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Let’s Talk About Inventory Turns With Network Analysis

At St. Onge Company, we design efficient and cost-effective supply chain networks. One of the key factors we consider is inventory turns. But what exactly are inventory turns, and why do they matter so much in network design?

Picture your inventory as a revolving door. Every time a product enters (is purchased), it needs to leave (is sold) to make space for new arrivals. Inventory turns tell you how many times this revolving door spins in a specific period, usually a year (365 days).

Here’s the formula:

Inventory Turns = Cost of Goods Sold (COGS) / Average Value of Inventory at Cost

COGS: The total cost of the goods you sell in a year.  Average Value of Inventory: The average fiscal amount of inventory you hold throughout the year (often calculated as the average of your starting and ending inventory levels, or a monthly average).  Sometimes if COGS are not available, using Total Throughput Units, Volume, or Lbs. can get you in the ballpark.

A high inventory turns ratio, without significant stock-outs, indicates efficient inventory management. You’re selling your stock quickly, minimizing storage costs and the risk of obsolescence, thus freeing up capital for other areas of your business. Conversely, a low turn ratio suggests you’re holding inventory for too long, leading to higher carrying costs and potentially outdated products.

Given the substantial impact of inventory holding costs, it’s imperative to factor in inventory turns during network design. Inventory turns can influence both fixed (costs that remain constant regardless of your production volume, like warehouse rent or salaries) and variable (costs that fluctuate with our production volume, like the cost of raw materials or transportation) costs.  Holding less inventory (high turns) can reduce storage costs (fixed) but might necessitate more frequent ordering (variable) to meet demand.

Now, let’s explore how inventory turns can affect your network design. Some ramifications include:

• Number and location of facilities: High inventory turns might suggest fewer warehouses closer to your customer base, facilitating faster stock movement. Conversely, lower turns might necessitate strategically placed warehouses with larger storage capacities.
• Mission of facilities: A facility focused on fast-moving consumer goods might prioritize rapid order fulfillment over extensive storage space. In contrast, a facility handling specialty equipment with lower demand might require more storage and potentially delayed deliveries.
• Size of facilities: High turns often translate to smaller, strategically located warehouses to minimize storage costs. Conversely, lower turns might necessitate larger warehouses to accommodate bigger stockpiles.

It’s also essential to note that Not Every Turn is Created Equal. Variations exist across industries, with the “ideal” inventory turn ratio varying significantly based on industry dynamics. Consider these examples:

• Grocery Stores: Target high turns (often exceeding 12 times a year) due to rapid product turnover and short shelf lives.
• Electronics: Typically aim for moderate turns (around 6 times a year) due to shorter product lifecycles and increased storage space requirements.
• Automobile Manufacturers: Generally experience low turns (around 2 times a year) due to complex components, lengthy production cycles, and high-value inventory.
• Fashion Apparel: May achieve 6 – 12 turns per year, reflecting the fast-paced nature of the fashion industry and frequent product releases.
• Furniture: Typically achieve 2 – 4 turns per year, considering the custom nature of products and longer product lifespans.
• Construction Materials: Target 1 – 4 turns per year, depending on the material, with lumber typically having higher turnover rates than specialty tiles.
• Pharmaceuticals: Usually aim for 4 – 8 turns per year, balancing expiration dates with sufficient inventory to meet demand.
• Luxury Goods: Aim for 0.5 – 2 turns per year, reflecting the high value and limited production of luxury items.

By integrating inventory turns into your network modeling process, you can design a supply chain that optimizes overall costs (balancing variable and fixed costs), enhances customer service (ensuring product availability while avoiding excessive stock), and boosts agility (adapting to market fluctuations with a flexible network layout).

In summary, inventory turns serve as a vital metric in supply chain network design. Understanding their impact on costs and considering industry-specific factors allows St. Onge Company or any other consultancy to tailor a network that optimizes inventory flow and delivers optimal outcomes for your business.
 
—Odi Niyomugabo, St. Onge Company
 
 

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