On the balance sheet, inventory is one line. In the warehouse it is tens of thousands of items, each held for a different reason, and some held for no reason at all. Executive discussions about inventory usually stay at the level of the line ("we need to cut ten days"), which is why inventory programmes so often end with a service crisis in the products that matter and the same pile of slow movers at the back of the warehouse.
Treating inventory as capital means asking of each part of it what a portfolio manager asks of each investment: why is this money here, what does it earn, and what would happen if it were somewhere else? The answer needs two cuts of the data and one decomposition.
Two cuts: value and predictability
The ABC classification ranks items by their share of annual consumption value: A items are the 15-20% that make about 80% of sales, C items the long tail. The XYZ classification ranks the same items by how predictable their demand is: X items are steady, Z items erratic. Crossing the two gives nine cells, and each cell deserves a different policy.
The pattern is common. The items that make 80% of sales hold only a fifth of the inventory, because they move fast and are easy to plan. The C items, 5% of sales, hold more than half, and the erratic C-Z cell alone holds a third. That cell is where forecasts are worst, minimum order quantities are largest relative to demand and nobody reviews the parameters, so stock accumulates quietly.
One decomposition: why each unit is there
Every unit in stock belongs to one of four buckets. Cycle stock exists because orders arrive in batches; it is set by order quantities. Safety stock protects service against demand and supply variability; it is set by the target service level and lead times. Excess is stock above what policy requires, usually from forecasts that did not materialise. Obsolete stock has no realistic demand left.
The decomposition changes the conversation. Of the 120 million, 55 million is excess or obsolete, and 43 million of that sits in C items. Cutting inventory there does not touch service at all. Cutting safety stock on A items, by contrast, saves little money and puts 80% of revenue at risk. An across-the-board target of ten days usually does the opposite of what it should, because the planners can only cut quickly where stock moves quickly: the A items.
Policies by cell
- A-X: lean, frequent replenishment, tight forecasts, possibly vendor-managed inventory. Small safety stocks, reviewed often.
- A-Z: the hard cell. Higher safety stock is justified, but so is investment in demand sensing and in shorter supplier lead times.
- C-X: automate. Simple reorder points, larger and rarer orders, little planner attention.
- C-Z: question whether to stock at all. Make to order, centralise in one warehouse, accept longer lead times or delist.
What finance should contribute
Finance owns two numbers that make the programme work. The first is the carrying cost of inventory, usually 15% to 25% a year once capital, storage, insurance, handling and obsolescence are counted; it is the price that justifies or rejects every stocking decision. The second is the provision for excess and obsolete stock, which should follow the same buckets: a provision that is set as a percentage of total inventory hides where the problem is and removes the incentive to clear it.
Bartor S.
Founder
