Four Supply Chain Metrics that Drive Inventory Velocity
What is Inventory Velocity?
While inventory velocity is not a new term, it is always good to begin such topics with a clear and simple definition. Inventory velocity is the speed at which the inventory is cycled in a given period for each item. Inventory velocity is the underlying measure to improve Inventory turns, which accountants define as follows:
Inventory Turns = Cost of Goods Sold / Average Inventory On-Hand
Management consultants often emphasize that if one can measure, one can improve. Unfortunately, measuring inventory turns alone does not provide the means to improve inventory velocity. Inventory turns are measured at both the corporate and division levels while inventory velocity is measured at the individual item level. In order to improve inventory turns (output) we must first identify the critical metrics (inputs) that affect “cost of goods sold” and “average inventory on-hand”. Here is an excellent article on SupplyChainBrain.com titled Taming and Managing Inventory Velocity in a Fast Paced Consumer World.
The Four Key Metrics that Drive Inventory Velocity
- Planning Cycle Time – This is the time lag between receiving the demand signal and releasing the order to a supplier. Sometimes this is uncovered when doing a value stream map which includes information flows. High variability or excessive order lead time negatively impacts material flow. The goal is to simplify communication with suppliers (reduce variability) and reduce order lead time to as close to zero as possible.
- Supplier Lead Time – This is the time lag at the supplier between receiving the purchase order and shipping the order. This metric is often overlooked because many assume the supplier owns the inventory at this stage, so there is nothing one can do as a customer to improve the supplier’s turnaround of an order. In fact, one’s ability to respond to changes in demand is directly proportionate to the supplier’s ability to quickly deliver orders on a consistent basis. Also, the supplier’s inventory turns affect their financial health, so there is dual motivation to collaborate to improve a supplier’s performance.
- Transit Time – This is the time from supplier shipment until you receive the order. This may or may not include time to move goods from dock to stock. This is typically a large focus of logistics departments and has gained more attention lately due to skyrocketing fuel costs and offshoring. Going from a domestic supplier with a two day transit time to an offshore supplier with a 30 day transit time can reduce your ability to respond to changes in demand.
- Variability of Demand – This is a measure of how much variability there is in customer demand. It can be measured by taking the standard deviation divided by the mean, or S/X ratio. In this case, the “customer” is the downstream node in the supply chain which consumes material being ordered. This could be a warehouse, distribution center, a supermarket, or a work center. Variability of demand can help you segment your inventory and determine which type of reorder policy to use. For example, if an item has fairly consistent demand (low S/X) then you might want to put the item on kanban (pull) replenishment. However, for items with inconsistent demand (high S/X) you might want to use a schedule based ordering policy. The schedule could be driven from an MRP run or other forecast method. Items with extremely low or lumpy demand might be ordered on an as needed basis and not to stock.
How to Track and Improve These Metrics
A common challenge that most Supply Chain organizations face is their MRP or ERP system was not designed to track these metrics reliably. At best these systems lump the aforementioned top three metrics together. Worse yet, they do not track the fourth metric (variability of demand) at all! If your metrics are limited then you can only achieve limited results. At the root of this problem is high focus on supply chain forecasting and planning but little focus on supply chain execution. The good news is that more and more companies are starting to leverage cloud supply chain execution systems like Ultriva to improve visibility and supplier collaboration. With this approach companies can track these metrics to identify areas for improvement such as smaller lot sizes, sourcing location strategy, kanban replenishment, vendor managed inventory (VMI), etc. Finally, tracking these metrics on an ongoing basis will ensure that you sustain improvements in inventory turns.
This is great, but where do I start?
As with any improvement initiative, the first step is to identify areas for improvement which will provide the highest return on investment. Ultriva has developed a patent pending web-based tool and assessment process to do just that for you in a few minutes. During the assessment we plot historical demand and calculate your demand variability (S/X) at a part level. We show you how to segment your demand and then identify suppliers/parts to target for inventory velocity improvement projects.
Do you agree with this list above? If not, feel free to leave a comment and let us know what factors you feel are critical to improving inventory velocity.