How Manufacturers Lost The Inventory Battle

Today’s average manufacturing company carries 30 days more inventory than at the beginning of the 2007 recession. As inflation takes its toll on cash cycles and the levels of inventory increase, the Cost of Goods Sold (COGS) is increasing. (The formula for COGS is Beginning inventory + Inventory costs – Ending inventory = Cost of Goods Sold.) As a result, most manufacturers lost the battle to improve inventory balance sheet positions over the past five years. Technology investments were not equal to the challenge.

Inventory is the most significant source of waste and the most important buffer for the supply chain. As variability increases, organizations experience tension in managing inventory trade-offs. The rise in inflation puts added pressure on decisions. Few companies are equal to the challenge.

Caught in a system of dysfunctional metrics, inventory piles grow as teams push for manufacturing efficiency. The management of inventory is typically the responsibility of everyone, and as a result, it becomes no one’s responsibility.

Rise In Inventory Levels

From 2004 to 2022, average global manufacturing inventories grew by thirty days. This is despite the increase in supply chain planning and Enterprise Resource Planning (ERP) investment. Our research found that 93% of manufacturers greater than $500M in annual revenues deployed this type of technology.

Days of Inventory by Industry Over the Period of 2004-2020

There are three primary reasons for the increase:

1. Rise In Product Complexity. Increasing product complexity increases manufacturing cycle stock requirements (the time to cycle through a product line in manufacturing).

2. Shifts In Sourcing Cycles. The lead time cycle increases due to global sourcing, manufacturing, and distribution outsourcing increased in-transit inventories. (Inventory on trucks, barges, containers, and third-party locations.) Leadtime variability over the last thirty-seven months acerbated the issues.

3. Increases In Demand Variability. As product complexity increased, product forecastability decreased, growing the need for safety stock. A company with a product portfolio with a long tail (low-volume products with high demand variability) requires more significant safety stock inventory levels. (Traditional approaches for demand planning as less effective as it becomes more difficult to forecast an item.)

Consider the impact of rising inventories and inflation on a company like P&G:

What To Do?

Educate the organization on the basics of inventory and stop using spreadsheets to make supply chain decisions. (Companies using only spreadsheet analysis on cost miss the impacts on inventory of shifts like tax efficiency, outsourcing, or sourcing strategies.) Use scenario planning in network design optimization and what-if analysis in discrete-event simulation to set inventory levels for each form and function of inventory.

Analyze the current health of inventories. As companies recover from the past thirty-seven months of disruption, warehouses worldwide are bloated with incorrect inventories. High levels of inventory decrease customer service reliability. (A full warehouse is inefficient, requiring more labor and sophisticated approaches for inventory management. As a result, order reliability drops as inventory levels rise.) Take the hit—write off slow and obsolete inventories. As you manage the write-offs, analyze the root cause of the inventory write-off as a learning exercise for the organization.

Summary

Traditional methods of focusing on cost management on spreadsheets or using safety stock optimization in supply chain planning must be revised. Train the organization to recognize and manage the form and function of inventory as the organization makes shifts in product complexity, sourcing strategies, and financial tax efficiencies to measure and understand the impact on the form and function of inventory. Manage inventory as an asset. Avoid waste.