Managing Inventories in a Changing Economy

How to reduce excess inventory and free-up working capital.

Gary GossardOrange County Chapter

Session Overview• Inventory and supply chains• How 20% sales drop → 50% turns drop• Why it happens and how to avoid it• The Inventory Quality Ratio• Interactive demonstration • Case study results• Summary and Quiz

Inventory: Our LifebloodInventory has been and continues to be the lifeblood of supply chains, especially in times of economic difficulties. Properly managed, it drives revenue and efficiency for companies by reducing working capital and simultaneously increasing customer service levels.

– Aberdeen Group

33%

43%

44%

40%

44%

49%

58%

59%

62%

67%

72%

Collaboration

Manufacturing Cycle Times

Plant Utilization

Reducing Mfg. Overhead

Warehouse Operating Costs

Transportation Costs

ATP to Customers

Improved Fill Rate

Reduction in Cycle Times

Decreased Carrying Costs

Increased Inventory Turns

Importance of Business Benefits of Supply Chain Management

©AMR Research

How a 20% drop in sales can result in a 50% drop in turns

NormalCondition

Sales 100COS 60Inventory 10Turns 6.0

Typical company with 60% COS and 6 turns

How a 20% drop in sales can result in a 50% drop in turns

PreviousCondition Wishful

Sales 100 80COS 60 48Inventory 10 8Turns 6.0 6.0

20% Sales Drop

Wish that inventory would go down with sales

How a 20% drop in sales can result in a 50% drop in turns

Wishful HopefulSales 100 80 80COS 60 48 48Inventory 10 8 10Turns 6.0 6.0 4.8

20% Sales Drop

Hope we can keep inventory at the same level

PreviousCondition

How a 20% drop in sales can result in a 50% drop in turns

Wishful Hopeful LikelySales 100 80 80 80COS 60 48 48 48Inventory 10 8 10 16Turns 6.0 6.0 4.8 3.0

20% Sales Drop

Likely that half of lost COS ends up in inventory

PreviousCondition

Excess Inventory IncreasesAfter a year-long decline, U.S. inventories rose by $6.2 billion in the 4th quarter of 2008, according to figures from the Commerce Department This increase underscores the rapid fall in demand faced by both large and small manufacturers.

– Wall Street Journal

Why does this happen?• We had too much inventory to begin with• We don’t react to changes soon enough

Major Reasons• Our inventory systems and metrics are

backward looking – turns not demand driven• Our ABC classifications are out of date• Our order quantities and safety stocks are

based on past usage• We are still planning part quantities rather

than managing inventory dollars

How do you use ABC classes?2008 Conference Responses

• Not sure what an ABC analysis is 3%• Don’t do ABC inventory analysis 15%• Use ABC for cycle counting only 29%• Use ABC for managing inventory levels

(days-on-hand, order quantities,etc.) 21%• Use for both cycle counting and active

inventory management 33%• Over half use ABCs to manage inventory

What is your ABC based on?2008 Conference Responses

• Unit cost 14%• Inventory quantities 12%• Current inventory dollars 13%• Past usage dollars (last 12 months) 36%• Future demand dollars 11%• Other 10%• Not sure 5%• Only 11% are forward looking

Are we out of synch?• New orders for manufactured durable goods in

July 2009, up three of the last four months, increased $8.2 billion or 5.1 percent.

• Inventories of manufactured durable goods in July 2009, down seven consecutive months, decreased $2.9 billion or 0.9 percent.

– U.S. Census Bureau

• Important to be forward looking when the economy changes in either direction.

Introducing IQR• A demand-driven logic for managing

inventory dollars

• A more useful method of measuring inventory performance

• Developed by 35 materials managers.

• Forward looking and dollar focused.

Inventory Quality Ratio• Inventory management technique• Works with your current systems• Top-down focus on inventory dollars• Identifies opportunities by segment• Gives planners and buyers the information

they need to free-up working capital• Enhances any MRP/ERP/SCM system• No additional data entry required

A B C

MRP / ERP

ExtractData

IQR Logic

R H

A B C

MRP / ERP

ExtractData

IQR Logic

E3

R H

A B C

MRP / ERP

ExtractData

IQR Logic

E3

R H

A B C

MRP / ERP

Extract

A B C

Data

IQR Logic

E3

R H

A B C

MRP / ERP

Extract

A B C

Data

AWWRV

IQR Logic

E3

R H

A B C

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %AWWRV

IQR Logic

E3

R H

A B C

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWRV

IQR Logic

E3

B

R H

A B C

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWRV

IQR Logic

A2

E3

B

R H

A B C

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWRV

IQR Logic

A2

E3

B

R H

A B C

E2

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWRV

IQR Logic

6

A2

E3

B

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A2

E3

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

E3

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

E1

E3

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

Data

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

E1

E3

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

GHK

Data

BOHV

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

E1

E3

12

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

GHK

Data

BOHV

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

SM

E1

E3

12

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

GHK

Data

BOHV

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

NM

SM

E1

E3

12

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

GHK

Data

BOHV

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

6

A1 A2

NM

SM

E1

E3

12

BB

R H

D E F A B C

E2

MRP / ERP

Extract

A B C

GHK

Data

BOHV

80 - 15 - 5 %4 - 12 - 24

AWWUV AWWRV

IQR Logic

Inventory Quality Ratio

IQR =Active Inventory Dollars

Total Inventory Dollars

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

A1 + A2 + E1 + E2 + E3 + SM + NM

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

Perfect IQR = 100%

A1 + A2 + E1 + E2 + E3 + SM + NM

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

Average IQR = 30-45%

A1 + A2 + E1 + E2 + E3 + SM + NM

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

Average IQR = 30-45%

10%

A1 + A2 + E1 + E2 + E3 + SM + NM

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

Average IQR = 30-45%

10%

A1 + A2 + E1 + E2 + E3 + SM + NM

Inventory Quality Ratio

IQR =A1 + A2

IQR =Active Inventory Dollars

Total Inventory Dollars

Average IQR = 30-45%

10%30-50%

A1 + A2 + E1 + E2 + E3 + SM + NM

The IQR Logic• Analyzes inventory using:

Balance on hand and unit costPast usage and future requirementsDynamic ABC classes and user-defined rules

• Develops inventory quality categories:Active: reqmt/use, balance within user’s rulesExcess: reqmt/use, balance over user’s rulesSlow Moving: no reqmt, no use in 6 monthsNo Moving: no reqmt, no use in 12 months

• Measures overall inventory performance• Identifies opportunities by segment

Interactive Demonstration

• Quick Look

• Action Items

• Custom Analyses

• Target Setting

• Movement Matrix

• Performance

Tools for the Company• Functional Areas

– Materials Planning– Purchasing– Master Scheduling– S&OP Support– Supply Chain– Accounting & Finance– Information Services– Manufacturing– Engineering– Sales & Marketing– Senior Management

• Productivity Tools– Inventory segmentation– Action items– Inventory movement– Product family analysis– Location rebalancing– Inventory reserves– Custom reports– What-ifs & potential– Change effectivity– Special promotions– Profit improvement

First Year Results Pharmaceutical Company22% Overall Inventory Reduction & 46% Excess Reduction

0

10000

20000

30000

40000

50000

60000

70000

80000

0

10000

20000

30000

40000

50000

60000

70000

80000

Active 1Active 2Excess 1Excess 2Excess 3Slow MovingNo Moving

Total Inventory by CategoryCombined.IQR (Run Date 30/04/2004)Total Inventory by IQR Category

Inventory Dollars and IQRPurchased Parts by Category and IQR Performance

0

2,000

4,000

6,000

8,000

10,000

12,000

0 1 2 3 4 5 6 7 8 9

Months After Implementation

Inve

ntor

y D

olla

rs ($

1000

)

0

5

10

15

20

25

30

35

40

45

50

Inve

ntor

y Q

ualit

y R

atio

(%)

ActiveExcessSM+NM IQR%

Lucent Technologies & GTE

Inventory at Factory SiteFocused on Improving to 28 Turns

UTC/Carrier CorporationMar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06

ABC Rule 1-4-7 1-4-7 1-4-7 1-4-7 1-4-7 1-4-7DEF Rule 1-4-7 1-4-7 1-4-7 1-4-7 1-4-7 1-4-7

Active 1 81 129 141 121 51 79Active 2 6,148 4,930 6,803 4,690 5,877 6,297

6229 5059 6944 4811 5928 6376

Excess 1 1,052 889 878 869 455 320Excess 2 6,230 4,505 4,828 5,408 3,006 3,524Excess 3 150 86 131 191 241 165

7,432 5,480 5,837 6,468 3,702 4,009

Slow Moving 274 298 189 215 204 208No Moving 84 211 191 125 191 176

358 509 380 340 395 384

Total 14,018 11,047 13,162 11,619 10,025 10,769

IQR Ratio 44% 46% 53% 41% 59% 59%Notes: Location & currency unspecified, rules set to target 28 turns/yr. Target turns reflect site history, material types and supplier lead times.

Inventory Analysis at Any Level

Plant 1 -- Oracle

Business Units

Planner A

Products Contracts

Planner B Planner C

Planning MgrMake Parts

Buyer D

Suppliers Commodity

Buyer E Buyer F

Purchasing MgrBuy Parts

Materials Director Finance

Plant 2 -- SAP VP Supply Chain

Division A

Corporate

Product Team 1

Product Team 3

Product Team 2

First Year Results Electronics Company18% reduction in 5 months & 32% reduction in 12 months

All Teams Combined – 3/29/2009

Typical Results of Using IQR• Improve cash flow & capital immediately

• Reduce inventory 20% to 40%

• Increase turns with fewer shortages

• Maximize planner & buyer productivity

• Continuously improve overall inventory performance

IQR Environments• Manufacturing companies

material plannersbuyersproduction schedulersoperations managementfinancial management

• Distribution and logistics• Utilities and MRO stores• Management consultants

Use of IQR is Spreading• Airtechnics• Alcatel• Allergan Medical • American Capital• Andrew Corporation• Armstrong • ArvinMeritor• Avery Dennison• Banner Pharmacaps• Beckman Coulter• Binney & Smith• Black & Decker• Bosch Corporation• Boston Scientific• Bunn-O-Matic Corp• Carrier Corporation• Cummins Inc.• Dana Corporation• Dialogic - Intel Corp.

• Dow Chemical• Dr Pepper Snapple• Eastman Chemical• Engenio - LSI Logic• ERICO Incorporated• Esterline Corporation• Hendrickson Int’l• Hope Global• HunterDouglas• Hyundai• Johnson & Johnson• Kinetic Concepts• Korry Electronics• Kohler Companies• Krebs Engineers• LuK Automotive • Motorola• Nature’s Way• Newell-Rubbermaid

• Oakley• Ocean Cuisine• Pfizer - Pharmacia• Rheem Manufacturing• Sanford Corporation• Schlumberger• Sherwin-Williams• Sikorsky Aircraft• SP Richards Company• Telex Communications• Tighe Industries• Tyco Electronics• Unilever Bestfoods• Valmont Industries• Vita-Tech International• Wellman Products• Wenger Corporation• Woodward Governor• Yamaha Corporation

• Inventory systems are backward looking• Future demand is better than past usage• IQR logic is demand-driven & dollar-focused• Keys to improving inventory & working capital

– Identify excess by segment– Focus on the dollars– Prioritize reduction opportunities– Update MRP inventory settings– Monitor and track performance.

Summary

Summary• Inventory systems are backward looking• Future demand is better than past usage• IQR logic is demand-driven & dollar-focused• Keys to improving inventory & working capital

– Identify excess by segment– Focus on the dollars– Prioritize reduction opportunities– Update MRP inventory settings– Monitor and track performance.

• Makes the planner & buyer jobs easier

• Inventory systems are backward looking• Future demand is better than past usage• IQR logic is demand-driven & dollar-focused• Keys to improving inventory & working capital

– Identify excess by segment– Focus on the dollars– Prioritize reduction opportunities– Update MRP inventory settings– Monitor and track performance.

• Makes the planner & buyer jobs easier• Improves turns, cash flow and profits!

Summary

Seven Quiz Questions1. Do you measure performance by segment?2. Are your improvement opportunities prioritized?3. Are your ABC classes future-demand driven?4. Are your inventory rules revised often enough?5. Are your rules forward or backward looking?6. Do your inventory systems have a dollar focus?7. Do you know your inventory reduction potential?Your score: 7-6 Excellent. 5-4 Very Good

Seven Quiz Questions1. Do you measure performance by segment?2. Are your improvement opportunities prioritized?3. Are your ABC classes future-demand driven?4. Are your inventory rules revised often enough?5. Are your rules forward or backward looking?6. Do your inventory systems have a dollar focus?7. Do you know your inventory reduction potential?Your score: 7-6 Excellent. 5-4 Very Good

Could more “yes” answers help you to reduce excess inventory and free up working capital?

Thanks for attending!

Questions?• Things to think about in any economy

• Are we being proactive in managing inventory?• What are my specific reduction opportunities?• How can a dollar focus help me?

• For future questions or information:• Gary.Gossard@IQR.com• Phone 949-487-5400