Creating shareholder value is the ultimate goal of all businesses, so all processes should be directly tied to it.(1) The wholesale distributor’s core business process framework is a collection of process groups called 7S – source, stock, sell, ship, supply chain planning, and support services. Linking these process groups to shareholder value are the process metrics – percentage of slow moving inventory; and the financial framework. This framework consists of the financial elements – inventory; the financial key performance indicators – GMROII; and the financial drivers – profitability. Inventory stratification is a specific business process under the inventory management subgroup in the stock process of 7S. Like most processes there is a common, good, and best practice for inventory stratification. Inventory stratification which includes the GMROII (gross margin return on inventory investment) method of A, B, C, D, X and Y items is considered best practice. A, B, C, and D represent items in inventory ranked by percentage of profitability from higher profitability down to zero profitability respectively.
X and Y represent items with zero inventories, X represents items with gross margin dollars and Y represents items without any gross margin dollars. GMROII focuses on the items profitability making it a financial driver and is considered best practice. However, for optimal inventory stratification solutions, the final rank should include a combination method of the GMROII method; sales volume method – representative of customer-centric data; and the hits method – representative of logistics based data. Once the weighted combination data is compiled, best practices can be implemented throughout all the 7S process groups and in every section of the financial framework linking inventory stratification (process) directly to four financial drivers: asset efficiency, profitability, cash flow, and growth. These four financial drivers increase ROI (shareholder value). With inventory stratification complete sourcing has integral data to complete best practice process metrics for supplier management. Supplier stratification can help a firm modify their supplier base into one that is profitable and efficient for all channels within the supply chain.
Supplier scorecards can be created which leads to numerous financial elements being increased. Inventory stratification is key for best practice levels in determining the right number of suppliers as inventory stratification status of the product in terms of movement and profitability. This indirectly defines the required customer service level as well. With supplier performance improvement, higher satisfaction rates evolve both with the distributor and further more with the customer.. If the distributor is tracking the supplier’s performance and is able to having periodic meetings with their supplier’s based on the results of the scorecards this will drive efficiency and supplier performance improvement. Also, higher supply chain reliability occurs since the supplier knows where the distributors need increased satisfaction levels to be able to continue servicing their customer at high standards.
If the scorecard says the supplier is lacking in the area of competitive pricing the distributor then has the data to begin price negotiations. This knowledge allows sourcing through the subgroup supplier management to eliminate suppliers who only provide C and D items finding the right number of suppliers for the organization. Eliminating C and D items reduces inventory and increases GMROII. You now have the option of reinvesting the resulting capital into A and B items, paying back loans, or other business opportunities. In the debt reduction case, the impact can be readily seen on the balance sheet. The investment in A items leads to further sales opportunities. The reinvestments and its associated expected inventory turns will help in calculating additional revenue and resulting improvement in EBITDA. Reinvestments can also be for capital purchases to position the business for future growth.
Inventory stratification also affects the ship and store segments of the 7S process group. With the knowledge that can be obtained from the data slow moving items can be removed from branch inventory and a Regional Distribution Center (RDC) may be implemented. This allows the branches to carry more A or B items, or simply to reduce their inventory cost. RDC’s are usually able to operate with less inventory by sales volume. Labor expense is also reduced driving profitability to the shareholders. Inventory stratification is the primary driver for sales forecast and helps populate fill rates by rank. Forecasted demand combined with lead time and safety stock is the primary component to reorder point. Inventory stratification minimizes the normally time consuming forecast process both with information systems resources and with human resources.
The best practice forecasting model is driven off the inventory stratification and is therefore driven by the sell segment, this numerically factual forecast will be void of the emotional forecasting of the sales force. Marketing can use the inventory stratification to process what customers’ needs are or what customers are interested in. Inventory stratification is integral in both customer stratification which once completed and redeployment of the sales force has occurred additional revenues are recognized and cost to serve are reduced again driving profit to shareholders. Customer service often drives large, inefficient inventories in an attempt to be all things to all people. Shareholder value seeks to carry only profitable products, at reasonable levels, producing maximum sales, while also increasing market share. Inventory stratification is an integral part of this process.
(1) Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line, by Senthil Gunasekaran, Pradip Krishnadevarajan, F. Barry Lawrence, NAW Institute for Distribution Excellence 2009.