Improving Inventory Turnover/Developing Supplier Partnerships

Inventory Turnover

Most business people who I meet know how much inventory that their company has on hand, either in dollars or units. Some also have an idea of the turnover rate that they are achieving, but usually in a macro sense only.

Inventory turnover should be a critical performance measure for any company that manufactures or distributes products. The classic definition of inventory turnover is:

Inventory turnover =
Average annual cost of sales
12 months average inventory dollars

While this calculation is the “standard”, it does not provide realistic turns on a monthly basis because it uses averages. To get an assessment of what the business is doing in terms of current inventory performance, substitute actual ending inventory dollars for the month in the denominator. Tracking both measurements will give you both a short and long term view of the velocity of your inventory.

Once the turns rate has been established, the question is what can be done to improve it. The first step that I usually suggest is to develop an understanding of the turns by product line, type of inventory (raw material, finished goods), or whatever categorization is meaningful to your business. Turns are not easy to benchmark, because even public companies do not usually report the number in their published financials. I check industry associations and business publications for benchmarking data.

In manufacturing companies raw materials and purchased components represent the lowest cost inventory followed by work-in-process, and finished goods. A good approach is to develop turns data for each of these segments and try to maximize turns for finished goods vs. raw materials or components. Manufacturers can use several techniques to improve turns. Reducing internal and external lead times, working with suppliers to optimize material flow, just-in-time or lean manufacturing techniques are commonly used approaches.

For distributors, the challenge of improving inventory turnover has to be balanced against customer service. A straightforward technique that I have used with several clients focuses on fast moving items (the “top”) and slow movers (the “bottom”). The top or “A” items usually represent a large percentage of total sales, so improving their turns by a relatively small amount has a significant result. The bottom items turn less than one time a year, if at all. It is costing your company at least 20% of their cost to carry them for a year. Eliminating at least some of these items is essential to realizing improvement in total turnover.

One additional suggestion for either manufacturers or distributors is to think about measuring turnover against your forecast or actual future orders. By definition turnover is measured by looking at history, last year or last quarter, etc. But the inventory that you have on hand today is there to fill future orders. So use either the forecast or actual orders, annualize them (at cost, not sales) and calculate your “future turns” rate. If your business is either in a growth mode or is in a downturn, the future rate can be an early indicator of adjustments to schedules, purchase commitments, etc. that need to be made right now. It usually takes 3-6 months to change the direction of inventory from growing to shrinking or vice versa.

Purshasing – Partnerships

In recent years, partnership has become a popular phrase to describe the type of relationship that companies have, or want to have, with their suppliers. My position is that not every good supplier is a partner, nor should they be. Partnership to be meaningful has to meet certain criteria.

The basis for partnering or any productive supplier/customer relationship is trust. If trust is not established, purchasing is compelled to look for alternative sources and market test pricing frequently. The supplier will be reluctant to share technology, offer cost savings ideas, etc.

Once trust has been established, what makes the relationship a partnership? I look for the following:

  • Open communication at several levels of the two firms – senior managements, purchasing/sales, product development, planning/scheduling.
  • Shared information on both costs and future plans.
  • Joint projects and shared goals.

Communication in a partnership should emulate internal communication whether that be in meetings, emails, or phone calls. Importantly, the owners or senior managers have to have bought into the relationship so that their support is apparent to all the other parties involved. Purchasing and Sales are usually the groups that manage the partnership and its daily activities. An annual plan and events schedule should be developed and then presented to members of both organizations. Product development, R&D, and/or marketing should come together where the supplier can assist the customer in making its products more attractive and competitive in the marketplace. Increased sales for the customer will generate more business for the suppliers as well.

Information sharing is also critical in a partnership. If the customer has capacity issues, is exploring a new business or product opportunity, etc., these may be areas where the supplier will want to help. Some of the partnerships that I helped to create used joint investments in equipment to produce components that were critical to our business.

Cost sharing can be the most controversial topic in addressing a partnering relationship. Most people have the traditional mind-set that a supplier should not share cost information with a customer. But, since cost has become ever more critical in today’s environment, developing an understanding of total cost for the items that the supplier provides and their impact on the customer end product is an essential part of a partnership. Working together to take cost out of the system should be a continuous effort if the partnership is to succeed.

Finally, it is important that all of the communication and information sharing lead to something specific. Set some joint goals and develop project plans to support these efforts. Senior management’s role is to provide the support and resources within both companies.

Which suppliers should you consider as partners? Logically, the answer is one or more of your key vendors of a critical component, raw material, or service. Select a supplier with whom some level of trust is already established. Your purchasing people should be able to get the process started but do not expect them to build the partnership without the help of the other groups that I mentioned earlier.

Closing Thought

Even with the economy staring to improve, there are still a lot of excellent people looking for an opportunity. As part of my business development, I come in contact with lots of those people, especially in purchasing and inventory areas. If you are looking for someone for your company or know of a situation elsewhere, let me know and maybe together we will help an individual and an organization.

Also, I am on the Advisory Board of the Greater West Town Training Partnership. GWTTP graduates are trained in either shipping and receiving or woodworking. Many are successfully employed in Chicagoland. If you have warehouse or woodworking entry level needs, let me know.

Thanks for taking the time to read this newsletter. Your comments are always welcome, send me an email at herb@hshieldsconsulting.com. Please feel free to forward this newsletter to others in your organization who might have an interest. If you do not wish to receive future letters, please send a reply to that effect. All rights reserved.