Inventory Management Is as Easy as ABC
Inventory Management Is as Easy as ABC
Use a system that maximizes both working capital and customer satisfaction.
Rupe S. Hansra, O.D.
Downers Grove, Ill.
When stocking a cutting-edge dispensary, regardless of its size, operating profit and customer satisfaction can erode quickly without the proper checks and balances. Too much inventory consumes working capital and disrupts cash flow, while not enough has a negative impact on product sales and customer service. (See “Learning From Swift and Slow,” at the end.)
Inventory control balances these conflicts. This does not mean the more product you have, the better the inventory. The object is to optimize customer service with inventory costs. In essence, carry the right amount of inventory to match customer demand. For contact lenses, this might mean carrying enough boxes to meet patient needs today, while having the rest of the supply delivered to the patient's door within two days. For frames, this could mean having sames-day availability in your practice of those frames you market on your website.
Before you implement an inventory management program, you must provide a sound foundation of leadership. Ask yourself these three questions:
► Who is managing your inventory?
► What systems and benchmarks do you have in place?
► How well are you achieving your goals?
It's critical to answer these questions because eyecare practitioners (ECP's) must take an active leadership role in supervising their inventory levels of eyewear and contact lenses. While delegation is an important part of leadership, you must have a well-thought out strategy to be able to execute your inventory management plan.
Where do you start?
To determine proper inventory levels, start by looking at your current stock. Then, answer these questions to provide insights into how well you manage your dispensary:
► Did you order a large number of frames on closeout that aren't selling?
► Did you fail to plan accordingly for “Back to School” or “Insurance Week,” which left holes in your inventory and caused you to lose customers?
► Do you have any safety stock of your highest turnaround items?
► Is there anything else in the marketplace or season, which might affect stock levels?
► How often do you order stock?
► Who oversees ordering?
► When is this person available to authorize the order?
Create a “patient-centric” system
Availability is a measure of how well you satisfy your customers' needs based on the percentage of how many complete orders you filled compared with the total number of customers desiring the product. We can express availability as:
Availability = (Number of orders delivered)/(Total orders)
While we can shoot for 100% availability, chances are 100% is probably not realistic due to the sheer complexity of contact lens prescriptions, as well as the cost of frames. What might be considered acceptable availability is different based on the items and your previous experience. For example, you might choose to limit the availability of a specialized item, such as prescription ski goggles.
To optimize availability, consider developing a strategy that answers the following questions as they relate to the mission and core values of your practice:
► Will you have the same availability across the board?
► Will you focus on your most valuable customers?
► Will you enhance service on your most sensitive products?
► What products are you willing to let go on backorder?
► Will you have the greatest availability on the most profitable frames?
► Is your staff aligned on communicating estimated delivery dates?
► When delivery dates are not met, what protocols are in place to connect with the manufacturer as well as the customer?
Once your practice establishes an availability strategy, you can then set your sights on optimizing your levels of inventory to meet your practice's unique needs.
Peapods and Prada
At this point, our inventory journey takes us to Italy. Let me explain: While working in his garden, Italian economist Vilfredo Pareto noticed that 20% of the peapods produced 80% of the peas. This well-known theory, called the Pareto Principle, has been extrapolated to many forms of business, which implies that 80% of the effects come from 20% of the causes. We can modify this principle to manage our inventory levels.
That is, we can take advantage of this principle by assigning a value to each stock item, through multiplying the unit cost by the annual turnover. If 20% of the lines represent about 80% of the stock, the principle would suggest we reduce the high stock value items. Traditionally:
► The first 10% to 15% of the stock items provide 65% of the turnover value.
► The next 20% to 25% of the stock items provide 25% of the turnover value.
► The remaining 70% of the stock items provide 10% of the turnover value.
Figure 1 offers a fictitious sample inventory of 10 items. This figure takes into account usage, cost, annual turnover and “stock value rank”(a ranking by annual turnover cost) as shown.
Figure 1. Sample Inventory.
In Figure 2, we take the same information and organize it by class ranking. Now we see that the “A” class amounts to 10% of the frames inventory and represents about 65% of the annual turnover. We also note the next 20% of the lines, our “B” class, constitutes 23% of the annual turnover. The remaining 70% of the lines, “C” class, accounts for only 12% of the annual turnover.
Figure 2. The Sample Inventory classified by usage.
The purpose of ABC analysis is not to provide different levels of service, but to provide a high level of service with the least amount of effort. The analysis tell us:
► “A” class items carry the most value and are few in number, yet have rapid turnover. These items require more effort and need tighter control with personal supervision. Use a computerized inventory system in conjunction with your market expertise to arrive at and maintain stock levels at the lowest appropriate level to maintain highest-service levels.
► “B” class items amount to more in number, but have a low stock value. Personalized supervision might be too cumbersome for this relatively low percentage of your inventory. Allow the computer to manage these items with a lean stock policy and fast appraisal method.
► “C” class may contain many items, but they might turnaround slowly. In cases of slow-moving, high-cost items, consider ordering as purchases are made. If inexpensive items move quickly, consider investment in extra stock.
Pareto in practice
Many ECPs find that they have too many “A” class items. This is especially evident as some practice managers advocate a one-size-fits-all mentality by suggesting you expect three turnarounds a year on each frame. This does not represent a good balance between maximizing service levels and protecting your profit and loss.
If you stock 750 frames, your “A” class inventory should be equivalent to about 10%, or 75 frames. Hand count these frames everyday. You also might find you have a large number of “C” class inventory, some of which is slow moving. Consider asking why? If an item, such as sports goggles, is out of season, perhaps a markdown might be in order to move them out of your system. You also might find you need to winnow some other items, and move to an order-when-purchased policy.
Calculate stock cover
Next, in order to help you analyze your current inventory levels, calculate your Stock Cover:
Stock Cover = (current stock x 52)/Annual Usage
This calculation gives you the number of weeks on hand for a
particular item. For example, if you have 16 boxes of −2.00 XYZ contact lenses and you sell 832 boxes a year, you would anticipate (16 x 52)/832 =1, or, your office is carrying one week worth of inventory. Or, you would exhaust your inventory of 16 boxes in one week if you did not re-order. You also might find you have 20 pairs of a large double-bridge frame style, and forecast you will only sell six pairs. We find that (20 x 52)/6 = 173 weeks to sell the product—way too much inventory.
A good rule of thumb to achieve optimal stock targets:
► “A” class items: one-to-four weeks on hand
► “B” class items: two-to-eight weeks on hand
► “C” class items: three-to-20 weeks on hand
Paradoxically, you might hold lower stocks of your best sellers and order more frequently, which allows you to maximize working capital and cash flow.
By executing an inventory strategy (see “Your Leadership in Action” on this page) you'll establish a foundation for effective management. And equally important, you'll assure your practice maintains a competitive advantage by using sound business principles to drive customer satisfaction. OM
|Learning From Swift and Slow|
|To understand how inventory controls can have an immediate impact on an optometric practice, consider the example of two fictitious practices, Office Swift and Office Slow. Both practices have annual net sales of $400,000 and expenses of $260,000.
Office Swift has a tightly controlled inventory management system. Office Slow carries an excess of $50,000 in inventory due to a large understock and needlessly pays an additional $5,000/year in financing charges.
With its greater profitability, Office Swift can invest more back into the practice—in this case, $5,000. Office Swift acquires a device that measures macular pigment optical density, which ultimately improves the patient experience, quality of care, referrals and practice growth. Not to mention, Office Swift grows sales by 5% the following year, increasing their net profit by an additional $7,000. Office Slow continues to do nothing different the next year and maintains flat sales.
The profit differential between the two offices in year two is now $12,000. Office Slow blames the economy and the competition, while Office Swift prepares for expansion and the cycle continues…
|Your Leadership in Action|
|To optimize the inventory levels in your practice, use these five action steps:
► This week: Set aside an hour to review your inventory.
► By mid-week: Have your office manager calculate the annual turnover in dollars and percentage.
► By the end of the week: Collaborate with your manager to rank and classify your frame and contact lens inventory.
► In 10 days: Have your manager provide a recommendation on how inventory can be optimized (daily manual counts, reductions, etc.) and how to communicate this new policy to staff.
► In 30 days: Review the changes with your manager.
||Dr. Hansra is the senior director of eye care at Luxottica Retail. Contact him at email@example.com. Send comments on this article to firstname.lastname@example.org.
Optometric Management, Issue: September 2011