Manufacturers must create conditions in which their customers enjoy better availability, a better assortment, sell more, and are not forced into markdowns caused by overstock of certain items.
A Decisive Competitive Edge is created when we satisfy a significant need of customers to a degree that no significant competitor can match.
The customers are trading companies that hold inventory. What is their significant need?
More Inventory or Less?
To secure their sales, trading companies must ensure the availability of their product portfolio and expand and change that portfolio. To sell more, they must: increase inventory. On the other hand, these companies must ensure positive cash flow and reduce warehousing costs, losses from obsolete goods, and markdowns. To control costs, they must: reduce inventory.
To manage stock levels, companies use a system of defined minimum–maximum stock levels and sales forecasts.
About forecasts, one thing can be said: they are always wrong!
Some products sell faster than forecast. Others sell more slowly.
The Cost of Stockouts and Overstock
Trading companies lose sales due to stockouts of some items while at the same time holding significant inventory of others. Sales lost to stockouts average around 4%, but in some cases reach 25-30%. Beyond lower revenue, in the long run this can lead to the loss of customers.
On the other hand, excessively high stock levels of other items lead to increased warehousing and transport costs, write-offs, and markdowns. Markdowns cost another few percent of turnover, and when they are frequent, they damage the company's image — customers come only when there are markdowns.
Zero availability and excessive availability. Because of these two factors, trading companies worldwide lose on average 7.5% of their turnover.
What does 1% more or less in sales mean for a trading company? Because operating expenses are fixed, 1% more sales can mean 10% more net profit.
The "End-of-Month" Syndrome
The problem is deepened by manufacturers' drive to "push" more goods onto the trade. "Buy more and get a bigger discount," combined with the sales department's monthly targets, produces the "end-of-month" syndrome. This is an artificial spike in sales that often creates excessive load on production — sales of some items from the manufacturer to resellers run 10 or more times higher than at the start of the period. The resellers' warehouses are overflowing with goods and their cash reserves are low. Some items are out of stock, but because the overall stock level is high, there are no free funds for replenishment. In practice, there is no increase in sales to end customers.
The significant needs of the customers — trading companies — are: better sales, more assortment, and reduced stock levels. Improved inventory turns and a better return on investment.
Is it possible?
The Solution: From "Push" to "Pull"
The foundation of the solution is shifting the model from "push" to "pull." Instead of forecasting what customers will buy in the future and "pushing" more goods, we make frequent deliveries based on actual consumption and the changes in it. To do this, we build a mutually beneficial system in which our customers send us a daily report on the sales of our products. We make more frequent deliveries and supply only the items that are selling, with the delivery quantity equal to the consumption of the preceding period.
A system is used in which the priority of delivery (and production) depends on which zone of the stock buffer a given item is in.
Dynamic Buffer Management
Because the consumption of different items changes over time, a mechanism is needed to keep the stock level of every item — in the finished-goods warehouse and in the customers' warehouses (and stores) — always aligned with actual consumption. That mechanism is dynamic buffer management.
An example of consumption and replenishment of a single item at a single stock location over one month: the replenishment time is 2 days, orders and deliveries are made every 2 days, and there is consumption every day. At the start of the month, the target level is 100 and availability is 50 units. Consumption at the start of the month is relatively low, and the item's stock level stays in the green zone of the buffer. This means there is too much of this item at this stock location — so we reduce the target level by one third and skip one delivery, because the level is above the green zone. Over the following days, consumption begins to grow and the stock level enters the red zone of the buffer. To avoid missing sales, the target level is increased by one third. At the next delivery, in addition to the consumption of the previous period, we supply an additional quantity in line with the increased target level. Consumption keeps growing, and entering the red zone of the buffer again increases the target level by one third. The system adapts the stock level to actual sales. If there is no change in the consumption pattern, the stock level is kept in the yellow zone of the buffer.
Frequent deliveries and dynamic buffer management driven by consumption — this dramatically reduces sales lost to stockouts while at the same time keeping the overall stock level significantly lower.
The TOC MTA solution includes additional elements such as inventory aggregation, different management models for different categories of goods, assortment management, price ranges, synchronizing the end of a product's life cycle with the introduction of new products, synchronizing production and raw-material supply with actual consumption, and more.
The Results
- Sales increase of 5-30%
- Improvement in inventory turns of 50-300%
- Satisfied customers, with no dead stock
- Lower warehousing costs and fewer markdowns
The MTA solution for production management typically reveals 15-50% of hidden production capacity. The lead time for fulfilling production orders is reduced. The overall level of inventory in the system is reduced (10-50%).
About the Theory of Constraints
The Theory of Constraints (TOC) is a management methodology based on the understanding that the results of any organization depend on only a few elements. Finding and appropriately managing the system's constraints leads to rapid results and harmony across the entire system. TOC was created by Dr. Eliyahu Goldratt. He is known to millions of people around the world as a scientist, mentor, and business guru. TOC is applied with exceptional success in almost every field of human activity — from industry and healthcare to public administration and education.
Originally published on LinkedIn
More sales with less inventory?
Contact us for a consultation and find out how this solution can be applied in your company.
Contact us