A client called to tell me that the level of inventory had gotten him into trouble with the bank he uses for asset-backed financing. Even though the recent purchase-cost of many items had decreased (think copper, steel, oil-based materials), which actually lowered the average value of inventory, the value at actual cost had soared. He wanted to find out why his expensive, relatively new ERP system had allowed the inventory level to balloon even though sales had plummeted. And he wanted to know how to use his system to prevent the level of inventory from growing any more.

I asked him if in mid to late ’08 inventory management and purchasing users made any changes in the way the system was set up or being used. His response was something like, “Of course not, the system runs by itself.” In “normal times” he would be correct. But in these severe times, he and every other distributor should take the following system-related actions.

When Customers Vanish

When sizeable customers go out of business, the most sophisticated forecasting formulas available will not avoid purchasing too much. The same can be true when sizeable customers stop buying certain items completely. That’s because the historical data used in forecasting includes data for sales that will not recur, and if the ex-customers do not all fold in the same month, a formula will react too slowly to the sales decline. The best way to address this situation is to enter manual adjustments to the sales data for the items involved; don’t touch the real sales data. This way, if some customers form new businesses (or start buying items they had stopped buying), selected manual adjustments can be undone.

If the ex-customers accounted for a major portion of the sales of the items they had been buying, and those items were fast movers, they may now be slow movers. So if those items had been manually classified as fast movers for inventory management purposes, they might need to be re-classified as slow movers, and related parameters re-set..

If safety stock was kept to provide great service to the ex-customers, reexamine it and any other customer-specific inventory controls.

Sales Are Way Down

Even if no customers cease operating, when sales drop 20% or 30% over a short period of time, the computer system should not be allowed to function as usual. If it is, inventory will not decrease fast enough, or may grow.

Because a sales decrease usually impacts some items more than others, the historical data used in forecasting should be reviewed for those items for which unit sales have substantially decreased. The manual adjustments mentioned earlier might be needed, as might a re-classification of the method of inventory management; and related parameters might have to be changed.     

Lead times have always been difficult to accurately estimate, but they still need to be reviewed. For some items, lead times are actually growing as manufacturers scale back production in the face of declining sales. And even though some manufacturers have decreased their minimums, now is the time for a careful consideration of whether to buy items not yet needed, in order to meet a vendor’s minimum; judge whether to wait on all the items in question, and run the risk of stocking out.

A final comment about manufacturers and inventory: When banks didn’t worry about the value of the inventory they were financing, manufacturer’s deals involving dating and free goods were usually too good to pass up. But after several months of declines in the cost of items, buying more than is really needed can create a problem if a bank refuses to provide the money needed to finance the extra quantities - or finance anything. Let the buyers know that, and give them guidelines for judging deals that are offered.

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