32 KPIs That Drive Inventory Optimization
Inventory can be a manufacturer’s most important asset. Too little of it when and where it’s needed can create unhappy customers. But a large inventory has its own liabilities such as cost to store and insure it, along with the risk of spoilage, theft and damage. Organizations looking to use less capital while maintaining a saleable inventory employ optimization best practices to balance their investment constraints against their business objectives and stock-keeping unit (SKU) fulfillment targets.
A few key components to a successful inventory optimization process include the ability to account for uncertainties in supply and demand; to oversee supplier lead times, delivery patterns and schedules; to track changes in buyer behavior; and to factor in seasonality and promotional campaigns. Key performance indicators (or KPIs) help to facilitate these requirements and drive higher inventory optimization outcomes as a result for manufacturers, distributors and other supply chain-centric businesses.
The Basics of Inventory Management KPIs
Key performance indicators (KPIs) in inventory management are metrics that help you monitor and make decisions about your stock. In inventory management, KPIs matter because they offer information about turnover, sales, demand, costs and more. They can help to increase sales and revenues, make the business financially competitive, improve customer satisfaction, reduce operating costs, eliminate supply chain issues, and ensure that marketing and merchandising are effective.
In an effective KPI strategy, we always recommend that leading indicators that help provide insight into future performance should be balanced with lagging indicators that tell companies how they’ve done. I also suggest to our manufacturing and wholesale distribution clients that they keep the following basic principles in mind relative to their KPI strategies.
- Every inventory KPI needs a clearly defined goal. This goal needs to be something that can be numerically defined (quantitative not qualitative) and attainable in a reasonably finite period of time.
- It is very important that you are able to objectively measure your progress toward the goal by collecting and interpreting data.
- There must be a clearly defined data source with a standardized process for collecting and measuring that data. To accomplish this, our clients rely on the built-in data hub of our Stratum reporting application. The Stratum data hub collects, organizes and stores data from multiple sources and serves as a single version of the truth for helping our clients analyze performance KPIs and metrics across their businesses. Plus, Stratum’s packaged inventory analytics (along with analytics that span other areas of their organizations) enable our clients to effectively report on and visualize both their manufacturing-centric and enterprise-focused KPIs.
While there are many inventory KPIs and metrics in use today, I am presenting some of the most effective ones that Silvon has deployed for manufacturers and wholesale distributors over the past 25+ years. Many of these metrics now come packaged in our Stratum KPI solution or can be easily created in Stratum to support an organization’s inventory optimization initiatives.
Categorizing inventory KPIs by business operation type lets leaders focus on areas in need of change so they can implement process adjustments and track improvements. These types of metrics are Sales KPIs, Receiving KPIs and Operational KPIs.
Sales KPIs are influenced by your customers’ actions and let you know how your inventory is affected.
- Available to Promise – Available to promise (ATP) is the uncommitted portion of a company’s inventory and planned production maintained in the master schedule to support customer orders. It allows a business to keep the minimum amount of a given product within their warehouses so that use of inventory space is efficient.
- Inventory Turnover – Inventory turnover measures how many times your entire inventory is sold over a certain period and is a good indicator when it comes to efficient production planning, marketing and sales management. When your turnover rate is low, it indicates you have weak sales and excess inventory. Most high-performing businesses tend to have inventory turnovers between 5 and 10.
- Demand Forecast Accuracy – Demand forecasting resides in the field of predictive analytics. It is a percent of how close the actual on-hand quantity is to the forecast. Using it as input for calculations to determine target inventory levels is key to inventory optimization by preventing stock-outs and other negative inventory positions
- Gross Margin Return on Investment (GMROI) – Gross margin return investment (GMROI) will tell you how much money your business has made compared to how much you’ve spent on your stock or inventory over a particular period. With this information, you can take measures to invest, instead, in the inventory that offers a consistently solid return while reducing expenditures on inventories that aren’t.
- Average time to sell – Average time to sell is one of the KPIs for inventory control that will provide you with useful information about your storing processes and give you more information on how to develop your procurement strategies. Ideally, the average time to sell should be as low as possible.
- Days On-Hand – Another useful sales-focused inventory KPI is days on hand (also known as sales in inventory, days inventory outstanding, inventory turnover days or inventory days). The KPI is a ratio that shows how many days, on average, it takes a company to sell its inventory. The lower this number is, the better, because it results in lower carrying costs and less cash tied up in inventory.
- Weeks On-Hand – Weeks on-hand is an essential inventory metric for manufacturing and other inventory-heavy sectors. It quantifies investment in terms of time rather than items or units of currency. Weeks on-hand provides a definitive outline of the average amount of time your inventory actually sells in a given week. The reason this specific metric is so effective is its ability to weed out any roadblocks slowing down the time it takes for an item to enter your system, sell, and head to its final destination.
- Inventory to Sales – Also called stock to sales radio, this inventory KPI is one metric that’s helpful for evaluating potential overstocks. Combined with the inventory turnover or carrying cost of inventory metric, it will give you a better picture of the financial stability of your business.
- Sell Through Rate – The sell through rate KPI indicates how much of your inventory was sold over a specific period of time. This KPI varies by company and industry, but in general a rate above 80% is good. Average sell through is about 40% to 80%.
- Backorder rate – The backorder rate is an effective way to monitor goods or items that can’t be filled at the time a customer confirms or places an order. By using this metric to your advantage, you can set a definitive fill rate target and track your progress over a weekly, monthly, or annual basis.
- Product Sales – Product sales, also known as sales revenue, is the income from customer purchases minus any returns, canceled sales, discounts and allowances. It is normally reported on a monthly or annual basis.
- Cost per Unit – This KPI represents how much a single unit of product costs a company to produce or buy and is most used in companies that manufacture and sell large amounts of a single product.
- Gross Margin by Product – Gross margin by product is the amount of money a company keeps per dollar of sales. This metric removes any costs from producing the item.
Receiving KPIs, also known as warehouse KPIs, may overlap with operational KPIs, especially regarding storage. Receiving KPIs are specific to the process of bringing in, receiving and immediately dealing with inventory.
- Time to Receive – Time to receive is the rate at which staff members bring in and prepare to sell new stock. This KPI measures the efficiency of a company’s stock receiving process by drilling down into stock fluency and movement.
- Put Away Time – Put away time is the amount of time it takes for a company to store inventory. By decreasing this time-related inventory metric, lead time decreases.
- Supplier Quality Index – Supplier quality index (SQI) aggregates and weighs a supplier’s performance in core areas like material quality, corrective actions, promptness of replies, delivery quality, and more. This is the broadest metric companies can assign to their suppliers. Many companies we work with report monthly weighted scores, then calculate SQI for an annual average.
An operational KPI is a quantifiable value that depicts a business’s performance over a shorter period of time. Operational KPIs are used in different industries to track organizational processes, improve efficiency and help businesses better understand the insights provided by KPI metrics.
- Average Inventory – Average inventory is the mean value of a business’s inventory over a set time period. Knowing this KPI is useful because it provides a window into how much money is typically tied up in inventory at any given moment in time, exclusive of seasonal fluctuations and other variables. Many companies use this metric to assess inventory shrinkage in order to prevent any further supply chain losses or inefficiencies.
- Dead Stock / Spoilage – Dead stock is inventory no one wants to buy and that cannot be sold after a period of time. Spoilage is the same concept, but for fresh items that have expired. Dead stock is an important metric because it indicates the company’s viability, and companies with more than 25-30% dead stock generally are not competitive.
- Fill Rate – Fill rate is the percentage of customer orders you’re able to meet without running out of stock at any given time. This KPI metric simplifies inventory forecasting and helps to spot the bullwhip effect in your supply chain, whereby demand at the customer level is greater or less than anticipated, which can dramatically alter the rate of fulfillment. By noticing this quickly, a company can adjust its procurement strategies to reduce financial losses.
- Inventory Accuracy – Inventory accuracy is a metric that is critical for preventing stockouts, shortages, shrinkage, controlling inventory quality, and maintaining a positive customer experience. It measures the difference between warehouse stock records and real-life inventory counts. We recommend to our clients that they try to keep this ratio over 92%.
- Inventory Carrying Cost – Inventory carrying cost, also known as holding costs or the cost of carrying inventory, is the percentage of the total value a company pays to maintain inventory in storage. The costs include warehouse, insurance, rent, labor and any unsellable products. Usually, carrying costs amount between 20% and 30% of the company’s inventory value, and this significant percentage makes it an essential factor to account for and closely monitor.
- Inventory Shrinkage – Inventory shrinkage is the amount of inventory a company should have on-hand but cannot account for, usually resulting from theft, damage, miscounts or fraud.
- Lead Time – Lead time is the time it takes for a customer to receive a product after they order it. This KPI measures the efficiency of the entire supply chain or business.
- Lost Sales Ratio – A lost sales ratio is an operational KPI that highlights the number of days a specific product is out of stock compared to the expected rate of sales for that product. It indicates when a company runs too lean on its inventory.
- Order Cycle Time – Order cycle time is the average time it takes for a company to fulfill a customer order. It demonstrates how well a business meets demand, including product readiness, shipping and delivery.
- Order Status – Order Status tracks the real-time status of orders and categorizes them by actions taken, like “backordered,” “on hold,” or “shipped.” In addition to monitoring the date and status of orders, this metric can also include information such as inventory accuracy.
- Percentage of Products Sold Within Freshness Date – This is one of the inventory management KPIs built to reduce waste and enhance operational efficiency for food, beverage and other fast-moving consumer goods businesses. The KPI offers a comprehensive breakdown of how many items have sold within a certain time frame in relation to their expiration dates to help businesses pinpoint the products or items that might need better quantity management or merchandising while developing promotional initiatives to turn over your inventory within a suitable time frame.
- Perfect Order Rate – Perfect order rate is a measurement of how many orders a company ships without any issues like damage, inaccuracies or delays.
- Reorder Point – The reorder point, also known as ROP, is the inventory level at which an order is triggered to replenish the inventory stock. The reorder point KPI generally connects the following metrics: sell through, lead time, and level of safety stock.
- Safety Stock – Safety stock inventory, sometimes called buffer stock, is a term used by inventory managers to describe a level of extra stock that is maintained to mitigate risk of stockouts or shortfalls in raw material or finished goods due to uncertainties in supply and demand, forecast inaccuracies and other unforeseen circumstances.
- Service Level – Inventory service level a metric that addresses the percentage of customers who do not experience stock-outs. You can use this metric to balance excess inventory costs with costs related to not having enough inventory to fulfill orders.
- Stock-Outs – Stock-outs represent the percentage of items not available in inventory when a customer places an order. This metric can help to identify the factors that lead to stock outs, including underestimated demand, supplier delays, production delays, delivery issues, and more.
While not all-inclusive, I hope this list sparks some ideas for the inventory KPIs and metrics that you should be using as part of an inventory optimization strategy. In my next posts, I’ll dive into more detail about each of the KPI categories highlighted above.
Silvon helps mid-market manufacturing and wholesale distribution companies accelerate growth through our suite of financial and operational planning, reporting and analysis applications. See how we can help you execute your KPI strategy and all of your performance management initiatives from the C-suite to your production and distribution facilities.