How to lose your inventory management game in 7 ways. Part 1

Inventory is the main asset of any retail business. Efficient inventory management and continuous monitoring make it possible for the business to multiply profits and avoid excess inventory and financial losses. Read in our material in two parts what factors affect the success of the chain and what mistakes in inventory management should be avoided.

1. Not having a process to get clear, up-to-date data

Even the most efficient inventory management system fails without high-quality data. Qualitative data refers to factors such as accuracy, completeness, relevance, reliability, and consistency. Why is this so important?

In terms of inventory management, one of the most important tasks is the accuracy of orders. It is based on the analysis and simultaneous consideration of a large number of factors to determine dependencies, the elasticity of demand and building forecasts. Without correct sales and inventory data, it is difficult to build baseline forecasts using standard statistical methods. And if we are talking about using ML/AI methods, for example, to predict promotional sales, then statistics are indispensable, because huge amounts of data are used to build models (for example, LEAFIO AI Retail Platform takes into account: promotional sales with reference to discounts, types of promotions and mechanics, information on additional places, etc.), which are most often found in different sources and can be contradictory and with different formats of data or not available at all.

Except for the above, other factors also affect the accuracy of orders: the availability and correctness of the product matrix, up-to-date information on delivery schedules, suppliers’ minimum order quantity, timely closing of orders and carrying out inventory, write-off procedures, etc.

The quality of incoming data directly and very strongly influences forecast errors, which entail the negative consequences of surplus and shortages and can cost a company a lot of money. There is also a huge potential for using factors and data that are not currently involved in machine learning models.

To avoid data quality failure, you should:

1. Establish business processes: at the system level, prohibit backdated operations and adjustments after document closure, ensure timely posting of documents, regulate inventory and write-off processes, automate the acceptance and closing of orders, etc.;
2. Reduce the number of manual operations = the influence of the human factor: forgot, entered information incorrectly or into the wrong system;
3. Strive for a single source for entering and updating incoming data;
4. Appoint those responsible for each process and the relevance of the data, those who approve and who make changes;
5. Automated error checking: for example, checking for duplicates, data formats, omissions/missing data in values, for inconsistency. With errors shifts the focus of attention only to problem areas, which increases the likelihood of working out and correcting shortcomings;

Operational dashboard for daily tasks in Leafio Inventory Optimization System

6. Conduct data analytics in order to identify non-trivial errors. For example, in the LEAFIO AI Retail Solutions system, it is important to work with the following reports:

1. The report on doubtful residual inventories shows a product with a residual, but with no sales for a certain period of time (depending on the category of demand for the product). With this report, you can identify goods with a frozen residual and work them out, which will ultimately increase turnoverю
2. The order quantity report shows when the goods lower than the quantity was delivered. By working with it, you can find errors in the data, which helps to improve the order accuracy and avoid unreasonable surplus.

Data quality improves the accuracy of BI analytics tools and makes business users more likely to rely on them than on their own intuition or spreadsheets. This leads to more efficient business decision-making and subsequently increases sales, optimizes internal processes and gains competitive advantage.

2. Not having correct KPIs for each supply chain manager (category managers, demand planners, trade marketing team, logistics dept.)

There is a wide range of KPIs for supply chain management. But the basic metrics for inventory managers are considered to be the following:

• Inventory level – this indicator must be viewed in dynamics (for example, using the LFL report). It is important to study the structure in order to understand where the frozen funds are.

LFL report in Leafio Inventory Optimization System

• Surplus is an excess inventory created due to a decrease in sales or an excess order of goods. As a result, turnover worsens and money gets held up.
• Lost sales occur due to short deliveries and incorrect forecasts, affecting the company's profit. It is very important to see the amount and percentage of lost profits.
• The availability percentage is similar to the lost sales KPI but in quantity. It provides insight into how well the approved assortment is maintained. Low availability can result in the loss of a customer.
• Sales and profit (marginality) and gross income make it possible to evaluate the business growth and its economic efficiency.
• Inventory turnover reflects the ratio of inventory to retail sales. This is a relative indicator and, most often, it is analyzed in the context of a chain or category.

It is important to be aware of the KPIs of past periods, whether they got better or worse, and compare them with the target standards. This is the only way you can draw a correct conclusion about how efficiently you manage inventory.

The right combination and integration of these metrics have a much greater value for the efficiency of the entire system than using KPIs separately from each other. Bad examples of using single targets in the motivation system can be quite costly for a company.

• For example, focusing only on the revenue indicator can pose risks to the return on sales KPI.
• Turnover is important, but it should be evaluated in conjunction with lost sales, the level of service, analysis of inventory profitability, and earned profit.

A great example is the availability and turnover KPIs for purchasing managers that give a real indication of inventory health by balancing each other out. The category manager KPI can be focused on fulfilling the turnover plan (considering rebates), marginal profit of the category and turnover, as well as assortment optimization KPI (share of hard sell and low-turnover goods), compliance with category inventory standards (%), comparison of category development dynamics on the market and within the company. For demand planners, these are statistical indicators of forecast accuracy (for example, WMAPE) and financial indicators for lost sales, surplus and turnover. The trade marketing specialist team monitors the account growth and the increase in brand awareness, i.e., brand loyalty KPIs (these are: profits, penetration, average check, market share, profit per shelf meter, etc.).

Yes, each metric has its advantages and disadvantages, but remember that each business has its own goals: for example, rapid growth or maintaining market share. Accordingly, the “correct” supply chain KPIs will vary depending on the company.

Sometimes, finding the “right” KPIs is a matter of trial and error. To make it easier, try to avoid common mistakes in building a supply chain KPI system:

• The KPI system is too complex to understand, there are a lot of metrics. Do not forget about the letter K. It is hard to expect managers to scrutinize dozens of indicators daily or even weekly. Instead, KPIs should include a few metrics that your teams can actually track and continually respond to.
• No KPI owner. Each metric should have an “owner” who will monitor changes in the metrics and respond to them, and also be able to directly or indirectly influence this indicator.
• Business goals are not supported by key performance indicators. For example, the company's goal is to achieve rapid growth, and KPIs are built on profitability, turnover, and nonconvertible stock. Instead, it is necessary to clearly follow and understand the strategic and tactical goals of the business. The advantage of such a system is that management can influence any parameter of the work of employees. For example, the goal of a business is to fight against nonconvertible stock – for this, the “quantity and share of nonconvertible stock” parameter must be included in the motivation system of category managers and buyers.
• Individual KPIs that are not reinforced or balanced by others. The secret is to maintain a balance between critical but divergent metrics. For example, we recommend that you enter metrics for profit and turnover in conjunction. Why is this important? If you only think of turnover, the employee will introduce mainly high-turnover goods into the assortment – at the expense of profitable ones. And vice versa, if the employee is responsible only for profit, the assortment will be skewed towards expensive high-margin goods, and attention will not be paid to goods with a low margin. Such examples are particularly observed with monetary motivation for fulfilling KPIs.
• KPIs do not have planned real values. That means there is no motivation to make them. To avoid this, you can research the history of your own business or benchmark. In any case, each performance indicator should have a target or threshold with a minimum acceptable level of performance.
• It is a mistake not to update KPIs for years, as over time they lose their relevance.

In general, KPIs provide insight into how well a company is progressing towards its goals and inform of the decisions made. In the event of inventory management, close monitoring of KPIs can help improve order accuracy, detect and respond to changes in demand, reduce surplus and lost sales, and consequently increase profits.

3. Not having top-notch tools for inventory management

The importance of having an effective inventory management tool cannot be overstated these days. These tools are designed to perform the following tasks:

• Autonomous forecasting and demand planning;
• Automatic orders generating;
• Timely replenishment and balance at every level of the supply chain in an environment of low predictability and constant change.

The system objectives are to achieve high order accuracy, prevent stock-outs, speed up turnover and reduce write-offs, all of which increase sales and profits. This gives managers more time to analyze and eliminate problematic issues due to current assignments.

You should urgently reconsider using your inventory management tool if you notice the following triggers:

• Unbalanced assortment: fast-moving and high-demand goods are often missing, and hard sell clutters the warehouse and shelves. There are lost sales. Availability levels average 80% or less.
• A high level of surplus freezes working capital. Slow movers are written off as losses or sold at low prices.
• Managers constantly complain about the lack of inventory, although the warehouse is rapidly expanding in terms of space and staff.
• Goods rejected at the warehouse (regrading, shortages in orders formed and sent to the client) are increasing.
• Additional costs for moving goods between storage locations for urgent deliveries.
• There is no automated order generation. To calculate forecasts and orders, the expert opinions of managers and the author's methods are used; managers are not interchangeable.
• A large percentage of errors are due to human factors.
• There are no operational tools to measure and control lost sales, surplus and turnover.

Proper inventory management will improve customer satisfaction and the efficiency of the entire supply chain.

We share the results of our clients: reduction of surplus by 30-60%, sales growth by 20%, turnover acceleration by 20-30%, and release of money out of inventory.

HOW TO LOSE YOUR INVENTORY MANAGEMENT GAME IN 7 WAYS

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Continue reading in Part 2.