Stock administration and strategies - An overview

A common doubt that always unites and may even cause conflict among product managers, logistics administrators and marketing analysts is the stock strategy for a product: Should we have it in stock? How much should we keep? When and how often do we request more? It is a tricky question and we intend to give you and overview of it in this post.

Why do we stock products?

When selling products or providing services that need to use some product, demand and supply are not 100% predictable and also there are lead times with uncertainties. If lead time was totally reliable and demand and production could be perfectly predictable, there would be no reason to ever exist stock. Why would you consider having the company's money stuck over stocked products?

Imagine we're in a hypothetical world, and we have a product demand that is constant and we know for a fact it will be constant for a long time. Also, imagine your production (or supplier) is very reliable and you can have as much product as you want, at the moment you ask for it. In that scenario all you would have to do is set your production (or your purchase orders) to the exact same quantity as the demand and voila, you would fulfill 100% of your demand with zero stock levels! Success!

Unfortunately, that is not how the real world works. Demands vary a lot, production lines have break downs, or unreliabilities, suppliers fail and lead times sometimes are long and unreliable.

Look at the chart below. It is an example, from a food company in Brazil that worked with JM in the past, of how the demand varies weekly for pasta products in a full calendar year:

Weekly demand chart for a full year

As you can see in the chart demand varies a lot week after week. No production line, either from you or your supplier, would have such great flexibility to produce from slightly over a thousand ton in week 16 to almost 5.5 thousand tons in the next week 17.

Also this company supplies pasta for the entire Brazil market out of three factories with lead times to clients that can vary from a few hours to more than 20 days!

Therefore, companies need to stock products to prevent from demand and supply variations and lead times in order to avoid losing sales.

The term that better describes how much of the demand a company is fulfilling is service level. It is very easy to calculate, it is just the customer orders the company fulfilled divided by the total of customers orders it received.

Why not stock as much as possible and go full service level?

One might say, why not just have your supplier deliver you a great load of product and your production line go full power and a produce a huge stock quantity, so that demand can vary as much as they want, it would never be unattended and service levels would be up near 100%?

The answer is as simples as: because money costs over time! When you purchase products from a supplier, you converted the company's money into products in your stock, when the production lines work, labor and raw material are put in that product in your stock, that is also money there. Until that product is sold, that money is stuck in the shape of a product.

That money that you converted into stock could be used to pay employees and other monthly costs, invested in marketing campaigns, or even in producing or purchasing other products. A company may even be forced to get loans to pay bills, invest or even go bankrupt with a huge inventory that it over dimensioned.

Stocks need to be very carefully dimensioned!

How to handle that? How to settle on a proper stock strategy?

As stock levels cannot be through the roof, but you don't want to miss sales because you ran out of product for sale. So how to handle the situation?

Luckly the world has been studying the issue for a long time. Many many techniques have been created and tested over time. There are multiple strategies for different kind of industries, products, shelf life, demand and geographic scattering. Of course, JM team is on top of this!

First thing, we must understand what stocks are composed by. Even though it sums up to one thing,  it has multiple parts and it is important to know and understand each one of them. In JM we use the most classic names for it as shown in the diagram bellow.

Traditional name for final product stock level composition

Even though this might sound boring, knowing what is really in your stock and naming it, helps a lot when planning it! There sure are other names to it and even other parts of a stock, but here we are in an overview post, and these are the main names.

The professionals in JM have already been through many projects in which these strategies were applied and put to test. We are very confident to present here some of our favorites when approaching a stock strategy problem. Bellow we are listing some of our favorite techniques with a brief description of them. We plan to offer you more details on the basics over each technique in future posts, so stay tuned to our blog:

• MTO/PTO x MTS/PTS Classification: Products can be kept in stock or only produced or purchased after a firm customer order is received. When it is a produced product, it can classified as Make To Order (MTO) or Make To Stock (MTS). When the company does not produce it, but buys from a supplier to the re-sell it, the decision is to classify it as Purchase To Order (PTO) or Purchase To Stock (PTS). Choosing each classification takes into account a great amount of information and decision, including some analysis listed below;

• ABC Analysis: In this strategy, products demands are analyzed in a full year horizon (to avoid seasonal interference) and ordered from the most income to the lowest. From that list, products are classified in A (the products that correspond to 80% of the company's income and usually are no bigger than 20% of the portfolio), B (products that correspond to the next 15% of company's income) and C (products that sum up to 5% of the income and usually are over 50% of the portfolio). The objective is to allow stock administration to spend a greater effort in planning and understanding A products, not as much in B and as little as possible in C products. Of course this strategy has many considerations over it, you need to look further the data and combine it with other techniques to determine your strategy;

• Demand Variation Analysis: Also known as the XYZ classification, the idea is to understand how the demand of a certain product behaves over time. The analysis is to compare the average sale over time and the standard deviation. Products with very small variations over income are classified as X, medium are Y and heavy variations are set as Z. X products are very easy to predict and may require low stock levels, while Z have nightmare stock planning and are strong candidates to be turned into MTO or PTO;

• Service Level Determination: This strategy aims to find a balance between the calculated cost of keeping products in stock and the cost of losing a sale. A lost sale may not be completely lost, as customers might just wait until you have that product in stock, but other cases the customer may acquire the product from your competidor or use a substitute. This varies a lot for each product, time, market and can be calculated to form the cost of losing sales. This strategy minimizes the sum of the cost of losing sales and the cost of keeping product in stock to find the ideal service level for each product;

• Product turnover analysis: Products can also be evaluated by how fast it takes it to be sold from the moment it enters a company's stock. The faster, the better: it means that purchasing or producing that product will not mean a financial struggle. In the other hand, slow movers must have stock levels reviewed and, in some cases with the agreement with product managers and marketing team, put out of the portfolio.

• Stock Replenishment strategy: There are many strategies to determine when and how much  product units should be requested to replenish the stock. From the classic min/max stock level strategy, to the Kanban board, as to consigned stock with direct communication with the supplier, etc. there are multiple and very effective stock replenishment strategies that are most adequate for each product according to its own characteristics. Determining the best for each item or group of items is key.

• Sales and Operation Planning (S&OP): This complex, but extremely beneficial, process offers the company a robust communications improvement throughout most of the players in the company. Combining statistical analysis, commercial and marketing inputs with operations restrictions input and putting people to discuss in formal meetings, allows a consensus planning that puts the whole team in the same page when advertising, selling, purchasing, producing and moving products to be set. This makes the service level raise without having to increase inventory levels.

• Supply Chain Process Improvement: In order to raise service level without incurring greater inventory levels, the supply chain productivity must be raised: reducing lead times, reducing production output level variation by avoiding failures or quality issues, having stronger agreements with suppliers, better communication with other areas and internally, as well as organization in the operation areas;

These are some of our favorites, we know other techniques, but we don't want to make this long post even longer. There are some advanced methodologies like Lean and Six Sigma, that have broader objectives and are very beneficial to the company and reduce stock levels and inventory costs. These powerful methodologies are also well known in JM and we love to discuss it with our clients.

So, as you can tell, stock administration is not an easy task and, for this very reason, the world has formulated and tested lots of methodologies that go way beyond the warehouse and the production lines. It is a supply chain matter that affects all areas of the company and beyond the company lines.

JM is vey aware of that. Our team has a long history of stock administration and strategy know-how. Since we strongly believe, due to experiente, that every company is unique, it is pointless to just apply a strategy in its standard form in a client. One must deeply understand how the company is structured, how is the market and competition environment it works in and then verify what strategy or what group of strategies to apply.

Talk to us! Visit our website www.jmanguino.com.br and let's discuss your company's stock administration. I am sure we will both learn together!
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