Why Inventory Is Such an Important Metric for Supply Chain Management
As initiatives like S&OP illustrate, inventory can be a vital part of managing supply chains. Because of this, the status of a firm’s inventory is often used as a litmus test for the overall “health” of its supply chain management processes and decision-making. For example, consider the firm that has excessive amounts of inventory in the form of safety stock. Such high safety stock is indeed a problem in and of itself because of the costs of holding this inventory and the opportunity costs of having working capital tied up in assets that aren’t being converted to sales. The larger issue here, however, is that this safety stock situation is likely a symptom of some sort of ineffective supply chain management decision-making. Perhaps demand forecasting is constantly and significantly inaccurate, maybe supplier lead times are unnecessarily long, perhaps firm operations are laden with bottlenecks and inefficient inventory handling, or maybe transportation carriers are not providing quality service in the form of delivering inventory damage-free and on-time. These are but a few examples of supply chain management ineffectiveness that often manifest in the form of either extensive levels of stagnant inventory or consistent out-of-stocks. Hence, inventory is an important supply chain measurement tool because it is likely one of the first signs that some root cause(s) is causing supply chain inefficiencies.
This has resulted in industry analysts, supply chain consultants and researchers, and even Wall Street paying close attention to inventory metrics to glean insights about supply chain performance trends and changes. Measures such as inventory turns, days of inventory, and cash-to-cash cycle have become popular, as they are all indicators of how well a firm’s supply chain is being managed. These inventory measures tell us, for example, how quickly inventory is moving through the supply chain, how likely the firm can handle the fulfillment of customer demands, how the firm’s liquidity is impacted by its investment in inventory, and may even signal how effectively supplier relationships are being managed.