The goal of effective inventory management is to meet or exceed customers' expectations of product availability while maximizing the organization's net profits or minimizing its inventory related costs. One of our primary areas of concentration has been the improvement of future predictions of product sales or usage otherwise known as demand forecasts. In previous advisories we have discussed how to develop demand forecasts and replenishment plans for:

  • Items with sporadic usage
  • Items with recurring usage
  • New inventory items
  • Products maintained specifically for one customer

But the accuracy of any demand forecast is dependent on the “goodness” of your sales or usage history. Does your data truly reflect what would have been sold or used under “normal” circumstances?

A lot of software packages identify possible unusual usage at the end of each week, month or other inventory period. The simplest of these systems compare usage in the month just completed to the total usage recorded over the previous “x” months or inform you if you were out of stock for more than “y” days. More advanced systems bring to the attention of a buyer significant differences between the demand forecast and actual sales or usage recorded during the inventory period just completed. A common trait of both methods is a belief that usage or sales history has been recorded correctly.

But is it safe to make this assumption? As we will see in this article, how usage is actually recorded in your system can have a significant effect on the accuracy of your forecasts.

Usage and Substitutes

Usage should normally be recorded for the product ordered or requested, not the product actually shipped. If you are out of the product your customer orders, you've probably disappointed the customer. If you provide another item in its place, and record usage for the substituted product instead of the product originally requested, you are setting your company up to disappoint the customer again. Unfortunately, most systems record usage based on what was shipped, not what was ordered. If your computer software does not have the capability to properly record usage when a product is substituted, check to see if your sales entry program can be modified to allow the salesperson to hit a function key to specify an alternate product that should receive the usage history for a specific line item.

Record Usage When a Customer Wanted the Product

The following chart records, by week, quantities of a product due to customers, on hand in our warehouse and actually delivered to customers:

Week 1 Week 2 Week 3 Week 4 Week 5
Product due 10 20 15 12 22
On hand 30 20 0 0 51
Product delivered 10 20 0 0 49

Notice that the company was out of stock in the third and fourth weeks. All quantities ordered during this time period were backordered and shipped when stock was replenished in week five. If we record usage when product was shipped, usage history will reflect a “blip” in usage in week five following no usage in weeks three and four. But this is not when customers actually wanted the product. We don't want to replenish inventory to satisfy this pattern of product usage. To avoid repeating stocking mistakes in the future, usage should be recorded when customers wanted a product, not when it was actually delivered. To accomplish this, some systems will record usage at the time of shipment based on the customer's required date or the date you promised to deliver the material. Other systems will record usage at the time of order entry.

Usage and Superseding Products

A superseding product replaces an existing stock item. A useful utility program allows a user to add the usage history of a discontinued item to the usage history of a designated superseding item:

Product Jul Aug Sep Oct Nov
Discontinued — A100 usage 100 20 12 2 0
Superseding — A102 usage 0 84 93 104 110
Total A102 usage 100 104 105 106 110

Notice that the usage of product A100 is added to the Usage of item A102. This allows you to accurately account for both the decreasing usage of A100 and the increasing usage of the superseding item.

Recording Usage in the Proper Location

Imagine a situation where one of your good customers usually obtains material from branch “A” of your company. But today branch “A” has a stockout of a very popular item and you have to supply the customer's needs from branch “B”. Usage for this sale should be recorded in branch “A” because this is the branch you want to resupply to meet the customer's future needs. If you post usage in the shipping location it is unlikely that branch “A” will ever have enough stock of the product to meet this premier customer's needs. To ensure that usage is recorded in the proper location you can make a note of a customer's “home” branch in their customer record. This warehouse will post usage for all shipments to the customer regardless of the location that actually supplies the material.

Recording Usage When Maintaining an Internal Supply Chain

In a multi-branch distributor, often one warehouse will serve as the normal source of supply of certain products for other warehouses. The supplying location is commonly known as a central warehouse or distribution center. A common question faced by inventory planners is: Should transfers to a receiving branch be recorded as usage in the shipping location? This depends on the design of your computer system.

In a “push” replenishment system, transfers from a central warehouse to a receiving branch are included in the central warehouse's usage only if the central warehouse is designated as the normal source of supply for the item in the receiving branch. This allows the central warehouse to replenish its inventory to repeat these transfers in the future. No other transfers are included in any branch's usage history.

If your computer software utilizes “roll up” usage accumulation, no transfers are added to any warehouse's usage history. Before forecasting future demand for products, usage (or the actual demand forecast) in the receiving branch is rolled up into usage of the central warehouse or distribution center. This allows the distribution center to consider the sales or other usage of the product at the designated receiving warehouse(s) when it replenishes its stock.

Regardless of whether your system's design features “push” or “roll up” replenishment, it is critical that you properly identify the primary replenishment source (i.e., a vendor, a central warehouse or distribution center, or an assembly area within your own warehouse) for every product in every branch.

Summary

We have covered a lot of ideas in this article:

  • Usage and substitutes
  • Recording usage when a customer wanted a product
  • Usage and superseding products
  • Recording usage in the proper location
  • Recording usage when maintaining an internal supply chain

Ensuring that usage is properly recorded may seem like an unattainable goal. But it is not. First understand how your computer system deals with each of these situations. Then meet with your software support team to determine how your system can be modified or enhanced to ensure that usage is properly recorded.

There is an old expression, “What we shipped in the past is a good indication of what we will sell in the future.” As we have seen in this article, this attitude can easily result in many stocking problems. In order to help develop the most accurate forecast possible, replace the “old” expression with a commitment to be sure that usage is recorded for the product, in the time period, and in the location to best meet your customers' ongoing needs.

© 2007 Effective Inventory Management, Inc., All rights reserved. Jon Schreibfeder is president of Effective Inventory Management, Inc., a firm dedicated to helping distributors maximize the profitability and productivity of their investment in inventory. Contact Jon at (972) 304-3325 or jons@effectiveinventory.com.