How to optimize inventory in an API company
“If you want to improve customer service level, you need to increase your inventory. You have no choice”. Does this phrase sound all too familiar?
This belief leads to the misconception that inventory is the snake oil of customer service excellence.
Especially in the API industry where your shelf life is around five years, the company has plenty of time to consume its inventory.
The top-down approach, “let’s cut inventory by 20% to meet our financial target.” This short-term strategy may look amazing when presented on a well-designed PowerPoint presentation for company executives. However, in reality, this could lead to a lower service level; where you stop ordering raw materials. The shortage will prompt a delay in production and consequently cause inventory to decrease in the short term. Concurrently the service level goes down. Lack of supply may create pressure to increase inventory. The results in the midterm is a higher inventory level than previously.
To reduce your cholesterol level, you change your diet and incorporate exercise into your daily routine. Similarly, to reduce your inventory, you need to optimize the factors that influence your inventory to create sustainable results.
How you can reduce inventory by 20–25% and improve your service at the same time
In this article, I’m going to describe the journey to optimize inventory in the API industry effectively. How you can reduce inventory by 20–25% and improve your service at the same time. This article is not a 101-inventory management course.
If you are reading this article, then you must have spent significant time in your career struggling to reduce your inventory.
Inventory is an indicator of your organization’s health!
The Challenges that influence your inventory.
The sourcing strategy for most pharma companies is identical; they plan to have more than one supplier for each molecule to reduce their risks. Consequently, this strategy creates more demand variability and uncertainty.
The bullwhip effect describes a phenomenon where a small variation at the end customer's demand (the patient) creates a significant change at the end of the chain volume. In some industries, changes as little as 5% in the end-customers demand translates into a demand change of over 300% at the upstream supplier.
The quality is another factor of uncertainty, and for some products, you can have a long series of rejected batches.
There is a growing request from customers for ‘fresh batches’ — Batches newly manufactured with the most extended shelf life.
In the last few years, sourcing for RM has gotten increasingly difficult. Suppliers of intermediates and KRM ( Key raw material), find it hard to keep their promises due to regulation or environmental compliance that disrupts their business. Ultimately, increasing the variability.
Another critical element is the long lead time of most processes. Supplier lead time, order processing lead time, manufacturing lead time, QC lead time, and shipment lead time. An extra day in lead time also results in a day increase in inventory.
Lastly, the delicate balance to find between efficiency and customer service. A situation where your production manager wants a much longer campaign and your planning team the opposite.
A closer look at the picture below reveals the Days of sales inventory or days on hand, which can be above 200 days, and in some cases, much higher.
Inventory- prevent and optimize
Inventory optimization should first be a focused effort to identify a bad inventory and establish a roadmap to reduce it; this is the project part. In parallel to building a system that prevents the emergence of bad inventory, where processes and routine management create sustainability for the results achieved by the project.
Face reality I- Ensure your data is correct
Measure your inventory accuracy between your electronic record in the ERP system and your physical stock. 99.9% accuracy should be the target.
Physical inventory count allows you to set a baseline; however, you don’t always start your project on January 1st. Start with a Pareto check, check the first 20–30 items with the highest value in your warehouse. According to inventory accuracy, decide if you need full physical counting or you can rely on your current records.
At the same time, start to initiate a cycle counting process where every month, you count around 10% of your total stock. In less than a year, all your items should have been counted, and you keep your warehouse updated continuously. Then analyze top deviations and find the root cause for these misses in your processes.
Face reality II- Understand the quality of your inventory
There is bad and good inventory, like bad and good cholesterol as my physician reminds me of all the time. Good cholesterol is contributing to the proper running of our body. Good inventory is necessary for our system to work smoothly and answer uncertainty. On the contrary, bad cholesterol sticks to our arteries. Over time, it creates plaque, causes of a heart attack while the oxygen cannot reach the heart. Likewise, bad inventory confines our cash, which is the oxygen of any company.
Good inventory is safety stock, cycle stock, managerial stock, and transit stock.
Bad inventory is obsolete, excess, or rejected inventory. You want to keep your bad inventory as close to 0 as possible.
The next step is to classify your current inventory to understand the value and percentage of each category below. This exercise will indicate the required effort to reduce bad inventory.
1. Keep in the range [green]- good inventory, achieve the target inventory.
2. Monitor[orange], see if the consumption rate is stable, consider if you need to delay production or RM orders.
3. Act[red]- decide what the necessary action to reduce this inventory to the minimum.
To categorize your inventory, I suggest using the analysis below.
1. Age of your inventory — this helps you to identify how long the material has stayed in your inventory. Aging is a lagging indicator, a reflection of past decisions and fluctuation impact. In an API company, the average aging should be in most of the case between 120–140 days.
2. Inventory coverage- how many months of supply is in your inventory based on the demand. If you don’t manage a forecast, I would suggest you use historical sales and make corrections.
In this example, 40% of the total inventory value is Bad and requires urgent attention. The value identified is also a potential inventory reduction. However, don’t forget that in some cases, you need to increase inventory ( SS is low ) and you cannot make all your excesses disappear.
3. Understand the root causes — take top 10–20 value items, Pareto works most of the time. Analyze the root cause and understand the gap in your process, behavior, and capabilities of your team. Also setting an action plan for those items will bring rapid results.
4. Rejected batches value — you need to understand if those batches are for reprocessing or destruction due to quality issues. At this stage, it’s common to see a long list of batches waiting for reprocessing for years. The best approach is to work with your planning team to integrate those batches into your production plan. Give priority to rejected batches before starting fresh batches and postpone raw material purchasing accordingly.
If you work in a multi-site environment, share with all your partners, your definitions, KPI’s, and formulas to be able to make the results comparable. Please make it clear that there is no exception. Any inventory has to be taken into account. A full reconciliation between the book’s inventory and your analysis should become a regular practice.
After completing your analysis, you can tell the value of the good and bad inventory. Moreover, this gives a rough estimate of potential reduction. This analysis is an opportunity to bring the management on board for this journey and understand how much the company cash flow can be improved.
Henceforth, you should maintain this transparency and share it regularly with your management to also show the trend of improvement.
The journey of inventory optimization can begin; this journey is a joint effort. Finance, sales, quality, procurement, and operations can all contribute to the reduction of bad inventory.
The first step of the journey will be to maximize the reduction of “red” items. Every quarter, you need to check the new batches that meet the criteria of “act” and agree on a solution.
Action plan for KMA
Act- Key actions for inventory reduction- Optimize
0. Set a target- thanks to your analysis you can set a reasonable target and communicate it to all the stakeholders.
1. The immediate response is to stop the bleeding. In other words, stop planned production and cancel the purchase order of raw material.
2. Prioritize rejected batches available for reprocessing in the production plan before any new production.
3. Destroy rejected inventory that cannot be reprocessed or sold as it is. You pay holding costs for this inventory and other added complexity. So destroy it.
4. Ensure your system operates on FEFO; first expiry first out.
5. Build a sales plan for excess inventory with the sales team. It could be “fire sales” or qualify the product for another market.
6. Return rejected raw material batches to vendors.
7. Check for the possibility of transferring raw material to other sites.
8. Balance the production between two sites if you have two sites supplying the same API and the same qualified customers.
9. Build all these activities as a plan and monitor responsibility, execution, and timeline.
At the same time, you also have to develop sustainable processes that will allow you to avoid b inventory in the future.
Key actions to improve inventory management- Prevent
1. Build a safety stock model. If you have one, ensure it is a statistical one and not “X days of inventory” for every product. Build a process to challenge your model every six months.
2. Synchronize the frequency of production to your customers’ needs. Segmentize your portfolio by runner, repeater, and stranger and set the manufacturing policy accordingly. The classification should be a collaborative effort with manufacturing and sales, taking into account the changeover cost, inventory and sales variability.
3. Plan according to your coverage and not only your PO or forecast, this is a full topic to cover.
4. MRP implementation; it will help you to order the right amount of raw material at the right time if the parameters are correctly set.
5. Set targets for QC release cycle time for RM and API
6. Initiate a cycle time reduction for the production of the Pareto API.
7. Initiate or suggest initiating a product robustness project for the products creating rejected inventory.
8. Define Clear PO policy; for your raw material, you cannot order for a slow-moving product, only with the CEO's approval (convince him).
9. For API, I don’t believe you need an advance statistical model. Instead, it would be best if you had the deep involvement of the sales team in preparing the forecast. Ensure that this is not an under or overestimated forecast for bonuses merely for keeping top management happy.
10. Negotiate minimum order quantity with your suppliers. Sometimes, the minimum order already covers a long period of supply.
11. Align with sales about minimum order quantity and multipliers. You should not always happily agree with everything.
Once you complete the prevention and optimization phase, you should redo the previous analysis. This time, it will be much more accurate and not a one size fits all approach. Also, define a solution for the new items in red.
So, you have successfully reduced your bad inventory and put in place the right system to prevent the next slow-moving inventory. At the same time,
· You free your production capacity; you don’t spend production resources on items you don’t need.
· You avoid the next inventory excess ( bad inventory)
· You increase your visibility and transparency
· You increase inventory Safety stock for specific products
· Your cycle time must have certainly improved.
So, there is a high possibility that you will also upgrade your customer service during this journey.
if you have other ideas on how to reduce inventory, share your experience, and please comment below.
The author is a former VP supply chain at TAPI and is currently the CEO of OPYflow, working with several API companies on supply chain excellence.