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Performance Measurements in Purchasing and Inventory Management

“People focus on things that are measured.” During my corporate career, I witnessed the truth of that statement many times. However, in my consulting work, I see many instances where the lack of measurements has created operational issues and less than desired results. The subject of this newsletter is: What measures should you use in Purchasing and Inventory management?

Inventory

The two most basic measurements for managing inventory are accuracy and velocity (turnover). If location accuracy is not 99+% in your plant and/or warehouse, inventory decisions may result in schedule adherence and/or customer service issues. Location accuracy is defined as: the part number and actual count in a location match the data in the computer. The best way to develop and maintain location accuracy is a cycle count program. Physical inventories on an annual, quarterly, or even monthly basis will not lead to improved accuracy.

I like the term velocity because it reminds us that inventory at rest is costing your company money. Inventory that is moving through a manufacturing process or that is being picked, packed, etc. in a warehouse is potentially earning money. Turnover is defined as follows:

Inventory turnover =
Average cost of goods sold
Average inventory

Most companies measure turns for the entire business and think they can mange inventory at the “macro” level. Don’t stop there. Inventory decisions are made at the item and product family level of detail. You need to find the manageable “chunks” of inventory for your business – i.e. product lines, locations, finished goods, work-in-process, purchased materials, etc. When you can measure the turns for each chunk, you can make fact-based decisions about how much inventory to produce, buy, or hold. Another benefit of chunking is that you may have different people managing the chunks. Now you can establish a measure of their performance relative to inventory and they can be held accountable.

A third important measure is forecast accuracy. Forecast accuracy directly impacts the amount of inventory in your system and how many turns you can achieve. Sales people often resist the idea of measuring forecast accuracy or take the position that it is “impossible” to develop a forecast for your business. However, most sales people will agree that they know something about who their customers are and what the customer is likely to buy over the next 6-12 months. There is also some history regarding sales data except for your newest products and customers. The information may be labeled “sales budget” or sales “quotas”, but it is a forecast. Start to measure forecast accuracy, it will never be 90+%, but even small improvements can result in inventory reductions.

Identify your company’s cumulative lead time – the idea is that any permanent reduction in lead time should result in less inventory. Start to analyze your end-to-end lead time. Can you find activities in your supply chain process that can be done in parallel, rather than sequentially? (My December ’06 newsletter addressed this concept in detail, e-mail me if you want a copy.)

Purchasing

Here are some typical operational measures:

  • Total dollars by commodity and by supplier
  • Number of purchase orders or releases per month
  • Number of suppliers
  • Supplier quality and delivery

These are all valid and provide some useful information. Here are some additional suggestions that focus more on performance:

  • Cost reduction – how much money has been saved by lowering the total delivered cost of the items or services that you purchase?
  • Cost avoidance – what is the value of price increases that were reduced through negotiation by either lowering the percent increase or delaying the effective date?
  • Supplier certification – how many suppliers have had their process certified and ship product without inspection?
  • Supplier inventory programs – have you implemented any programs to reduce total inventory in the system, not just pushed it back to the supplier?
  • New suppliers – how many new suppliers were introduced this year? Has the total number of suppliers been reduced?
  • Supplier visits – how often do your purchasing people and sourcing teams visit supplier facilities?

There is a lot more to say about each of these measures and how to implement them. Let me know if you want additional information. Thank you for reading this newsletter. If you know of someone in your company or in another company that would find it of interest, please forward it to them. If you do not want to receive future newsletters, you may reply and indicate that.

Copyright 2007 HCS Consulting – all rights reserved.