Strategy, Legal & Operations

Inventory management solutions: For small businesses, the best model might not be Toyotas

For small and medium businesses that carry high inventory costs (like manufacturers and retailers), it’s only natural to be interested in inventory management solutions that can reduce inventory carrying costs: Just in time (JIT) is one of the systems that has a strong appeal to these companies.

Does the just-in-time method actually work for small and medium businesses like it does for Toyota? Sure, some businesses make it work, but inventory and supply chain experts caution against rigidly adopting an inventory system that doesn’t match the company’s business model.

What is just-in-time (JIT) inventory management?

The just-in-time inventory system was developed in Japan in the 1970s when Toyota, over the course of several years of trial and error, standardized the system at its automobile manufacturing plants. Toyota sought to reduce inventory levels to the absolute minimum by receiving items from suppliers just as the last of those items were being pulled from Toyota’s warehouse shelves.

There were certainly bumps in the road: In one well-known example, a supplier of a brake part had a factory fire and couldn’t supply Toyota with new parts for the assembly line. With no parts in reserve, Toyota’s entire assembly operation ground to a halt for several days before another supplier could hastily refit its own manufacturing process to build the missing part.

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The challenges of JIT for small businesses

Yet for the typical small and medium business, unforeseen interruptions to the supply chain—like fires at supplier manufacturing facilities—are really the least likely worry when trying to adopt just-in-time inventory practices.

Supply-management consultant Ian Johnson argues that few small and medium businesses have the purchasing power and strong economies of scale necessary to successfully adopt just-in-time inventory management: “Ultimately, large companies can make JIT work because they have guaranteed contractual supply agreements in place. Small businesses typically have infrequent demand patterns and low volumes and are almost never their suppliers’ number one priority. In essence, small businesses are typically at the end of the line in terms of priorities—regardless of what their suppliers say.”

Small and medium businesses have other challenges, Johnson notes, when trying to adopt just-in-time processes: Small businesses simply don’t have the constant and linear demand necessary to make lean-inventory methods work like they do for large companies: “Companies that are successful running this inventory management approach are required to ship product daily, weekly and monthly. In some cases such as Dell, they ship product on the hour. This is the essence of linear demand. It’s constant and almost never seems to end.”

Disadvantages of JIT inventory management for small businesses

JIT inventory management makes small businesses vulnerable to a supply shock. Sudden changes in supply or demand can prevent a small business from meeting customer demand. Moreover, JIT systems work on the assumption prices remain constant.

A small box merchant operating on a JIT system would find their profit margin largely determined by fluctuations in the cost of cardboard. This is why most small businesses are better suited with more traditional inventory management techniques.

The best inventory management strategy for SMBs

So, if just in time is off the table for most small and medium businesses (except, as Johnson notes, for those companies with a limited product offering and high sales volume across that offering), what are the options for a business looking to reduce the capital costs of retaining inventory while also insuring its ability to avoid stockouts and missed sales opportunities?

Businesses shouldn’t emulate an inventory management system just because another business is running it or because (as is the case with Toyota’s just-in-time method) a system has been valorized in the business media. “Focus on one simple rule to supply chain optimization,” Johnson advises. “Match your inventory strategies to your customers’ needs, your markets business cycles and your product’s sales cycles. If that means running Min-Max, or a demand-driven derivative, then so be it. Just don’t run something you can’t merely because someone else is.”

Inventory management techniques for small to medium businesses

Anyone with an inventory needs to track it. Small and medium businesses can make this simpler with the right inventory management technique.  The Economic Order of Quantity (EOQ) can help you determine how to mitigate inventory costs by knowing precisely how many units you need in stock.

The costs of holding inventory, shortages, and orders are balanced through continuous review. This allows you to establish par levels for a product. And as inventory falls below a specific quantity, orders can be automatically initiated.

How inventory solutions can help your profitability

Regardless of the inventory management system your small or medium business uses, the right technology can help you cut inventory costs by eliminating errors and automating purchasing orders.

Look to software to create inventory profitability reports that show you which items are selling and which have the greatest and lowest profit margins. For manufacturers, software can help you create assemblies that define exactly how many parts, components, or materials are needed to complete a product.

And for any small or medium business with a significant inventory component, look to technology to increase productivity and efficiency by automating purchase orders, which replenish inventory when it reaches a predetermined level.

Holding excess inventory increases overhead costs while reducing liquidity. Having insufficient inventory prevents you from satisfying customer needs. It’s a balancing act. How well businesses can strike this balance heavily can heavily influence profitability. Inventory solutions help because they offer easy, accurate means of closely tracking these factors as they fluctuate.

List of general techniques

Businesses need to regularly audit their stock with some specific procedure, but the appropriate technique will vary from one organization to the next. Here are some general ways businesses can audit their stock:

  • FIFO: The first-in first-out principle (FIFO) prioritizes the distribution of older stock, which is important for any perishable product. FIFO warehousing and storage procedures can be used to dictate the way items are stored and removed from inventory.
  • ABC technique: By contrast, the ABC technique involves prioritizing inventory management towards high value products with lower sales. This is due to their larger financial impact and lower turnover relative to low-cost, high turnover products.

Inventory management tools for small to medium businesses

The right inventory management tool is the one that best helps a business meet customer needs. Different businesses have different needs with respect to warehouse management, product management, order management, inventory management, and general inventory management. Having the appropriate tool can help integrate stock information into a more cohesive picture, make better projections about the future, and more easily manage the scale of a business.

Here is a list of inventory management systems that may be useful to SMBs:

  • The periodic review system involves inspection of stock on some regular interval. Taking into account likely demand between the time of your review, this system can lead to better informed decisions about necessary levels of inventory.
  • The JIT system is excellent for large scale businesses. It minimizes inventory through flexible production, working to provide greatly increased liquidity.
  • Bin systems are simple and effective. Inventory is placed into two bins, then taken from the first bin until empty. The empty bin triggers an inventory order. And the quantity of inventory placed in the second bin is determined by the expended delivery of new inventory.