B-03

Gary Gossard, PE

A Best Practice for Inventory Reduction

ABSTRACT inventory managers responding to the 2001 survey,

This paper describes a simple inventory management their top inventory reduction practice for the eighth
technique that has become a best practice for reduc- consecutive year is the periodic review. Over 65
ing inventories. It shows how several best practices percent cited periodic review to determine ways to
have been combined into a few successful strategies reduce inventory as one of their top five practices.
for rapid inventory reduction and achieving world- The survey went on to rank the 20 most favored
class performance. The paper stresses the impor- practices. All of the following top ten practices were
tance of going beyond the planning of inventory employed by at least 20 percent of the respondents:
quantities to actually managing inventory dollars, 1. Conduct periodic reviews. 65%
and it demonstrates how you can do this with the 2. Analyze usage and lead times. 50%
data in your current material requirements planning 3. Reduce safety stocks. 42%
(MRP) or enterprise resource planning (ERP) sys- 4. Use ABC approach (80/20 rule). 37%
tem. Through actual case studies, the paper shows 5. Improve cycle counting. 37%
how to identify your biggest reduction opportunities, 6. Shift ownership to suppliers. 34%
set realistic reduction objectives, reduce excess in- 7. Re-determine order quantities. 31%
ventories, update existing systems, increase turns, 8. Improve forecasts of A and B items. 23%
and improve cash flow. After inventories have been 9. Give schedules to suppliers. 22%
reduced 20 to 40 percent, the same technique is use- 10. Implement new inventory software. 21%
ful for keeping them down. This technique, known While not all of these inventory reduction prac-
as the Inventory Quality Ratio (IQR), was originally tices meet the criteria of best practices as defined
developed by materials managers to measure and above, they certainly represent the most widely used
monitor inventory performance. IQR has since be- practices in industry today. One conclusion of the
come a comprehensive best practice for inventory survey is that inventory managers are using an in-
reduction. creasing number of analytical approaches for review-
ing and reducing inventories. Their comments and
reported experiences also confirm that it often takes
DEFINITION OF BEST PRACTICE more than one practice to achieve and maintain in-
Surprisingly, the APICS Dictionary does not provide ventory reductions.
us with a definition of best practice. Following are
two definitions culled from the literature. THE INVENTORY QUALITY RATIO
A Best Practice is a process, technique, or inno-
vative use of equipment or resources that has a Seven of the top ten practices being used by inven-
proven record of success in providing significant tory managers today are incorporated in one com-
improvement in cost, schedule, quality, perform- prehensive inventory management technique. The
ance, safety, environment, or other measurable Inventory Quality Ratio (IQR) is a methodology that
factors which impact the health of an organiza- has become a best practice for inventory reduction
tion. (The Best Manufacturing Practices Center and is the subject of this paper. The IQR logic was
of Excellence) developed collectively by the materials managers of
A Best Practice is a group of tasks that optimizes 35 companies. It was used by them to reduce inven-
the efficiency or effectiveness of the business dis- tories a total of $500 million (25 percent average
cipline or process to which it contributes. It must reduction) while improving on-time deliveries to
be implementable, replicable, transferable, and their customers. It has since been used by planners
adaptable across industries. (The Gartner Group) and buyers in manufacturing and distribution com-
panies worldwide to reduce inventories 20 to 40
percent.
TOP TEN INVENTORY REDUCTION MRP, DRP, and ERP systems do a good job of
PRACTICES planning future requirements and getting inventories
A survey of inventory reduction practices is con- on the shelf. But they dont deal effectively with the
ducted annually by the Inventory Reduction Report, a excess, slow-moving, and obsolete inventories that
subscription newsletter for Improving Logistics have built up over time. The proliferation of various
and Supply Chain Management. According to the practices for inventory reduction is an indication

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 1
 A Best Practice for Inventory Reduction

that we should be doing more to monitor inventory INVENTORY REDUCTION

performance, to avoid inventory buildup, and to fine STRATEGIES AND CASE STUDIES OF
tune our MRP systems to keep them current and IQR RESULTS
effective.
The Inventory Quality Ratio is a simple analyti- The following sections of this paper present three
cal technique for measuring inventory performance, successful strategies for reducing inventories, de-
managing inventory dollars, and making the plan- scribe how the strategies employ various best prac-
ners job easier. IQR incorporates the popular prac- tices, and provide actual case studies of the results
tices of periodic reviews and ABC analysis to achieved by three different companies. The three
identify the best opportunities to reduce inventory. strategies are these:
It uses both past usage and future requirements to 1. Identify and reduce the excess, with a case study
calculate days supply, and user-defined parameters of Rapid Inventory Reduction at International
to measure current inventory performance. It pro- Game Technology.
vides planners and managers with an easy way to 2. Revise material ordering guidelines, with a case
reassess lead times, safety stocks, order quantities, study of Working Smarter, Not Harder at AG
and replenishment cycles on a weekly, monthly, or Communication Systems.
exception basis. IQR also enhances existing MRP 3. Use continuous improvement, with a case study
systems by adding a dollar focus to prioritize current of World-Class Performance at Steelcase
reduction opportunities. Incorporated.
According to the experts cited earlier, the prin-
cipal prerequisite of any best practice is a proven
THE IQR LOGIC record of providing significant improvements. Best
Using the data from any existing MRP system, the practices must also be implementable, replicable,
IQR logic first divides inventory into three groups: transferable, and adaptable across industries. The
items with future requirements, items with no future following sections demonstrate why the Inventory
requirements but with recent past usage, and items Quality Ratio has become a comprehensive best
with neither. As shown in Figure 1, the items in practice for inventory reduction.
these groups are then stratified into typical ABC-
type classifications based on their future dollar re- Identify and Reduce the Excess
quirements (ABC), their past dollar usage (DEF), or
their current dollar balances (GHK), respectively. A The biggest opportunities for inventory reduction in
target inventory level or rule is set for each item most companies are with the Excess 2 inventories.
based on its classification. The balance on hand of These are parts for which there are future require-
each item is compared to the rule, and the dollars of ments but the balances on hand exceed the rule. The
each item are categorized as either Active (A1 or IQR logic identifies excess inventories according to
A2), Excess (E1, E2, or E3), Slow-Moving (SM), or the inventory rules (expressed in days or weeks
No-Moving (NM). These are called the inventory supply) that the planners and buyers have set for
quality categories. their particular manufacturing or distribution envi-
The Inventory Quality Ratio is the ratio of the ronment.
active inventory dollars to total inventory dollars. In Excess inventories represent not only the big-
a theoretically perfect situation (i.e., with no excess, gest but also the best opportunities for inventory
slow-moving, or no-moving inventories), the IQR reduction. This is true for several reasons:
would be 100 percent. Using very generous inven- Reducing excess inventories reduces inventory
tory rules of 4-12-24 weeks supply for A-B-C items, dollars on the balance sheet, so turns, return on
respectively, the IQR for most of the hundreds of assets, and all of the financial ratios improve. But
companies we have surveyed is in the 30 to 45 per- unlike scrapping obsolete inventories, there is no
cent range. This means that approximately 60 per- negative financial impact from inventory write-
cent of their inventory dollars are tied up in excess, offs.
slow, or no-moving items. Further, we have found Reducing excess inventories improves cash flow
that slow and no-moving inventories account for by deferring incoming purchases until the excess
about 10 percent of the dollars and that one cate- inventory is consumed and replenishment is actu-
gory, Excess 2 (E2), typically accounts for 30 to 50 ally needed. Generally, there is a dollar-for-dollar
percent of the total inventory dollars. Identifying improvement in cash flow from reducing excess
reduction opportunities and monitoring ongoing inventories.
inventory performance are both facilitated by the Very simply, the less excess inventories we have
IQR logic. today, the less likely we are to have slow-moving
or obsolete inventories tomorrow and write-offs
in the future.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 2
 A Best Practice for Inventory Reduction

As shown in the following case study, the IQR With two months left in the calendar year, they
logic quickly identifies the excess inventories. Fig- didnt let up. Overall, the reduction in total invento-
ure 2 shows inventory dollars by quality category for ries in the five-month rapid reduction effort was
purchased vs. manufactured items. Other analyses $16.4 million or 31.5 percent from August to De-
provide inventory breakouts by individual planner, cember. A major contributor was a 53 percent re-
product line, stock type, buyer, vendor, commodity, duction in Excess 2 inventories. A major additional
account number, ABC classification, storeroom, and benefit was a $14 million increase in cash flow.
plant location. The planners can drill down on any Because of the results they had achieved, IGT de-
number and see all of the items that make up those cided to have all of their planner/buyers and inven-
inventory dollars. The planners can also drill down tory managers use the IQR logic. In January they
on any item and see all of the detailed information held formal training classes and began analyzing
for a given part number. The part details include the their material ordering guidelines. They also began
information analyzed by many of the best practices, uploading the dynamic ABC classifications from the
including past usage, future requirements, weeks IQR analysis back into their MRP system to keep
supply, open orders, safety stocks, lead times, ABC their ordering policies current with changing market
classifications, and the order policy codes and quan- demands.
tities that are determining replenishment orders in In January they began their continuing im-
the MRP system. provement phase and expanded the IQR analysis to
additional segments of their inventory that had been
Case 1: Rapid Inventory Reduction, Inter- excluded from the rapid reduction phase because of
national Game Technology their high mix and relatively low dollar volume. This
$14 million addition actually doubled the number of
International Game Technology (IGT) is the world
inventory items being managed with IQR from
leader in the design and manufacture of casino gam-
10,000 to 20,000 part numbers. These additional
ing equipment. They have grown rapidly in sales
inventories temporarily decreased their IQR per-
revenue and market share. For over 10 years they
formance because the parts had not been previously
relied on traditional MRP systems to manage their
managed and had an IQR of only 20 percent. Fig-
inventories. As their markets evolved from high-
ure 3 shows the inventory reduction results de-
volume/low-mix to low-volume/high-mix, their
scribed above. Within 14 months of beginning the
inventories ballooned to over $50 million and they
program, IGT reduced total inventories by $30 mil-
were struggling with two turns per year. With four
lion (43%). Excess 2 purchased parts were reduced
months left in their fiscal year, IGT hired a man-
by $20.3 million (61%) and slow and no-moving
agement consultant with the following two objec-
parts were reduced by $3.8 million (52%).
tives: design a comprehensive long-term solution to
their overall inventory problems and achieve a short-
term inventory reduction of $10 million before fiscal Revise Material Ordering Guidelines
year end. A second major strategy for reducing inventories is
Following a brief diagnostic review, the consult- to change MRP parameters. All MRP systems con-
ant developed a proactive plan that involved several tain order policies and quantities that should be re-
best practices and use of the IQR logic. Figure 2 viewed and revised by the user as conditions change.
shows IGTs purchased parts and manufactured The two most significant of these affecting inven-
inventories near the beginning of the study. You can tory levels are safety stock and cycle stock, where
see that the biggest and best opportunities were not cycle stock is determined by order quantities or lot
with the slow-moving and no-moving items but with sizes. Rather than conducting separate ad hoc analy-
the $27 million of Excess 2 inventories. The IQR ses of these parameters, the IQR logic can be ap-
analysis not only identified immediate reduction plied in a way that combines the following inventory
opportunities, it also allowed the consultant to reduction practices in a simple analytical exercise:
quickly establish and monitor new inventory policies. Conduct periodic reviews.
The IGT planner/buyers used the weeks sup- Analyze usage and requirements.
ply information from IQR to adjust scheduled re- Use ABC approach.
ceipt dates for the largest value orders closer to the Reassess safety stocks.
actual need dates. This not only reduced inventories Re-determine order quantities.
but also improved cash flow. The consultant showed The Inventory Profile uses the IQR logic to
them how to use other information in IQR to adjust simulate the impact of different material ordering
lot sizes and safety stock levels as well. In only three guidelines (safety stock and cycle stock) on future
months the consultant helped IGT reduce their Ex- inventory levels. As shown in Figure 4, the Inven-
cess 2 inventories by 27 percent and achieve their tory Profile displays the number of items in each of
short-term objective of an inventory reduction of the ABC and DEF classifications, the future re-
over $10 million. quirement dollars, the past usage dollars, and the

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 3
 A Best Practice for Inventory Reduction

current inventory balances in both dollars and days items the priority that they deserved. Their invento-
supply. This type of analysis can be done on the ries consisted of 20,000 part numbers and a total
entire inventory or on different segments of the value of $25 million ($16 million purchased parts
inventory. Next, the Inventory Profile uses the mate- and $9 million WIP and finished goods). They de-
rial ordering guidelines for each class of inventory to cided to apply the IQR methodology first to their
calculate the average inventory days and converts purchased parts and found that their IQR was only
that to dollar balances. It then compares the guide- 23 percent with nominal rules of 4-12-24 weeks.
line dollar balances to current inventory dollars for Seventy-seven percent of their inventory dollars
each class of inventory and shows the reduction were tied up in excess, slow, or no-moving items,
potential. Different scenarios in terms of safety with 60 percent in Excess 2.
stocks and cycle stocks can be evaluated offline While dealing with the existing excess and obso-
without the danger of changing any current MRP lete inventories, it became clear that the easier way
settings. to manage inventory dollars was to avoid buying the
Planners and buyers can use this information to excess inventories in the first place. So, the planners
set realistic inventory reduction objectives for differ- strategically redefined their lot-sizing and frequency-
ent segments of their inventory. For example, for- of-delivery rules. These then became the basis for
gings and fasteners would likely have very different establishing their IQR rules and measuring inventory
lead times, order cycles, and safety stocks. Based on performance. Since MRP generated the purchase
their knowledge of the parts and vendors involved, requisitions, they also wanted to synchronize the
the planners can enter some viable alternatives and MRP planning parameters with the planners mate-
quickly assess what the dollar impact on inventory rial ordering guidelines. This ensured that the safety
levels would be. Once the appropriate material or- stock levels and frequency-of-delivery rules in MRP
dering guidelines have been determined for each were consistent with the planners ABC classes and
segment and/or class of inventory, they can be up- IQR rules for inventory performance.
loaded to bring the MRP order policy codes and This strategy permitted the planners to put B
quantities in line with the desired inventory levels. and C parts on auto-pilot planning with greater con-
This will fine-tune MRP and allow it to generate fidence, and allowed them to focus their time and
replenishment orders that are consistent with the energy on managing the high-impact A items. This
overall inventory objectives. was dubbed working smarter, not harder, and
processes were put in place to periodically upload
Case 2: Working Smarter, Not Harder, AG dynamic ABC classifications from the IQR logic to
Communication Systems the MRP system. Weekly performance review meet-
ings allowed the planners to present their activities
AG Communication Systems (AGCS) manufactures
and results, and to learn from each others experi-
computerized switching systems for telephone com-
ences. This provided a valuable forum to exchange
pany central offices. They were running a sophisti-
ideas and generate suggestions for improvement.
cated, state-of-the-art, closed-loop MRP II system
Figure 5 shows how AG Communication Sys-
and had already integrated many best practices, in-
tems doubled their IQR for purchased parts from a
cluding event-driven replenishment of purchased
baseline of 23 percent to 46 percent in the first nine
parts, JIT subassembly manufacturing, and make-to-
months. Two major benefits of this improvement
order final assembly. Then, due to unprecedented
were a 35 percent decrease in excess inventories and
technological changes, they were grappling with in-
the resulting $3.8 million increase in cash flow that
creased sales, many new product introductions, rapid
funded the purchase of active inventories for their
growth of their part populations, and shortened
new products. It is important to note that this was
product life cycles. Notwithstanding their extensive
accomplished during a time of 25 percent sales
systems, best practices, and experienced planners,
growth and several new product introductions. Un-
this resulted in dramatically increased inventories
der such circumstances it is normally all a planner
and carrying costs, a drag on their cash flow, and
can do to avoid shortages, but the dollar focus of the
growing multimillion-dollar financial reserves for
IQR logic allowed them to continue their inventory
slow-moving and newly obsolete inventories.
reduction efforts. The company now uses the IQR
The materials director concluded that for all its
methodology to help manage both purchased and
sophistication, their MRP system lacked the dollar
manufactured inventories.
focus needed to gain control of their inventories.
Because MRP is essentially a part-driven tool, their
planners were spending more time balancing supply Use Continuous Improvement
and demand for B and C parts than they were for Although the periodic review is a favored practice,
the high-dollar A items. Given planner time con- continuous reviews and exception reporting are
straints and ever-increasing part populations, they much more timely and effective in managing inven-
believed the IQR logic would give the high-dollar tories and stemming some problems before they

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 4
 A Best Practice for Inventory Reduction

happen. Until recently the limiting factor has been Case 3: World-Class Performance, Steelcase
the time required to do continuous reviews of inven- Incorporated
tory performance.
Steelcase has been a world-class manufacturer
Based on experience, we all know that inventory
since before we started using the term. So it was not
reduction is a two-step processgetting the inven-
surprising to learn that they were one of the first
tories down and then keeping them down. Done
companies in the United States to employ the IQR
properly, the second step never ends. Periodic re-
logic for improving their inventory performance.
views can be effective as an ad hoc practice to re-
Although Steelcase was already turning raw materials
duce inventories. However, such reviews are
30 times per year, they were always looking for ways
probably the most widely used industry practice
to do better. They began using the IQR logic in four
simply because they have to be repeated over and
neighboring plants and found that with beginning
over again. Reducing inventories without taking cor-
rules of 4-12-24 weeks their IQRs were in the 80 to
rective action regarding the root causes of inventory
90 percent range, some of the highest ever seen.
buildup will only yield temporary results. Before
To identify additional reduction opportunities
long the inventories will go back up and it will be
Steelcase revised their rules to a much more aggres-
time for another periodic review to reduce inventories.
sive 1-2-6 weeks. This lowered their IQRs to the 40
Some of the root causes are as simple as out-of-
to 50 percent range and gave them new targets to
date material ordering guidelines that no longer re-
pursue. Within six months, each of the plants had
flect current part volumes or lead times. Other root
found new ways to reduce inventories and had in-
causes can be more complex, such as inflated sales
creased their IQR approximately 15 points, to the 55
forecasts or excessive engineering changes that may
to 70 percent range. Using the IQR logic helped
require senior management intervention. Identifying
them increase their raw material turns from 30 to 42
the root causes of inventory buildup (and their dollar
times per year.
impact) is best done with a continuous review proc-
It has been interesting to note that at Steelcase
ess that identifies out-of-whack situations as soon as
and elsewhere, the companies with good inventory
they happen. Examples of these include:
practices and above-average performance are the
open orders for parts with no valid requirements
ones most attracted to making further improve-
orders due to be received long before the parts are
ments. When the best companies strive to do even
needed
better, they develop and employ what later become
safety stock levels greater than several months
recognized as best practices.
usage or requirements
items that have changed IQR categories from
Active to Excess or worse SUMMARY
questionable order quantities, lot sizes, due dates, MRP systems generally do a good job of planning
and lead times. requirements and getting inventories on the shelf.
These situations can be easily identified on a But they dont do a very good job of helping us deal
routine weekly basis. They can also be prioritized by with the excess, slow-moving, and obsolete invento-
their dollar impact so the planners and buyers can ries that accumulate over time. The increasing use of
address the most important issues first. These types analytical techniques to reduce these inventories is
of analyses and exception reporting no longer need an indication that we should be doing more to avoid
to burden the materials planners or managers. They the buildup of inventories in the first place.
can be done in a matter of minutes using the infor- The IQR methodology provides a simple way to
mation in any MRP system. go beyond merely planning inventory quantities to
An inventory movement analysis uses the IQR actually managing inventory dollars. It combines the
logic to highlight inventory items that have changed information from existing MRP systems with best
quality categories from one week to the next. Both practices and a dollar focus to address inventory
good movement (excess to active) and bad move- reduction in a more comprehensive manner. The
ment (active to excess, excess to slow-moving, or IQR logic has helped companies worldwide to:
slow-moving to no-moving) are identified for fur- Assess their true reduction potential by inventory
ther review. This permits the planners to take cor- segment.
rective action immediately. It also allows the Identify and reduce excess inventories and im-
managers to identify and document the root causes prove cash flow.
of inventory buildup such as cancelled sales orders, Clean house of slow-moving and obsolete
engineering changes, or poor forecasts. When senior inventories.
management has the facts and figures, they are bet- Calculate dynamic ABC classes based on future
ter equipped to change fundamental business practices. requirements.
Analyze safety stocks, lot sizes, order policies, and
past usage.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 5
 A Best Practice for Inventory Reduction

Simulate the impact of different material ordering Perhaps the greatest benefit of the IQR logic is
guidelines. helping the planners and inventory managers to be
Fine-tune MRP systems to keep them current and more effectiveby giving them the information
effective. they need, and by showing them exactly where and
Monitor inventory movement and identify the how they can have the biggest impact on inventory
root causes of inventory buildup. performance and savings.
Manage inventory investment and avoid future
write-offs. ABOUT THE AUTHOR
Set realistic reduction objectives and track progress Gary Gossard, PE, is president of IQR Interna-
over time. tional, a California-based company providing man-
Companies in a variety of manufacturing and agement tools to the manufacturing and distribution
distribution environments have implemented the industries. He is a graduate of the USC School of
IQR methodology as their own best practice for Engineering and the Stanford Executive Manage-
inventory reduction. It has a track record of provid- ment Program.
ing significant improvements and it is implement-
able, replicable, transferable, and adaptable across
industries.

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 6
 A Best Practice for Inventory Reduction

FIGURE 1. IQR LOGIC DIAGRAM

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 7
 A Best Practice for Inventory Reduction

FIGURE 2. INVENTORY DOLLARS BY IQR CATEGORY AT IGT

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 8
 A Best Practice for Inventory Reduction

FIGURE 3. INVENTORY REDUCTION AND IQR IMPROVEMENT AT IGT

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 9
 A Best Practice for Inventory Reduction

FIGURE 4. INVENTORY PROFILE WITH MATERIAL ORDERING GUIDELINES

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 10
 A Best Practice for Inventory Reduction

FIGURE 5. INVENTORY DOLLARS AND IQR IMPROVEMENT AT AGCS

2001 International Conference Proceedings, 2001 APICSThe Educational Society for Resource Management 11