Why We Struggle (continued)

Our Actions Make It Worse

The theory that the normal forecast re-order process will self-correct also ignores how our actions thwart the correction cycle and extends it further. Consider the following:

  1. Forecasts tend to be optimistic or we add safety levels to protect against the times we forecast too little. Most organizations are under pressure to capture all the sales they can. No one wants to be the reason for not having enough of a specific product. Therefore, it is better to err in having too much than too little, especially if there is a possibility demand will increase. We forecast on the optimistic side or pad with safety for many SKUs. This starts our total inventories higher and with safety levels, keeps them higher.
  2. If suppliers are less reliable or we have been burned during a launch, we will increase the safety levels or manipulate the forecast to cause inventory to arrive well before it is needed. If the suppler is really bad, we order twice just so we can get one. This increases total inventories when the suppliers do make their deliveries.
  3. When sales are lost to important customers due to lack of inventory, we usually respond by increasing the forecast or safety levels of the SKUs involved and sending the resulting orders as expedites. This has the effect of raising inventory and may create supplier and manufacturing problems depending on the availability of materials, parts, and capacity to respond to the expedites.
  4. When sales do not materialize as expected, we often hang onto inventory thinking the customer is just late or we forecasted the demand too early. We manipulate the forecast or safety levels to hold the current inventory and keep ordering for future demand. It is usually not until the end of the selling season, product life, or financial year that we finally adjust to reality. The result: inventories are increased until the correction is made.
  5. When ordering from our suppliers and manufacturers, we often have order minimums, price incentives for larger orders, and transportation costs that cause us to increase order quantities beyond the period forecast. Results: more inventory.
  6. Despite our optimism and protective actions as described above, minimizing inventory is still the goal. However, our actions can only be focused on those SKUs that sell. This is a basic law of inventory. If we want to reduce, we can only reduce by those products customers are buying. So we reduce them as low as we dare. Unfortunately, our efforts backfire when demand is higher than expected or our suppliers and manufacturing fail to deliver on time. And this is where things start to spiral. Depending on the customer or the severity of the supplier or manufacturing failure, we cycle back to behaviors described in #2 (order early or more because of unreliability) and #3 (protect the customer). It is a spiral because actions #2 and #3 increase inventories, adding more pressure to try and reduce inventories of products that are selling. The alternative to squeezing inventory is to dump overstocks by offering big discounts.
  7. Dumping of overstocks has the effect of starving future demand from customers. The discounts give them incentive to buy more than they need or as an alternative to a product that is selling. Forecasting rarely takes this into account and we continue to order inventory as if sales will be normal. Now we begin another spiral by cycling back to the actions in #1 (be optimistic) and #4 (hold inventory because demand is late), and then try to cope using #6 (reduce things that are selling). When that fails, we return to this action (big discounts).

The actions above have us constantly erring on the side of holding more total inventory yet still getting stock-outs on SKUs that are selling. They thwart timely correction and amplify the variation in order quantities to suppliers and manufacturing. In addition, expedites are increasing costs with overtime and shipping.