5 ways COOs can reduce inventory costs

COOs are always looking for ways to reduce inventory costs, yet managing inventory levels too aggressively brings risks as well. COOs must follow the proper inventory cost reduction strategies to ensure success.

Stock levels that are too low can lead to late deliveries, lost sales and increased costs because of the need to expedite orders. Too-high stock levels can also result in increased costs. However, companies can reduce inventory costs while still maintaining a high level of customer service.

These five strategies can help COOs save money, as long as the strategies include clear alignment across the functions and roles within their organization.

1. Improve forecast accuracy

Inaccurate forecasts increase inventory costs because of the accumulation of excess inventory or stockouts, and traditional statistical methods can fail to account for promotions, product cannibalization and external demand signals, among other factors.

COOs should suggest that their company start using AI/ML-powered demand planning tools that analyze historical data, structured input from sales and marketing and external factors such as weather, macroeconomic indicators and social media sentiment. Build out a formal integrated planning process (S&OP or IBP) that includes ownership, target KPIs and escalation paths.

Cross-functional collaboration is key. CSCOs and sales leaders should both be held accountable for forecast accuracy, especially for forecasts related to high-impact SKUs.

2. Right-size safety stock and buffers

Segmentation is critical for reducing inventory costs. Carrying out blanket reductions or using arbitrary safety-stock numbers almost always leads to excess inventory in some areas and frequent stockouts in others.

COOs must spend the necessary amount of time and attention on segmentation and use a data-driven approach that incorporates probabilistic modeling. Classify SKUs by demand variability, lead-time reliability, margin and strategic importance and apply different service-level targets and safety-stock calculations to each segment instead of using a single rule of thumb across all categories.

COOs should use advanced planning systems to optimize safety stock by SKU and location and require that any proposed inventory reductions be backed up by service-level KPIs and financial objectives.

3. Shorten and stabilize lead times

Excessively long or unpredictable lead times often cause companies to maintain higher safety stock levels to ensure they achieve service goals. Improved collaboration with suppliers can mitigate this problem and thus reduce inventory costs.

CSCOs and COOs should work together to reduce both the length and variability of lead times. Utilizing nearshoring or supplier diversification for critical items can reduce transit time and mitigate the risk of supply chain disruption.

In addition, supplier development programs should include continuous performance monitoring and ongoing risk assessment. Performance-based contracts that reward suppliers for on-time, in-full delivery and include the sharing of forecast data will likely reduce the “just-in-case” buffers both parties create. COOs can further improve the relationship by ensuring demand signals sent to suppliers are credible.

4. Increase end-to-end visibility and reduce shrinkage

Every percentage point of inventory shrinkage effectively increases inventory costs. Factors including spoilage and administrative errors cause discrepancies between the recorded quantities on hand and actual stock, which forces planners to hold “just in case” buffer stock.

COOs should require a disciplined approach to warehouse and supply chain visibility. Routine cycle counting, exception-based auditing and automated data collection will all help improve the accuracy of inventory data. Serialization and traceability technologies reduce both shrinkage risk and the cost of any necessary recalls for high-value or regulated goods.

5. Properly manage obsolete and slow-moving inventory

Obsolete stock ties up working capital and reduces warehouse productivity. Prevention is significantly less expensive than remediation. In addition to converting aging goods into cash, COOs and CSCOs should work together to improve upstream planning so inventory doesn’t become obsolete in the first place.

COOs should implement monthly or quarterly reviews of aging and slow-moving inventory, establish plans for disposal of excess stock and work with product management and engineering to align new product launches with exit strategies for predecessor products. CSCOs can negotiate return or obsolescence protection clauses with suppliers for new items.

Reducing inventory costs requires continuous measurement and improvement, including the tracking of inventory value, fill rates, expediting costs and customer satisfaction levels. COOs should pilot changes in low-risk categories first, then scale improvements to a broader range of SKUs. By taking the right approach to inventory optimization, COOs can deliver sustainable cash and margin improvements that strengthen overall corporate performance.

James Kofalt spent 16 years at SAP working with SME business applications and was a product manager for integration technology at Microsoft's Business Solutions division. He is currently the president of DX4 Research, a technology advisory practice specializing in ERP and digital transformation.