Building an effective organizational structure for inventory management

Inventory management is a multi-level process, where each section of the supply chain performs its own function while cooperating with other specialists and departments. To ensure efficiency and consistency of operation, it is important to build the organizational structure of the Supply Chain correctly and identify key performance indicators from the start. In addition, the performance indicators should be developed in a way that prevents conflicts of interest between the specialists, and helps them work together towards achieving the common goal of the company.

How to identify a problem in inventory management and what it can lead to?

If the purchasers have a conflict of interest with other departments, if the team cannot achieve synergy, and the department's work reminds of the fable of “The swan, the pike and the crawfish”, where everyone pulls the cart in their own direction – it's time to optimize the inventory management structure. And there are several reasons for that:

• In addition to lowering the effectiveness of the entire company, it also harms the workplace energy and morale, which will influence the performance of employees.
• A wrong organizational structure will be an obstacle to any innovation: projects will fail to finish on time, which will create a need to invest more and more extra funds. Imagine that the network is working on 50 projects simultaneously, and they all are delayed. As a result, the goals of those projects are not met, and additional resource allocation is necessary.
• It is impossible to react quickly enough to external changes. The 2020 lockdowns are clear proof of that. The companies where the team responded to the challenge quickly were the ones that came out winners: they optimized their assortment, switched to omnichannel and online trading, and improved their algorithms.
• If a conflict between specialists is already present, it will only grow over time. And it doesn't matter in what form it manifests itself.

The correct organizational structure and KPI with the specialists’ motivation taken into account will help to both solve the mentioned problems and improve the financial performance of the retailer. Many business owners fail to consider this perspective and do not notice the direct correlation between the structure of inventory management and the profit of the network.

Step 1. Building organizational structure for inventory management

The structure of the inventory management department can take different forms – it all depends on the company's operation specifics, the network size, and even on the company's development history.

As we can see from the EnVista survey, 34% of retailers prioritize profitability when optimizing inventory management, aiming to reduce costs and increase revenue through reorganizing inventory management. Building an organizational structure is one of the tools that can help increase profits.

When building the purchasing department the first question that comes to mind is who should supervise it.

From our experience, putting the Supply Chain director as the head of inventory management would be best. This position requires the person to be focused on the benefits for the entire company. This specialist works in synergy with the CEO and can facilitate communication between the different departments that form the supply chain. When there's someone who directs the vector of actions, purchasers steadily move towards the company goals, instead of getting entangled in a multitude of different operational tasks.

Related: Inventory Valuation Methods - FIFO, LIFO, WAC Difference

In practice, the purchasing department is often managed by the logistics department. Although there is a conflict of interest here:

• A logistics specialist is interested in increasing the sizes of orders and lowering order frequency, which reduces transportation costs, as well as the costs of receiving and storing the goods if these operations are performed less often.
• For the purchaser though, the accumulation of surplus or lost sales, which may happen due to infrequent orders and large batches, is harmful.

There are cases when the purchasing department works under the commercial department. This isn’t always a good thing either, and here's why:

• Interpersonal relationships influence the workflow – usually, the category manager defends the interests of the network, which may lead to disagreements with suppliers.
• Orders lose transparency due to personal bonuses from suppliers for category managers.
• The motivation may not be the same for the category manager, who will prioritize margin and sales, while for purchasing effectiveness turnover plays an equally important role.

The result of the conflict of interest between the category manager and the purchaser is evident in the case of a certain large retail chain. Due to the fact that category managers are highly involved in the process of forming orders, the entire purchasing budget was spent early at the beginning of the month. The volumes were increased and distributed according to the category manager's plan. By the end of the month, there were no funds left for making new orders. Product availability suffers, resulting in lost sales and loss of customer loyalty. The company may suffer from this kind of imbalance when commercial interests are put above logistics.

It’s best to make the purchasing and category management units work in parallel. These are completely different areas with their own objectives and KPIs.

Who is the Supply Chain Director and what is his role in the supply chain

A Supply Chain director is a specialist who must view inventory management not just through the lens of his KPIs. This specialist must possess qualities such as an analytical mindset and proactivity. Creativity, the ability to generate retail-related ideas, and entrepreneurial talent are equally important. This position should be well-paying and should leave freedom for the specialist to implement his ideas.

The responsibility of the head of the purchasing department is to see ahead, predict trends, create demand forecasts, and constantly analyze the situation. Several management tools can help him do his job successfully and efficiently. If the need arises, he can address the team directly and ask some questions like:

• Why do we have so many orders in category D?
• Why are the goods that we ordered not on display in the sales area yet?
• Why do we break financial discipline with suppliers, which later affects the regularity of deliveries?
• How can we improve the sales in our network?

There is a concept called "Evaporating Cloud" In the Theory of Constraints – it has to do with conflicts that are not always obvious, but still, affect the productivity of work. And the management's duty is to avoid such situations by organizing the correct structure and building managers’ KPIs.

The Supply Chain director smooths out these conflicts within the company and finds a balance. Therefore, you can consider introducing such a position to optimize inventory management if the company does not yet have anyone doing this job.

How many people are needed for effective inventory management and how to formulate motivation

It is important to allocate responsibility. Each specialist must be responsible for his area, understand his KPI and collaborate with colleagues. You don't need a lot of people, you just need to correctly assign responsibilities for each process.

The fewer people are involved in the process, the faster it goes.

For small networks, you won’t need more than a few people. With centralized management, 1-5 specialists are enough. Responsibility can be divided based on different criteria:

• The inventory manager is responsible for certain categories of goods or certain suppliers. On the plus side, this person perfectly navigates and knows the ins and outs of the category or specifics of working with a supplier. There is also a downside – it takes a lot of time to train such a specialist, and he will be hard to replace if he leaves.
• The manager is responsible for specific stores. This approach is effective for chains that have retail outlets in different regions. The regional manager understands the specifics of the market and the details of working with local suppliers. Usually, this applies to the Fresh category, which involves goods that are easier to source from local suppliers, than to deliver from far away. The specialist can quickly respond to emerging problems and knows how to solve them with maximum efficiency.

You can also divide the managers into those who work with risky suppliers and order volumes, those who focus on analytics, and those who are responsible for promotions, special offers, and seasonality.

Step 2. Identifying KPIs

There are two primary players in purchasing. The category manager defines the assortment plan. The purchaser is an executor, responsible for the availability of goods from the assortment plan in stores and DCs.

Assortment planning requires analytical thinking, creative approach, clear understanding of trends and your customers. The category manager profession implies a good understanding of the market specifics.

The category manager’s KPI can be focused on sales, margins, and turnover. In most cases though, he is motivated only towards the turnover. Therefore, sales get priority, as well as optimal price agreements with suppliers. In this paradigm, the category manager should not be the head of the purchasing process department, or the conflicts listed above will be inevitable.

To avoid imbalance, motivation can be formed not only around turnover but also around margin and sales.

The purchaser’s KPI. Combining several indicators, namely, availability and turnover, will be the most effective approach here as well. This kind of balance will eliminate the main risks:

• When the purchaser focuses only on turnover, he can create out-of-stock situations, because a low turnover rate becomes favorable.
• When the purchaser focuses only on availability, he will tend to overstock the warehouse or the stores in order to get 100% availability.

You could also add sales to the KPI, but in practice, the purchaser does not really have a direct effect on sales.

Step 3. Centralizing the inventory management system

The abovementioned order transparency problems can be solved or minimized by centralizing the purchasing process. We are not talking about purchasing through the DC, but about centralized management of the entire network’s inventory from the main office.

Centralization is the work done by managers in the central office, who can see the whole picture across the entire network and supervise orders across all stores accordingly. It is a way to organize the work of the inventory management department, as well as ensure that specialists’ KPIs are achieved. In other words, even with the right structure and motivation setup, it is still necessary to make the process even more transparent, simple, and manageable.

Examples of LEAFIO Inventory Optimization’s analytics

Such a management structure is essential if executives or investors are planning to scale up the network. Centralization allows you to follow the vector of the company's development with greater precision. Specialists in each individual store focus on their own customers – that's normal. But in times of change, a clearly outlined strategy is more important than focusing on operational activity.

The downside of decentralization is that too many people with different levels of expertise are involved in the inventory management process. Quality suffers from quantity. Centralization, on the other side, solves many problems that can hinder the inventory management process.

• When it comes to chain stores, and especially large ones, that have retail outlets both in metropolises and small towns, the problem of “local experts” is always present. Without centralization, local employees are the ones who make purchasing decisions. Their levels of expertise may vary, and sometimes there’s not enough control over them. This poses several risks for the retailer at once:
• Lack of order transparency – when personal agreements with the supplier can become a decisive factor;
• Different specialists have different levels of expertise, so sometimes orders are formed based on personal opinions, instead of sales figures;
• A manager can be overwhelmed with the workload, which would make it too difficult to measure the required quantities for the order, calculate all the coefficients, etc.
• Failure to follow the assortment plan. This happens due to manual system edits or manual formation of orders at retail outlets. As a result, all decisions are still made by the product experts of each individual store.

Centralization is a powerful instrument that improves financial metrics.

The decision to centralize inventory management initiates a new stage of development for the network and moves it to the next level quality-wise. This creates an urgent need for a specialist who could lead this structure. And the best person for the job would be an entrepreneurial purchaser.

Step 4. Improving the efficiency of inventory management through automation

Inventory management involves a lot of different processes, operational tasks, and manual work. It is very difficult to resolve unexpected problems and promptly react to changes in these conditions. Purchasing specialists should use the assistance of modern technologies to obtain better control over the entire process.

There are 50 outlets in the network; the assortment consists of 10 thousand SKUs, which is 500 000 objects to manage. Can one person deal with it manually? It is possible, but you won't get the maximum efficiency from it.

Not a single company today operates without automated processes. The automation process usually follows this sequence, based on what's most important for the company's development:

• financial management – implementation of the ERP system;
• acceptance of goods automation;
• inventory management;
• warehouse storage.

Automation should be viewed as an investment and not as an expense.

In fact, it is easy to calculate the ROI of implementing an automation system. From previous experience, the ROI of Leafio Inventory optimization projects is 6 months of using the program.

Which aspects of inventory management should be automated and which require human supervision

Everything that’s related to data and needs mathematical calculations should be partially or fully automated. Formation of orders can be easily represented in numbers: balances, demand, sales, write-offs – all this is specific data. Therefore, there is no point wasting extra time and human resources on it when there are programs that can solve these tasks automatically.

Supplier relationships should be automated. It is better to set up automated emails for product requests according to the delivery schedule, than send out these emails manually all the time.

At the same time, processes that require creativity and expertise should be left without automation.

What can hinder the automation process

There are organizational difficulties associated with the human reliability factor, and there are technical ones related to the data in the customer’s accounting system. The issue that comes up the most during the transition to an automated inventory management system is the frequent sabotage from the employee side. It is up to the management to resolve this issue. The CEO must oversee the process: appoint people responsible for the implementation of the new system, communicate with the team, and accept feedback from the company providing the software. At LEAFIO, we pay special attention to building relationships with the clients, because when the client invests in our product, they don’t just acquire high-quality software; they gain a long-term consulting partnership.

Another problem that interferes with automation is the inaccuracy of the data required for the inventory management system operation. Most of the time, many things are missing from the accounting system of the network, e.g. the multiplicity of packaging for an order. It is extremely important for inventory management to have correct data on:

• remaining goods and all movements that are affected by them;
• assortment plan, presentation, order quantity steps, suppliers.

But all this can be adjusted during the implementation of the system.

Another mistake that is not so obvious but can slow down the process is the lack of responsibility distribution. There should be a clear understanding of who is responsible for what.

You also need to choose a reliable vendor who has accumulated enough experience in project implementation. The right software is a step towards success, but quality support at the stage of system implementation and launch is as much important.

What does the future hold for inventory management

Inventory is a retailer’s main asset. The margins for branded product categories are decreasing, so operational excellence comes to the forefront. By focusing work on the stock, you can keep freeing up extra funds for network development. These funds can be directed to new projects in trending areas.

Talking about trends in retail, there are several directions to point out:

• Replacing manual operations with automation
• Reducing labor costs with staffless stores and Q-commerce (Quick-commerce) – faster delivery
• Omnichannel and improved customer experience
• E-commerce development

Artificial Intelligence in retail also remains a hot topic, although this topic is a rather controversial one.

What is AI in inventory management?

Artificial intelligence in retail has been a major topic for the last few years. Sounds like something from sci-fi, a way to solve all business problems with one push of a “magic button”. But it doesn’t work like that in real life. Figuring out what it means would be a good start.

Artificial intelligence is a set of algorithms that interact with data in some way. It begins with Machine Learning. Next comes the process of creating neural networks. And finally, the stage of Deep Learning, which forms a full-fledged intelligence, capable of making decisions based on the information received, just like a real person.

Today we are working in an environment where retailers are trying to limit the human reliability influence on the supply chain, and artificial intelligence along with robotics is becoming an excellent solution.

Gartner predicts that by 2023, half of all CIOs will be implementing artificial intelligence in their businesses.

Artificial intelligence needs to be trained for specific business tasks, which consumes time and financial resources. In today’s conditions, there is a lot of more important tasks that AI will not solve right away. But it is definitely one of those trends that retailers should keep an eye on. Quite possibly something innovative will soon appear on the market. For example, buyer face recognition – for generating personalized offers, and a closer study of consumer behavior. Provided that the moral aspect and privacy of people will be regulated. Therefore, the capabilities of AI are quite limited, but we’ll see what tomorrow has in store for us.

With the help of technology, retailers can quickly adapt to change, which allows them to make decisions under such conditions that previously made it impossible.

In LEAFIO clearly understand the pain points and challenges facing our customers. For this, we have built the algorithms of our LEAFIO Inventory Optimization solution so that our clients are always one step ahead in matters of inventory management and with a more efficient organizational structure that we help them build.