3.3.1 Inventory Management Metrics table

INVENTORY METRICS	CUSTOMER PERSPECTIVE	FORECAST ACCURACY METRICS
Turnover Inventory Turns	In-Stock Percent at Point of Sale	Sales Forecast Accuracy Track actual sales vs. forecasted sales variances Forecasting Utilization of Inventory Assets The higher the inventory turns, the better the firm uses its inventory assets.
Inventory Levels Dollars and/or units at various points in supply chain	Purchase Order Fill Rate Percent Percent Shipped on time Percent Delivered on time	Order Forecast Accuracy
Order Quantity Order Processing/ Setup Cost, Inventory Carrying cost, Back Order Cost, Excess and Obsolete Stock Cost	Reliability Stock out percentage, delays, loss and paperwork involved.	Order Forecast Accuracy
Critical Inventory Average Inventory, EOQ	Stock out percentage, Percentage of orders fulfilled	Maintaining proper Inventory levels Determining method for reordering inventory
Space Utilization & Layout % space utilized (cu.m.)		Forecasting Storage Space and Lead Times involved
Stock to Sales Ratios Weeks/days of supply	Lost Sales Analysis Evaluate actual/potential lost sales due to lack of inventory	Track actual order qty. vs. forecasted order qty. variances at critical times that could influence production Includes   non-compliant orders with frequency and volume as two options
Industry Ratio Comparison with others	Part Count Accuracy Percentage Quality-Percentage Defects Price of Non-Conformance(PONC)	Percent Variability in Lead Time
Engineering Changes per Month	Communication Effectiveness Measure collaborative cycle time/issue resolution time	Customer Satisfaction
Markdown Dollars/ Liquidation Loss	Cycle Time May include series of time segments measured for specific aspects of the process from raw materials to merchandise delivered to POS (e.g., manufacturing time cycles, order time cycles, packing time cycle, shipping time cycle, etc.)	Frequency of Emergency or Cancelled orders Track- quantity, cause, actions taken to limit reoccurrence
	Communication Effectiveness Measure collaborative cycle time/issue resolution time	Issue Resolution Time Accuracy Customer Satisfaction

3.3.2 Metrics and Benchmarking for Inventory Management

The metrics for inventory management are given in the above table. The corresponding metrics from the customer perspective are also listed and the forecast accuracy metrics are derived accordingly. Thus, the above table gives an overview of the inventory management metrics from various perspectives.

The various metrics and terms used are defined briefly in the subsequent sections. Though some definitions are pretty basic, they help explain the various terms used in defining the metrics.

Inventory Turnover

On the cost side, the first measure, inventory turnover, is the ratio of the cost of annual sales to the average inventory level. The higher the inventory turns, the better the firm uses its inventory assets.  Another common measure is days of supply.  A firm's days of supply is found by dividing the average inventory level by the cost of one day's sales.

As an example of these measures, assume a firm has an annual cost of sales of $180 million and an average inventory level for the year of $20 million, then

Example:

Inventory Turns = Cost of Sales / Average Inventory Level = $180 / $20 = 9 turns

The cost of sales for a day is $180 million / 360 days = $0.5 million

Days of Supply = Average Inventory / Cost of a Day's Sales = $20/ $0.5 = 40 days supply

Inventory Levels

There are three basic types of Inventory: Raw Material, Work in Progress, and Finished Goods.

Raw Material

This includes all the purchased parts and direct materials that go into the end product. This type of material has value added to it as it flows together as subassemblies, assemblies and finally into the shippable product.

Work-in-Process

This is the inventory in the process of being assembled into final products.

Finished goods

These are ready inventories ready to be delivered to distribution centers, retailers, wholesalers or directly to the customers

The levels of inventory depend on the following:

1.Production Rate: The production rate can be defined as number of units manufactured over a period of time.

Production Rate = No. of Units Manufactured/ week.

The production rate is also influenced by the demand for the product. Which could be either periodic (seasonal/ cyclic) or a constant.

2. Lead-time: Lead-time is defined as time period from initiating of an activity to its completion. For inventory management we need following lead times: Purchase lead-time, Manufacturing lead-time, Delivery lead-time.

3. Rework/ Scrap Rate: This rate is dictated by the efficiency of the manufacturing process. It involves knowing the number of defective units that are produced by a manufacturing unit. This is highly an empirical rate and very much depends upon the skill of the labor operating the machine and the accuracy offered by the machine.

The Benchmarking for the above three metrics depends on the type of system.

Item Fill Rate

The item fill rate is the ratio of the total number of items shipped divided by the total number of items ordered.   The line item fill rate measures the percentage of line items on the order shipped in their entirety. Finally, the order fill rate is a measure of the percentage of orders shipped completely.

Benchmarking Values:

To illustrate these fill rate measures, consider the order in the exhibit.  First, there are a total of 5036 items on this order.  Since 4817 of the items were shipped, the item fill rate is

Item Fill Rate = 4817/5036 = 95.6 %

A more strict measure is the line item fill rate.  There are 10 lines of items ordered, and of these 10 line items, only 5 of them were filled in their entirety, thus the line item fill rate is Line Item Fill Rate = 5/10 = 50%

Finally, the order fill rate is the percentage of orders filled completely.  Clearly, this order counts in the unfilled category. This measure is probably the strictest of the three measures of customer service fill rates discussed above

On-Time Delivery Percentage:

Can be analyzed over a year. Higher the value, the better the situation. Generally has a value between 96-100% as a benchmark.

Order-Entry Lead Time:

Measures the time taken to take customer order. After the implementation of the online ordering systems, the benchmark could be set to be lesser than a day.

Order-Entry Accuracy:

Measures the accuracy with which a customer order is interpreted and maintained in a database. Generally associated with human errors. The benchmark is set at about

0.1%.

Percent Variability in Lead Time:

Measures the level adjustment of the SKU to variation in pattern and quantity of demand.

Represented as a percentage. A value of 1-2% is set as a benchmark.

Order Quantity

In the manufacturing turf, material gobbles up between 60 - 85% of the revenue from sales, depending upon the industry. In the electronics sector, it would is about 85%, with overheads of about 12%, and direct labor of around 3%. All these figures point in the direction of Inventory. Inventory is by far the single greatest cost that needs to be examined. A cursory study reveals the main factors that contribute to these huge figures.

The Order Processing/Set-Up Cost:

Many people are oblivious of the real cost of placing and processing a purchase order. The total cost includes the cost of purchasing, receiving, incoming inspection and the accounts payable. Each of these departments exists to satisfy continuous demand for material. We arrive at a simple equation to calculate the Avg. cost per order as

Avg. Cost per Order = Total Budget / Number of Orders placed per year

For manufactured items the equivalent cost is known as Set-Up. This includes all the costs that are not related to the order quantity (The costs incurred to prepare the order paperwork, processing and tracking the order operations, the cost of setting up the machine, and first off inspection). This total ordering/processing cost is eventually passed on to the products.

Values for the benchmarking depends on the type of system.

Inventory Carrying Cost

The very fact that an item is held in stock accrues cost. These are the real costs, the stark reality that has to be dealt with. Several elements make up this cost. Some of them have been discussed below.

Cost of capital

This is charged at the "Lost opportunity cost" and not the interest rate. Typically rated at 25%, this "Lost opportunity cost" is the return that could have been obtained if the capital had been invested in anything other than inventory.

Insurance

Insurance accounts for a portion of the inventory costs. Since it is better to be safe than sorry, companies generally get the material insured. It generally works out to 1%.

Pilferage and spoilage

This accounts for anything from 2% upwards, depending on the industry and the type of inventory that is being carried.

Obsolescence and Deterioration

This is inventory which is classified as being unfit to sell, or lying in the storage waiting for the appropriate use. It is typically estimated to be about 1% of the Inventory carrying cost.

Storage and Handling

This includes the total warehousing facility. This is typically 6%. The total cost to the company is 35% per annum of the value of inventory held, or 3% a month.

Stock-out/Back Order Cost

No manufacturing facility can afford to keep sufficient stock to meet every demand. Stock-outs occur at some point. Stock-outs result in either a lost sale, or if the customer is prepared to wait, a back order. Lost sale result in the losing the business to competition. In addition, back orders cause additional costs, viz. extra paperwork, the time spent handling this extra paperwork, a system to handle the back orders, extra delivery notes, and invoices, extra packing and delivery costs.

Excess and Obsolete Stock

Excess inventory is the quantity of material in stock or on order that is greater than the anticipated demand for an agreed time period. Obsolete inventory on the other hand is the inventory that results from an unanticipated demand. This inventory typically occurs due to model run outs, engineering change notes, or supplier’s minimum/multiple order quantities. Companies tend to be reluctant to write off this value as it is a loss in the books of accounting, and so affects the profit.

Critical Inventory

Critical inventory is the minimum level of inventory that must be on hand. Before reordering.

There are a number of factors, which go into determining the value of the critical inventory. Some of them are discussed below.

Average Inventory

Average inventory is defined as half the batch size plus safety stock. Safety stock is determined from such factors as customer service level required, demand variability and replenishment lead-time. Once the customer service level required is agreed upon, safety stock is calculated.

Average inventory = (Order quantity + Safety stock)/2

The assumption made is that at any point in time, the cycle stock (stock planned to be used excluding safety stock) is on an average half the recipient quantity i.e. it is half way in between the receipt quantity and zero left. The practical implication of this is that it reduces order quantity and the average cycle stock by half. If a part is manufactured in smaller batches the inventory goes down.

Economic Order Quantity

In fixed order quantity systems, it is defined as the size of an order that minimizes the total inventory cost, under a given set of circumstances, obtained by trade off analysis between the cost of placing an order and the cost of holding stock

EOQ= sqrt [(2*U*S)/(I*C)]

Where

U= annual usage

S= ordering or set-up cost

I= inventory holding cost

C= unit cost

Stock-outs

No manufacturing facility can afford to keep sufficient stock to meet every demand. Inability to meet a demand due to lack of inventory is called Stock-out.

Unit of measurement : Stock out percentage

It is calculated as the number of orders, which were not able to be satisfied to the total number of orders.

Methods for Reordering Inventory

There are several methods for reordering inventory. Typically they are:

Fixed Order Quantity

Lot for Lot or Discrete Ordering

Period Order Quantity

Periodic Ordering

Least Total Cost

Part Period Balancing

Space Utilization

Costs associated with Warehouse space utilization are regarded by accounting departments as fixed costs, it is often overlooked however, that it can be an area of tremendous savings if used efficiently. Warehouse space should be thought of as a variable as in labor, supplies, and utilities, with the same implication that something can and should be done to control it. Warehouse space utilization has become increasingly important in today’s world of reduced cost and maximized assets. The total cost of a warehouse worker with fringe benefits is about the equivalent of the cost of leasing 10,000 square feet of space. Of courses this varies, but it does highlight the importance of space.

Optimize Storage for Efficiency

Throw out the junk

Move excess and out-of-season product to other storage areas.

Clean up your returned goods area

Every space consuming activity that does not directly interface with current picking operations is a candidate for relocation off-site.

Reduce number of SKUs

Eliminate at least one old item for every two new items brought into inventory.

Just in Time

Don’t bring the product in at all

Warehouse Space Optimization

To store more products in a given space you must make better use of the total available cube.

Overhead Space

Reduce Aisle Sizes

Deep Pallet Storage

Stack Pallets on top of each other

Store high cube/ high movement product in one reserved area of the warehouse

Unit of measurement: Space ratio

The space ratio is applied to storage and warehousing operations. A space ratio of 60% in a warehouse would represent a favorable figure.

Stock to Sales Ratio

The stock to sales ratio can be used to compare actual orders and forecasted orders. This can help keeping track of stock-outs, losses due to stock outs and any flaws in the existing forecasting system.

The unit of measurement will be Days of supply

Days of Supply = Average Inventory / Cost of a Day's Sales

Performance Measurement

What was the forecasted order quantity?

What is the actual order quantity?

What is the variance of actual order quantity versus forecasted order quantity?

What is the percentage of non-complaint orders?

What is the frequency of stock-outs?

What is the deviation of the actual order quantity from the forecasted order quantity?

What is the actual/potential lost sales due to lack of inventory?

Markdown Dollars

A markdown is a devaluation of a product. It is an attempt to sell it at a lower price that originally planned because we bought too many or it is the wrong size, style, specification, etc.

In other words, a markdown is simply a reduction in the price of an article; a discount. Stores markdown, or discount, their inventory for a variety of reasons. A few of these reasons are sales, promotions, clearance sales, meeting competitor’s prices, and selling off discontinues items.

Markdown = Price To Be Reduced-Reduced Price

Unlike markup, the markdown is always given as a percent of the price to be reduced. Even if it is not stated, it is understood.

3.3.3 Benchmarking

Some general industrial benchmarks are shown and suggested in the following paragraphs.

Industry Ratio:

It involves an objective measure of our own SKU with respect to other competitive SKU’s where general performance criterions are measured. Defined as the ratio of our own performance metric with respect to the industry average.

Generally represented as a percentage.

Example:

Lead time plays an important role in the management of inventory .It involves the

time between placing an order and the point at which it is actually delivered.

An industry ratio for that would be

(Lead-time for our SKU)* 100

Average Lead-time for other SKU

A value of 70% or lesser could be set as a benchmark.

Range in the number of orders issued per day-

Acts as a measure for the variability that might exist in the system. Helps in the analysis of the demand characteristics. Frequency of emergency or canceled orders could also be taken into account.

Engineering Changes per Month: Product Complexity

Measures the number of changes that is happening per month on a particular product. This change is very important when we consider that the design of the product actually influences the type we they are handled in an inventory managing SKU. The changes should be as low as possible. Generally a benchmark of 2 changes per month is set.

Part Count Accuracy Percentage:

Measures the accuracy with which the suppliers deliver the parts. Measures accuracy in terms of quantity. Benchmark is set at 100%.

Quality-Percentage Defects:

Percentage of defective products delivered. Benchmark set at 99% but depends on the quality level that has been set.

Price of Non-Conformance (PONC): The price paid by the system for delivering faulty goods. The Ratio is:

(PONC Expense)*100

Inventory Spending

A generally accepted formula is:

Target PONC improvement=Previous PONC%-(0.3)*(Previous PONC)

Percentage of Time on Preventive Maintenance:

Measures how well the system is maintained. Generally a 15% allocation is set as a benchmark.

Forecast Accuracy:

Measures the accuracy of the forecasting process. Generally taken as the difference between the actual and the predicted forecasts and it should be as low as possible for an efficient forecasting process.