Executive Briefings

Slashing Inventories Can Cost You Money

Easy enough to cut back on inventory when sales are slow. But a knee-jerk reaction to tough economic times can end up costing you more in the long run.

This apparent paradox is cropping up in certain warehouse operations, especially where supply-chain processes are walled off from one another and companies have little sense of their total costs.

Software giant Oracle Corp. has seen the discrepancy occurring within its consumer goods and high-tech customer base. Jennifer Sherman, senior director of logistics product strategy, says the issue arose in "casual conversations" with members of the company's customer advisory board.

"Several members said that [despite] all this talk of a downturn, what they were seeing was increased transactional volume in the warehouse," Sherman says. In other words, less inventory, but a need for more labor to push it out the door.

The explanation is simple. Customers might be buying less product overall, but they're ordering more frequently, and in smaller quantities. And suppliers need more bodies in the warehouses to process that activity. The result is higher costs for order fulfillment.

Consider as well the conservative nature of many retailers during a downturn. They'll assume a continued drop in activity, then be caught by surprise when sales of a given product surge. And who else is surprised by that phenomenon? The supplier, of course. Then everyone has to play catch-up. As Sherman imagines them saying: "Perhaps we were all being a little too pessimistic." Right.

Good suppliers are prepared for an unexpected boost in sales. Either they'll cover it with safety stock, or a supply chain that's agile enough to move product through the pipeline on short notice. But things can get more challenging as retailers grow antsy about committing to large orders, and shorten their planning horizons. For suppliers, the temptation - and the wrong response - is simply to slash inventory and labor.

They can avoid making rash decisions by getting a complete view of their costs and profit margins. Unfortunately, the walls of a warehouse tend to be both literal and metaphorical. What goes on inside a distribution facility is frequently kept separate from other parts of the chain, in terms of information systems, accounting and planning.

Unit cost alone doesn't tell the story. "Standard accounting doesn't give you a picture of the full cost to deliver that product to [the customer's] door," says Sherman. Outsourcing is one major element that doesn't always get factored into warehouse planning. Longer supply chains have a significant impact on the level of product that must be kept close at hand to meet unanticipated demand. Rebates and chargebacks can also affect the total cost of fulfillment, wiping out the savings that were achieved through inventory reduction.

Optimistically, one might chalk up the problem to an improving economy, and the failure of suppliers to react in a timely fashion. "I wonder if this isn't just a function of us operating [at] an inventory level that was appropriate a year ago," muses Sherman. "As things are picking up again, we have to re-rationalize those levels."

Recovery or not, suppliers of consumer goods need to do a better job of assessing their true cost to serve. In an effective supply chain, the human resources function will be integrated with the company's warehouse management system, to achieve an accurate view of labor expense. Or the WMS will contain a detailed labor-costing model. Or the supplier will be running activity-based costing or billing modules. Or the reporting of transactions within the warehouse will be sufficiently granular that the company can view volume trends over long periods of time. There's more than one way to reach the goals of total cost visibility and effective inventory optimization.

Further down the road, Sherman says, new technology promises the ability to incorporate all of those elements into a comprehensive business intelligence application, complete with management dashboard for tracking key metrics.

Business processes need to change along with systems. Sherman says teams made up of representatives from the various organizational silos need to come together on a regular basis, to talk about such issues as global trade, rebates, channel revenue, trade-promotion management and warehouse strategy.

They're only starting to do so. "People still talk about the perfect order," Sherman says. "I haven't seen a good report card for that operation." She's certain of one thing, however: the problem will only get worse as the economy improves.

"There's been a lot of talk about managing through a downturn," she says. "But are we managing the upturn?"

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Easy enough to cut back on inventory when sales are slow. But a knee-jerk reaction to tough economic times can end up costing you more in the long run.

This apparent paradox is cropping up in certain warehouse operations, especially where supply-chain processes are walled off from one another and companies have little sense of their total costs.

Software giant Oracle Corp. has seen the discrepancy occurring within its consumer goods and high-tech customer base. Jennifer Sherman, senior director of logistics product strategy, says the issue arose in "casual conversations" with members of the company's customer advisory board.

"Several members said that [despite] all this talk of a downturn, what they were seeing was increased transactional volume in the warehouse," Sherman says. In other words, less inventory, but a need for more labor to push it out the door.

The explanation is simple. Customers might be buying less product overall, but they're ordering more frequently, and in smaller quantities. And suppliers need more bodies in the warehouses to process that activity. The result is higher costs for order fulfillment.

Consider as well the conservative nature of many retailers during a downturn. They'll assume a continued drop in activity, then be caught by surprise when sales of a given product surge. And who else is surprised by that phenomenon? The supplier, of course. Then everyone has to play catch-up. As Sherman imagines them saying: "Perhaps we were all being a little too pessimistic." Right.

Good suppliers are prepared for an unexpected boost in sales. Either they'll cover it with safety stock, or a supply chain that's agile enough to move product through the pipeline on short notice. But things can get more challenging as retailers grow antsy about committing to large orders, and shorten their planning horizons. For suppliers, the temptation - and the wrong response - is simply to slash inventory and labor.

They can avoid making rash decisions by getting a complete view of their costs and profit margins. Unfortunately, the walls of a warehouse tend to be both literal and metaphorical. What goes on inside a distribution facility is frequently kept separate from other parts of the chain, in terms of information systems, accounting and planning.

Unit cost alone doesn't tell the story. "Standard accounting doesn't give you a picture of the full cost to deliver that product to [the customer's] door," says Sherman. Outsourcing is one major element that doesn't always get factored into warehouse planning. Longer supply chains have a significant impact on the level of product that must be kept close at hand to meet unanticipated demand. Rebates and chargebacks can also affect the total cost of fulfillment, wiping out the savings that were achieved through inventory reduction.

Optimistically, one might chalk up the problem to an improving economy, and the failure of suppliers to react in a timely fashion. "I wonder if this isn't just a function of us operating [at] an inventory level that was appropriate a year ago," muses Sherman. "As things are picking up again, we have to re-rationalize those levels."

Recovery or not, suppliers of consumer goods need to do a better job of assessing their true cost to serve. In an effective supply chain, the human resources function will be integrated with the company's warehouse management system, to achieve an accurate view of labor expense. Or the WMS will contain a detailed labor-costing model. Or the supplier will be running activity-based costing or billing modules. Or the reporting of transactions within the warehouse will be sufficiently granular that the company can view volume trends over long periods of time. There's more than one way to reach the goals of total cost visibility and effective inventory optimization.

Further down the road, Sherman says, new technology promises the ability to incorporate all of those elements into a comprehensive business intelligence application, complete with management dashboard for tracking key metrics.

Business processes need to change along with systems. Sherman says teams made up of representatives from the various organizational silos need to come together on a regular basis, to talk about such issues as global trade, rebates, channel revenue, trade-promotion management and warehouse strategy.

They're only starting to do so. "People still talk about the perfect order," Sherman says. "I haven't seen a good report card for that operation." She's certain of one thing, however: the problem will only get worse as the economy improves.

"There's been a lot of talk about managing through a downturn," she says. "But are we managing the upturn?"

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