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By Root 2887 0

stock location to keep a large amount of SKUs is limited either by cash or by floor/shelf space, the decision is crucial. Just taking into account the inventory turns is not enough because some items are sold at such a low margin that even if they are cheetah items they contribute little to the bottom line. In addition, a certain item can be sold only once every year (an obvious elephant item), but the margin is so high relevant to the inventory investment that it is a great item to have. For the M/D, a measurement like that can be used to support the decision of which products he should eliminate from the supply chain offering. Is there a good measure for making this decision?

The best measurement for comparing which items to stock and not stock is to determine how much a certain SKU is worth keeping at the stock location. The Return on Investment (ROI) for each inventory item24 provides an excellent method of comparison across SKUs for the retailer. Retailers are usually limited by the amount of cash or space, so they should focus on the items that contribute the most to the bottom line.

Using TOC the question becomes, “How much Throughput (meaning margin) does one gain from this SKU over a year?”25 This question can be written as T = selling price – TVC. To calculate the Investment, consider the following:

The inventory kept at the stock location to cover immediate demand (the actual stock).

In-transit inventory to refill the buffer. The inventory in-transit is also an investment in order to protect from the fluctuations in demand and to cover for regular consumption.

Taking these considerations into account, the best number to represent the Investment needed to generate the T this SKU realizes is the buffer size. By multiplying the buffer size by the TVC (TVC/unit of SKU) of this SKU, the real inventory investment needed to generate the annual T of this SKU is realized. Note, one does not consider the timing of who owns the in-transit stock. You ordered it, and therefore there is an obligation to buy it. Hence, it should be part of the calculation.

Therefore, the formula is very simple. To calculate the ROI, the annual T of this SKU should be divided by the TVC per unit from this SKU multiplied by the (average) buffer size throughout the year.

The ROI measurement enables differentiating between three different groups of SKUs based on financial contribution:

1. Star items. These items represent a very high ROI for the retailer and certainly should be stocked appropriately throughout the chain to support the retailer. These are excellent candidates for placement at other retailers to see if consumers at those locations demand them as well.

2. Regular ROI items. These items are not in either category.

3. Black hole items. These items have a low or possibly negative ROI. These items are potential candidates for elimination from inventory. However, this is not conclusive, as some items (usually referred to as strategic) are necessary to have even though their margin is so low and/or the quantity sold is low, which places them in this group.

It is obvious that there is a correlation between the cheetah items and the star items, but this is in no way a 1:1 correlation, as is clearly demonstrated by the extreme cases discussed earlier and which will be further demonstrated by Fig. 11-8.

The decision of how to set the limit between the different groups is dependent on the specific environment, but the general guidelines are taking the top 10 percent based on ROI as stars and the bottom 20 percent as black holes. Of course, a check is needed whether these items have been replenished regularly and are not in a class because of bad management. This check shows that you have poorly managed the inventory of the black holes. One approach to improving the ROI is to reduce the investment significantly in that SKU while maintaining its T. An obstacle that must be addressed in these situations is the purchasing unit of measure; the amount that must be purchased at one time needs to be reduced. Some items are