Why the C-suite should pay more attention to inventory strategy

Pre-Covid, it would be fair to say that most executive boards didn’t have inventory high on their list of corporate priorities. Inventory is mundane. If you sell goods then you almost certainly need it, in the same way that you also need accountants or electricity.

But it wasn’t the board’s job to deal with that. Someone somewhere in operations or supply chain dealt with that sort of thing while the board concentrated on more strategic topics like M&A, R&D, growth.

But in the same way that you only really notice the necessity of electricity when you are deprived of it, the supply chain disruption caused by Covid suddenly made inventory a critical topic. Do we have enough? Can we sell any of it? Can we get it to where we need it?

And this brought to executive light a whole range of challenges all too familiar to supply chain professionals: how easy is it to know how much inventory you have (and where) in anything close to real time? How much inventory should you hold, given demand is even more uncertain than usual? How do you deal with supply lead times being very much longer (and more uncertain) than customer lead times?

It is said that you should never let a good crisis go to waste, and the pandemic has had a number of positive effects on supply chains: the profile of the discipline has risen, its criticality underlined. Many companies have invested and continue to invest in technology to support and enhance supply chain processes.

But there is a risk that the wrong lessons have been learned and that the investments go to waste. Having enhanced inventory visibility makes established ways of working more efficient and effective. You need to know how much you’ve got before you can decide how much more or less you need, right?

But one of the biggest mistakes in inventory management is assuming that humans are good judges of how much inventory is required. The only bigger mistake is in thinking that technology is any better.

This sounds negative. The main problem is that in most cases, inventory is not really managed. It is the by-product of business processes, in particular, various supply chain planning processes (S&OP, production scheduling, material requirements planning, etc.) And you end up with a volume of inventory not because you wanted that volume of inventory, but because that is how much you have once the effect of all the various processes in your business have netted themselves out.

And one of the problems with this is that incentives and KPIs across the organization are not aligned with a specific inventory target. For example, many organizations look to the sales department for a forecast. Sales staff are incentivized to maximize sales, they’re not incentivized on forecast accuracy, still less on inventory levels (unless, after the fact, they’re incentivized to shift excess or obsolete stock).

Production staff are incentivized to run production efficiently and to hit output targets, they’re not incentivized to maintain particular inventory levels. Supply chain planning teams may have inventory turns on their scorecard, but it is only of secondary importance compared to material availability.

The net result of all this is that there are multiple forces which drive inventories inexorably upwards. All of the other incentives are good and add value – you want higher sales, efficient production and good material availability – but because the counter-incentives are overpowered, it becomes very difficult to find the right balance.

The result of this lopsided incentivization is excess and obsolete inventory. This generates write-offs and waste, it fills up warehouses with inventory that costs money to hold, and it clogs up production schedules, making companies slow to respond to changing market conditions.

The only reason this state of affairs is allowed to continue is that more or less everyone else is doing the same thing. In a market economy, you don’t have to be good, you just have to be better than your competition.

If investments in supply chain technology and capability only allow the status quo to function more efficiently, they are missing a massive opportunity.

The best way to solve the problem is to put inventory right at the heart of your supply chain strategy. You want enough inventory to protect you against uncertainty and volatility. But you don’t want so much that it makes you slow to react to rapidly changing conditions, and you don’t want to be regularly scrapping it or writing it down to less than cost. This will make your supply chain resilient and give you competitive advantage.

This requires different ways of thinking about inventory and different orchestration of the enterprise and this is why inventory strategy needs to be a board priority. We know from repeated experience that supply chain can’t fix this on their own. Not because they don’t know what needs fixing, but because so many of the key levers are outside of their sphere of influence.

Too much inventory management software is either designed to facilitate old ways of working or is incorrectly being used to replicate old ways of working. But even if it can genuinely carry out advanced inventory optimization calculations, it is powerless to deliver change without the right alignment of people and incentives.

The C-suite shouldn’t be doing supply planning’s work for it, but it should be creating the environment and conditions for supply chain to be successful.

Instead of having periodic purges of excess inventory, boards should rethink their inventory strategy and align their whole organizations with it. Only in this way can they hope to truly build resilience.

Matthew Bardell is managing director, nVentic.