Inventory turnover is a metric that is widely used by distribution intensive companies to manage and observe trends in their inventory levels. We are often asked how companies can increase their inventory turns.
Definition: Inventory turnover is typically calculated by taking the Annual (last 12 month) COGS and dividing by the Average (or current) inventory level in dollars.
First, it should be pointed out that there are some inherent weaknesses in using Inventory Turns as a metric:
1. One issue is that inventory turns is a historic calculation (ie. it only tells you how many times you turned inventory over the last 12 months which may or may not be reflective of how you’re going right now). It would be more useful if you knew what you were turning right now and in the next few weeks. You could then be more confident in knowing whether your current inventory policies were proper of if they needed adjustment.
2. The second issue with inventory turns is that if you use the annual numbers, you are only getting an average number of turns for the year. It would be nice if you could see during which parts of the year you are overstocked and when you are understocked.
3. Finally, companies typically views Turns as an aggregate number, which may be misleading. Even if the aggregate number is at your goal, it is very likely that you are experiencing many out of stocks and overstocks within different product groupings that may be masked in the rolled up number. Obviously, high turns are not necessarily good if you are losing tons of sales through out of stocks in key product groups that may be masked in the aggregate number.
In putting together a plan to increase inventory turns, companies should consider the following in order to properly define and achieve inventory turns goals:
1. First, inventory levels should track with sales. In other words, inventory levels should rise when sales demand is higher than average, and they should drop when sales demand is lower. Unless your sales are flat throughout the year, turns should be evaluated more frequently than annually. Monthly evaluations should provide good feedback of how inventory is fluctuating relative to sales.
2. Maintaining optimal inventory levels is complicated by seasonal patterns which are often SKU or product family specific. Evaluations of potential issues should involve “drilling down” beyond aggregate numbers to see which product groupings are ramping up in time for seasonal demand and ramping down coming out of the season.
3. Management of inventory turns is also complicated by varying lead times, especially long lead times. Global sourcing requires higher inventory levels, thus lower turns, and the cost of the increased carrying cost should be factored into the cost savings offered by the foreign vendor.
4. Large pack sizes should also be considered in a plan to improve inventory turns. Do you know if you’re buying 3 months or 12 months of supply when you have to buy 1000 units of an item in a case? Vendors with larger pack sizes, or larger minimum purchase requirements increase your inventory carrying cost.
5. Costs add another element of complexity to reducing inventory turns: you don’t want to carry 12 months of supply of really expensive items but you might want to do that with a really cheap item.
6. Finally, are the buyers getting timely and actionable information to help them buy the proper quantities? Typically, it is hard for buyers to be proactive adjusting inventory levels – for example with big customer orders, subtle increases in trends, or the latter part of a product’s lifecycle (especially if they have a lot of items to manage).
How the Thrive system increases turns
Typically, many items are overstocked. Buyers use their subjective intuition based on experience and company philosophies. Even though everyone realizes that there are certainly costs to carrying inventory, most companies would prefer to carry more weeks of supply of inventory rather than to stock out and lose sales. Most academics and inventory practitioners calculate the carrying costs of inventory to be between 25% and 30% of the inventory value in dollars. For most companies, millions of dollars in working capital is tied up in inventory unnecessarily which reduces profitability and cash flow. But in lieu of a smarter way to manage the inventory, most companies have come to accept these costs as a given.
However, if an intelligent system designed to support distribution and retail buyers automatically crunched the numbers each night, carried the right amount of stock for each item to support company service level goals, and helped buyers proactively prevent stockouts and overstock, the overall inventory would go down and sales would go up, increasing inventory turns.
The Thrive system does exactly that, reducing aggregate inventory dollars relative to sales. The system is designed to buy the proper quantities for each individual SKU based on its upcoming demand, seasonal pattern, lead time, sales volatility, pack sizes, EOQ, and many other variables that are taken into consideration. Thrive automatically replenishes inventory levels by item based on projected demand and optimized safety stock. It alerts buyers every day to current stock outs and identifies items that may stock out in the future so that they can react quickly. Thus lost sales due to stock outs are significantly reduced. Although it increases inventory turns, more importantly, it automatically enables the buyers to stock the proper levels of inventory for each item. Thus Thrive also increases service levels and fill rates.