Inventory Management Explained in One Flow Chart

Categories: Inventory Management

By Mark Tomalonis
Principal, WarehouseTWO, LLC

As the graphic to the right suggests, inventory management is a balancing act between two opposing goals:  "asset efficiency" (having less inventory) and "transaction efficiency" (having more inventory).

How do you explain to your employees the decision process behind inventory management?  How do you explain it to your sales team?

An employee with a basic understanding of inventory management should be able to answer these three questions:

1. Under what conditions should an item be put into stock?
   
   
2. What is the difference between a “static” and a “dynamic” stock replenishment method?
   
   
3. What determines whether a person or a computer (ERP software) should manage an item’s inventory plan?

To assist in training your employees, the flow chart below distills inventory management down to a series of questions and possible outcomes.  (Click here to download a large PDF version.)

This flow chart shows that there are five basic types of inventory management methods:

1. Automated Dynamic Stocking Plan: intended for frequently sold (“high velocity”) items.  Inventory plan considers usage trends (such as average monthly usage) and lead time trends.
   
   
2. Static Stocking Plan:  intended for infrequently sold (“low velocity”) items.  Inventory plan considers typical order size, and assumes that the inteval between orders is larger than typical lead time.
   
   
3. Micro-Managed Plan:  a hybrid of ERP system directed inventory management and frequent review by a human, due to exceptional circumstances associated with the sale of the item.
   
   
4. Speculative Stocking Plan:  No sales history justifies stocking this item.  Stocking this item is in anticipation of new sales or due to other customer support or business issues.  This item should be reviewed frequently by a human, at least until realized sales justifies reclassification of this item’s inventory management method to a different one.
   
   
5. Nonstock item:  Anticipated sales volume or frequency does not justify owning this item, and there are no other factors requiring that this item be in stock.  To be purchased for backorder only.  For better availability and to circumvent long lead times from this item’s supplier, leverage peer distributor’s inventories of this item by participating in inventory-sharing (“inventory-pooling”) with them.

Of course, the above flow chart does not account for all factors that influence whether to stock an item or how to manage an inventoried item.  Other considerations include:

• unit cost of the item
  
  
• annualized cost of goods sold ($ACOGS) for the item
  
  
• average profit margin on sales of the item
  
  
• expected lead time for replenishment
  
  
• supplier’s purchasing restrictions (e.g., minimum purchase order value, minimum purchase order quantity, package quantity restrictions)
  
  
• returnability of the item
  
  
• shelf life of the item
  
  
• seasonal variances in demand
  
  
• special needs for storing the item
  
  
• customer-specific stocking obligations
  
  
• customer-provided forecasted usage
  
  
• fulfillment rate goals
  
  
• inventory turns goals
  
  
• regional versus centralized warehousing preferences

I bet that you, the reader, can add to this list of considerations.

Inventory management has a significant effect on customer satisfaction and your company’s financial performance.  And it is a complex discipline.  This is why people get degrees or certifications on the subject, why there are professional consultants available to share their expertise, and why your company has (or should have) a modern ERP system to help automate many of the decisions and actions relating to inventory management.  Also, it is why your inventory manager should be the smartest person in the room.

Got a question or comment about this article?  Email me.

About the Author
After a successful career in sales and operations management in the wholesale-distribution industry, Mark Tomalonis is now principal of WarehouseTWO, LLC.  He amuses himself by writing articles, such as this one, to help manufacturers and wholesaler-distributors execute their operations better.  Mark’s articles and tips are published in WarehouseTWO’s monthly e-newsletters.  Click here to subscribe.

About WarehouseTWO
WarehouseTWO, LLC is an independent “inventory-pooling” service created exclusively for durable goods manufacturers and their authorized distributors, and for any group of durable goods “peer” wholesaler-distributors, such as members of a buying/marketing group or cooperative.  To learn how inventory-pooling with WarehouseTWO can help your business, visit the WarehouseTWO website, or email info@warehousetwo.com.