What if you could reduce your company’s inventory by as much as 75% and materials costs by over 20% using information you already have? I’ve worked with several companies that have done just that, and in this newsletter I’d like to share with you how we did it.
Much of the data needed is probably already in your Enterprise resource planning (ERP), it just needs to be mined, reported and analyzed in a way that drives action to improve cash flow and reduce costs. Data analytics can help cut costs by managing three key areas:
- Stock keeping units (SKUs)
These three performance indicators allow you to “follow the money” and maximize the results from your cost- and inventory-reduction efforts. Here’s how it works.
SKU management includes potentially reducing the total number of SKUs you have in your system, and maximizing the effectiveness of those that you keep. The number of SKUs tends to grow over time by ramping up new products without ramping down old ones, by adding variations on the same product such as different colors and sizes, and by adding similar products to your portfolio. I often encounter opportunities to reduce product portfolios by up to 50%, which opens doors to inventory and cost reduction.
The report that is the most helpful with this is known as a turn and earn report. Although it’s common in inventory management among distributors, it’s useful, with some modifications, in manufacturing as well. The report lists the following for every part number:
- Part description
- Total revenue year to date (for finished goods part numbers)
- Total units sold/used
- Revenue per unit for finished goods
- Part cost
- Units sold/used times part cost = total cost year to date
- Units on hand in inventory
- Units on hand times cost = total inventory value
- Gross margin per unit
- GMROI on inventory
- Date last sold/used
You can see that this report can tell you a lot. Download it into Excel, and you can sort it in any number of ways. For instance, you can see which items generate the majority of your revenue (the 80/20 rule applies…and it’s usually more like 90/10), which items consume your inventory dollars, which items generate acceptable levels of margin, and which items are slow or obsolete. Using this report, one client found that over a third of their inventory yielded negative gross margins, and this only scratches the surface. Running this report for a rolling 12 months is usually best, and I suggest running it once per quarter.
There is usually a report available through your accounts payable system that lists your suppliers and the total year to date paid to them. You can usually get a similar report from your purchase order system, but I believe accounts payable does a better job of showing what you have actually spent. I suggest running this report only for suppliers related to your products or services and not expenses like rent, phone, taxes, payroll, etc.
This report allows you to identify your top suppliers in terms of spend. When I ask executives to name the top five suppliers with whom they spend the most, they might know two or three, but rarely all five. Keep in mind that materials often comprise the most money a company spends, so to reduce materials costs, it makes sense to focus on your top suppliers.
The report includes:
- Supplier name
- Key commodity
- Total year to date spend
- Percent of the total spend for all product/service related suppliers
Then you can sort in a number of ways to guide your efforts. First and foremost is descending by spend. Most of my best clients find that the top three to seven suppliers account for 50% of the spend and the top 13 or so account for 80% of the spend. Because every supplier requires POs to be issued, credit checks run, accounts payable checks issued, and other costly activities related to vendor management, if a company has hundreds of suppliers that only makes up 20% of the total spend, consolidating the number of suppliers saves money.
Over the years, the number of suppliers you use will grow; I’ve seen companies use eight or more suppliers for the same thing. While having multiple sources does help reduce risk, two or three suppliers for essential materials is usually plenty. Consolidating purchases with key suppliers provides a one-time opportunity for cost reduction through volume increases, which can yield a 20% or more reduction in materials costs.
By using direct cost/contribution margin to track your variable materials costs, then reporting the trend in materials margins over a 12-month cycle, you can easily see if your cost reduction efforts are paying off. Many companies just report materials dollars, but that doesn’t tell the whole story. If your materials dollars cost went up last month, that’s not necessarily bad. Watching the trends in your percentages of variable costs compared to revenue shows what’s really happening, and can also help track cost reduction efforts on your suppliers’ part. You can use this tool to help justify additional fixed costs such as adding manufacturing engineers.
Using data to drive cost reduction and cash flow improvements can yield surprisingly high returns in a short period of time. Once client cut their inventory by over 60% and reduced materials costs by over 10% in just a few months. All it took was mining the data and following the money. By using the approaches described in this newsletter, you can start down the road toward world-class performance in accelerating profit and growth.
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