, B or C categories on the basis of sales. The product category should indicate whether a specific product is at the initial or final stages of its life cycle. For this purpose, a product life cycle-based ABC+ categorization method has been developed for products. New and EOS (end of sales) products require separate categories. A rising trend, stable demand and decreasing trend can be represented using symbols '+', '=' and '-'. As a result, the ABC category of a volume product with a rising trend is ‘A+’. The category of a volume product with decreasing sales is ‘A-’ and that of a volume product with stable demand is ‘A=’.

A Min–Max range is specified for each ABC category within which the product’s stock balance must be kept. For example, the minimum level (i.e. safety stock) of an A+ product can be a quantity corresponding to the consumption of one month and the maximum level can be a quantity corresponding to the consumption of three months. Thus, the traditional ABC categorization has been replaced by the new, product life-cycle based ABC categorization.

Mr. Salmivuori states that while this method is not aimed at optimizing costs related to the ordering process, it can significantly reduce costs arising from the undervaluation of obsolete products because the stock levels can be reduced in a controlled manner following the product’s life cycle. At the same time, the capital tied to the inventory can be reduced and product availability can be improved.

Final Thoughts

Optimizing inventory level is a high priority and critical to maintaining a healthy balance sheet. The product life-cycle based analysis method described above should work well for small to medium size companies looking for more clarity as to SKU velocity and appropriate min-max inventory levels. These companies should probably do ABC SKU activity profiling on a quarterly basis.

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