The role of inventory management and inventory optimization in ERP

Inventory management and inventory optimization in ERP is important because it provides a buffer to balance out the uncertainties between demand and supply. However, while it can be viewed positively, holding inventory also creates problems. Physical space used by stock comes at a cost –  inventory ties up cash and working capital which could be better deployed elsewhere. As an asset on a company’s balance sheet, reduced inventory results in a higher return on assets. In a recent survey, 40% of respondents mentioned rising inventory costs as a top business risk. So if inventory costs money and negatively impacts cash flow, why not just reduce it?

Too little inventory also creates problems — for manufacturing, customer service, and maintenance. That is why the role of inventory management is so important — to balance the needs of the business to hold inventory against the costs it entails. One of the biggest uncertainties of inventory management is how much stock to hold to meet changing demand. Keeping the right level of inventory requires a technique called inventory optimization.

The role of inventory management

For a small manufacturing operation, with limited inventory items, a small storage area, and a few customer orders, a spreadsheet might manage inventory sufficiently. But for larger, complex environments, a more sophisticated inventory management system is needed to collect, process, manage and report on all the data, in as near to real-time as possible. Failure to follow every incoming and outgoing inventory item can seriously impact turnover. Inventory management is therefore essential for any growing manufacturing company.

The role of inventory management is to maintain appropriate stock levels for the needs of the business. It helps to:

• control stock quantity, accuracy, quality,
• support regulatory compliance through traceability,
• optimize the order and replenishment process,
• ensure customer service levels by having the right stock at the right location,
• regulate movement and distribution of stock,
• manage inventory valuations and costs,
• provide points of inspection.

Benefits of an inventory management system

The benefits of using an inventory management system include:

• achieving optimum levels of inventory at the correct location,
• enabling inventory to be managed at a more granular level,
• reducing inventory losses, obsolescence, and excess inventory,
• improving order fulfilment and on-time delivery,
• preventing interruptions to production through stock shortages,
• making stock-taking more efficient,
• information that can improve procurement and replenishment processes,
• better visibility of inventory information, enabling better, more informed decisions.

The problem with inventory is that the more variable the demand, the tendency is to hold more stock as raw materials for work-in-progress so that production is not interrupted. It is not only since the pandemic that supply and demand shocks have demonstrated problems with current inventory methodologies and practices. Over ten years ago, in 2012, various reports referred to turbulence in business as the “new normal” with volatility increasing and demand becoming more unpredictable. The rise of Industry 4.0 is also exposing the limits of conventional inventory management regarding accuracy, visibility, and efficiency.

Inventory optimization

For manufacturers, the challenge is to get the stock levels required, keeping as little as possible while providing ‘just the right amount’ of stock. The search for optimal inventory levels is therefore a key objective.

Inventory optimization (IO) takes inventory management to the next level, providing a more dynamic and holistic approach which allows managers to assess various signals in the supply chain that may be relevant to managing inventory. It allows a business to estimate inventory levels to maximize profit and minimize waste. IO can model different potential outcomes using a number of variables, and help to pick the best stock holding and re-order policy for each product group or set of stock items.

Using IO as part of inventory management gives a better view of demand, which will help in reducing both safety stock and overall inventory. It involves:

1. analyzing stock codes for importance and behaviour and then classifying them into like groupings;
2. generating estimates of demand forecast for each stock code — high forecast accuracy is the holy grail;
3. modeling the effect of a stock policy to see whether it can meet the competing requirements of raising service levels while lowering inventory;
4. replenishing stock according to the forecast and the stock policy.

The key technical requirements when aiming for optimized inventory levels are data accuracy and timeliness. This is not typically found in situations where the technologies used are spreadsheets or stand-alone applications,

Data-related problems are far less likely to occur if the planning and optimizing inventory is integrated with an ERP system. An integrated ERP solution eliminates issues of data accuracy and timeliness as well as the problem of synchronizing master data.

IO is not a one-off activity. It is a cross-functional process, involving many role players, and is therefore not easy. It requires continuous review and ongoing education, but presents the opportunity for big gains.

The need for inventory management and optimization

Effective inventory management should be a priority for every manufacturing business and should therefore be a critical component of any ERP system. With it, a business gets a unified view of inventory, presented in real time. This detailed real-time data is essential for effective customer service and profitable management. In a business environment where uncertainty, cash and customers are major concerns, an inventory optimization project is a good investment for improving working capital and customer service levels.

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