January 24, 2006
Volume 2 Issue 46

 Encouraging Inventory Accuracy

In the wholesale distribution business, the warehouse is where the action is. It’s a place where hundreds of thousands of dollars worth of inventory remains in continuous motion – from the instant an item arrives, gets put away, picked, packed and staged to the moment it’s loaded onto a truck. And as a result, your capability of keeping track of the entire process can make or break the success of your entire business – because errors in the warehouse can both slow your operations and chip away at customer satisfaction.

Most distributors realize the significance of inventory accuracy – that is, having the available quantity of an item in your computer agree with what is actually on the shelf in your warehouse. Management should realize that bad things, such as this, happen when inventory accuracy doesn’t exist:

• Wasted Time: If your inside salespeople continuously have to go out to the warehouse to check stock, they’re wasting time. They can’t walk out to the warehouse and answer phone calls at the same time. Plus your customers’ time is also wasted as they sit on hold while you rush out to check stock. Do they really take pleasure in listening to elevator music or to a ten minute advertisement reciting your commitment to customer service?
• Wasted Money: If inventory is nowhere to be found in your warehouse, whether through misplacement, theft, or breakage, it must be replaced. Buying replacement material is an expense. And like payroll, rent, or any other expense the replacement material must be paid for with part of the distributor’s net profits. For example, if $100 of material is lost per week ($5,200 a year) this $5,200 comes off of your bottom line. If your net profit before taxes in 4%, it takes $130,000 in new sales to make up for this loss ($130,000*.04 = $5,200)!
• Disappointed Customers: If you guarantee material to a customer based on what your computer says is in stock, but the material actually isn’t available in your warehouse, the result is often a very dissatisfied customer. You’ll lose your reputation as a dependable supplier. Not being a reliable supplier is the greatest way to boost your competitor’s sales.

There’s little doubt that management realizes the value of inventory accuracy. But, how do you convince your employees that inventory accurateness is essential? Here are two simple ways:

• Convince them that inventory accuracy is a vital element for the success of your company – and that their professional futures are dependent on the success of your company.
• Provide economic incentives for maintaining correct inventory.

What’s good for the company is good for the employee

It is crucial that all of your employees, from the guy who sweeps the floor on up, recognize that your company makes money by buying material at one price and selling it to other companies/individuals at a higher price. If too much material is lost there won’t be enough money in the pile to meet payroll. At the end of every month, let your employees know how much the material that was lost that month cost the company – how much money was wasted instead of being accessible to pay salaries, benefits, and other worthwhile expenses. In an ideal world, all of your employees would realize that their future is tied to the success of your company and they would look after your inventory and other assets as if they were their own.

We’ve studied several inventory-accuracy-related compensation programs and we’ve found that the most successful ones are tired to cycle counting. Cycle counting is the process of physically counting part of your inventory every day and comparing the quantity found on the shelf to the on-hand quantity in your computer. Part II’s newsletter will focus on cycle counting. The following is a great example of a compensation program that was implemented by a typical distributor.

The distributor involved was loosing one-tenth of his inventory to theft every year. It was discovered that the majority of the pilferage was being committed by employees. Because of the transient nature of the local workforce (the company was located in a resort area) it was determined that it would be easier said than done, if not impossible; to convince the employees with words alone that their long term future was tied to the profitability of the company. So the distributor instituted a new radical compensation program. Instead of paying everyone by the hour, a considerable portion of every warehouse employee’s compensation was now dependent on the accuracy of the inventory counts in the warehouse. Management cycle-counted part of the inventory every day and employees didn’t know in advance when a specific item would be counted. The inventory accuracy goal was titled the "97-3" rule. If 97% of the counts in a two-week period were within 3% of the quantity that the computer determined should have been in inventory, every employee received an incentive bonus. If the cycle counts fell short of the goal, no employee received the bonus. When the bonus was earned, warehouse employees earned 10% more than they did before the program was implemented. When the goal wasn’t met, they earned 10% less.

The program resulted in every warehouse employee becoming an "inventory watchdog." They realized that if there was an inventory shortage, the end result would be a reduction in their next paycheck. If they saw someone stealing, they viewed that person as stealing from them personally, not from the business. The result was that inventory shortages decreased significantly. Employees will either buy into this approach or they won't, but in either case a distributor can’t maximize productivity and profitability unless inventory accuracy is achieved.

EVERYONE WINS WHEN INVENTORY IS ACCURATE

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