Information technology suppliers often suggest that inventory and sales control systems are transforming the way efficient companies manage their holding of both supplies and finished goods. An entire business can react instantly to each customer order or purchase decision. Companies failing to take advantage of the latest systems, it is said, will find themselves at a serious competitive disadvantage.
This kind of thinking is even found in the corridors of the world's central banks. No less a figure than Alan Greenspan, the chairman of the US Federal Reserve, has argued that modern techniques of information management have increased business flexibility so that we can expect a much reduced magnitude of booms and busts in future business cycles.
The reality is more mundane. Gradual improvements in inventory management have been taking place for the best part of half a century. While the application of computers allows these improvements to be taken further than ever before, the key issues are little changed.
Central to modern manufacturing inventory and supply chain operation is the managerial philosophy known as "just in time". Pioneered by the Toyota Motor Corporation in Japan in the late 1950s, this concept long predates the widespread use of computers in business.
The key insight is that inventory, while necessary for all business, is an idle and unproductive asset. Management should therefore focus on reducing inventory to as low a level as possible, while at the same time maintaining operational integrity and flexibility.
Management must devote particular attention to supplier relationships. Orders must be fulfilled quickly and lead times must be completely reliable. Orders for replenishing raw material inventory can then be left until the last possible moment, in the knowledge that the factory can rely on a delivery arriving "just in time". Retail businesses and durable goods producers face the additional challenge of matching inventory levels to anticipated demand.
Unsold inventory, especially perishable goods or fashion items, may have to be sold at deep discount or even written off. Out of stock situations are equally unwelcome since they represent both lost sales and the erosion of customer relationships.
Understanding customer needs, still as much an art as a science, is central. And the challenge is really one of effective risk management - sensible choices about the balance between risk and reward. Do I take the risk of building up final inventory in the expectation that demand will be strong? What are the costs if these expectations are disappointed?
The recent massive inventory write-offs by Cisco Systems are a case in point. They had the most up- to-date systems available for tracking order flow on a real-time basis, but no system can perfectly predict demand. In retrospect it is clear that the risk Cisco was taking, producing in anticipation of future sales, did not justify the reward of winning a few more customer orders.
This is not to deny that information technology is crucial to achieving the most efficient possible management of inventory. Web pages are far more efficient than old fashioned parts books or microfiche for storing information in an accessible form. Telecommunications linked with computers greatly accelerate the speed of order flow. Error and exception processing can be cut dramatically.
But in order to be cost-effective, information technology needs to be used and operated as part of a coherent and focused inventory strategy. Three features are key:
- It should provide senior management with a good grasp of the overall picture, helping them to see the wood not just the trees
- Specific benefits, for example reduced order times, must be assessed in the context of the entire business process - it is the slowest stage of the process that determines the overall speed
- While routine processes can be automated, human judgement and interaction is still essential for maintaining the supplier and customer relationships at the heart of any business.
Alistair Milne lectures in banking and finance at the City University and holds a PhD on the ecomomics of inventory investment