One of my family’s favorite movies is “The Princess Bride”. If you have never seen it, it is truly a classic and funny family friendly movie.
One of our favorite lines occurs early in the movie when the hero is pursuing a group of characters who have kidnapped his love. The group leader is a Sicilian named Vizzini who overestimates his master plan of hurdles which he is confident cannot be overcome by the hero. As the pursuing hero defeats each one successfully, Vizzini is astonished and describes each consecutive feat as ‘inconceivable’. Finally one of the group’s characters, a likable Spanish swordsman named Inigo Montoya, tells Vizzini “I do not think that means what you think it means.”
When we talk with distributors about their inventory, we usually discuss their current inventory policies which are typically to carry a certain time supply of inventory. For example, a distributor might tell us that they typically carry one month of inventory. To quote Inigo Montoya, I do not think that means what you think it means!
To calculate one month of supply, you have to know your monthly demand , right? Are you using an average month’s demand? Well that’s fine if all your SKU’s have demand that looks like this:
If you are at the beginning of June, if you have inventory of $100, you could easily say that you have a month’s worth of supply in stock. But what if your demand looks like this much more real world scenario?
Now if you are at the beginning of June again with $100 of inventory, how much time supply of inventory do you have?
If you use a 3 month average to estimate a month’s demand, you would add March – May ($100 + 0 + $200 = $300) and divide by 3 months = $100. So if you have $100 of inventory, you would again say that you have a month’s worth of supply. But I do not think that means what you think it means!
This is obviously a seasonal item that sells heavily in the summer months. If you think you are carrying a month’s worth of supply in June, and don’t start buying heavily you will definitely lose sales.
The reality is that you in fact do not have a month’s worth of supply. At the beginning of June, you actually have less than a week’s worth of supply and depending on your lead times, could be losing sales until you get more product in.
But you might say, yes but how would we be able to know we were going to sell those numbers in June – August? If this is a new item, then probably the best thing to do is to get input for the sales team. Or if you have inventory forecasting software, you can probably copy the seasonal profile from a similar SKU if one exists.
If you have demand history for this SKU with year on year data, good inventory forecasting software should be able to pick up the seasonality automatically and predict it for you. Today’s state of the art forecasting methodologies can actually predict numbers like this with 80 – 90% accuracy.
Most distributors using an ERP system are forced to rely on some type of average demand when estimating time supply on hand but as we’ve just discussed, this can be quite inaccurate.
Relying on poor estimates of future demand means you are relying on bad assumptions which not only affect your tactical buyers but also greatly reduce the quality of your inventory metrics which impairs your strategic decisions. Let’s go back to our example that your inventory process is currently to carry one month of supply. You might make decisions thinking that you are carrying one month of supply when in fact you are not. Often far from it. At a company wide level, you might be close but as you drill down into product categories and buy lines, you get more and more inaccurate on the true amount of inventory that you have on hand. This increasing inaccuracy at a granular level is a big driver of out of stocks and overstocks at the SKU level.
Since Thrive inventory forecasting software's predictions of your future sales are much more accurate across all of your SKU’s, our calculations of your true time supply of inventory are also much more accurate. For example, when we run your actual data through our system, we will inevitably find some items that have sold heavily in the last few weeks but were one time sales. Your ERP system might show that you have four weeks of supply when you in fact have a year of supply because those exceptional sales will not repeat in the future.
Conversely, you could have items that have recent stockouts so your ERP system thinks you have 8 weeks of supply when you really only have 2. Your ERP will not suggest an order when you actually need to place a PO desperately. But an advanced inventory forecasting software, such as Thrive Technologies, will suggest an order to prevent lost sales.
If you are interested in learning more about Thrive Technologies' software, click here to schedule a free demo.