What Inventory is Good Inventory? (Part 2)

As discussed in Part 1, there are risks and benefits to both buying as needed and keeping inventory. Although keeping inventory may be great for keeping products at hand when needed, there are many details to consider.

Holding Costs

Holding costs may be associated with keeping inventory at a site. While every company will be different, a common number used for holding costs is 8% per year. This is valid for a company with a significant inventory amount (>$5,000). Consider the space and labor needed to keep it.

Holding cost includes the space, which must be secured. While that space is used for stock, it cannot be used for other purposes (lost opportunity). You are paying for every square foot of space you control. It also includes the labor necessary to buy it, pay for it, secure it, track it, count it, and analyze it. That labor is lost in relation to generating billable income. Taxes might be another issue if you reside in an area that charges an inventory tax.

Holding Cost Example

From a cost basis and 8% holding cost; if you buy a $100 item and hold for a year, you will have invested $108 for that item.  Hold it for two years and it has cost you $116.64.

Some prefer to look at the effects of holding cost as a decrease in inventory value.  So in the above case after one year the item is only worth $92.  After two years it’s worth $84.64. Either way you took a hit to your bottom line by stocking the item.

Risk

Investing in inventory has a risk. You must cover that risk. What are risks?

1. Obsolescence- Items may have an expiration date and go bad (chemicals, glue, plant material, etc). Or they might be replaced by a newer better item that all your customers want instead. Typically not a big issue related to irrigation, lighting, and other mechanical systems.
2. Theft- This is unfortunately a real problem. Which is one of the reasons why your stock must be secured.
3. Mistakes- This is the biggest reason your stock will not match your inventory tracking system and is the second reason your stock must be secured. With no malice, people will grab things and go. All they are focused on is getting the job done for your customers. They have best intentions of documenting the item movement later, but they forget.
4. Documenting- Another is documenting the wrong part numbers. Either way, what you think you have isn’t really there.
5. Damage-  Items may be damaged by accidents or acts of nature. Being dropped, banged, flooded, or eaten by bugs; it doesn’t matter, you have less than you paid for.

A risk factor may be very low (1%) or very high (10%) depending on your situations. If keeping significant stock value, consider insuring it; which adds more cost.

Mitigating Holding Costs and Risk

To overcome holding costs and the risk, you need a discount. The discount must at least be as much as the holding cost and risk for the time you believe the item will be held. If your target is one year or less, then you need at least a purchase price discount 8% to 10% below your normal price.

If your discount simply matches your holding cost and risk, you breakeven. But why risk the investment just to breakeven?  I’d use the cash to hire people and buy equipment. At least you have an asset that can produce revenue for many years. No, you must factor in a profit on top of the risk and holding cost. Typically folks look at 5% profit.

If you are paying interest for the money to make the purchase, then that too must be added in. So, that means if you can buy for 16% to 20% less, buying big may be a good deal. It may be a good deal as long as you secure and track your stock. Otherwise, shrinkage and mistakes will eat up any return you might get. This means an inventory system. To truly manage inventory you must:

• Be willing to hold staff accountable.
• Invest in software and technology.
• Educate someone to be a purchasing and inventory manager.
• Institute new procedures into your company’s culture.

Service Stock and Install Stock

Service people must have what they need on their truck so a service job can be completed in one call. At least that’s the ideal. Which means, a service truck has an ongoing inventory. Installation crews usually know what materials they need a few days or weeks before they show up at the job site. Installation stock can normally be purchased as needed. Different inventory strategies will be needed handle the difference between the two stock types.

Service Stock

The following are some service stock tips:

1. Generics- Service stock can be difficult given the variety of brands, models, and types of product customers may have. Look for ways to stock one item that can replace many. Example; a Rain Bird spray head nozzle works just fine on a hunter spray head.
2. One Day Only- Only stock a truck with what might be needed on a typical day. Restock at the end or beginning of each day. Service guys are hoarders!   They will hoard all they can get on their trucks.
3. Track and Verify- Keep each service truck as a separate “location.” Cycle count the stock to insure your records match the reality.
4. Two Day Safety Stock- If restocking from a holding inventory at your office, keep two days worth of stock. Replenishment is usually not a problem. If your primary supplier can’t replenish you within 2 days, others in town can fill in (and you need to reconsider your supplier’s ability). No need to invest deeper than that. The one day safety stock covers you while your supplier gets you handled or you find stock elsewhere.
5. Express Pick-Up- If resupplying service trucks from your supplier’s warehouse, make sure orders are ready for pick up when your service guys get there.
6. Delivery- Trips to a supplier’s counter are expensive. I’ve seen whole crews spend 30 minutes chatting after picking up $154 worth of parts. Trips to a supplier is a break from the heat for the crew but a serious time cost for you. Keep the time it takes to a minimum. Seriously consider supplier delivery instead of counter visits.
7. Automation- Automating your replenishment orders will help. Work with your supplier so they understand you objectives. Working together you can find a system that helps you and your supplier.

Installation Stock

Because you normally know in advance what is needed to do a job, your supplier can have your order ready for you. For more savings, instead of picking up your order have it delivered to your job site.

Installation stock can be nothing or large. It depends on if you can buy deep enough to afford a big buy stock. Personally, I’d suggest you don’t do big buys; rather, get your job stock when you need it. If you invest early in the year, will you have the right stock? How do you know what you will need for jobs you haven’t won yet? A monthly stock plan is a good compromise. This helps lower your overall investment and allows time to fix inventory problems.

Whose Program?

Perhaps you’re thinking you have to live with the programs a supplier lays out for you.  Not true, it’s a two way street. Be fair to your supplier, but seek a program that works for you. Any sane supplier will readily agree if they also see a benefit.

The big buy programs are supplier favorites. Many good things happen for the supplier, but as mentioned above it may not be a good deal for you.

The supplier gets to move product in bulk, reducing their transaction cost. Even with the discount they are taking advantage of reduced labor and manufacturer rebates. The supplier locks out competition. By stocking you up they don’t have to worry you might buy that product from a competitor.

Good suppliers are willing and able to work with you defining a good program. Just be fair. Margins are tight in the supplier world. Suppliers are always looking for ways to shave costs out of the system and are but a few points away from certain transactions being unfavorable. There are no big discounts left that do not have some other purpose, stated or hidden, attached to them. Such as loss-leader or relationship spoiling competitive strategies. The actual purchase price you pay for supplies should be number three or four on your list. Shaving a couple points off your materials cost is meaningless if you are wasting thousands of dollars through inefficiency.

The Big Picture

Keeping inventory can be tricky. Focusing on maximizing labor, removing unnecessary activities, and reducing asset loss will repay themselves many times over. Make sure you and your team are prepared to stay on all the details to running a smooth inventory operation.

Inventory by Nick Youngson CC BY-SA 3.0 Alpha Stock Images