I visited a large manufacturer last week to review their inventory management polices and procedures. I was impressed with their knowledge and the systems they had in place. As I spoke with various department managers, one question was continually asked: "How does our inventory turnover compare to others in our industry?" Why did they ask this question? To judge the performance of their planners and buyers.

I refused to answer. Not because I didn't know, but because there was no other company in their industry whose turnover could be equated to this firm's performance. Why? Because this company's supply chain was unique. It received many components and raw materials from an overseas subsidiary of its parent company. This source of supply was dictated by the parent company and could not be changed by local management. Therefore it was in a unique position for acquiring material. To compare its turnover to any other company, or to the industry at large, would be comparing apples to oranges.

So we began looking for other measurements to judge their planners and buyers. One of those I suggested was to measure the day's supply of a product on-hand when a replenishment shipment is received. Our term for this "left on shelf" inventory is residual stock. This may seem like a strange measurement, but let's look at why it is important.

There are two questions a buyer must answer in replenishing the stock of a product: when to place a replenishment order, and how much of a product should be reordered. Economic lots, price break analysis, and the economic order quantity formula provide the answer to how much to order that minimizes the company's cost of inventory. The new measurement, day's supply on-hand when a replenishment shipment is received (residual stock), helps to ensure that we are ordering at the right time.

We don't want the replenishment position (ON-HAND - COMMITTED + ON ORDER) of an item to fall below the order point before we issue a replenishment order. There are three components to consider in calculating the order point:

Demand  Anticipated usage of the product.

Anticipated Lead Time  How long it will take to receive the replenishment shipment and prepare it for use or sale.

Safety Stock  Safety stock is insurance against running out of an item because of unexpected demand during the anticipated lead time or vendor shipment delays.

These three components are used to calculate the order point:

Order Point = (Demand/Day x Anticipated Lead Time) + Safety Stock

If the residual stock is greater than "x" day's supply at the time of the last three stock receipts, one or more of the following conditions probably exists:

• Demand forecast predictions consistently exceed the actual usage and must be evaluated for accuracy.

• The anticipated lead time is greater than the actual experienced lead times.

• The maintained safety stock quantity exceeds the amount necessary to protect customer service  that is, there are not great variations in lead time or demand from month to month.

To decrease the residual stock to its target of "x" days supply, we can reduce inventory levels by correcting demand or the anticipated lead time, or by maintaining less safety stock. If demand, anticipated lead time, and safety stock are properly maintained for the item, our target order from the vendor (i.e. free-freight amount, truckload, lot size, etc.) may be too large to optimize the company's turnover and net profitability.

If the residual stock is less than "y" day's supply at the time of the last three stock receipts, one or more of the following conditions probably exists:

• Demand forecast predictions are consistently less than actual usage and must be evaluated for accuracy.

• The anticipated lead time is less than the actual experienced lead times.

• The maintained safety stock quantity is not adequate to protect customer service  that is, there are great variations in lead times and/or usage from month to month.

We need to correct demand or the anticipated lead time, or to maintain more safety stock.

There are no fixed values for the "x" and "y" day's supply parameters. The target residual day's supply to for each item depends on such factors as the importance of the item to the company's sales or processes and its general availability.

While residual stock analysis doesn't provide a measurement that can be compared to other company's results, it does bring to the attention of the buyer products that have the potential of turnover improvement or that may be hindering customer service  that is, it is a valuable tool for the company to achieve its goal of effective inventory management.