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MAKING "SYSTEMS"-USE and OPERATIONS MORE-PROFITABLE
For Distributors, WHOLESALERS, Manufacturers
This article was inspired by a comical story on National Public Radio, which went something like this. A flight arrives at its destination two hours late. Upon disembarking, 100 of the passengers get together and agree to each email the airline a note thanking it for being two hours late. Over the next several weeks, the collaborators do exactly that, but only a few send an email on any given day. The airline’s super-smart software detects customer desires by reading emails and discerning the meaning. After a few weeks of analyzing emails, the software sends a message to flight operations suggesting that the flight number in question be scheduled to always arrive two hours late!
In the world of inventory management, seldom are there malicious actions that impact inventory levels, but there are unusual situations that cause inventory and other problems. Here are three.
Don’t Disappoint A Customer
A customer calls and wants product A right now, but the distributor is out of stock and not due to get any A for a few weeks. So the customer service rep offers to sell product B, a very slow moving expensive product that is a compatible, higher grade product and is in stock, at the same price as A. The rep keys in the product code for B, and the sale is made, but at a loss for the distributor. The next day, the same substitution occurs; B is sold, even though the customer wanted A. B is substituted for A a few more times during the next two weeks, and then A comes in.
The distributor’s ERP system detects that the quantity on hand for B has reached its "trigger" point, and recommends ordering more; it is selling frequently and in volume. The system ignores A because there has been no demand that could trigger a suggested purchase of A, and it is already on PO backorder. B is purchased. Then someone notices that every sale of B is at a loss, and discusses the situation with the service reps. But what can the reps do until product A is received in? Continue selling B.
The technical way to avoid this situation is to use ERP software that allows order entry personnel to enter the product code for product A, but then cancel it and enter a code that indicates a substitution; then enter the product code for B, the substitute. The ERP system would then use data for B in sales reports, but use only data for A in determining when and how much to buy. Absent such sophistication in an ERP system,
the alert of this problem is a daily report listing products that were sold for less than the target gross margin; data for products sold at a loss would appear at the top of the report.
Buy At A Lower Cost
A customer order is taken for a very large job, and the order aught to be shipped by the factory direct to the job site. But the service rep realizes that the costs for such a large quantity are so low that he/she asks someone in purchasing to order extra quantities, bring it all into the warehouse, and keep the extra quantities in stock (while shipping the customer-needed quantities to the job). So the PO is placed and the products received into the warehouse.
The ERP system stores each new low cost as the "last cost", and re-computes each "average cost", both of which are now much lower than before. If automated pricing is based on average cost or last cost, the system could compute new lower, prices for these products, even though most of what will be sold was in stock prior to the receipt of those very large quantities; and is in stock at higher actual (accounting) costs. The combination of lower prices and higher real (accounting) costs means real lower gross margins on sales of these products, but the system would not detect that – it "thinks" that the costs are the new, much lower ones, and the margins are the same as before. Eventually, when more of these products are purchased at higher costs, the average cost will be correct (and last cost will be correct upon receipt of higher cost products). Sales commissions based on gross margin might also decrease.
But wait, there’s more bad news. When the ERP system forecasts future sales, it uses data on the sales of the products that are shipped from the warehouse to the job site where they should have gone in the first place. When it is time to purchase the products in question, the system uses that forecast and recommends buying a very large quantity to satisfy projected, large future sales. But this was likely a one-time job, so the large quantity could sit in the warehouse for a long time.
Had this order been handled as a direct-ship, the ERP system would not have distorted costs, prices, margins, sales commissions or purchase quantities. The way to avoid this situation is to establish a policy that no direct-to-job orders can be diverted to come in house without approval from executive management (who would be able to make adjustments in the ERP system so that the problems are avoided when the large
quantities are received). A way to possibly detect the problems is to print a daily list of purchase orders generated today and involving more than $X; on the report, show any PO notes, such as "for customer order #nnnn; ship to job site xxxxx."
Allow All Customer Returns
To be competitive, almost all distributors allow good customers to return undamaged, stock products well after they were purchased; sometimes, non-stock products, but that is another story. So three months after receiving large quantities of many different stock products that had been shipped factory-direct to a job site, a customer returns many different products; including a very large quantity of a product that the customer did not use at all.
There is no problem with the costs data, but the ERP system stores the returns transactions as negative product movement – negative movement for products that had not been sold from stock. When the system forecasts sales for these products, it takes negative movement into account, and would forecast less than is really needed for future sales from stock. Especially for the product for which a very large quantity was returned. If the forecast gives more emphasis to recent "sales", those returns would drastically reduce the forecasted quantities. Due to the extra quantities in stock, any purchase of the products in question would be delayed (because it would take longer to reach the "trigger" point), but the recommended purchase quantities would be less than is needed to satisfy real demand (undistorted by the returns).
One way to avoid this problem is to train the people who key in data for returns to look for information that would indicate that the products being returned had been shipped factory-direct to the job site. One clue might be that the return took place several months after the purchase. Train these people, or others, to process the returns as adjustments to inventory, not "returns." (The returns would still show as negative sales, and average costs would still be impacted). When forecasting, most ERP systems ignore adjustment transactions. Due to the extra quantities in stock, any purchase of the products in question would be appropriately delayed, but the purchased quantities would not be distorted by returns. One way to detect the problem is to print a daily list of returns of direct-ship sales (as indicated by a code in the order data), and then make adjustments to counter-act the already processed problem transactions.
There are more of these inventory oddities, so someone involved with operations should talk with sales, warehouse and inventory management personnel and create a list of the possible problems. And even though my contact information is shown below, when someone thinks of other inventory oddities, "Wait, Wait Don’t Tell Me" -- which is the name of the radio program that inspired this article. But do take action to avoid inventory-impacting and margin-impacting situations, and set up alerts or reports to inform managers about problems when the odd situations do occur.
Dick Friedman, the author, is a recognized expert on inventory management strategy and tactics for distributors. He is a Certified Management Consultant and isobjective and unbiased, so he does NOT SELL software or technologies. Based on more than 30 years of experience helping distributors manage inventory more profitably, he has developed unique ways of managing inventory – ways that increase customer service and ROI. Call 847 256-1410 for a FREE consultation, or visit his Web Site www.GenBusCon.com for more information or to send e-mail.