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Measuring Your Total Inventory Cost Baseline

 Last week, I laid out three key inventory cost measuring factors that should be considered to arrive at your total cost of inventory management baseline.  Once again, they are:

  1. Inventory Cost
  2. Process Cost
  3. Procurement Cost

Knowing these three numbers (and understanding the processes that drive them) will better prepare you to develop cost effective strategies and bring real improvement to your business that will go directly to the bottom line.  This week, I will go into more detail about inventory costs and identifying areas where costs creep into your inventory.  Many believe they can look at their order history or, if they are fortunate enough to have an inventory database, simply produce a report and have an accurate inventory cost.  Unfortunately, neither of these methods account for the factors that cause leaks in most inventory measurement processes.   In truth, you need three pieces of information to determine an accurate inventory cost;

  1. Accurate Item Price – Do you have accurate information to measure your inventory, once you know what you have?
  2. Accurate Inventory Count – Do you know what you have?  Do you really?  What is hiding in that warehouse where project supplies get dumped?  What is hiding in those closets the Maintenance Manager keeps locked?  Do you think it is accounted for in your system?
  3. Inventory Service Level Cost –   In other words, how much is it costing you to be out of stock?  Consider the added procurement costs (extra PO’s), the cost to expedite shipments, the cost of downtime, etc… 

Something else that really needs to be considered, but is almost always overlooked, is the “leakage factor”.   Costs leak out of inventory processes in three major areas.

Having inventory that you don’t need – Having inventory that you don’t need soaks up money in the form of storage costs, maintenance costs, and process/handling costs.  These “soft costs” are often overlooked because they can be difficult to identify and quantify. Symptoms are revealed as you ask yourself the following questions; How much time do your employees spend looking for parts? Do you see people “buying around” the inventory system rather than search for a needed part?  Are there a lot of closets and “hidey holes” that contain products?   All of these are indicators that your company has costs leaking out of your inventory management processes.     

Not having inventory that you do need – Not having the inventory you need, at the time you need it costs money, most obviously, in production downtime, but also in non-productive employees. An additional problem comes into play as people hoard this same inventory (so they won’t run out next time).  This hoarding results in ever increasing dollars tied up in excess (and often hidden) inventory.    

Not knowing what you have – Not having a complete understanding of what you have is probably the most insidious leakage factor of all because you don’t realize what you don’t know.  Most companies have about twice as much inventory as they think they have.  What does this translate into for your company?  When companies don’t know what they have, they buy more (and tie up inventory dollars), they don’t sell or dispose of (you can make money on this) slow or non-moving items.  The worst part is, if they don’t know what they have, they build new solutions right on top of old problems thinking they will improve their situation when in fact, they are just perpetuation them.  

I say all of this, not to frighten you away from engaging in this type of project, but in an effort to manage your expectations.  Too often people leap into a project like this without understanding the time implications only to get frustrated and not get the project accomplished at all.  These companies experience the frustrations but don’t complete the project, so they never reach the point of realizing the increased efficiencies and profits. 

In conclusion, determining the cost of your inventory can be a detailed and time consuming process fraught with hidden sources of leaks which could negate the best of plans if built on anything but the firmest foundation.  On the other hand, if done correctly, the foundation will be firm and the potential rewards tremendous, and by that I mean financially rewarding solutions reaching straight to the bottom line.  

In next week’s blog, we will delve further into determining process costs.  As always, PM2 stands ready to assist you with your projects or questions.  Just give us a call at (813) 249-0834 or contact us.

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