A client called a few months ago to tell me his inventory levels had gotten him into trouble with the bank he uses for asset-backed financing. At that time, the purchase-cost of many electrical supplies (particularly copper, steel and petroleum-based items) had gone down, decreasing the average value of his inventory. However, his inventory level and value at actual cost had soared.
This distributor wanted to find out why his expensive, relatively new ERP (enterprise resource planning) system had allowed inventory levels to balloon even though sales had plummeted. And he wanted to know how to use his system to prevent the level of inventory from growing any more. I asked him if he remembered whether or not the company's employees responsible for inventory management and purchasing back in mid- to late-2008 had made any changes in how the system was set up or being used. His response was something like, “Of course not, the system runs by itself.” In “normal” times he would be correct. But in these times, he and every other electrical wholesaler should take the following system-related actions.
When customers vanish
When sizeable customers go out of business, the most sophisticated forecasting formulas available will not avoid purchasing too much. The same can be true when sizeable customers stop buying certain items completely; perhaps large conduit for new construction projects. That's because the historical data used in forecasting incorporates sales that will not soon recur. And if the ex-customers do not all fold in the same month, all formulas will react too slowly to the sales decline.
The best way to address this situation is to enter manual adjustments to the sales data for the items involved. Don't touch the real sales data. This way, if some customers (electrical contractors, perhaps) form new businesses or start buying items they had stopped buying, selected manual adjustments can be undone.
If the ex-customers accounted for a major portion of the sales of the supplies they had been buying and those items were fast movers, they may now be slow movers. So if those products had been manually classified as fast movers for inventory management purposes, they might need to be re-classified as slow movers and the related parameters re-set. The same goes for products that now, relative to all electrical supplies, used to be slow movers, but now are fast ones. If safety stock was kept to provide great service to the ex-customers, re-examine it and any other customer-specific inventory controls. Ditto for customers whose sales have dropped like a bomb.
Sales are way down
Even if none of your customers have gone out of business, when sales drop 20 percent to 30 percent over a short period of time and are not likely to recover in the short term, the computer system should not be allowed to function as usual. If you let your ERP system continue to automatically set inventory levels during these sales declines, then your warehouse inventory will not decrease fast enough to match market conditions. In fact, it may actually grow.
Because a sales decrease usually impacts some items more than others, the historical data used in forecasting should be reviewed for those items for which unit sales have substantially decreased. The manual adjustments mentioned earlier might be needed, as might a re-classification of the method of inventory management. Related parameters might also have to be changed.
Although lead times have always been difficult to estimate accurately, they still need to be reviewed. In the face of declining sales, lead times for some supplies and equipment are actually growing as manufacturers scale back production in the face of declining sales. And even though some manufacturers have decreased their minimums, be careful about buying products you don't yet need in inventory just to meet manufacturers' new minimum order levels.
I have one final comment about manufacturers and inventory. When banks didn't worry about the value of the inventory they were financing, manufacturer's deals involving dating and free goods were sometimes too good to pass up. But after several months of declines in the cost of some products, buying more than you really need can create a problem if a bank refuses to provide the money you have asked for to finance the purchase of this extra inventory — or to finance anything. Let your buyers know that, and give them clear and tight guidelines on how to judge any new deals electrical manufacturers offer.
Sales are up
Good news — some electrical wholesalers have experienced a few months of increases in sales. Bad news — these wholesalers expect a return to prior, lower levels. Worse news — their ERP systems don't “know” the increases are only temporary, and will most likely recommend increasing purchase quantities to accommodate the apparent up-trend in sales. Don't let the system do it. One way to avoid bloated inventory is to enter manual adjustments to the sales data for the items involved in temporary increases. These adjustments make it look like sales did not increase. Another time-consuming method is to have buyers review the data underlying each system-suggested purchase order involving the supplies in question, and override system suggestions when needed. This approach enables buyers to spot purchase quantities that should not be overridden by manual adjustments.
Dick Friedman's firm helps distributors select ERP and WMS systems, and negotiate specific performance contracts. Visit his Web site at www.GenBusCon.com, call him at (847) 256-3260 or e-mail him at dick@GenBusCon.com.