A-09
Mark K. Williams, CFPIM
Ten Keys to Inventory Reduction
Companies exist to service their customers. The
primary service provided by manufacturing and dis-
tribution companies is in the form of a raw material
or component that the customer then processes into
its own product, or a finished goods item that the
customer resells. It is therefore critical that each
company has a set of inventory objectives that allow
it to provide this service profitably. The main inven-
tory objectives for most companies seem deceptively
simple:
Provide the right product
at the right place
in the right quantity
at the right time and
at the right price.
If a company does these five things, it will sat-
isfy its customers and become extremely profitable.
Although this inventory objective sounds simple,
hard and often painful experience tells us that it is
not. A forecast of the customers demands is based
on past history, but if a customer places an item on
promotion, the supplier may not have the right
quantity. Most of the required product is in the
Texas warehouse, and suddenly the demand is heavy
in Boston. A company stocks up on a new product
that Marketing knows will be a hit, and it turns out to
be a dud. Or worse, a new product is suspected of
being a dud so very little is stocked, and it turns out
to be a hit, leaving Marketing and the customers
mad.
The days are long gone when customers would
routinely accept shipments from suppliers that were
70 percent complete. Many companies will cease
doing business with a supplier that cannot maintain
a service level of at least 98 percent. Of course, a
supplier without customers will quickly go out of
business. Therefore, if a company experiences ful-
fillment problems, the solution demanded by the
Sales Department and the corner office is usually,
Bring in more inventory and get rid of these stock-
outs or else!
INVENTORY ISNT FREE
A company can indeed add more inventoryand
more, and more, and morein an attempt to pro-
vide customers with better service. Many companies
do this, but then they run into a few problems. Their
warehouse begins to fill up, and soon they need to
rent another one. Their employees report that it is
becoming more difficult and time-consuming to find
2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management
the product that is in stock. The company has to go
back to its bankers repeatedly to borrow money to
support the higher levels of inventory. At the end of
the year they receive a nasty surprisetheir taxes
have increased! Then the company often has to con-
front one final problem; their service level has not
increased despite the increase in inventory.
What does increase is the cost associated with
holding the inventory. This is because even though
inventory is listed on the books as an asset, increas-
ing the amount of inventory a company holds has an
impact on many individual costs not recognized by
many companies. When we look at the components
of inventory carrying costs (see Figure 1), it be-
comes clear how increased inventory levels lead to
increased costs.1
Our challenge is to reduce our inventory, lead-
ing to a reduction in the associated inventory carry-
ing costs. However, we must simultaneously increase
our service levels to our customers or risk losing
them. Is this possible?
Fortunately, yes, it is possible to reduce inven-
tory while increasing service levels. There is no
magic bullet, but by working diligently to implement
the following 10 keys to inventory reduction, those
two vital goals can be achieved.
1. Improve Inventory Accuracy
A rush shipment is being prepared for a key cus-
tomer. According to the figures in the computer,
there is enough stock of each item on hand to fulfill
the customer needs. Based on this information, the
customer is assured that the shipment will be com-
plete. However, when the order is picked, 3 of the
10 items come up short! Now the customer must be
given the bad news. In order to make sure this does
not happen again, the supplier considers adding
more safety stock to its inventory.
By simply adding safety stock in hopes of en-
suring enough inventory the next time, the core
problem is not addressed. After all, according to the
computer records, there was enough stock to com-
plete the order. The real problem in this situation is
that the inventory on the shelf did not match the
inventory figures in the computer. Will increasing
safety stock solve this problem? No, quite often it is
1 Ross, David Frederick, Distribution Planning and
Control, Chapman and Hall, 1996.
1

aggravated because now there is more inventory to
track.
Overall inventory accuracy depends upon con-
ducting each process flawlessly, including Receiving,
Putaway, Picking, Shipping, and Invoicing. Some
things that help improve inventory accuracy are:
unique SKU numbers for each part
well-identified aisle/bin locations
use of bar codes for inventory tracking
a workforce that understands the consequences
of inaccurate inventory figures
a cycle counting program aimed at detecting
and correcting errors in the process
2. Eliminate Obsolete Inventory
Do some companies keep inventory that has been in
stock for over five years? They hesitate to get rid of
it for fear that if they do, they will receive an order
for the item the very next week. And if that happens,
the salespeople will go absolutely ballistic. Unfortu-
nately, for many companies that scenario is all too
familiar. They hold on to old, probably obsolete
inventory because they feel that keeping it is safer
than getting rid of it.
However, there is another way to look at inven-
tory that is doing nothing more than taking up
space. First of all, it is taking up valuable space! As
discussed earlier, inventory carrying costs are not
free, they average 20 to 36 percent per year. If the
company has a 36 percent carrying cost, in three
years the inventory will have been paid for twice
once when purchased with cold, hard cash, and a
second time through the costs associated with carry-
ing inventory.
If we decide to get rid of the inventory, we can
get some benefit from it. Many closeout companies
will pay between $0.10 and $0.40 on the dollar for
the inventory. This may not sound like much, but it
is better than nothing. In addition, any inventory
that is disposed of for less than cost can be written
off against the companys taxes.
3. Implement ABC Inventory Management
Strategies
Do the people with inventory management respon-
sibility have enough time to focus on each part of
their job? Do they have enough time to strategize
and monitor each SKU in their inventory on a daily
basis? Or have their job responsibilities increased so
much that they sometimes do not know if they are
coming or going?
A manager who has ample time to monitor each
SKU daily and strategize the optimal ordering and
stocking of each of those SKUs is a rare breed in an
ideal situation. Those who manage inventory in the
real world have to decide what to doand what not
to do. One of the most powerfulyet simple
2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management
Ten Keys to Inventory Reduction
decision-making tools in the arsenal of the inventory
manager is the use of ABC stratification in setting
priorities regarding inventory ordering and stocking
decisions.
The concept behind ABC stratification is that
some items are more important than others and
therefore deserve more managerial attention. If one
is in charge of office products, and the range of
products extends from computers to paper clips,
does it make sense to pay as much attention to how
many computers are in stock as it does paper clips?
Common sense says, Of course notcomputers
are so expensive, they demand more attention.
Does this mean a department can afford to run out
of paper clips on a routine basis? No, that also is not
one of the options. So how does one set these
priorities?
This is where ABC stratification emerges as an
important option. There are a couple of steps that
must be taken in order to prepare for using ABC
stratification. First, an ABC analysis spreadsheet is
needed. To do this, the cost of each item is multi-
plied by its annual unit sales to get an annualized
cost of sales, and then each item is ranked in de-
scending order by this amount. In most companies,
the top 20 percent of items are fast moving and usu-
ally account for approximately 80 percent of sales.
These items fit the A category. The next 30 per-
cent of items are mid-movers and usually repre-
sent about 15 percent of sales. These go into B
category. Finally, there are the slow movers, usually
about 50 percent of items that combined only repre-
sent 5 percent of sales. These slow movers are classi-
fied C items.
Once sorted into the appropriate ABC classifi-
cations, it is time to apply the principle of prioritiza-
tion. In many companies, the same relative amount
of inventory is maintained for all items. For exam-
ple, a company will set the inventory level for all
items to equal two months sales. A company
switching to the ABC approach sets inventory levels
differently. Realizing that the fast-moving A items
make up a much larger portion of sales and are
probably always on order, the company tries to
maintain relatively less inventory. Instead of eight
weeks of inventory, the company maintains a four-
week level. The company compensates for the low-
ered inventory level by paying more attention to the
A items to make sure they do not run out. Al-
though the relative amount of inventory is lower, the
absolute value of the A inventory is higher than
either B or C items, because the sales level of
A items is so much higher. The B items would
maintain the inventory level of eight weeks. In order
to concentrate our attention on the fast-moving A
items, we increase the inventory level of our C
items to double the previous level. Because this
represents so many items50 percent of our total
2

it frees up a lot of review and monitoring time.
However, because of the sales volume these items
are based ononly 5 percent of salesdoubling the
amount while cutting the amount of A items in
half will still allow for a significant inventory
reduction.
As you can see from Figure 2, a company
implementing the ABC strategy will carry 33 percent
less inventory than a company that maintains the
same inventory level for all items. That is not only a
significant inventory reduction, but also normally
leads to an increase in customer service level.
4. Review Safety Stocks
Do some companies set their safety stock levels
uniformly for all itemsfor example, one month of
safety stock for each SKU? If so, they are making a
very common mistake. The level of safety stock
should be determined based on the variability of
demand. As an example, look at the two items in
Figure 3.
Both have sales of 600 units over a six-month
period for an average of 100 per month. All similar-
ity stops there. Item A-45 has a very steady sales
pattern, varying from its average of 100 monthly
units by 5 or less during any month. Keeping one
months worth of safety stock, or 100 extra units, on
hand for this item is surely a waste of inventory.
However, the same safety stock level for item B-14
would not be enough to cover the two peak months
of March and May.
There is another method of calculating safety
stock, based on the variation in demand. This
method assumes that an item exhibits normal de-
mand characteristics, including consistent demand.
In order to employ this method of setting safety
stock, we must first determine the Mean Absolute
Deviation (MAD).2 To determine this, we must find
the total absolute deviation from the mean and di-
vide it by the number of months. Let us determine
the MAD for each item above. See Figure 4.
After deciding on a target service level, we use
the Table of Safety Factors (see Figure 5) to deter-
mine the appropriate safety factor.3
If a 95 percent service level is desired for both
items, lets look at the different safety stock re-
quirements. (See Figure 6.)
Even though both items averaged 100 units per
month, the safety stock for A-45 is only 5 units,
while for B-14 it is 177 units. This is proof that due
to the variation of demand, one size does not fit all.
2 Arnold, J.R. Tony, Introduction to Materials Manage-
ment, Prentice Hall, 1998.
3 Arnold.
2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management
Ten Keys to Inventory Reduction
5. Reduce Lead Times
One very legitimate use of inventory in both distri-
bution and make-to-stock businesses is to serve as
safety stock. Safety stock is used to compensate for
the uncertainty of demand. One cannot predict the
future or the precise buying habits of customers, so
keeping safety stock ensures a good service level.
However, the level of demand uncertainty is not
static. It increases as lead time increases. The longer
the lead time, the greater the potential changes in
demand, which must be supported by higher levels
of safety stock. More unforeseen things can occur in
six months than in six days.
In order to minimize safety-stock-related inven-
tory, lead times must be reduced. By exchanging
information with customers, suppliers can find out
when customers are planning to order and anticipate
the demand. By adopting Just-in-Time techniques,
WIP can be minimized and throughput improved.
6. Partner with Customers
A distributor or make-to-stock manufacturer is ex-
pected to be able to supply its customers needs
from on-hand inventory. Determining those needs is
one of the most difficult tasks for most suppliers
because they rely on an internally generated forecast
based on their customers past purchases. This
works just fine as long as the future is identical to
the past. However, in todays fast-moving world, this
is rarely the case. So should a company just give up?
Of course notto give up is to cease operating.
A better idea is to establish a close relationship with
the customers so that they will make their future
requirements available. After all, the customers
probably already know their future requirements.
Many companies will happily share their anticipated
needs, if they believe it will allow their suppliers to
improve their service level and there are assurances
of confidentiality. There are several ways to obtain
this information from customers, through schedule
sharing, participating in a vendor-managed inventory
(VMI) program, receiving point-of-sale data directly,
and by using collaborative forecasting.4 Whichever
tool is chosen, one thing is certaingetting informa-
tion directly from the customer is almost always
going to be more accurate than even the best
forecast.
7. Partner with Suppliers
Often we maintain safety stock in our raw materials
inventory because we are working with suppliers
who have a poor on-time delivery record. In order
to provide timely service to our own customers, we
4 Williams,
Mark K., Critical Tools of the Supply
Chain, APICS 42nd International Conference Proceedings,
1999.
3

keep safety stock to compensate for those inevitable
instances when we receive late deliveries from our
delinquent suppliers.
One way to solve this problem is to switch sup-
pliers in the hope that the new one will have better
performance. However, before taking this drastic
step, ask one question. Could your company be a
major part of the problem? Is your companys order
pattern extremely erratic, making it difficult for a
supplier to anticipate its needs? Does it provide its
suppliers with its anticipated needs? It was stated
earlier that a customer and supplier should commu-
nicate their scheduling information in order to an-
ticipate each others needs. Has your company
provided the same information to its suppliers? Or
does your company send them a purchase order and
expect them to respond to its ever-changing needs?
Partnering with suppliers, supplying them with
anticipated needs so they can be prepared for them,
is often the quickest and most effective way to im-
prove a suppliers delivery performance. Grouping
your purchases by supplier in the computer system
and sending your key suppliers a copy of the portion
of the purchasing report that relates to them will
allow them to prepare to meet your needs.5 Will it
always work? Unfortunately, no, some suppliers just
do not understand the importance of on-time deliv-
ery. Replacing such suppliers is often the only way to
get better performance. However, providing most
suppliers with their customers anticipated needs will
turn poor performers into on-time deliverers!
8. Reduce WIP Space
In a manufacturing plant, there is one piece of con-
ventional wisdom that is usually trueinventory will
grow to fill the space given it. This is particularly the
case with work-in-process (WIP) inventory in a job
shop. If there are 50 square feet allotted to inven-
tory, it will not be enough, so it is increased to 100
square feet. This will suffice for a few weeks until
more is needed. This is because inventory is often
used to cover a multitude of sins. Everything from
frequent machine breakdowns (due to lack of a pre-
ventative maintenance system) to long setups (no
setup time reduction program) or frequent high lev-
els of scrap (no statistical process control program)
are compensated for by keeping lots of inventory
between operations so that part supplies are main-
tained even when problems are encountered.
In order to counter these problems, companies
should reduce the amount of space between opera-
tions where inventory can be stored. As space is
decreased, it will force underlying problems (ma-
chine breakdowns, long setups, poor quality) to the
5 Williams, Mark K., Information and Teamwork
Keys to Supply Chain Success, APICS 43rd Interna-
tional Conference Proceedings, 2000.
2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management
Ten Keys to Inventory Reduction
surface where they will be visible for all to see. As an
underlying problem surfaces, companies should di-
rect all efforts to solving the problem. Once the
problem is solved and the operation is functioning
smoothly with less space, reduce the WIP space
some more to uncover even more opportunities
for improvement!
9. Eradicate Individual Incentive Systems
Compensation exerts a strong influence on peoples
behavior. In many traditional manufacturing envi-
ronments, individual incentive systems based on
production are the norm to boost productivity. Un-
fortunately, when individuals can earn a bonus by
simply producing more, quality or reduced inventory
levels will be the furthest thing from their minds,
and instead they will strive to produce more units,
whether or not the product is needed. By contrast,
inventory reduction should be a team goal and
achievement. Once all employees understand that
inventory reduction is desirable, they can band to-
gether to make it happen. Few things can compro-
mise the drive toward inventory reduction more
than individual incentive systems based on
productivity.
In order to change the mindset of employees
who are used to individual incentives, the wise com-
pany will move in two directions. First, instead of
individual incentives, the company will move to a
group incentive involving everyone in the depart-
ment or plant. This will encourage employees to
work with the team, instead of just pushing out
more of a given item, regardless of whether it is
needed. Second, instead of basing the incentives on
production only, the new group incentives should be
based on other important goals such as quality, in-
ventory reduction, and safety in addition to produc-
tion. This will focus employees on the myriad of
elements needed to make manufacturers successful.
10. Educate and Train!
The tools and drive to reduce inventory are not
something innate to managers or employees. They
must be learned. Many companies with inventory
problems decide their salvation lies in the newest
software program on the market. They do not see
the wisdom of first educating their employees about
the basics of good inventory management. If some
of their employees cannot count, and they are re-
sponsible for keeping track of their production, no
software program in the world will help them.
Most companies can reduce their inventory
while improving their service level by making a con-
certed effort to train their employees in proper in-
ventory management techniques. These employees
are not just those in inventory management or pur-
chasing positions (although they are definitely in-
cluded), but the rank and file employees who do
4

the work in the organization. If a receiving clerk
routinely enters the wrong data into the system, if a
stocking clerk often places goods in the wrong place,
if a picker does not bother to accurately count the
product being picked, or if a shipping clerk puts the
wrong label on boxes, the inventory wont ever be
accurate. In these instances, a company will never
have the ability to safely reduce inventory without
hurting its service level. Only by training the em-
ployees in the importance of doing their jobs cor-
rectly and giving them the tools necessary will you
be able to create the best kind of inventory reduc-
tion teamyour entire workforce!
CONCLUSION
Companies exist to service customers. However, if a
company attempts to service its customers by main-
taining an extremely high level of inventory, it may
find itself with a serious cash flow problem. Compa-
nies have even gone bankrupt while having plenty of
assets because too large of a percentage of those
assets were tied up in inventory, and the company
could not meet payroll or pay its bills.
If a company aspires to maintain a high service
level while minimizing inventory, it will take hard
work, dedication, and teamwork. Ensuring an accu-
rate inventory of items that supplier and customer
2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management
Ten Keys to Inventory Reduction
agree must be in stock is a good starting place. This
requires precise recording and counting processes,
along with an understanding of ABC inventory
methods and a commitment to clear, timely, confi-
dential communications regarding needs and expec-
tations. Within either company, steps should be
taken to educate all people responsible for inventory
accuracy in proper procedures for reducing inven-
tory and the space allotted to WIP storage. Team
goals and incentives should be established to bring
about these ends, thus phasing out counterproduc-
tive individual incentives. Improving communica-
tions and processes, increasing accuracy, and raising
the awareness and commitment of workers at all
levels to inventory reduction will ultimately enhance
any companys bottom line. There are no magic bul-
lets, but if a company employs the tools and tech-
niques found in both this article and in the APICS
body of knowledge, it will be on the right path to-
wards achieving these dual goals.
ABOUT THE AUTHOR
Mark K. Williams, CFPIM, is a manager with the
North Highland Company and executive vice presi-
dent of APICS.
5
 Ten Keys to Inventory Reduction

Cost of Capital 1015%

Storage & Warehouse Space 25%

Obsolescence & Shrinkage 46%

Insurance 15%

Material Handling 12%

Taxes 23%

Total Annual Inventory Carrying Costs 2036%

FIGURE 1.

% of Total Value of Equal

Part Monthly Sales Cost of Inventory ABC Inventory
Sales (8 Weeks)
A $ 785,000 78% $ 1,570,000 $ 785,000 (4 weeks)
B $ 160,757 16% $ 321,514 $ 321,514 (8 weeks)
C $ 63,215 6% $ 126,430 $ 252,860 (16 weeks)
Total $ 1,008,972 100% $ 2,017,944 $ 1,359,374 33%
Inventory
Reduction

FIGURE 2.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 6
 Ten Keys to Inventory Reduction

January February March April May June Total

Item #

A-45 99 102 103 95 103 98 600

B-14 10 13 241 24 280 32 600

FIGURE 3.

Part A-45 Part B-14

Monthly Average Absolute Monthly Average Absolute

Month Sales Sales Deviation Deviation Month Sales Sales Deviation Deviation

January 99 100 -1 1 January 10 100 -90 90

February 102 100 2 2 February 13 100 -87 87

March 103 100 3 3 March 241 100 141 141

April 95 100 -5 5 April 24 100 -76 76

May 103 100 3 3 May 280 100 180 180

June 98 100 -2 2 June 32 100 -68 68

600 16 600 642

Total Ab-
Total Ab- solute De-
solute De- viation 646
viation 16 MAD= = = 107
MAD= = = 2.67
Number 6
Number 6 of Periods
of Periods

FIGURE 4.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 7
 Ten Keys to Inventory Reduction

Service Level % Safety Factor

50% 0.00

75% 0.67

80% 0.84

85% 1.04

90% 1.28

95% 1.65

98% 2.05

99% 2.33

FIGURE 5.

MAD Safety Factor Safety Stock (MAD x SF)

Part # (SF)

A-45 2.67 1.65 4.4 (or 5)

B-14 107 1.65 176.5 or (177)

FIGURE 6.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 8