A new age inventory management approach: triangulating service levels, margins and resilience to achieve competitive advantage

Supply chain uncertainty has worsened in the COVID recovery period, increasing risks of significant end of year write-offs for several organisations. Cash conversion cycles have become more challenging to optimise due to high demand variability. This has led to new age thinking around inventory, which requires a better triangulation on service levels, margins and resilience.

COVID-19 has highlighted the fragility of supply chains and the urgent need to tighten the grip on overall inventory management. Many organisations have seen +/-30% changes in demand patterns and adopted an overstocking approach as a kneejerk reaction to these shocks.

Average Inventory Days for UK based companies have increased from 66 days in FY18 to 74 days in FY20, reflecting the uncertainty driven by the pandemic and Brexit. 'Just in Time' has become 'Just in Case'. This has risked large stock write-offs, negatively impacting P&L's and margins, e.g. Drapers estimated fashion retailers to face stock write-offs of up to £15bn due to COVID-19 lockdown. For others, lack of supply and continued demand has brought inventory to its lowest point relative to historical levels. This has resulted in losing sales from stock-outs, losing customers due to poor service levels and even increasing risks of not meeting covenant scenarios – especially for organisations closer to debt maturity.

Recent shocks present the opportunity to reflect and reset. This has highlighted the 'new age inventory management approach' – a framework that focuses on balancing Service Levels, Margins and Resilience.

Prior to getting the triangulation balance right for the above, there are 5 key elements that need to be embedded within organisations -

A. Re-thinking foundations for demand planning

Do we truly believe that leveraging machine learning in demand planning is the magic wand to optimising inventory or cash conversion cycles? Let’s take a second and think about the variables linked to demand that changed during COVID and whether machine learning based demand forecasts could effectively solve the problem. Probably not – it is one of the tools, not the only tool.

The last 18 months have helped us realise that getting the basics right is key to success. These include:

• Cross team collaboration for demand planning (sales, supplier, purchasing, stores, production, fulfilment, customer)
• Standardizing service levels across key customer segments or contracts and working backwards to integrate the ecosystem to fulfil these
• Continuously improving communications using technology and controls across functional groups to monitor forecasts at an item level for at least 80% of sales and / or 80% of high margin SKU’s; especially functional groups that act as bottlenecks.

B. Shifting from confrontational to collaborative supply chains

Conventional supply chains can be confrontational, assuming that optimisation can only be achieved if it is at the expense of other supply chain partners, e.g. aggressive extension of payment terms to suppliers can deliver a short term working capital gain but often results in longer lead times and/or increased prices. COVID-19 has challenged this mindset as communities and businesses confront this crisis through greater cohesiveness, with collaboration becoming almost second nature. Could this shift in behaviours continue as we come out of this crisis or, will supply chains revert to a confrontational business as usual?

Organisations should:

• Initiate conversations imminently with key suppliers and customers and define steps to achieve greater collaboration, especially ahead of demand ramping up.
• Partners should work together to define joint objectives and KPIs as if a single entity.
• Consider technological enablers to leverage alternate suppliers with favourable sales terms & credit terms who demonstrate a willingness to grow and become a key provider over time.

C. Focussing on fewer but more meaningful harmonised KPIs to make informed decisions

Major shocks triggered by COVID-19 have made balancing even harder and exacerbated the lack of trust in supply chain processes, as data quality continues to be weak. Uncertainty, coupled with the need to react quickly, has meant that some organisations have by-passed  structured processes and made business critical decisions based on emotions.

To drive sustainable performance improvement, KPIs need to be simplified to be easily understood, based on timely and accurate data, translated into specific targets, easily measured and produced regularly. KPIs should also be consistent and incentivise the right behaviour in driving performance towards overall business objectives.

We have often seen organisations put sticky plasters across their digital landscape. In today’s times, not having an integrated system should not limit the quality of information being reviewed to make decisions. Leveraging BI tools with a clear line of sight to goals – both financial and operational, should be a good starting point to guide decision-making.

D. Extending scenario planning to model alternate strategies

Most organisations shy away from assessing trade-offs regularly. During COVID 19, the absence of making critical decisions based on a clear view of trade-offs, as an example, has left many organisation holding stock that they cannot sell due to changes in demand, which may result in significant write-offs.

Some of the common operational trade-off themes we see being used as a part of our lessons learnt insights with several organisations are:

• Product switch off – timing when to leave a product in the mix versus switch it off on a permanent or temporary basis.
• Stocking strategies – owning inventory and related risks versus moving specific SKU’s to a vendor management inventory model

Another element to consider for trade-offs from a financial perspective is leveraging repurchase or financing programs. Today, several third party service providers repurchase inventory and burn down inventory for a fee, or some provide financing solutions. This has a significant impact on improving the cash conversion cycles.

E. Simplifying inventory policy and leveraging early warning signs

Inventory policies and procedures are not always formally documented or consistent across business units. Even when they are, they can be overlooked, much like ignoring the instructions manual when assembling furniture. This results in significant variations of inventory performance across the business and overstocking.

A single inventory policy and procedures document should be developed, which captures best practices across business units. This should be applied consistently across the company. Compliance to procedures should be embedded through automation and IT where possible. This should be complemented with monthly / quarterly compliance assessments, linkages to early warning signs such a deteriorating covenant conditions (e.g. net debt/EBITDA), liquidity deterioration or changes in credit ratings.

Optimising inventory by balancing Service Levels, Margins and Resilience parameters often results in improving cash conversion cycles by 18%-34%

Interpath has found instances where companies taking a triangulated approach towards inventory management have had a knock-on improvement impact on receivables and payables and have also improved their cash conversion position.

For organisations that are open to taking the improvement challenge, we recommend looking at the following questions to start your thinking:

• How closely do you use some of the elements of the triangulation model?
• How far are you from best in class metrics within your sector on cash conversion cycles?
• Do you have an integrated cash management approach that acts as an effective early warning sign towards doing something different on how you manage inventory?
• Does your leadership team look at the right KPI’s, to begin with and is the relevance of meeting goals set to them important to key operators in your organisation?
• What have you tried differently on managing inventory that sets the bar in your sector?

Organisations that can master the art of triangulation across service level, margins, and resilience to manage inventory can create value for their shareholders and emerge as winners in the COVID recovery and post COVID phase.