(Part 2)

In Part 1 we identified that what is generally referred to as inventory optimization really doesn’t optimize inventory. Before identifying what does truly optimize we need to first understand the short falls in the process.

In the 1970’s a Harvard Professor named Chris Argyris recognised that in many fields of management we fail to challenge our constraints. Professor Argyris called this Single Loop Learning. The problem with Single Loop Learning is that you can never improve beyond your imposed constraints.

To achieve break through improvements in any field Professor Argyris argues that you need what he calls Double Loop Learning. This also includes the field of inventory reduction.

Double Loop Learning requires that you challenge the constraints and assumptions inherent in your original thinking. (Click here to read our article on Double Loop Learning)

So how does this apply to your inventory reduction program? Well rather than just use mathematical techniques to optimize within your constraints you need to challenge those constraints. This means challenging the assumptions about both supply and demand. Basing your solution on a review that only includes historical data does not do enough to challenge your constraints.

There is also another shortcoming with the so-called optimization approach that even Double Loop Learning doesn’t resolve. Consider for a moment the following statement:

“The outcome that is achieved from any process is a direct result of the policies, procedures, measures and reporting that manage that process”

This is what is known as Systems Thinking.

Peter Senge first described Systems Thinking in his iconic book, The Fifth Discipline (published 1992). In this book Senge describes how any outcome results from the inputs and processes that drive the outcome. In the case of inventory, the existence of excess inventory is the direct result of the policies, procedures, measures and reporting applied to managing that inventory.

The Inventory Cash Release^TM Process

So, if inventory optimization is not the answer, what is?

Well, a process has been developed that addresses all of these issues and enables companies to achieve a lasting and sustainable inventory reduction. This is called the Inventory Cash Release^TM Process and has the following key features:

1. It addresses the need to focus on the few SKUs that will make a real difference

2. It uses all seven of the actions for inventory reduction as a means of applying Double Loop Learning (optimization uses just one)

3. It addresses the systemic issues by reviewing the policies, procedures, measures and reporting that led to the initial over investment

4. It is implementation focused so that your team takes ownership and your systems change.

Let’s address each of these one at a time.

Step 1. Focus On The SKUs That Make A Difference

The aim of all inventory ‘optimization’ is to reduce the investment in inventory. This must be true because if you have had a stock out you will have adjusted your stock holding to make sure that this doesn’t happen again. Therefore, to be effective you need to focus on where the money is.

In my experience it is universally true that the vast majority of the inventory cash investment is tied up in a minority of inventory items (SKUs). This is known as the Pareto Principle. The Pareto Principle is named after an Italian Economist, Vilfredo Pareto, who lived more than a hundred years ago.

In a recent example a company had 80% of the inventory value held in just 12% of the SKUs. Therefore, for this organization, they need only concentrate on 300 out of their 2,500 SKUs if they want to make a difference to their inventory investment. They can ignore the remaining 88% of SKUs because the investment there is minimal. In addition it takes just as much activity to review low value items as it does high value items, so why let the tail wag the dog?

By using this approach companies can take the daunting task of reviewing a large number of items and turn it into a manageable task of reviewing just a few hundred. They can do this with the complete assurance that these few hundred items are where their true inventory reduction opportunity is.

2. Use The ‘7 Actions For Inventory Reduction’

When you free yourself of the constraints of Single Loop Learning you realize that there are many more ‘levers to pull’ for inventory reduction than just recalculating your inventory levels. Fortunately, however, there are only seven ways to reduce inventory so the approach is again quite manageable. The ‘7 Actions for Inventory Reduction’ are:

1. Have someone else hold it and/or pay for it

2. Sell excess and obsolete stock

3. Eliminate duplication

4. Change the factors that drive safety stock

5. Reduce reorder stock

6. More closely match delivery with usage

7. Reduce value of items held

When combined with the use of the Pareto Principle you now have an efficient and effective way to review inventory and make a real difference. This approach maximizes results while minimizing effort.

Now that we have an effective and efficient way of reviewing our inventory, in Part 3 we will address how to ensure that changes are implemented and maintained.

Click here for Part 3

(Click here if you haven't yet read Part 1)

About The Author

Phillip Slater is the author of the book Smart Inventory Solutions and the developer of the Inventory Cash Release^TM System - ICR^®06, a world’s best practice approach to inventory management and reduction. For more information visit his website at http://www.InitiateAction.com.

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