2 Types of Inventory Optimization and How They Impact Your Bottom Line
Cycle Stock vs. Safety Stock. What’s the difference and what does it mean for my production line or my customer?
In manufacturing, inventory has a huge impact on the profitability and working capital of a company. Managing the right amount of inventory can sometimes be challenging especially when demand levels fluctuate.
Operations managers, purchasers, and supply chain managers must determine the balance of appropriate levels of inventory, service level targets, and carrying costs. The goal is to maintain service levels that meet or exceed a specified target, while also keeping the carrying costs as minimal as possible. In this article, we define the two most common methods of inventory optimization and how they are used to achieve this goal.
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The first type of inventory optimization is called “Cycle Stock”. In this method, the company seeks to keep an average of half of the demand volume in stock over a set time period (or business cycle). Cycle Stock satisfies regular sales orders based on a forecast, or replenishment as they are sold.
When minimal carrying costs is the primary goal of the company, Cycle Stock is a great option. This is because it optimizes the inventory levels to the minimal amount based on demand. However, if the demand changes or the forecasting is inaccurate, the company will either stock out or over supply, which increases costs. There are many circumstances that can bring about this result such as a delay in a shipment or a sharp increase in demand.
A company can aim to increase the optimization of their Cycle Stock method by decreasing individual order volume and increasing the frequency of supply shipments. However, the increased logistics costs and potential loss of individual order volume discounts should be considered. Finding the appropriate balance of average Cycle Stock is crucial to optimizing inventory and costs in this method.
Because of the uncertainties in demand and forecasting, Safety Stock may be your preferred method of inventory optimization. This method provides a type of inventory buffer that minimizes the effects of variation in supply and demand. You can consider it like an “emergency fund” for scenarios where demand spikes or shipments are delayed. This way the potential for a stock out is greatly mitigated, but at slightly higher carrying costs.
There are two factors to consider when deciding how much buffer stock to maintain. The first is usually determined by examining the historical amount of variation that exists in the supply chain. If shipping delays and changes in demand are more common, then you may consider a larger volume of safety stock. The second is determined by establishing a target service level. This is the amount of time your company is willing to be “out of stock.” For example, a 99% service level would mean that your products or inventory is in-stock 99 percent of the time.
As you increase your service level, your costs exponentially increase. That is why companies do not set a target service level of 100% because it is statistically unachievable. Instead, they target around a 95% service level. Whatever number you choose must balance your customer’s expectation with the amount of capital your company is willing to invest in inventory.
How We Optimize Your Inventory
Without disruptive innovation, companies risk becoming obsolete through competition. In order to greatly increase your company’s service level without greatly affecting costs, new innovative processes or strategic partnerships must be put in place.
We act as safety stock, but without the extra investment. Because of our scale, AMS enables highly optimized inventory management. We do this by enabling the short-term absorption of carrying costs, decreased logistics costs, and just in time inventory management solutions. With our partnership, your company is able to move further up the service level scale with very little working capital investment. The result is higher MOQ at reduced part cost, and more efficient operations.
Our scale enables us to act as the short-term working capital investment plus inventory management on your behalf.
The more working capital that exists to build the business the better. When inventory management and carrying costs absorb that capital, the business is unable to grow as fast, and as profitably. To optimize the method of storing and managing inventory, choose the method that increases the amount of working capital while also maintaining the level of risk your company desires.
Our DFM is always complimentary, and therefore no risk to you. We would love nothing more than to see how we can build success for your company.