How to cut inventory costs in Food & Bev Supply Chains
Cut inventory costs is one of the best strategies to improve the profitability of Food & Bev companies. How can you ensure that inventory costs are kept low while guarantee stock availability and drive sales? In the post a few simple strategies to cut inventory costs in Food & Bev Supply Chain
Cost reductions challenges
Reduce inventory costs is a big challenge for food and beverage companies. There are many reasons why managing inventory leads to high costs:
Erratic demand is the main reason why SMEs in Consumer goods are exposed to high inventory costs: Seasonality, weather and the latest food trends can affect customer demand to the point where to ensure availability and avoid losing sales, planners often choose to overstock goods; this results in higher purchase commitments that affect the company’s cash flow but also high storage costs.
Handling costs: food and beverage companies are exposed to high handling costs due to the very nature of their products: stock requires extra care when handled across all the steps of the supply chain, care is required mostly due to packaging and the consistency of the products.
Storage costs are often higher in food & beverage when products require temperature-controlled storage. Three main temperature ranges are relevant to both food and pharma products: Temperature-controlled that goes between 4 to 23 degrees; here storage costs are high but still comparable to ambient storage. Chilled which is between 4 to 8 degrees are more expensive and frozen, where the temperature ranges between -22 and -18 it’s the most expensive of the three.
Obsolescence-related costs are all the expenses resulting from the loss of inventory. Most companies see the loss of inventory simply as lost opportunities but there is a problem with this approach: it does not account for the overall price paid for the batch of inventory purchased. When a batch of food or beverage items is purchased, the total costs are spread over the total quantity of the single selling units received. When part of that batch is lost due to obsolescence, the total price is now spread over less quality increasing the single unit cost.
How to balance stock availability and inventory costs
Inventory costs are directly proportional to stock availability; this means that the higher the availability the higher the costs. The perfect balance between supply and demand is the goal of Supply Chain and Operations executives. Two types of inventory protect the demand:
The cycle stock is inventory requires to cover the forecasted demand for specific cycles that match the average remaining shelf life of the inventory; here is an example:
Company A sells a dairy product with a remaining life of 2 months. The consolidated demand for this item is of 200 kg a day, this means a cycle of about 12T of product over two months. The inventory hold must not exceed a quantity of 12T or the company will be exposed to waste due to obsolescence.
The safety stock is calculated as the quantity required to fulfil demand based on the average demand variance and the additional transport or production lead time.
Inventory should also be balanced against working capital; not all cycles must be planned in their full length as this requires the company to use a large amount of capital. Depending on the company cash flow and overall payables and receivables terms, inventory could be purchased in lower quantities and more frequently. While this might result in higher logistics costs on weighted average or by selling unit, companies with high gross margin but cashflow concerns might want to shorten inventory cycles.
RH&D: The three main inventory direct costs categories
Direct inventory costs consist of all the activities necessary to move stock across the supply chain. Companies working with 3PL might be familiar with the concept of RH&D as these are usually agreed in the storage and distribution agreement and it stands for Receipt, Handling and Distribution costs:
Receipt refers to the costs of handling goods-in and it includes booking consignments, QC and put-away tasks
Handling costs include replenishment, picking and packing and other activities like labelling or repacking that are common in E-commerce when some items need to be put into hampers of gift-boxes
Distribution is essentially goods-out costs related to vehicle loading and transport costs
Which inventory costs have the highest impact on the bottom line? A matter of product design
Design is a critical element of the supply chain and company leaders in Food & Bev can include RH&D costs when designing the product. The design is not just an exercise to make a product more desirable, but also to make it sustainable for the company’s supply chain. Good design enables companies to move inventory across the supply chain with speed while minimising costs and resource utilisation. This is how design can affect RH&D costs:
Packaging that facilitates quality control and helps reduce handling costs
Dimensions that help maximise stacking
Flexible sizing that makes products suitable for multi-channels
·A formulation that focuses on increased shelf-life and minimizes the risk of spoilage if the cold-chain is broken
Cut inventory waste before inventory costs
Not all costs are created equal and not all costs can be expected to be reduced without impacting customers requirements. Companies should design cost-savings strategies depending on the overall supply chain and business strategy. With a strategic approach, companies can prioritise cost-savings activities over others while still allowing the company to meet the sales targets.
A good place to start addressing inventory costs is to tackle inventory waste. Waste is the first place to look at where inventory cost is too high. I talk about waste in this article.
Food and Bev companies who champion waste reduction almost always use a mix of Lean and SixSigma methodologies to reduce waste and improve the quality -therefore productivity - of their processes. Here we can identify 8 types of waste:
Defects: Products that are out of specification that either requires resources to correct or must be disposed of.
Overproduction: Producing too much of a product before it is ready to be sold results in waste of resource utilisation.
Waiting: Waiting for the previous step in the process to complete. Often measured in waste of labour/ admin time
Non-Utilized Talent: Employees that are not effectively engaged in the process. Waste of wages/ waste of talent
Transportation: Transporting items or information that is not required to perform the process from one location to another. Waste of resources, time and possibly (logistics) costs
Inventory: Inventory or information that is sitting idle (not being processed).
Motion: People, information or equipment making unnecessary motion due to workspace layout, ergonomic issues or searching for misplaced items.
Extra Processing: Performing any activity that is not necessary to produce a functioning product or service.
Develop a cost-effective inventory management plan
Inventory management plans designed around efficiency are essential to driving cost savings by targeting waste. Companies with lean inventory management plans spend less on inventory costs, experience lower wastage and overall better cash flow. There are no standard solutions to develop a cost-effective inventory management plan, particularly in the food & beverage where there is a large diversity of product ranges; different ranges that determine which strategy fits better and which does not. A general approach to formulate an inventory management plan can be broken down in three parts:
Define different supply planning strategies
The first step is to formulate a supply planning strategy for each channel, customer segment or product type. Effective supply planning strategies will include the following goals:
Demand forecast accuracy
Logistics and storage costs
Identify cost reduction challenges
Different supply planning models require a different cost-reduction approach; this is because the goals of the planning strategy are different.
A planning model to supply canned food to a national retailer should prioritise availability and because of the long shelf life, bulk buying should be a sensible option even though storage costs might be higher.
Selling dairy products to small businesses should require a more conservative planning model as the erratic demand plus the limited shelf life of the products will expose the company to high wastage. Such a scenario will probably require a Just-in-time purchasing method as opposed to bulk buying.
Make a waste and a cost budget
Companies in the food and beverage industry cannot eliminate inventory waste but they can manage it.
Managing waste begins with a budget – a target amount defined by the cost of the goods wasted – that the company should aim not to exceed. Top performing companies in this industry as well as pharma, have their waste budget measured, managed, and reviewed regularly.
TIP: Every product category in a food & beverage company should have a waste target factored in the costing method, this can be seen as an additional direct cost.
Formulate an inventory cost reduction strategy
Companies with strong and effective inventory management plan also design cost control strategies. The risk of operating isolated cost-cutting tactics without considering the main Supply Chain strategy goals is to drive down performance together with costs, I talk about this topic in this blog post.
An effective inventory cost reduction strategy can be complex, but a simple solution can start with 4 simple steps:
Identify drivers of costs
Identify the main drivers of costs first; sometimes high costs can be the price to pay to maximise availability for key customers therefore no cost savings can be achieved without affecting customer service. Other costs can be about transport or wastage can be addressed without affecting availability.
Brainstorm with end-users
Involve the team and facilitate brainstorming exercises to find cost savings opportunities. Teams are often more aware of the waste of time and resources; managers and team leaders can support and facilitate team members to come up with solutions to drive down costs.
Managers should avoid imposing solutions to the team when working with teams to find cost-savings opportunities; team leaders act more like coaches and mentors, when decisions are made by the team these are more likely to be implemented.
Involve your suppliers, hauliers and 3PL if necessary
The supply chain is an extended ecosystem that goes beyond the company walls. Business partners like suppliers’ hauliers or even customers can be involved with cost-saving policies. Achieving inventory cost savings may be also an opportunity to share the saving with the company’s partner.
Use technology to track costs in real-time
Like in any other element of the supply chain, cost control is better managed if measured effectively. The quality of the data is an essential element to understand a company’s cost and formulate a strategy to drive savings while ensuring availability and excellent customer service.
Companies that use Lean SixSigma methodology to reduce waste use data analysis performed within the company’s core systems or with applications that are integrated; manual data entry is error-prone and although a lot can be done in spreadsheets, data to monitor costs and the progress of cost reduction strategies should be managed within robust and secure software.
Reduce inventory cost is not an easy task for food & beverage companies. Supply chain and operations executives can effectively cut costs and waste by designing plans that are compatible with the supply chain strategy and support overall business goals.