Reducing inventory costs

by R.T. “Chris” Christensen

Inventory reduction was probably one of your goals for 2005. Now, having spent months trying to accomplish these goals, you begin to say to yourself, “I can’t do this. I need all of this stuff. There is no way I can lower the amount of inventory I have on hand and still get the job done.” 

But you can. How?

Take a step back and examine these goals. When your goal is to reduce inventory, you don’t need to measure how many parts you have in stock. Your real goal is reducing the amount of money tied up in inventory. If your goal is to reduce inventory by 5 percent, you don’t need to get rid of 5 percent of your parts. You need to reduce the amount of money invested in inventory by 5 percent. It’s a money issue and you have to figure out how to get the money out of your inventory. That’s all it is.

You must figure out how to take money out of inventory and still have the parts available when you need them. To do this, here are three ideas you can work on.

1) OPM
2) Timing
3) Vendor-managed inventory

Other people’s money
Consignment inventory is on-hand inventory owned by the supplier. You keep the stock on your shelf, but don’t pay for it until you need it. This is how large retailers like Wal-Mart do it. Suppliers stock the shelves, at their expense, at the local Wal-Mart store. Wal-Mart pays the supplier after customers like you pay for your purchases. Wal-Mart owns nothing. It pays its suppliers after it has your money. This is the theory of OPM, or Other People’s Money. You do business with the other guy’s money.

Work with your largest suppliers and negotiate a deal where they put their materials on your shelf and you pay for it only after you use it. You work with their money. You will have to pay extra for this service so the supplier can make more money for its efforts, and this is understandable. But because you bear no inventory costs, your overall cost decreases. And because you don’t own it, you have met your inventory reduction goal.

Timing
The second concept is timing. Here, you work with suppliers located close to your place of business. All you do is buy MRO parts when you need them. You don’t stock any inventory, so you have no inventory carrying costs.

In order to make this work, however, you must have two things in place. First, you need a reliable supplier that will have the parts when you need them. Second, you need a quick, cheap way to pay for the parts. This is where a procurement card comes in handy. A procurement card is a company credit card used to purchase goods on an as-needed basis.

The key to all of this is timing. If you can get the parts between the time you identify a need and the time when they’re needed for reassembly, this will work. If the timing works to your advantage, this is another inventory investment cost you can remove with no impact on your parts needs.

Vendor-managed inventory
The third technique is vendor-managed inventory (VMI). Many of you say you do this already. This technique uses a supplier to manage and stock inventory on your shelves. This approach saves you money because it frees you from having to manage inventory. But this is where most of you stop.

You can take VMI to the final step by placing this inventory on consignment, as well. This is where you’ll achieve real savings, since the supplier not only manages the inventory but owns it until you use it. Because it is on consignment, the inventory doesn’t represent money sitting on the shelf. This is another way to reduce your inventory investment and still have the parts when you need them.

R.T. "Chris" Christensen is the director of the University of Wisconsin School of Business' operations management program. If you have a question, contact Coach Christensen by phone at 608-441-7326 or e-mail cchristensen@execed.bus.wisc.edu. 

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