Inventory, Customer Service, and Demand: How Do They Interact With Each Other?

Many people assert that the primary focal point of what could be determined as the successful supply chain is the inventory management and, to some extent, inventory control. This premise leads to further questions: how do food business and companies manage their inventories? What are the main factors that seem to drive inventory costs? When seems to be a good idea to keep much larger inventories?

Back in the early 90s, some food manufacturers came up with the efficient consumer response in hopes of making the shift from merely controlling logistical costs too deeply examining supply chains. Customer service, unlike in the previous decades, became a crucial competitive differentiation point for companies whose primary focus was somewhat related to value creation for consumers. Under such circumstances, firms hold inventory for two main purposes: to reduce costs and to improve customer service. Nonetheless, the motivation for each seems to depend on whether firms choose to have too much stock (thusly leading to much higher costs) versus having too little inventory (thusly falling victim of lost sales).

A rather common perception and experience is that well-executed supply chain management can lead to effective cost savings, mostly through reductions in stock. Inventory costs have been increasingly falling by about 65% since the early 80s, while transportation costs have fallen by almost 22%. Such juncture has led many businesses to pursue inventory-reduction approaches and strategies in the supply chain. In order to develop an effective logistical strategy, a business must understand the nature of a product demand, inventory costs and, also, supply chain capabilities. As David Kiger previously asserted in a previous article, companies have different ways of monitoring and managing inventory.

Most retailers prefer an inventory approach that allows them to monitor stock levels by item. Manufacturers, on the other hand, are traditionally more concerned with production scheduling and use flow management to monitor and manage inventories; and sometimes some companies prefer not to actively manage stock—this does not mean that they just overlook inventory—. Instead, they hold large inventories simply because any possible potential savings from stock reductions are completely outweighed by the stock-induced reduction in production, procurement and transportation costs.

Often economies of size may cause long production runs, which inexorably lead to stock build-up. Simultaneously, seasonality leads to inventory accumulation of certain materials as well as outputs. Economies in procurement—such as forward buying in the food industry—increase inventory, and other forms of bulk shipping discounts also cause stock accumulation.

Why demand is so important?

Inventory management and monitoring is heavily influenced by the intrinsic nature of demand, including whether demand is either derived or just independent. A derived demand is the result of the production of another good. For instance, when a producer knows its demand for whatever they are selling, they can simply compute the demands for the parts and components needed to produce that specific good. Manufacturers, irrespective of their size and experience, use the aforementioned calculations which are part of flow management to monitor inventories, schedule deliveries and have a general overview of capacity. Flow management technologies have evolved from the traditional Materials Resource Planning too much more complex ERPs, which are fueled and set in motion by the demand for end-consumer products and goods.

 

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Image courtesy of Palo Cech at Pexels.com

Independent demand comes from demand for an end product. End-consumer products can be found across the supply chain. Wheat, for instance, is an end product for a grain elevator, as is cereal for a grocer or flour for a baker. By definition, an independent demand is systematically uncertain: this means that extra units or safety stock must be ensured to avoid falling victim of possible stockouts. Being able to manage this uncertainty is the key to effectively reducing inventory levels while meeting production requirements and customer expectations. Supply chain coordination can certainly decrease the level of uncertainty of intermediate product demand, thusly reducing the costs commonly associated with existent stock levels.

Inventory and Customer Service

It is obvious that there is an intrinsic relationship between customer service and inventory: the availability of the latter provides customer service. The IFR (Item Fill Rate) is responsible for measuring how often a particular good is available (or, rather, predicts how often a SKU is available). This metric is expressed as the percentage of time that end consumers can obtain the goods they seek. A company may set its customer service order policy at 90%, thusly seeking to fulfill 90% of the orders for a particular item from their stock.

Closing Thought

However, in reality, things can get a bit more complex. A customer might not obtain the product they seek for several causes: the seller may have run out of a product due to inaccuracies in the forecast, or the supplier may have shipped other package size or flavor; or maybe the goods are damaged; or, finally, the seller may not have the capability to actively and accurately track stock in the distribution facilities, hence the importance of “safety stock”.

* Featured Image courtesy of freestocks.org at Pexels.com

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