PERFORMANCE MONITORING IN STOCK MANAGEMENT

The inventory management process can be decomposed into four basic aspects: the policies and quantitative models used, the organizational issues involved, the type of technology used and, finally, the monitoring of process performance.

The objective of this article is to approach the aspect referring to the monitoring of process performance, discussing the commonly adopted practices as well as the characteristics considered as the most adequate. A monitoring system can be used for two purposes, measuring and monitoring the performance of the process as a whole and providing subsidies for employee recognition and reward programs, the first purpose being the focus of this article.

Structuring process performance monitoring systems has several aspects, such as choosing the type of technology to be used and defining responsibilities for the performance to be monitored. However, a key issue is determining which performance indicators will be used, so that the monitoring system meets all needs and is aligned with the company's strategy.

The performance indicators used in inventory management can be segmented into three groups: cost, service and process compliance. The first two groups of indicators are related to the results of the process that make up the basic trade-off of inventory management, that is, balancing the level of inventory with the level of service in order to obtain the lowest total cost. The third group of indicators, in turn, is associated with the reasons why performance is achieved.

These three groups of indicators are detailed below.

COST INDICATORS

Cost indicators are usually the most used in monitoring companies' inventory, often being the only ones; nowadays everyone is concerned with the size, value, of the stock. This great importance given to cost indicators is often due to the lack of a global vision of the inventory management process, which does not cover the impacts that reductions in inventory levels can generate on the degree of product availability and, consequently, on the level of company service.

Inventory management incurs two basic types of costs: inventory holding costs and costs associated with stock-outs. This second type of cost is related to the company's service level and is often neglected.

An indicator system that monitors only maintenance costs is able to answer the question of how much it costs the company to maintain its current level of inventory, but cannot inform how much inventory reductions can cost without technical basis. In this way, the system cannot help in the analysis of the basic trade-off of inventory management already mentioned above.

The two types of cost are discussed in more detail below.

STOCK HANDLING COST

With regard to this type of indicator, three issues must be addressed: the difference between value and cost of inventory, shortcomings in monitoring book values ​​and the need to use more than one indicator to obtain quality information.

The first point refers to the difference between inventory value and inventory cost. The value of the stock informs how much the stock is “worth”, that is, the total sum of the value of the finished products and the inputs owned by the company, but not how much this “costs” the company. This must be measured according to the opportunity cost of this stock, that is, what would be the return for the company if the amount invested in stock were applied in some other way, or, on the other hand, how much is lost due to the fact that that value be immobilized. This cost is reached by multiplying the value of the stock by the minimum rate of attractiveness of the company in question, that is, what is the minimum return that a project or investment needs for the company to decide to invest in it. As this value is often not known, it is common to use financial market rates, CDI and SELIC, to obtain this cost.

The second point refers to the use of accounting indicators to monitor inventory. As these indicators are built based on standards and accounting principles, many times they are not a faithful representation of the physical flow of materials in the company. This is particularly true with regard to the practice of abrupt reductions in the book value of inventories on the eve of closing quarterly balance sheets. These reductions can be achieved, among other devices, by postponing the payment of inputs until after the closing of the balance sheet, but with the product already received.

Another inadequacy of accounting indicators concerns the fact that they treat information in an aggregate manner, not making distinctions between products with different characteristics.

Finally, the third point concerns the need for more than one indicator for complete monitoring of the cost of holding stock. For complete monitoring, we consider that it is necessary not only to have information on how much inventory costs, an aspect covered by the indicator presented above, but also whether this cost is adequate to the characteristics of the company.

The answer to this second question can be obtained through the stock coverage indicator, that is, the time in which the existing stock is sufficient to meet demand, without the need for replacement.

Let's take an example to demonstrate the importance of combining these two types of indicators. A company with an inventory value of R$4 million and an opportunity cost of 20% per year has an inventory cost of R$800/year. However, this value may have different relevance from one company to another. For example, for a company with annual revenues of R$ 48 million, this value indicates that the stock is only enough for one month, on the other hand, for a company with annual revenues of R$ 8 million, this stock is enough for six months !

In this way, the same stock value can represent a very low level, as in the first example mentioned, but it can also be a warning sign, as in the second example.

COSTS ASSOCIATED WITH OUT OF STOCK

The costs associated with the lack of stock are closely associated with the level of service achieved, being its financial quantification. Despite their great importance, they are rarely used.

Finished products and inputs must have different indicators, despite being based on the same concept. In the case of finished products, the shortage cost is measured through the contribution margin of each lost sale due to product unavailability. That is, how much profit the company fails to earn by not being able to meet an existing demand. For cases of high-margin products, the cost of shortages tends to be quite significant, impacting the desired inventory level.

In the case of inputs, the cost of the shortage must be measured according to the impact that the unavailability causes for the company, using the same concept used for finished products: how much is lost, or loss of profit. This loss of profit can be achieved by estimating production stoppages due to lack of products. By this reasoning, the lack of a single input can result in the interruption of the production of a finished product. This implies that even inputs with very low added value can have a high shortage cost, due to their dependence on the production process. This logic can also be used for maintenance parts.

Often when measuring the cost of shortages, it is noticed that the inventory level must be high in order to reduce the loss of contribution margin. In fact, weighing the two types of basic costs present in inventory management is one of the main drivers of the entire process. By comparing the two costs, the inventory level that will result in the lowest total cost is determined, which is the sum of the inventory maintenance cost and the cost related to lost profit due to product unavailability. Figure 1 exemplifies this relationship, with the total cost curve equal to the sum of the other two curves.

OTHER ASSOCIATED COSTS

As inventory management encompasses a wide range of company activities, there are usually costs other than inventory maintenance or directly associated with product shortages, which are impacted by the management process. The definition of which costs should be considered depends on the operational characteristics of each company, and its main impacts on inventory management must be identified.

These costs must be monitored so that it is possible to assess the total cost of the materials management process. These are often as relevant as inventory maintenance costs or product shortages.

An example of this type of cost is the cost of destroying drugs in the pharmaceutical industry. This industry is characterized by products with high added value and very high perishability. In this way, high stock coverage generated by inefficient stock management can result in the loss of products due to perishability. When this occurs, in addition to losing the cost of the product, it also incurs the cost of destroying the drugs, which must be incinerated.

Another example is that of companies that have imported supplies, with purchases planned in advance and transport carried out by maritime modal. In cases of lack of stock, with a need for quick replacement, you can choose air transport, which has a much higher cost than sea transport. In this case, the difference in freight paid is a direct result of management failures.

SERVICE LEVEL INDICATORS

Service level indicators are associated with inventory management results in terms of product availability. Although less used, this type of indicator is of great importance, as the service target to be achieved will strongly influence the stock level.

These indicators can be divided into two groups according to their objectives: the cost of absence and availability monitoring indicators. The cost of shortages has characteristics that allow it to be classified both as a cost indicator and as a service level indicator, having already been discussed in the part of this article referring to cost indicators. Thus, the other type of service level indicator will be discussed from this point on.

Indicators related to product availability can be associated with two views: the customer's or the product's. From the customer's point of view, the level of service can be measured, for example, as a function of the percentage of orders with full availability (complete orders), or the percentage of order lines with product availability (an order can be made up of several types of product, where each product represents an order line). In other words, this view exactly represents the service provided by the company to the customer, these indicators should serve as a guide for inventory management to meet the needs defined by the company's strategy.

From the product point of view, the indicators are associated with the availability of each product, that is: percentage of demand for the product in a given period of time met immediately, frequency with which the product is out of stock, among others. As they convey more segmented information, these indicators allow identifying specific products that are experiencing problems, as well as monitoring groups of products with differentiated inventory strategies, such as, for example, higher desired service levels for more profitable products.

COMPLIANCE INDICATORS

The cost and service level indicators allow monitoring the final result of the inventory management process, however they are not capable of explaining the performance obtained. This type of information is obtained through process compliance indicators.

These indicators are fundamental for the most adequate sizing of the stock level. The main function of inventory is to ensure product availability based on the company's operating characteristics and to absorb current uncertainties. Within this context, the function of the compliance indicators is to monitor all aspects and uncertainties impacting the stock level.

The more complex, uncertain and restrictive the flow of materials, the greater the level of inventory required to achieve a given level of service. Thus, understanding the flow of materials is necessary to ensure that the defined inventory level, based on formalized policies and processes, is the most appropriate for the company's characteristics.

The flow of materials is composed of several different activities, each of which may or may not impact inventory levels. The main objective of understanding this flow is to identify which activities are relevant to inventory management and which, consequently, should be monitored. In order to exemplify this identification of relevant activities, we will follow the flow of materials in a traditional industrial company. The flow starts with the demand forecast, which will serve as input for production planning. Based on this planning, the need to purchase raw materials is defined, the schedule of which must respect the supply lead-times of each supplier.

These activities are all related to starting the flow of materials that will result in raw material inventory. In this way, this stock is influenced by the lead-time of resupply and by the reliability of the supplier. Another impactful activity can be the production planning itself, in some cases this undergoes frequent changes, and in a shorter time horizon than the replacement time. When this occurs, the inventory level must also be prepared to absorb this uncertainty.

Once the activities relevant to the raw material stock have been defined, we move on to the finished product stock. Also for this, the impacting activities are related to demand, in this case the accuracy of the sales forecast, and the uncertainties in its replacement. With regard to replacement, this is associated with production reliability, yield and quality control, and its response flexibility or manufacturing time.

Once the activities that must be monitored have been identified, the next step is to identify the impact of each one on the stock level. This stage requires that the stock policies used by the company are defined and structured, with regard to the mathematical models used in the definition of safety and cycle stocks.

As already discussed in the article “Managing Uncertainties in Logistic Planning: The Role of Safety Stock”, published in this journal in February 2001, safety stock can and should be parameterized according to the uncertainties existing in the process. Thus, a large part of the uncertainties previously considered relevant will already be considered to some degree for the calculation of the safety stock, in the form of some statistical measure. This statistical measure should be used as an indicator. Examples of this type of measure are sales forecast accuracy, production reliability, and supplier delivery time variability.

Figure 2 presents an example of process compliance indicators for an industrial company, which has an imported supply, with a long lead time and low supplier reliability. The need to schedule the supply in advance makes the sales forecast extremely relevant, its accuracy being one of the main uncertainties contemplated by the safety stock. As it is a chemical industry, sometimes the planned production is not achieved in its entirety, and its reliability is also monitored.

This use as model parameters is what allows these indicators to inform the causes for the stock level resulting from the management process. As the stock models are prepared for changes in any of the parameters used to indicate the need for changes in the stock level, the opposite can also be done. That is, the manager can look for the cause of any change in the stock by monitoring the process compliance indicators. For example, an increase in supply lead time automatically generates an increase in required inventory.

The relationship described above allows the indicator system to be structured based on a cause-and-effect logic, in which process compliance indicators and cost and service level indicators are related through the inventory models used. Figure 3 shows a cause-and-effect diagram based on inventory management indicators, for the industrial company already mentioned in figure 2, in which the inventory level and the service level result from the combination of the accuracy of the forecast of sales, reliability and delivery time, and production reliability.

This cause and effect relationship allows not only to identify the causes of movements in the stock level, but also to define strategies for stock reductions without compromising the level of service. With the policy parameterized, actions with the objective of improving some indicator will automatically result in stock reductions.

CONCLUSION

An adequate inventory performance monitoring system performs two extremely relevant roles for the inventory manager: it informs the performance of the management process, considering all the impacts caused by it, and it indicates the reasons for this performance.

Regarding the first role, a monitoring system that encompasses all the impacts of the stock allows decisions to be taken knowing all the implications thereof. This avoids seeking reductions in stock levels at any cost.

On the other hand, identifying the causes for stock performance allows stock reductions to be achieved through actions that will result in a reduction in stock “needs”, without compromising the level of service. It also allows the establishment of a process of continuous improvement of stock levels, promoting improvements in the most impactful activities for the stock.

However, for this type of monitoring system to be implemented, and for these objectives to be achieved, it is essential that there is a structured inventory management process behind it, with defined policies, parameterized and adequate to the needs and characteristics of the company. The reciprocal of this dependence is also true, that is, a structured and formalized inventory management process will not obtain all possible gains if it is not linked to a performance monitoring system.

BIBLIOGRAPHY

GARCIA, Eduardo Saggioro, LACERDA, Leonardo Salgado, AROZO, Rodrigo, “Managing Uncertainties in Logistic Planning: The Role of Safety Stock”, Tecnologística. February, 2001

KEEBLER, James S., MANRODT, Karl B., DURTSCHE, David A., LEDYARD, D. Michael, “Keeping Score: measuring the business value of logistics in the supply chain”, Council of Logistics Management, 1999