Inventory, accuracy, and corporate performance

Inventory accuracy has been a holy grail for generations. So why is it that we have yet to master it?

By Art van Bodegraven

When it comes to methods of analyzing an organization's financial performance, there are several options. One is the venerable DuPont Model, which though it dates back to the early 20th century, is still reflective of reality as well as simple to construct and easy to visualize. At the end of the day, it can display corporate return on assets (ROA) and/or return on equity, which 1) satisfies shareholders and senior executives, and 2) tells the story behind how well—or not—assets are being leveraged and what the impact of debt is onreal financial contribution.

Inventory, whether accurate or not, plays a role in several inputs to the DuPont Model. Total inventories constitute assets, with obvious ROA ramifications. Therefore, reductions to inventory levels are not simply cost-shaving moves, but also potential move-the-needle boosts to enterprise performance. The other consequences are not necessarily trivial, but they're still small potatoes in the bigger picture, affecting capital outlays and their timing, people costs to plan and manage, and the ratio of value-adding and non-value-adding activities.

WHAT AND WHERE ARE INVENTORIES?

The issue of "right" inventory levels is a question for another day, and if all business concerns could be erased by reducing inventories, life could be simple. But there are risks and consequences to be weighed, and the wiggle room we might have enjoyed a decade ago is intolerable today—and growing more so.

So, we'll concentrate on inventories and their accuracy for the moment. At a macro level, inventory rests at many stages, with varying degrees of exposure to inaccuracy and heartburn for managers. Try these as a starting point:

• On order: Delivery specified, but subject to weather, port congestion, labor action, transport availability, and **ital{force majeure; accuracy specified, but unknown until confirmation upon receipt
• In transit: Delivery estimated, subject to the above uncertainties; accuracy stated, but unknown in fact
• Arrived: Delivery confirmed; absolute accuracy unknown until entered in systems
• In stock: Accuracy confirmed or corrected upon physical putaway and entry into systems upon "official" receipt; subject to error with succeeding picks, returns, etc. Complicated by the possibility of residence in multiple facilities and/or multiple locations within a facility
• Returns to DCs: Accuracy confirmed upon receipt. Subject to deterioration during subsequent activities
• Store stocks: Dependent on quality of processes and systems for receipt, sale, return at store levels
• In transit returns from stores: Dependent on quality of processes and systems at store and DC levels
• Consigned inventories in: Accuracy dependent on processes, discipline, systems at resident location(s)—DCs, stores, suppliers
• Consigned inventories out: Accuracy dependent on processes, discipline, systems at resident locations—customer DCs, customer stores, our DCs, our suppliers.

Perhaps there are more to consider, but these should offer some insight into how difficult it is to establish and maintain total inventory visibility and accuracy.

RECEIVED WISDOM

Inventory accuracy has been a holy grail for generations. Academics, consultants, and practitioners have both preached and practiced cycle counting as a cure. In the abstract, cycle counting is compelling; in limited and contained applications, it has been—and continues to be—marvelously effective in maintaining accuracy at the stock-keeping unit (SKU)/location level in facilities in relatively real-enough time. In short, rigorous attention to process and detail can apparently work.

The general cycle counting approach is to physically segment a facility and cycle count/adjust inventory by location on some schedule that makes corrections relatively inconsequential. Furthermore, when an order picker finds an empty location while filling orders, the discrepancy is immediately corrected. In aggressive and progressive organizations, SWAT teams are assigned to identify and correct process weaknesses that result in identified cycle count adjustments. Practitioners include leading lights in the fast-moving consumer goods (FMCG) and retailing sectors as well as smaller players in many industry verticals.

To the dismay of some public accountants, strong cycle count programs in DCs have eliminated the hallowed physical inventory exercise as part of the annual audit process. But we are still at a point of not comprehending all inventories as part of our planning for effective asset investment, for dynamite supply chain partnering, and for accuracy in support of our performance objectives.

SO WHAT DIFFERENCE DOES THIS MAKE?

If the big pieces of inventory, whether or not accurate, are the day-shift drivers of performance, of asset investment, and possibly of outsourcing decisions, why are we concerned about nickel-and-dime accuracy issues? Here's what's at stake, and it just might have a bearing on the story DuPont has to tell over the long haul.

Start with how actuals short of what the systems tell us devalue and erode the quality of desirable sales volumes. If we cannot always—100 percent of the time—satisfy a customer order, our odds of retaining the customer, let alone growing business with him or her, plummet. And forget about testimonials and referrals. Don't forget that there is no bottom line without a top line. This is true in both the business-to-business (B2B) and business-to-consumer (B2C) worlds. Sales folks don't always appreciate profit when they are compensated on the gross, but this is one time we must listen to them.

Continue with operating costs and the effectiveness of staff—pick/pack/ship personnel, planners, analysts, trainers, supervisors, customer service reps, process designers, and others. In our never-ending quest to do more with less, those who have not mastered the inventory visibility and accuracy challenges will be spending precious resources on things that should never have happened in the first place.

Leaders will be spending their human capital on making customers, suppliers, and shareholders ecstatic. Guess who wins that race? Look, all the gee-whiz technology in the universe will not overcome inattention to the basics. Mastering the people, process, and technology components of the equation will beat every time working like a dog on the wrong things.

Add to that the explosion of mobile technology in the hands of both business customers and consumers. And then there's the scramble to be omnichannel (or multichannel, at least), with systems, asset, people, visibility, and transparency challenges, and accuracy at an exquisite level of detail rises, like cream on old-fashioned milk, to the top (or top of mind) for many. What to do? How to size and quantify, and prioritize the issue(s)? Which path to follow to deal with the inventory and accuracy questions and impacts?

AN INDUSTRY SOLUTION?

The question has picked up some steam as time has passed. Early radio-frequency identification (RFID) pilots uncovered participant inventory inaccuracies that had not been previously suspected, and the condition, with a few startling SKU-level examples, was found to exist in companies both large and small.

Forward thinker and legend of the profession Joe Andraski, who heads up the consultancy Collaborative Energizer, has proposed the creation of a volunteer industry group to tackle the key issues involved. The group's overall process is intended to identify and evaluate the prospective (and real) consequences of inventory inaccuracy and uncertainty. (Joe has provided some of the observations noted above.) The always rock-solid Dr. Lloyd Rinehart of the University of Tennessee is working with Joe to launch the initiative.

From that beginning, they expect to be able to construct corrective programs that focus on key opportunities. Further, the hope is to at last have a handle on the consequences of inventory mysteries on P&L and balance-sheet items that flow into DuPont Model outcomes, as well as on supply chain management functions such as forecasting, customer service, inventory investment and management, customer relationships, S&OP (sales and operations planning), and staffing.

We all, though, face the reality that inventory is not an object to be measured and managed in a vacuum. It is not a thing, but rather a collection of outcomes, from decisions made well, or not so well; of processes that are well structured, or less so. The decisions and processes, for leaders, must be flexible to turn on a dime when market conditions and/or customer imperatives demand more, and more forward, inventory locations, or fewer and farther-distant stocks to leverage changes in transport costs and customer cost sensitivity. Those, in this century, are non-negotiable in the success equation and have as much or more effect on inventory investment (and opportunities for inaccuracy) than transient corrective programs.

Ultimately, organizations choosing to pursue appropriate targeted activities will need to come to grips with designing and managing changes in the organization, roles, processes, and technology. The volunteer group will contain embedded resources who can structure and lead sustainable change management programs in aid of improving enterprise performance through improved inventory performance.

Given the approach and expecting quality resources from industry, it seems likely that the prospective effort will generate a return on investment (ROI) in its own right as it finds ways to bring inventory understanding and greater certainty into the 21st century.