Inventory Management Techniques and Concepts

Inventory management is an essential part of every business that sells a physical product. If a business runs out of inventory, they lose their ability to make money. But, the other side is having too much inventory that could potentially never be purchased, and increase storage costs. A product design can change and the business could be left with a bunch of outdated, worthless inventory.

Properly managing inventory helps balance the scale of having enough inventory to send to customers, and not having too much stock. In 2021, we’ve seen how a disruption in the supply chain can cause significant problems, and increased prices for consumers.

In this post, we’ll explain the different techniques and concepts that manufacturers and businesses use to manage their inventory.

What is inventory management?

Inventory management is a system that tracks inventory—raw materials, unfinished goods, and finished goods—from start to finish. An inventory management software can track everything from material purchases and inventory costs to the sale of finished products to ensure a business has everything they need to function.

The goal of inventory management is to increase the efficiency of a business. A company becomes more profitable and reduces waste when they know exactly what to order, when to order it, and how much to order. Of course, there isn’t a flawless system, but businesses can take steps to improve supply chain processes and reduce wasted resources.

Why is inventory management important?

Proper inventory management is essential for the longevity of every product-based business. Running out or running too low on inventory can cause a business to lose money and put extra strain on customer relationships. If a business’s inventory doesn’t match the current customer demands, you can expect lots of issues.

Inventory control and management doesn’t solely apply to companies that sell physical products. Even service-based businesses need to have the right resources on-hand to provide their services.

Proper inventory management is necessary if you want to scale a business and reach sustainable long term growth.

Types of inventory

The types of inventory depends on the business. At Spex, we manage raw materials, work-in-progress, components, and finished goods.

Raw materials are unfinished goods that are used to create a product.

Work-in-progress is a semi-finished product that’s in-between raw material and a finished good.

Components or parts are similar to works-in-progress. They’ve been worked on at one manufacturer, but are sent somewhere else to be assembled or worked on more before reaching the end consumer.

Finished goods are products that are ready for the end consumer to purchase and utilize.

How does inventory management work?

Inventory management ranges from very simple routines, to very complex systems. This depends on the nature of the business and their customers. If a business has 2 products and they sell 50 Product A’s and 100 Product B’s every month, they know how much of each they need to order to fulfill orders and avoid storing too much inventory.

A larger business like a Walmart has thousands of products that are all bought at different quantities every day. And some of the products like produce and meats are only good for a few weeks, so they need a robust inventory management system.

Small businesses might count inventory by hand, but that’s also time-consuming and can lead to human errors. Inventory management for larger businesses typically uses a database system that tracks sales, orders, stock on hand, and future sales projections. You can see in real-time how much of everything you have on hand within a few minutes. The system will alert the right team members when inventory drops below a certain threshold, or automatically order more raw materials or products.

3 common inventory management techniques

In the manufacturing industry, make-to-order and make-to-stock are two inventory processes most commonly used in manufacturing facilities.

Just in time inventory involves holding as little inventory as possible. This process reduces the costs of storing inventory and materials. This increases lead time and manufacturing costs, but it also allows for customization and avoids dead stock.

Make to order is an inventory technique where the customer places a bulk order. They might order enough products for a month. Once the order is placed, the manufacturer makes the product and ships it. This gives the business some extra stock compared to JIT, but the orders are based on actual customer needs.

Make to stock is an inventory management process that keeps extra stock on-hand. This allows manufacturers to have enough stock to fulfill orders faster and more efficiently. The manufacturer might have 6 months worth of safety stock that’s ready to ship to the customer. This significantly reduces lead times and helps avoid supply chain issues. Make to stock is based on estimates of customer needs, or demand forecasting, so it can increase some storage costs.

Learn more about Make to Order vs Make to Stock

Common inventory management challenges

Depending on the size and nature of the business, managing inventory can be quite challenging. As we’ve seen in the past few years, business circumstances all around the world can change dramatically within a few days or weeks. Inventory management needs to have systems and structure, while remaining fluid enough to implement changes.

Here are a few common problems and solutions:

Inaccurate numbers

Having inaccurate inventory counts can cause a lot of issues. If a car manufacturer thinks they have 4,000 steering columns on-hand and they actually only have 400, they can quickly run into production issues. You might think this is obvious and easily avoidable, but when a warehouse has thousands of different parts and isn’t organized well, inaccurate inventory becomes a common problem.

Changing customer needs

It’s almost impossible to predict customer needs 100% of the time. Even if a customer has consistently placed the same order for years, it can change overnight. Modern inventory management systems will help you track customer trends and provide greater insight into their needs.

Poor processes

Inventory management shouldn’t be left to guesswork. It takes time and effort to build proper processes, but it’s well worth the investment. Poor inventory management processes could be outdated or not understood by the team. It’s important for the processes to grow and evolve with the business. Using the same processes as 20 years ago isn’t going to fuel business growth.

How to improve your inventory management

Improving your inventory management has two primary benefits:

1. Reducing unnecessary storage costs.
2. Increasing customer satisfaction.

When you don’t have too much inventory, you won’t be paying for the extra storage, and when you always have enough stock to fulfill orders quickly, customer satisfaction increases.

Here are three ways you can improve your inventory management:

Understand your needs

Every business has unique inventory needs. Taking time to understand what inventory is the most important, your customer’s needs, and looking at historical trends helps you manage inventory effectively.

Build relationships with suppliers

Having a good relationship with your suppliers is essential. These relationships help get the inventory you need, when you need it. Long-term supplier relationships help you set realistic expectations and unlock the best possible prices. Spex helps customers reduce the number of vendors and suppliers in their supply chain, saving time and money.

Use real-time data

Having the most up-to-date numbers helps businesses make data-based inventory decisions. If inventory is updated on Monday, then a customer places a big order on Tuesday, you need to have updated numbers as quickly as possible. A system that shows you real-time inventory data can make a real difference in your business.

Inventory Management Metrics and KPIs

Measuring the effectiveness of inventory management is essential for organizations looking to optimize their supply chain operations and reduce costs. Various metrics and key performance indicators should be used to assess the performance of inventory management processes and identify areas for improvement.

Some common inventory management metrics and KPIs include:

1. Inventory Turnover Ratio: This metric measures how frequently a business sells and replaces its inventory during a specific period. A higher inventory turnover ratio indicates efficient inventory management and strong sales performance.
2. Days Sales of Inventory (DSI): DSI calculates the average number of days it takes for a company to sell its entire inventory. Lower DSI values indicate that the business is effectively managing its inventory and quickly converting stock into sales.
3. Stockout Rate: The stockout rate measures the frequency of stockout situations, where a business runs out of a specific item. A lower stockout rate suggests better inventory management and fewer lost sales due to unavailability.
4. Carrying Costs: Carrying costs represent the expenses associated with holding and maintaining inventory, such as storage, insurance, and obsolescence costs. Reducing inventory carrying costs without compromising customer service levels can lead to improved profitability and more efficient inventory management.

By tracking and analyzing these metrics and KPIs, organizations can gain valuable insights into their inventory management performance and implement data-driven strategies to improve their inventory management processes.