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SOLA Optical is a leading global manufacturer of lenses for prescription eyewear. Customers, mostly retailers and laboratories, purchase lenses as needed to fill prescriptions. With over 15,000 finished goods part numbers, few customers can afford to stock large inventories. SOLA meets the inventory requirements of the customer by stocking lenses at regional distribution centers (DCs) and providing overnight delivery to the customer. Products not available from the local DC are shipped, at SOLA expense, from another DC or are backordered. SOLA strives for a 95 to 99 percent service level as measured by same-day shipment from the preferred DC. (Service level is sometimes referred to as the order fill rate or the line fill rate.) The question is, "How much inventory do we need to reach our service level objective?" Too little would result in unacceptable service levels, but too much is expensive and wasteful. SOLA uses aggregate inventory management for master scheduling, capacity planning, and budgeting. Inventory is best measured as it relates to demand. Several ratios have been developed to aggregate inventory and compare it to current or expected demand. The question becomes, "Which inventory ratio should we use?" One of the most popular inventory ratios is turnover. The formula for inventory turnover is annualized cost of goods sold divided by average inventory, also at cost. Inventory turnover has been around for years and was probably very useful before we had computers to monitor inventory at the stockkeeping unit (SKU) level. Inventory turnover may still be the best tool we have to compare companies via their financial statements, but for internal analysis, inventory turnover has outlived its usefulness. The problem is that inventory turnover is a financial ratio. It takes our valuable SKU information and converts it to cost. It assumes that two $5 items are the same as one S10 item, even when one is backordered and we have a lifetime supply of the other. There is another problem with inventory turnover, but first I will show you months on hand analysis and describe how it solves the cost problem. Months on hand (MOH) overcomes the cost problem by expressing both demand and inventory in units. At SOLA, actual demand, as opposed to sales, is used for historical analysis and forecasted demand for planning purposes. Inventory is aggregated at the product family level (more on that later). Unfortunately MOH, like inventory turnover, assumes that a shortage of one product can be compensated for with additional quantities of another product, or that shortages at one location are offset by overages at another. This may or may not be important. After all, we are talking about inventory aggregation. Let's look at some actual MOH data. The scatter chart in figure 1 was produced in Microsoft Excel. The X axis is the inventory level, expressed in months on hand. The Y axis is the corresponding service level expressed as a percentage of orders shipped the day the order was placed. Since both inventory and service level are expressed as functions of demand, we can that more inventory (higher MOH) should result in higher service levels. We would expect the data points to go from bottom left to top right. To Be Continued STAY CONNECTED To stay current on Lean Management Basics and Best Practices, subscribe to our weekly MBBP Bulletin... and we'll send you our PowerPoint presentation "How to Survive in an Entirely New Economy." All at no cost of course. Your personal information will never be disclosed to any third party. privacy policy
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