Cycle Counting Can Eliminate

8/3/2019 Cycle Counting Can Eliminate

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Dealing with Items That

Experience Sporadic Sales

by Jon Schreibfeder

Do the buyers in your company face a mountain of replenishment decisions everyday? In the past several weeks I have worked with several firms that stocked morethan 16,000 unique products in each of several warehouses. Their buyers seemedoverwhelmed with the task of maintaining an adequate inventory of each of theseitems, most of which were not sold on a regular basis. At each company we worked to

"tame the replenishment beast." In this article we'll look at how we decided toreplenish items that are not sold or used on a regular basis.

The first step in the process of developing a set of replenishment ground rules forthese products is to separate items sold on a regular basis from those products thatexperience sporadic sales. To do this we sort all stocked products in each facility indescending sequence based on the number of times the product is sold, regardless ofquantity. This process is commonly referred to as ranking by hits. Here is a summaryof the 16,348 items stocked in one of our customer's warehouses:

Number of Items Number of Hits

2,076 or 12.7% 12 or more

2,501 or 15.3% 6-11

4,120 of 25.2% 2-5

7,651 or46.8% Less than 2

Notice that only 2,076 or 12.7% of the items were sold, on average, at least once amonth. The replenishment of these popular products should be micro-managed tomaximize inventory turnover (i.e., the number of opportunities to earn a profit) whileretaining a high level of customer service. Indeed most books and articles on

inventory management (including ours) focus on maximizing the profitability of theseitems that customers request most often. Most if not all of the methods described inthese publications involve a prediction of future demand based, at least in part, on acalculated average of past usage. Although the specific calculation may differ frommethod to method, most rely on the average or weighted average of the quantity soldor used over a specific period of time.

But can these same rules be used to replenish items that are sold less than once amonth? In this case that's 14,272 products or 87.3% of the stocked products in the


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warehouse! Can you determine proper stocking level of these products based on anaverage of past usage? Let's look at an example. Consider an item with followingusage history:

Ten pieces of the item were sold in December and another ten pieces were sold inMarch. The history displayed suggests that when customers order the product, theyorder 10 pieces. But any forecast demand formula based on an average (or weightedaverage) of past usage will calculate a forecast of future usage of less than ten pieces.To illustrate our point, we'll apply two common demand forecast formulas to ourusage history:

A. The Six Month Rolling Average Method that averages the usage recorded overthe past six months:

(10+0+0+10+0+0) 6 = Forecast of 3.3 units for April.

This is well below the normal sales quantity of ten pieces.

B. The Weighted Average Method that decreases the weight or emphasis of eachmonth's usage history over the previous five months in the average usagecalculation:

Month UsageWeight

(Emphasis) Extension

March 10 3.0 30

February 0 2.5 0

January 0 2.0 0

December 10 1.5 15

November 0 1.0 0

Total 10 45

C. The total extension of 45 pieces is divided by the total weight of 10 piecesresulting in a forecast of April's demand of 4.5 units. Again this is well belowthe normal sales quantity of the product.

We could apply other forecast demand formulas, but the results will probably be thesame. The demand forecast will be less than the normal sales quantity of 10 pieces,


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and as a result there will not be enough inventory on-hand to meet the customer'sneeds.

An item experiences sporadic sales if its normal sales quantity is greater than theaverage quantity sold or used per month. In the example above, the normal salesquantity is 10 pieces while the average quantity sold per month is 3.3 pieces.

If an item with sporadic sales should remain as a stocked product (the subject of nextmonth' s article), its replenishment parameters normally cannot be determined using aforecast based on the average of past usage. A better way is to set minimum andmaximum quantities based on the normal sales quantity. In the example above, youmight set a minimum of 10 pieces and a maximum of 20 pieces. When the stock levelof the product dropped down to 10 pieces (one normal sale quantity) a replenishmentorder would be issued for another normal sale quantity of the product. If due to thecritical nature of the product (or to extended or inconsistent lead times) additionalsafety stock must be kept for the product, consider setting the minimum quantity totwo normal sale quantities. On the other hand, if you are willing to risk a stock-outduring the time it takes to order and receive a replenishment shipment set the

minimum quantity to zero. In any case the minimum and maximum quantities forthese items should be based on the normal sales quantity or the normal quantity usedin an assembly or process.

How do you determine the normal sales quantity? The easiest way is to divide thetotal number of pieces sold or used over the past 12 months by the number of ordersfor the product received over the same time period. For example:

Total Pieces Sold or Used Over the Past 12 Months = 40 pieces

Number of Sales and Requisitions = 4 pieces

Average Sale Quantity = 10 pieces

The average sale quantity often reflects the normal sale quantity. However its

accuracy may be influenced by one or two unusual sales. A more accurate method ofdetermining the normal sales quantity is to search transaction history for the mode inthe transaction history of the product that is, the quantity that is most often sold orused.

Although items with sporadic sales or usage do not (or should not) usually represent alarge portion of your total inventory investment, stocking these items correctly is

crucial to providing a high level of customer service. It does not make sense to stockthese products unless you maintain the most commonly requested quantity in your

warehouse. Next month, we'll look at when it is advantageous to stock items withsporadic sales, and how the cost of the item and vendor package quantities play a part

in stocking decisions.

2001, Effective Inventory Management, Inc. All rights reserved. This article cannot bereprinted or reproduced, in whole or in part, without the expressed written permission of

Effective Inventory Management, Inc.

Next Article: Liquidate All Slow-Moving Inventory?


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Liquidate All Slow-Moving Inventory?

by Jon Schreibfeder

You want to stock the products that your customers request most often in your

warehouse(s). But what about products with sporadic sales, or no sales at all? A recentarticle (not by this author) suggested that you should discontinue and liquidate the

stock of any product that is not sold or used on a regular basis. No exceptions. Clean

them all out! Or so the author said.

But do you really want to do this? We don't think so. Most distributors andmanufacturers should maintain a stock of some slow-moving products, and even

products that have never been sold, in order to maintain a high level of customerservice and enhance their corporate profitability. Why?

A Product May Have "Critical" Qualities

What is a critical product? It is something that is needed to maintain the throughput oroutput of a manufacturing production line or is necessary to maintain a vital function

or process. If this piece broke or was inadvertently removed from a machine or theproduction process, a company or its customer would suffer significant or even

tremendous losses from lost production (or the temperature in someone's home woulddrop below freezing in the middle of winter). Even though a product is infrequently

taken from stock (or may have never been taken off the shelf), the item must beavailable for immediate delivery if it is ever needed.

Every business needs to create its list of critical repair products. But as you add eachitem to this list, consider two questions:

Is the item "critical" or merely "important"? A critical part not only shutsdown a machine, it shuts down an entire process or vital service. For example,one of our customers is a food processor. They have one large mixer that is

used to combine the ingredients necessary to make any of 25 differentproducts. If the mixer is out of service, none of the 25 products can be

produced. The company keeps on-hand in their inventory a spare piece ofevery component of the mixer. On the other hand, the company has 10identical wrapping machines. If one wrapping machine breaks down, its


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workload can be reassigned to the other machines. Production might bedelayed for a couple of hours, but the process would not be shut down. Thespare parts for the mixer are critical inventory. Those for the wrappingmachine are merely important and can be ordered as needed for next-day

delivery. Keep in mind that a critical item has the potential, on its own, to shutdown a process. When creating your critical item list be sure to note the

process that is dependent on each product.

How long can the company do without the process associated with this

critical part? Will a stock-out of this item definitely result in a crisis?Another one of our customers is a utility company on a remote island. Theyhave to keep more spare parts on hand than a utility company located in ametropolitan area. Why? Because the second company can get many partsfrom a number of local suppliers within an hour or two, while the island-basedcompany has a minimum two- to three-day lead time for any product. Mostconsumers would tolerate (though with some annoyance) an hour-long

blackout. But what about a power shortage lasting three days?

The Relative Cost or Profit of the Item

Besides being a critical item, it may be less expensive to stock an inexpensive productthan to bring it in to fulfill specific customer orders. Imagine a faucet washer thatcosts ten cents. Your best customer uses two a year, but your normal vendor sellsthem in a package of 12. Buying 12 pieces provides you with a six-year supply of theitem for $1.20. Maintaining this item in inventory is considerably less expensive than

buying one or two pieces whenever they are needed from an alternate source ofsupply. Keeping several years' supply of selected inexpensive products on the shelf

will not have a great effect on your company's overall profitability. And by putting asignificant amount of these items in inventory, you won't waste your buyers' timeforcing them to continually deal with these "nuisance" items. Concentrate on ensuringyou have the optimal quantities of those items that have the most dollars flowingthrough your warehouse.

High-profit, slow-moving items may also represent a good inventory investment. Thegross profit that results from each sale may be so large that it offsets the cost ofcarrying the inventory for a prolonged period of time. But how can you be sure?

Use the Adjusted Margin Analysis

To Justify Stocking All Slow-Moving Products

In the article, "Are You Making Money?", we introduced the concept of adjustedmargin analysis. This analysis subtracts the cost of carrying inventory from the gross

profits generated from the sale of specific items. Review this article and use itsanalysis to justify stocking each and every slow-moving product.


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y Critical items may not have an adjusted margin that is equal to or greater thanthe other costs the company incurs in the course of doing business. But theyshould be associated with other items whose profitability is large enough tocompensate for carrying the average investment of these products.

y The adjusted margin analysis will also identify the actual profitability of slow-moving products that experience high gross margins.

Most companies have to maintain slow-moving products in inventory. However, youmust be sure that each of these items improves your overall customer service and/oryour company's net profitability.

Next Month Should the stock in a branch location be replenished from a central

warehouse or direct from a vendor?

2001, Effective Inventory Management, Inc. All rights reserved. This article cannot bereprinted or reproduced, in whole or in part, without the expressed written permission ofEffective Inventory Management, Inc.

Next Article: Varying the Carrying Cost for Individual Products



Effective Inventory Management, Inc.120 S Denton Tap Rd, Ste 450-200

Coppell, TX 75019(972) 304-3325

Fax: (972) 393-1310

Email: [email protected]

Varying the Carrying Cost

for Individual Products

by Jon Schreibfeder

It is important to know your cost of carrying inventory. It is a critical factor indeciding what products to stock and when to reorder them, as well as the best quantityto order. Too often companies and organizations use an imprecise "rule of thumb" toestimate their cost of carrying inventory. The result: Bad inventory managementdecisions.


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In a previous article, "The Mysterious Cost of Carrying Inventory," we gave yousome direction for calculating an overall cost of carrying inventory for your entirecompany or an individual warehouse. The calculation considers these expenses andalternative opportunities for revenue:

y Moving material from the receiving dock to the proper bin location and

shifting it to other warehouse locations as necessary.y Rent and utilities for the portion of your warehouse used to store material.y Inventory shrinkage and obsolescence.y Physical inventory and cycle counting.y Insurance and taxes on the inventory.y Opportunity cost of the money invested in inventory that is, how much could

you make if the money tied up in inventory was invested in a relatively safe,income-producing investment. Or, if you finance your inventory purchases,the amount of interest that you pay the bank.

The sum of these factors is divided by the average inventory value to determine anoverall carrying cost percentage that is, what it costs to maintain a dollar's worth of

inventory in your warehouse for an entire year.

But some companies find that it costs more to stock some items. Maybe they take upmore space or are more susceptible to shrinkage and obsolescence. If the carrying cost

percentage is used in so many critical inventory-related decisions, doesn't it makesense to calculate as accurate a carrying cost as possible for each product? If you

believe that your cost of carrying inventory may vary for different segments of yourinventory, consider calculating a cost of carrying inventory for each item.

Insurance, Taxes, and Opportunity CostTo determine the specific carrying cost for a product, we first have to determine whatfactors of the carrying cost will not vary by item. These are the factors that are solelydependent on cost or value of the average on-hand quantity:

y Insurance and taxesy Opportunity cost of the money invested in inventory

If you take the total amount of these two elements and divide it by the averageinventory value, the result is the cost of these elements per dollar of your averageinventory investment. We will call it the ITO (Insurance, Taxes, and Opportunity

Cost) factor.

Shrinkage and Obsolescence

Shrinkage and obsolescence includes any stock material that is purchased but notsold, used to provide a service, or is part of an assembly or finished good. This


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includes material that is lost, stolen, broken, scrap, or becomes obsolete in ourwarehouse. Some products are more susceptible to shrinkage and obsolescence thanother items. We need to determine factors for these two important components of thecarrying cost.

To calculate a shrinkage factor for a specific item, divide the total amount of

adjustments due to shrinkage (material lost, stolen, broken, or considered scrap)recorded in the past 12 months by the total stock receipts for the product during thesame time period. Why don't we use the average inventory value in this calculation?Because all inventory adjustments are already reflected in the average inventoryvalue. We want to determine how much of the total quantity of the inventory that wasreceived could not be sold, used in production, or used to service a customer. Manycompanies calculate a shrinkage factor for an entire product line, rather than forindividual items. This allows a shrinkage factor to be applied to products that have notyet been inventoried for a full 12 months.

To get an accurate obsolescence factor, we usually have to use a longer time period.For example, if you normally consider inventory obsolete after it has been in your

warehouse for 12 months, you might want to divide the amount of write-offadjustments made this year by the total amount of stock receipts for the item last year.Why? Because any material written off due to obsolescence this year was probablyreceived last year. Again, it might be more meaningful if you calculate anobsolescence factor for an entire product line rather than an individual product.

If you don't liquidate obsolete inventory on an ongoing basis, you may also want tovary the time periods you consider in this analysis. For example, one of our customershad a large obsolescence write-off last year that covered material that had beenreceived anywhere from two to five years ago. To calculate their write-off factor, wedivided the amount of adjustments due to obsolescence over the past two years by thetotal amount of stock receipts recorded in that two- to five-year period.

Physical Inventory and Cycle Counting

Most companies count their fast-moving items more often than their slow-movingproducts. And some products are easier to count than others. As a result, the "cost ofcounting" can vary from one item to another.

In calculating the counting element of the carrying cost, we usually start by groupingsimilar stocked items that are stored in similar storage units. We then determine the

average number of products in each group that can be counted in one hour as well asthe labor cost of performing the count. This cost includes the time spent:

y Performing the actual county Entering the count information into the computer systemy Reconciling any discrepancies in the count


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The total cost per hour is divided by the number of products that can be counted inthat hour. The result is then multiplied by the number of times each product isscheduled to be counted in a year to arrive at the total cost of counting a specific

product.

Rent, Utilities, and Moving Material

Some items take up more space, and are harder to handle, than other products. Manycompanies feel that items that take up more space should absorb more of the total costof carrying inventory. In order to apportion the cost of space and material movementto individual products or product groups, we must determine how much of the totalspace used to store products is being used by an individual item.

1. Calculate the total cost of rent and utilities for the portion of your facility usedto store inventoried products as well as moving material in that area.

2. Determine the total cubic volume of space currently used to store stockmaterial. This may not be the total cubic warehouse space. For example, if you

just moved into a new warehouse and are using just 25% of the availablespace, the inventory stored in that area would still need to absorb 100% of thecost of rent, utilities, and moving material, not just 25% of the total cost.

3. Divide the total cost by the total cubes used to store material in order todetermine the storage cost per cube.

4. Determine the total cubic volume assigned to a particular producta. If you are utilizing fixed bins (i.e., a specific space reserved for an

specific item), this is the total cubic volume allocated to the product.b. If you are utilizing random bins (i.e., quantities of the product can be

stored in any open warehouse location), determine the cubic volume of

the average on-hand quantity of the product.c. Some companies store a particular product in both fixed and random

bins and have to combine the two factors that is, they must add thecubic volume of the total fixed bin space allocated to a product to thecubic space necessary to store the average amount of the same productstored in random bins.

5. Multiply the cubic space assigned to an item by the cost per cube to determinethe utilities rent and material movement expense that should be allocated tothe item.

Accumulating the Costs

Now we can calculate the specific cost of carrying a specific product or group ofproducts in inventory by totaling the five components:

y Insurance, Taxes, and Opportunity Cost: Multiply the ITO factor(calculated above) by the average inventory investment of the item or group ofitems.


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y Shrinkage Cost: Multiply the calculated shrinkage factor by the averageinventory investment. If history is any indication, this portion of the averageinventory value will eventually be lost, stolen, misplaced, or broken.

y Obsolescence Cost: Multiply the calculated obsolescence factor by the

average inventory investment. Again, if history is any indication, this portionof the average inventory value will eventually be classified as obsolete

inventory.y Cost of Counting: Add the annual cost of counting the item.y Cost of Rent, Utilities, and Moving Material: Add the calculated annual

cost that was based on the cubic volume of space required to store the item.

Divide the sum by the average inventory investment for the item to determine theproduct's specific carrying cost percentage.

Is this a lot of work? Of course. But if significantly different amounts of effort arenecessary to maintain individual inventory items in your facility, the exercise may beworthwhile. Remember that the cost of carrying inventory is one of the keys toeffective inventory management, and that accurate information usually leads to

outstanding results!


Next Article: A Questionnaire for New Inventory Items




Coppell, TX 75019(972) 304-3325

Fax: (972) 393-1310Email: [email protected]

A Questionnaire for

New Inventory Items

by Jon Schreibfeder


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In the past several months we've published several articles concerning the risk of newinventory items becoming dead stock. We've emphasized that you must carefullyconsider each new stocking opportunity. Unfortunately the decisions concerningstocking new products are usually still based on emotion. Several of our customers

have asked us to help them turn these emotional decisions into rational businessevaluations. In response to these requests we've developed a questionnaire for

salespeople to fill out when requesting a new inventory be stocked. In this article, wepresent the questions contained in a sample questionnaire along with some advice foranalyzing the responses. The questions are in bold letters and the commentaries arein italics. A brief discussion on the analysis of the sales of new inventory itemsfollows the questionnaire along with some ideas for determining commission rates forthese products.

Questionnaire

This questionnaire must be completely filled out by the appropriate salesperson. If asalesperson does not have the information necessary to fill out the questionnaire,he/she has not performed the analysis necessary to properly determine the market

potential of the new product. Here is the content of a sample questionnaire, along withsome suggestions for evaluating the responses:

Date

Salesperson

What is this salesperson's track record (see the Analysis section below) for

introducing successful new products? Speculating on what products might sell

(especially products requiring a significant investment) is an activity thatshould be reserved for salespeople with a history of successful product

introduction.

Location

What company locations should initially stock the product? Can it be test-marketed in one location?

Customer or Potential Customers

If the product is going to be used by only one customer, the risk of the productdying in inventory is much higher than if there were multiple potential

customers. If the product is going to be bought by only one customer, be surethat that customer has met his previous commitments for purchasing special

order products. If he/she has not, consider asking for a written commitment topurchase at least 75% of the initial purchase quantity.

Product


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Reason for the product to be added to inventory that is, how will the

customer(s) use the product?

y In an existing application or process?

o If the product was previously purchased from another supplier, why

did the customer decide to switch vendors? Be sure to have your

accounts receivable department perform a credit check with theprevious supplier to ensure that they are not on credit hold with that

vendor.o If the product is replacing another stock product, how will the

remaining stock of the old product be liquidated? Has the purchasingdepartment been notified to discontinue or modify the purchasing

parameters of the old product?

y In a new application or process?

o What is the customer's potential market for the new product? The

smaller his/her potential market, the greater the chance the customerwill not be able to meet his/her purchase commitments.

At what rate will the new product be used/consumed?

y

W

hat is the source of this prediction?y How reliable has this source been in the past?

How much product will be purchased in the initial order?

It is usually not a good idea to purchase more than a projected two-month

supply of any new stock item. Because the forecast demand quantities of new

stock items are historically inaccurate, there should be a substantial

difference in cost to purchase a larger quantity of the product.

Can a smaller initial quantity be purchased, even at a higher unit cost?

It is normally better to lose money on a small quantity of a new product (i.e., atest market) than to obtain a low unit cost and end up with a large amount of

dead inventory. If the small initial quantity sells within a reasonable amount

of time, it is probably safe to issue a purchase order for a quantity that will

provide the cost necessary to achieve the target gross margin.

What is the liquidation cost/value of this material per unit?


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If there is a cost of disposal for expired quantities of this product, the initialpurchase should be for the smallest practical quantity for test-marketing

purposes.

CompensationConsider a two commission rate structure for new inventory items:

y If a product's sales meet or exceed sales projections (to date), the salespersonwill earn a full commission on all sales of the product.

y If a product's sales fall below sales projections, the salesperson will earn a halfcommission on sales of the product, until sales meet or exceed the projections

provided by the salesperson.

Analysis

Every week a report should be produced listing the status of every product that hasbeen in stock for less than six months. The report should list the followinginformation:

y Product number and descriptiony Current month sales (in units)

y Sales projection for the current month (provided by the salesperson before theitem was added to inventory)

y Total sales (in units) to datey

Total sales projection to date (provided by the salesperson before the item wasadded to inventory)y Current on-hand quantity

y Minimum stock level of the itemy Maximum stock level of the itemy Name of the salesperson who requested that the item be stockedy Reason why the item was added to stock

Detailed records should be maintained, by salesperson and customer, for new stockitems that do not meet six-month sale projections. Also track, by salesperson andcustomer, the recovered value and any disposal cost of liquidated quantities of newstock items.


Next Article: A Key to Accurate Demand Forecasting




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Coppell, TX 75019(972) 304-3325


A Key to Accurate Demand Forecasting

by Jon Schreibfeder

I received a call from one of my customers this afternoon. "Jon, something is wrongwith my demand forecast. We usually have a sharp drop in usage in January becauseseveral customers have shutdowns. But the forecast is recommending we stock almosttwice as much as we did last year. We need a better forecasting model."

We had worked extensively with this customer to develop a comprehensive set of

forecasting models that I was pretty sure would provide reasonable estimates of futureusage. I looked at the customer's data to try to determine why the system was

producing an inaccurate forecast. I paid particular attention to the usage recorded inthe previous November through March (the months surrounding January):

"Mike," I said, "I'm looking at last year's usage history and I don't see a decrease in

usage in January. In fact, January's usage of 1,390 pieces is close to 15% higher thanDecember's usage of 1,210 pieces."

Mike quickly responded, "That's impossible. Let me look at the data."

The phone was silent for a few minutes before Mike sheepishly came back on the line."Now I remember what happened. Right after our year-end physical inventory weliquidated 790 pieces of excess stock with a broker. We never adjusted our usagehistory to take out that unusual sale."

Today's competitive market requires accurate forecasts for the future demand of each

product in inventory. We are constantly looking for ways to reduce the forecasting


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error (i.e., the difference between a forecast and the resulting usage). But these effortsare often frustrated by unusual activity imbedded in historic usage data.

Most computer systems realize the importance of usage history that is not exaggeratedby unusual activity. They try to identify, and possibly correct, possible unusual usage.A common method used by many computer systems compares the usage recorded in

the inventory period just completed to the total usage in the several previousinventory periods. One of the proponents of this method is recently retired inventoryguru Gordon Graham. He long advocated that a company might have experiencedunusual usage in the month just completed if the usage in that month was greater thanthe total usage in the five previous months*. For example:

The usage of 2,500 pieces in June is greater than the total usage of 1,825(410+290+375+450+300) pieces recorded in the five previous months. But thismethod would not have identified my customer's January usage as unusual:

Note that January's usage of 1,390 pieces is not greater than the total usage of the fiveprevious months. In fact, unless you knew about the anticipated drop in usage due tocustomer shutdowns, it would be hard to detect any unusual activity. For this reason,unusual usage should not be identified by comparing usage in the month justcompleted to the usage recorded in previous months. It should be identified bycomparing usage in the month just completed to the forecast of usage in that month.

There are software packages that compare the forecast of demand to actual usage andautomatically adjust usage for any suspected unusual activity. One system presumesthat any usage is greater than x%, or less than y%, of the current forecast representsunusual activity that probably will not recur. This system will correct the usage for theinventory period to equal the forecast plus x% or the forecast minus y%:


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In the example above, both the high and low limits for unusual usage are set to 75%.

The high limit for usage is the forecast of 164 pieces plus 75%, or 287 pieces. If theactual usage for the inventory period was more than 287 pieces, it would be correctedwith a reduction to equal 287 pieces. The low limit is 164 pieces less 75%, or 41

pieces. If the actual usage for the inventory period was less than 41 pieces, it would beincreased to equal 41 pieces. Other systems correct usage in a similar way using

statistically calculated standard deviations.

Unfortunately this method does not always accurately correct unusual usage activity.To understand why, we must look at the three reasons why actual usage might deviatesignificantly from the forecast:

1. Unusual usage activity that will probably not occur again in the future.2. The start of a significant new trend in the usage of the product.3. The wrong forecast formula or method being applied to the item.

The process of automatically adjusting history for unusual usage will address mostunusual activity that will probably not recur in the future. But if a product suddenly

gains or loses popularity, automatic usage adjustment might actually removesignificant usage history. For example, if a product suddenly experiences a 150%increase in usage in one month and the product is destined to remain popular,automatic adjustment will take sales that will probably occur again out of usage. Theresult will be future forecasts that will not accurately reflect your customers' needs.And, if a system continually corrects usage to be no more than a certain percentage ofthe forecast, how will you ever know if the usage activity is actually normal, but youare using the wrong forecasting method for the item?

We have found a better method is for a computer system to identify, but not correct,items that might have experienced unusual usage activity. Buyers, planners, and/orsalespeople review the list of items and determine whether unusual activity actually

occurred, a significant new trend has begun, or the wrong forecasting method hasbeen applied to the item. They can then manually adjust actual usage to reflect whatusage would have been had no unusual activity occurred. For example, a systemmight list items whose usage was more than 300% (i.e. three times) of the forecast orless than 20% of the forecast. The buyer or other appropriate employee would thenreview the list of products and make usage adjustments as necessary.

Advanced systems allow the user to vary the definition of unusual activity fordifferent types of products. For fast moving "A-ranked" products it might be


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important to see any situation where usage is more than twice the forecast (forexample, if the forecast for an item was 10,000 pieces and actual usage exceeded20,000 pieces). At the same time, unusual activity for a slow-moving product might

be anything more than 400% of the forecast. The forecast for an item might be one

piece, and unusual activity might be usage of more than four pieces in the month.

Regardless of how your system identifies unusual usage, in order to accuratelyforecast future demand of products it is imperative that historical usage be correctedfor any unusual activity.

*Graham, Gordon, Distribution Inventory Management for the 1990s, Inventory Management Press1987, page 77.



Next Article: Is It Sporadic or Is It Seasonal?




Coppell, TX 75019(972) 304-3325


Is It Sporadic or Is It Seasonal?

by Jon Schreibfeder

It is no secret that an accurate forecast of the future demand of a product is crucial inachieving the four "rights" of effective inventory management: that is, getting therightquantity of the rightitem to the rightlocation at the righttime. As we'vediscussed in previous articles, products with different patterns of usage requiredifferent forecasting methods. The forecast for items with recurring usage is usually

based on four elements:

y Some sort of average of past usage.y A trend derived from past usage.


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y Future anticipated usage that is not revealed in past usage or trends.y A forecast horizon reflecting when material ordered today can be received and

the length of time for which inventory must be purchased.

If an item has recurring usage (that is, it is sold or used on a regular basis) we can testvarious formulas that apply different factors to each of the four elements to determine

the best method of forecasting future demand of each item. But applying theseelements to an item with sporadic activity (i.e. one that is not sold on a regular basis)

produces strange results. Look at the usage history of this item:

This product is not sold that often, but when it is sold the customer wants 12 pieces.Any forecast formula that includes some sort of average of past usage will probably

base the product's replenishment parameters on an average usage per month of about

three pieces (36 pieces 12 months). Will stocking the product based on selling anaverage of three pieces per month satisfy our customer? Probably not. When theyorder the product they request 12 pieces. This typical purchase quantity should serveas the basis of our minimum and maximum quantities. Maybe we will reorder 12

pieces of the item when there are 12 left on the shelf. Or maybe we are willing to riska stock out and will wait until the stock of the item is completely depleted before weorder 12 more pieces.

Because different methods are used to control the replenishment of products withrecurring and sporadic usage, it is imperative that we are able to accurately andconsistently identify whether each stocked product falls into one category or the other.

Sporadic usage items are sold infrequently, maybe in less than six of the past 12months. Can we say that any item with usage in less than six of the past 12 monthshas sporadic activity? The item in the above example meets this criterion, but so doesthis one:

The product is only sold in five months out of the year (June through October). Butdoes it have sporadic sales? No. The product appears to have recurring sales during a

specific season of the year. If the average sale quantity of the product was one piece,and we based our replenishment parameters on this "normal" transaction, ourcompany would probably experience significant stocking problems. This item is

probably best forecast using a seasonal formula that includes all four elements forforecasting items with recurring usage.

But how do you differentiate between items with sporadic sales and seasonal items?Retired industry "guru" Gordon Graham in his book, Distributor Survival in the 21stCentury, suggests that an item is usually seasonal if 80% or more of the sales in the


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previous 12 months occurred in just a six-month time period*. The item in the lastexample meets Gordon's seasonal criteria, but look at the usage of this next item:

Four of the five pieces (i.e. 80% of the total) were sold in a six-month period. But this

appears to be a product that experiences sporadic, not seasonal usage. Grahamrecognized this problem. He suggested that a buyer manually review each item

selected by his 80% rule and determine whether it has seasonal or sporadic activity.For many companies that means sifting through thousands of product history records.

That's a lot of work and there is a strong possibility that some items will bemisidentified or overlooked.

Other forecasting methods differentiate between seasonal items and those withsporadic sales by examining the total usage in a twelve-month period. Items withsporadic sales should have low total usage (say, less than 12 pieces per year). Right?Well, what if you sold a large quantity just two or three times a year:

Should the purchasing parameters of the above item be based on an average quantitysold per month of 100 pieces (1200 pieces 12) or the normal usage quantity of 600

pieces? The "Total Quantity" maxim doesn't reliably differentiate between items with

a high volume of sales in a limited number of transactions and those that haverecurring usage activity.

We think we've found a better way to identify sporadic items. Actually, it is a simple,reliable way to identify items that do not have sporadic activity! We start by dividing

the past 12 months into nine four-month groups:

If a product does not have usage in at least three of the four months or at least one of

the nine four-month groups, it is identified as having sporadic usage. Let's takeanother look at the item in the last example:


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Notice that none of the nine groups has usage in three or four months therefore it iscorrectly identified as having sporadic usage. Let's see if this method of identifyingseasonal items will work with other items we've examined:

Example #1:

Because no group contains usage in three or four months, this is a item with sporadicusage.

Example #2:

Note that the item was sold in three or more months in groups five, six, seven, andeight. This product definitely has a seasonal usage pattern, not sporadic sales.

Once we've determined that an item does not have sporadic usage, we can test severalformulas (both seasonal and non-seasonal) to determine the best forecasting methodfor that particular item. Minimum and maximum quantities for the sporadic usageitems will be based on the normal sales quantity.


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It's easy to see that forecasting future usage of an item using an incorrect formula willresult in stocking the wrongquantity of the wrongitem in the wronglocation at the

wrongtime. To achieve effective inventory management, it is essential to be able todifferentiate between items with sporadic sales and those with recurring usage

activity.

*Graham, Gordon, Distributor Survival in the 21st Century, Inventory Management Press 1992, page40.


Next Article: Achieving Cycle Counting Success




Coppell, TX 75019(972) 304-3325


Achieving Cycle Counting Success

by Jon Schreibfeder

In previous articles we've described cycle counting, the process of counting somestock items or warehouse locations every day, as a valuable tool in ensuring the

accuracy of your perpetual inventory. We've seen numerous cases in whichorganizations, after implementing a comprehensive cycle counting program, have had

a much more accurate perpetual inventory than they had when they performed fullphysical inventories. Because accurate on-hand quantities are vital to both providingoutstanding customer service and maximizing inventory turnover, it is not surprisingthat more and more distributors and manufacturers are implementing cycle counting

programs.

But cycle counting programs can be difficult to maintain over a long period of time.Many firms become frustrated with the "coordination" problems inherent in cyclecounting that are usually not found in a full physical inventory. When companies


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conduct a full physical inventory, they temporarily halt all normal material movement that is, they stop filling orders, putting away stock receipts, shipping material, etc.Before this is done, a special effort is made to ship as many orders as possible and putaway all stock receipts. During the actual counting process the business is virtually

closed down. Counters do not have to worry about someone doing something that willaffect the quantity in stock during the full physical inventory process.

Extensive preparation is necessary for a full physical inventory. It is not practical tocomplete this preparation before each daily cycle count. It is equally difficult toconduct cycle counts only when a business is closed and there is no materialmovement. After all, cycle counting should be performed every day. Even if acompany counts before or after normal working hours when there is little or nomaterial movement, paperwork involving items being counted can be "floating"somewhere in the warehouse or office. For example, a quantity of an item may have

been pulled from the shelf but not yet shipped. Or a stock receipt for a product mayhave been put away but not yet entered into the computer system.

Because of these issues, it is necessary to reconcile cycle counts to determine if a

particular count discrepancy is an actual shortage or overage, or just the result offloating paperwork. Because paperwork is often scattered in numerous placesthroughout the office and warehouse, it is not surprising that many firms spend moretime reconciling a cycle count than they do actually counting products. Some firmshave found the process so frustrating that they have abandoned their cycle counting

programs.

The implementation of radio-frequency (RF) bar code equipment can almost eliminatecycle count reconciliation problems. In most RF warehouse systems, the on-handquantity in the computer is updated as soon as material is added to, or removed from,a bin location. There is no "time lag" in updating computer records. Thereforewhenever someone cycle counts a product, their count should match the computer'son-hand quantity.

But RF systems are cost-prohibitive for many companies. Is there a way to implementa successful cycle counting program without RF equipment or devoting an inordinateamount of time to the reconciliation process? The answer is yes. Here is an outline ofa set of procedures we developed to accomplish this task:

1. Early each morning (or just before leaving on the previous day) the cyclecounter receives the list of products to be counted that day.

2. As soon as he or she receives the list, the counter goes to each warehouselocation containing a product to be counted and puts a temporary label on the

bin reading "Product Being Cycle Counted". The counter also places a card inthe bin to record all material movement of the product before the cyclecounting process is completed. This card contains the following information inthe header:

o Dateo Itemo Bin Location


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Four columns on the card allow anyone removing material or placing stock inthe bin to record that transaction:

o Timeo Type of Transaction (Normal Order, Handwritten Order, Confirmed

Order, Stock Receipt, Sample, etc.)

o Order Numbero Quantity

3. After the cards and labels have been distributed, the counter will note the time,and print the count sheet to record the quantities of the items being cyclecounted. He or she will then proceed to count the items.

4. Whenever an employee fills an order or puts away a stock receipt for an itembeing counted, he or she will note the time, type of transaction, order number,and quantity involved on the card that was previously placed in the bin.

5. As an item is cycle counted, the cycle counter will look at the transactionslisted on the card, comparing the time of each transaction to the time of thecount:

o Quantities on customer orders, work orders, outgoing transfers, and

other material disbursements removed from the bin before the countwas taken will be added to the quantity actually counted. The resultrepresents the on-hand quantity of the product when the cycle counting

process began. The computer's on-hand quantity for these orders hasnot yet been reduced, but the material has been removed from the

shelf.o Quantities on stock receipts placed in the bin before the count is taken

will be subtracted from the count quantity. These quantities were notincluded in the computer's on-hand quantity at the beginning of the

cycle counting process.6. If there is a discrepancy between the quantity listed on the cycle count sheet

and the on-hand quantity, the cycle counter will note the discrepancy, not theactual quantity on hand. For example, he or she might note "-2 pieces" if thesheet says there should be 42 pieces and the actual on-hand quantity is 40

pieces.Noting the difference rather than the actual quantity will allow theperpetual inventory system to be updated any time after the cycle count has

been completed, even after additional transactions for the item have been

processed!7. As the counter finishes the count of each item, he or she will remove the count

label and count card from the bin.8. If there are discrepancies between the computer's perpetual on-hand quantity

and the quantity actually counted, the counter will proceed to the stagedorders, will call, and tag and hold areas of the warehouse. All paperwork for

these filled but still-open orders should be kept in one place. The counter willlook through the orders looking for any quantities of items that were countedthat day but not yet confirmed in the system. These quantities will be added tothe quantity he or she actually counted. If this process is cumbersome and timeconsuming, consider developing a computer report that lists, by part number,

all outstanding orders.

This simple process has the potential to dramatically cut the time necessary toperform daily cycle counting. No longer will people roam around your facility trying


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to determine if a particular order was picked or put away before or after a product wascycle counted. The result: More accurate inventories with less effort and frustration, awinning combination for any organization. Why not try this method? It could turn outto be a very valuable tool in your quest to achieve effective inventory management!

2002, Effective Inventory Management, Inc. All rights reserved. This article cannot be

reprinted or reproduced, in whole or in part, without the expressed written permission ofEffective Inventory Management, Inc.

Next Article: Adjusting Usage for Lost Sales




Coppell, TX 75019(972) 304-3325


Adjusting Usage for Lost Sales

by Jon Schreibfeder

A customer requests a product and it's not in stock. They can't wait for you to obtainthe item so they purchase it elsewhere. You've lost a sale. That means you have lostthe opportunity to earn a profit, disappointed the customer, and probably put somedoubt in his or her mind about your reliability as a supplier. A lost sale is not a good

thing.

But a lost sale is made even worse if you don't use it as an opportunity to evaluate andpossibly revise the replenishment parameters for a product tThat is, to try to prevent

future lost sales. Indeed, many companies try to capture all unfulfilled customerrequests and add them to the actual usage recorded for a specific inventory period.

They believe that by including these lost sales in usage history, future demandforecasts will be adequate to cover the unfulfilled sales or usage experienced during

the current inventory period.

But there are some inherent flaws in this practice:


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Your Salespeople May Not Consistently and Accurately Record Lost Sales: Mostcompanies do not experience a consistent level of sales activity throughout the day.Often, customer orders (or customers themselves) arrive in spurts. During these hectic

periods, salespeople may not have the time to accurately record what customers

request. They are too busy processing actual orders.

A Single Request May Be Repeated: A customer calls today and asks for a productthat is not in stock. A lost sale is recorded. They call again tomorrow to see if the itemhas been received, but they talk to a different salesperson. The product is still out ofstock and another lost sale is recorded. You have recorded two lost sales for the samerequest. If lost sales are automatically added to usage, you have captured false or"phantom" demand for the product.

An Area-Wide Shortage May Cause a Greater Than Normal Number of

Requests: If your competitors are also out of a product, their customers may call yoursalespeople looking for the item. If all of these requests are treated as lost sales andadded to usage, you may again capture phantom demand for the product.

As part of a comprehensive customer relationship management (CRM) program, it isimportant to capture lost sales in order to see what customers are not being adequatelyserved. Indeed, your sales manager probably wants to know if your most importantcustomer requested an out-of-stock product five days in a row. But as we've seen,adding lost sale quantities to actual usage may not truly reflect the quantities of a

product actually needed. The adjusted figures may distort future demand forecasts andresult in either additional lost sales or excess inventory.

We've found that there is a better way to adjust actual usage for lost sales. Thismethod does not require sales people to accurately record customer requests and

protects you from capturing phantom demand. As with other aspects of our inventorymanagement philosophy, we have different recommendations for items with recurringactivity (i.e. those that are sold or used on a regular basis) and those with sporadicusage.

Recurring Items

These products are sold on a regular basis. As these are the products customersrequest most often, it is important to correct for out-of-stock situations in order toensure a high level of customer service.

1. Specify whether each of these inventory items will or will not accumulatebackorders. If an item willaccumulate backorders, customers will wait for youto receive the product. As a result, these items tend not to experience lostsales. If the product will notaccumulate backorders, customers will goelsewhere to obtain the item. These are the items that will probably experiencelost sales.

2. At the end of each inventory period (i.e. week, month, four-week period, etc.),record the number of days each product was out of stock.


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3. For items that will not accumulate backorders, multiply the days out-of-stockby the forecast demand/day and adjust monthly usage by this quantity.

For example, say a very competitive popular product was out of stock for six daysduring the month that just ended and the forecast for the item was seven pieces/day.Forty-two pieces (six days x seven pieces/day) will be added to the month's actual

usage to compensate for possible lost sales.

Sporadic Items

These are items that are not sold on a regular basis and whose replenishmentparameters are based on the normal quantity sold or used in one transaction asopposed to the forecast demand for an upcoming inventory period.

1. Record the number of times a product is out of stock (or its available quantity

drops below the normal or average sales quantity).2. If the product is out of stock more than one or two times in a six month period,

automatically increase the minimum quantity for the product by the normalquantity sold or used in one transaction.

For example, a specific type of seal is used when a certain engine is rebuilt. As twoseals are required in the process, a distributor maintains the stock of the item withthese replenishment parameters:

Minimum Quantity = 3Maximum Quantity = 4

When the available quantity falls below the minimum of three pieces (i.e. when twoseals are left on the shelf), another two pieces will be ordered to bring the maximumstock quantity to four pieces. But because the item was out of stock two times in a sixmonth period, the system will increase the minimum to five pieces and the maximumto six pieces. Now the item will be reordered when the available quantity falls to four

pieces that is, when there is still enough stock to rebuild two engines.

Note that to avoid an unrealistically large inventory investment, most organizations

will tolerate a certain number of stock-outs of non-critical sporadic-usage items. Thatis why we normally will wait for several stock-outs to occur over a certain period

before making the adjustment. However, this rule is not "cast in stone," and should be

adapted to each company's specific situation and needs.

As I've said many times, a good forecast is the foundation of an effective inventorymanagement program. The better the prediction of future demand of a product, theeasier it will be to provide a superior level of customer service while minimizing youroverall inventory investment. Correcting actual usage for lost sales opportunities is anessential part of the forecasting process. But to be effective, these corrections must

predict, as accurately as possible, what would have been sold or used had the itemcontinuously been in stock.


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Next Article: Controlling Open-Stock Inventory

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Coppell, TX 75019(972) 304-3325


Controlling Open-Stock Inventory

by Jon Schreibfeder

When the stock level of an item falls below the minimum quantity, it is time to

reorder the product, right? But we've found some instances where it is difficult tomaintain accurate stock levels because it is impractical to record each individualmaterial disbursement. For example:

y Items like pencils, pens, and other office supplies stored in a supply cabinet.y Nails, screws, and similar items that are sold from open containers in hardware

stores.y Fasteners, solvents, and other items that are used as needed in an assembly or

repair process.y Sugar packets, complementary bottles of shampoo, and other amenities

provided to guests in restaurants and hotels.

These are usually very inexpensive products that are taken from stock as needed bythe user. But most of these items do have significant usage. And in many cases, a

company would suffer a hardship in the event of a stock-out. After all, a product doesnot have to be expensive in order to shut down production or to be deemed important

by customers.

If each material disbursement is not recorded, how do you know when to reorder theproduct? How does a buyer know when the stock level of the item falls below its


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minimum quantity? How do you record usage to forecast future demand of the item?In other words, how do you maintain effective inventory management of these itemswithout accurately recording every material disbursement?

It is easy. We change our focus and don't concentrate on what people are using orbuying. We track the rate at which we have to replenish the "open stock" available to

consumers or other users of the product. The on-hand quantity in the computer systemreflects the total quantity in unopened containers (boxes, cartons, gallon bottles, etc.)in "bulk storage" that have not yet been released for sale or use. Note that bulk storagecould be a locked cabinet, a high shelf, or a bin location in the back room orwarehouse. It just has to be a location that is not accessible by end users of the

product. This bulk storage inventory is used to replenish the "open stock" of the item(i.e., the stock available to consumers). As a container is taken from bulk storage andmade available to workers or customers, the on-hand quantity is reduced by thecontainer quantity. Therefore the on-hand quantity in the computer reflects anaccurate count of the quantity in bulk storage. When the on-hand quantity drops

below the minimum stock level or order point, the product should be reordered. Usagehistory of the product reflects the number of containers of the product that were

released from bulk storage in a day, week, month, or other significant inventoryperiod. This usage history can be utilized to forecast future demand for each bulk-storage item. Unexpected increases in replenishment from bulk storage should bereported to management as it might reflect pilferage or some other problem thatshould be investigated.

From an accounting point of view, we are "consuming" the entire quantity when it isreleased to consumers. That is, the total inventory value is being reduced by the valueof the container, though the product is still in your facility in an "open" bin. Is this a"perfect" solution to maintaining an accurate inventory? No. But the world is not

perfect. And we have found it both difficult and counterproductive to have:

y Workers in a fabrication shop carefully account for every nut, bolt, and pieceof sandpaper they use.

y Hotel chambermaids carefully record which rooms receive a new bar of soapon a given day.

y Cashiers verify that customers correctly recorded the right item number whenthey filled their own order from one of several kegs of nails.

Even though the on-hand quantity of open-stock items is not reduced when anindividual piece is sold or consumed, customers or projects often must still be chargedfor the items. This can be accomplished in several ways including:

Issuing a special charge based on the average amount of open-stock materialconsumed on each order or in the course of a month. Most consumers are nowused to their automobile dealers adding a line item on repair or maintenance invoicesfor "fluids and other consumable maintenance items." And many companies chargeeach department for a share of the total office supplies consumed in a month based onthe number of people in that department.

Utilize a special type of inventory item in the computer system for open-stock

products. These items can be billed out to a customer on an invoice (i.e., nails being


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purchased in bulk at a hardware store), but an individual sale does not reduce the on-hand quantity of the item.

Because they are usually small, inexpensive, and/or hard to count, open-stock itemshave proved to be a nightmare for many manufacturers, distributors, and retailers.Unfortunately they are often necessary elements in a manufacturing process or crucial

in maintaining a high level of customer service. Our goal should be to maintain anadequate inventory of each of these products with the least amount of effort.



Next Article: Handling Maintenance Repairs and Operations Inventory




Coppell, TX 75019(972) 304-3325


Handling Maintenance Repairs

and Operations Inventory

by Jon Schreibfeder

Most of the articles on our website involve inventory that is either assembled orstocked for resale to other companies or organizations. In recent months we've

received a lot of inquiries about managing products that are going to be consumedinternally by an organization. This is normally referred to as maintenance, repairs, and

operations (MRO) inventory. Typical questions we receive include:

y How do we decide what products we should stock to maintain our operations?y What quantities of these products should be kept on hand?


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In this article we'll address these questions and help you develop an action plan forachieving effective MRO inventory management.

What Products Should be Stocked?

Many organizations have too much inventory in their maintenance and repairsinventory. Unlike inventory for resale, MRO inventory is not an investment; it is anexpense of doing business. Make sure that you are not adding to this expense withunneeded items. Be sure that there is a valid need or justification for stocking everyone of the products in your current MRO inventory:

y The product cannot be obtained in the time period necessary to fill a need oncethe need has been determined.

y The product must be purchased in a quantity greater than what is needed to filla particular need.

y The cost of carrying a product in inventory is less than the procurement cost.

Often companies will have spare parts in stock for machinery that is no longer inservice. When they retired a piece of equipment, no one bothered to check to be surethat all of the spares for the machine were removed from the parts room. That is whywe recommend that once a year you examine each of the products currently in yourMRO inventory that have not been used in the past 12 months. Question whether it isabsolutely necessary to continue to maintain a quantity of each one of them. It is alsoa good idea to develop a spreadsheet listing each MRO product, the machine(s) oroperation(s) it supports, and the quantity of the product normally needed for a repairor maintenance activity. That way, when you discontinue a process in the future, youcan easily identify the replacement parts that can be removed from your MRO

inventory.

How Much of Each Item Should be Maintained in

Inventory

You can separate your MRO inventory into three categories:

y Continual-Use Items These are maintenance items and other products thatare continually used.

y Specific-Need Inventory Though not continually used, these items are usedon a regularly scheduled basis.

y Emergency-Repair Parts These are parts whose use sporadic usage cannotbe predicted.

Every one of your MRO stocked products should be assigned to one of thesecategories. Continual-use items are just like the recurring stock products we addressin other articles and our books. Please refer to these resources to determine how to


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calculate a forecast of future demand and other purchasing parameters for these items.Most organizations have too much money invested in the other two types of MROinventory. Specific-need inventory products are required for scheduled maintenanceoperations. Unless these are very inexpensive items (i.e., they don't cost much to carry

in stock), most companies are best off acquiring just what they need before eachscheduled task. Emergency-repair parts are a different story. Since you don't know

when each of them will be required, how can you determine how many of each one tostock?

Part of developing your MRO stock list was defining where each spare part is used inyour operations. Now we must determine the "critical nature" of each one of theseitems. We've found it helpful to assign each of these items into one of threecategories:

Very Critical Parts The operation or machine this product supports iscritical to the success of your company. There are no readily available"workarounds." Lack of this part will cause a major, expensive problem foryour company. For example, one of our customers is a food processor with

one large (actually room-size) mixer. If this machine breaks down, allproduction stops. Therefore, any part that is necessary for this machine'soperation is very critical.

Somewhat Critical Parts The loss of the machine or operation these partssupport will shut down an important machine or operation. The same companyhas 14 wrapping machines. If one of these machines breaks down, it maydelay the completion of a production run, but it would not completely shutdown operations. While processing delays over an extended period of timewould cause major problems, the company can limp along for a day or twowithout one or two of the wrapping machines.

Non-Critical Parts The loss of the machine or operation these parts supportwill have no or little effect on overall production. There are availableworkarounds that can be utilized for an extended period of time.

The target stock level of a repair part is determined by a combination of its "criticalnature" and lead time. In the following matrix, we define the number of normal-usequantities that should be maintained in stock for each repair part:

For very critical parts that can completely shut down operations, we will keep onenormal-use quantity of each item in inventory even though we can get a replacement

part in less than a day. And if the lead time of a very critical part is greater than aweek, we will probably want to keep three normal-use quantities on the shelf in our

parts room. The cost of this "insurance" is the annual cost of carrying inventory


32/179

(normally 20% to 25% of the inventory value of the target stock level). You mustweigh this expense against the cost of shutting down operations. Notice that we arenot even considering maintaining an inventory of a non-critical part unless it has anextended lead time.

The average-use quantity suggestions in this table are not "cast in stone" and should

be adjusted for your organization's specific needs. However, if you must reduce thevalue of your spare-parts inventory, we strongly suggest you discontinue or reduceyour stock of non-critical and somewhat critical parts before reducing the target stocklevel of any of the very critical items. After all, these products support the lifeblood ofyour vital operations.

With proper management of MRO inventory, an organization can maintain anoutstanding level of productivity at the lowest possible overall cost. But like any other

process, it cannot be accomplished without a logical, methodical action plan.



Next Article: Why Weekly Forecasting?




Coppell, TX 75019

(972) 304-3325Fax: (972) 393-1310


Why Weekly Forecasting?

(Part One)by Jon Schreibfeder

Recently I received a call from a distributor who had a dilemma. They were runningout of a particular popular product every month. The buyer's frustration vibratedthrough the phone line as I spoke to her.


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She explained, "We're doing a pretty good job at estimating future demand of theproduct. The average difference between the forecast demand for the month andactual usage is less than 10%."

I explored another area. "How consistent are the lead times? Could shipment delaysbe causing the stock-out problems?"

"No," she sighed, "the vendor always delivers four business days after we order theproduct."

"How many customers do you have for the item?"

"We have several large customers who place a large order for the item each month,and several smaller customers who pick up a few pieces when they need them."

"When do you receive the large-customer orders?"

"Usually in the first 10 days of the month."

The buyer had just uncovered the problem. Her replenishment system forecastdemand of future usage by month. For example, in September it predicted sales of 550

pieces or about 25 pieces per business day (assuming 22 business days in the month).Actual usage was 539 pieces. Her system automatically calculated the following order

point for the item:

Order Point = Anticipated Lead Time Demand + Safety StockAnticipatedLead Time Demand = 25 pieces/day x 4-day lead time = 100 pieces

Safety Stock= 50% of lead-time usage = 50 piecesOrder Point = 100 pieces + 50 pieces = 150 pieces

The order point is a "minimum" quantity for the product, and is equal to anticipateddemand during the lead time plus a safety stock quantity. Safety stock is insuranceinventory to protect customer service from unusually large usage or shipment delaysduring the time it takes to replenish inventory. When the stock level falls below theorder point of 150 pieces, a replenishment shipment would be issued to the vendor.

The problem is that the distributor does not sell 25 pieces per day throughout themonth. Here is the weekly usage recorded for the September:

Week Business Days Weekly Usage Usage/Business Day

1 4 324 81.0

2 5 132 26.4

3 5 40 8.0


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4 5 33 6.6

5 1 10 10.0

The majority of the demand for the product (324 pieces, or 60.1% of total monthlyusage) occurs in the first week of the month. The order point of 150 pieces representsless than a two-day supply in the busy first week of the month. If we reorder a productwhen there is a two-day supply on the shelf and it takes four days to receive areplenishment shipment, it is not surprising that the item experiences regular stock-outs.

We recommended that the company change the time period of their forecast frommonths to weeks. Analyzing history over the past 12 months, we found that a formulathat averaged usage for the same week in each month over the past four monthsresulted in the least forecast error. We went back and reforecast the five weeks ofSeptember. Note that the fifth week included one business day for September and four

business days for October (i.e. the start of the next high volume time period):

Week Weekly Forecast Business Days Forecast/Day

Week 1 (Sept) 331 pieces 4 82.8/day




Week 5 (Sept) + Week 1 (Oct) 336 pieces 1 + 4 67.2/day

Each week would have had its own order point:

Week Lead-Time Usage Safety Stock Order Point

Week 1 82.8/day x 4 days = 331 166 497

Week 2 27.0/day x 4 days = 108 54 162

Week 3 7.4/day x 4 days = 30 15 45


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Week 4 9.4/day x 4 days = 38 19 57

Week 5 67.2/day x 5 days = 336 168 504

Each new order point becomes effective at a date equal to the first business day of theweek minus the lead time. So, four business days before the start of week one, if thestock level of the product was less than 497 pieces, a replenishment order would beissued. If the stock level was equal to or greater than 497 pieces, the buyer wouldleave the item alone because he has plenty of stock available to see him through thefirst week of the month. The result: The distributor will have this critical itemavailable when their customers want it. Also notice that the order point drops duringthe period of the month with less usage activity. We are not ordering the material farin advance of when it will be needed. This will help improve the inventory turnoverand overall profitability of the distributor.

Weekly forecasting works well for products that experience cyclical patterns of usagethroughout a month. Next month, we will examine two additional applications forweekly forecasting: new stock items and products whose sales or usage is dependenton a particular event.



Next Article: Part Two




Coppell, TX 75019(972) 304-3325


Why Weekly Forecasting?

(Part Two)

by Jon Schreibfeder


36/179

"What you sold or used in the past is usually a good indication of what you will sell oruse in the future". This is one of the basic "truths" of forecasting future demand ofstocked items. In our last article, "Why Weekly Forecasting (Part One)," we examinedwhy, for some products or industries, maintaining usage history by week rather than

by month will result in more accurate forecasts. These tended to be items whose usagefollowed a cyclical pattern throughout the month. For example look at a bar graph ofthe usage, by week, of this item over a three-month period:

Notice that 50% - 53% of total usage each month occurs in the first week of themonth. If we are to base our stocking decisions on selling an average of 5.0 - 5.6

pieces per day, we would probably not have enough stock for the first week in eachmonth where usage is 10.7 to 12.9 pieces per day. As a result, the demand forecast forthis item should be based on weekly usage. There are other situations wheremaintaining usage by week is necessary for accurate forecasts of future demand. Inthis article we will look at two of them: new stock items and products whose usage isdependent on a specific event.

New Stock Items

It is common for new stock items to have a spike in sales or usage volume soon afterthey are introduced. This temporary high volume may be due to:

y Promotions for the new item or salespeople featuring the new item in salescalls.

y Customers wanting to try the new product.y Customers establishing a normal stock quantity of the product in their

inventory.

Whatever the cause, this spike in sales is often followed by a dramatic decrease inusage:


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Though the duration of the temporary increase will vary, it can usually be measured inweeks rather than months. Look at the usage of a specific new item that was added to

inventory in January:

The item will be overstocked if we base the stocking decision for February onJanuary's usage of 295 pieces. Because it is hard to predict when the "peak" of thenew item usage will occur (as well as the subsequent "trough"), buyers should review

the usage of new items every week (and make any necessary adjustments toreplenishment parameters) until a consistent pattern of usage is observed.

Items Associated with a Specific Event

Lights for Christmas trees, fireworks for the Fourth of July, and pumpkins carved forHalloween are examples of items associated with a specific event but all specific-event items are not necessarily "holiday goods." Several of our clients sell industrialsupplies. Many of their manufacturing customers schedule plant shutdowns and

maintenance around July 4th and the week between Christmas and New Year's Day.Again, for many items, we see a usage pattern in which the quantity sold in one ortwo specific weeks in July and December is very different from the usage in otherweeks of the month:


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As in our other examples, if we were to stock based on monthly usage (i.e., four or

five pieces per day), we would not be adequately stocked for the scheduled plantshutdown weeks. Accurate forecasting for these seasonal events again requires

examining weekly usage that is, the quantity sold or used in the same week lastyear, adjusted for increasing or decreasing trends in business.

An accurate demand forecast allows use to meet or exceed customer expectations ofproduct availability with the least amount of inventory. While few demand forecastsare 100% accurate, we must continue to strive to reduce the forecast error (i.e., thedifference between the forecast and actual usage) to better predict future demand of

products. After all, no major league baseball player has ever achieved a battingaverage of 1,000 but this fact does not stop them from trying to improve and play

better baseball. Shouldn't you also continually do your utmost to improve theprofitability and productivity of your investment in inventory? One of the ways to dothis is to apply forecasts based on weekly usage whenever it is appropriate.



Next Article: Reconciling Cycle Counts




Coppell, TX 75019

(972) 304-3325Fax: (972) 393-1310



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Reconciling Cycle Counts

by Jon Schreibfeder

Cycle counting is the process of verifying the on-hand quantity of a specific numberof stock products every day. In previous articles, I have described how to set up andmaintain an effective cycle counting program and why this process is usually betterthan a full physical inventory for maintaining an accurate perpetual inventory in yourcomputer system. But verifying on-hand quantities is only one of the advantages ofcycle counting. The other benefit of a cycle counting program is to improve your

business processes, including:

y Making sure that all material movement is properly recorded.y Ensuring that stock receipts are put away in the proper location.y Verifying that the right quantity of the right item is shipped on outgoing orders

or is pulled from stock for an assembly.

y Preventing shrinkage from theft and the mishandling of stocked items.

Process improvement results from carefully analyzing significant stock discrepancies.A discrepancy is the percentage difference between the actual quantity physicallycounted and the stock level in the computer system at the time of the count:

[Absolute Value of (Quantity Counted Current Stock Level)] CurrentStock Level

Including the "absolute value" of "Quantity Counted Current Stock Level" in this

equation signifies that a discrepancy should be analyzed if significantly more or lessinventory is found during the cycle counting process. For example, assume that adistributor has a cycle count tolerance percentage of 5%.

Note: Most distributors, manufacturers, and retailers use a cycle count tolerance percentage of 2% -5%. The percentage may vary by item. Inexpensive items that are stocked in bulk quantities shouldhave a higher tolerance percentage than expensive items that normally have few pieces in stock.

This means that any actual count that is more than 5% greater or more than 5% lessthan the current stock level should be analyzed and investigated:

ItemStock

LevelCounted

Quantity Difference (%)Need to

Investigate?

A1005 100 91 -9.0% Yes

B7324 55 54 -1.8% No

A4509 18 16 -11.1% Yes


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C3467 24 31 +29.2% Yes

Many distributors will also investigate discrepancies if the difference in monetaryvalue between the stock level and the counted quantity exceeds a certain number ofdollars.

Investigating cycle count discrepancies can uncover procedural mistakes made in yourwarehouse, including:

y Wrong quantity taken to fill an order.y Wrong product taken to fill an order.y Products filled from the wrong stocking location.y Stock put away in the wrong bin location.y Units of measure confused or misrepresented.y Data entry errors.y Damaged material mixed with good stock.y Material movement not properly recorded.

Let's discuss some of the things that can indicate these specific reasons behindinaccurate stock levels, and actions you can take to improve material-handling

policies and prevent future stock discrepancies.

Wrong Quantity Taken to Fill an Order

Indicator:

y There is no offsetting quantity of a similar inventory item.

Actions to Take:

y Review recent transactions. Did the order picker(s) count out the pieces to beshipped, or did he or she ship sealed cartons?

o Are specific pickers associated with frequent discrepancies?o Can you detect a pattern of sealed cartons from a specific vendor not

containing the proper quantity of a product?y Make sure employees know how to properly measure or count quantities to

Cycle Counting Can Eliminate

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