How to turn inventory reduction into successful transformation

Working capital reduction is once again hot. How to take inventory reduction one step further and turn it into successful transformation?

Working capital reduction is once again hot. This trend is likely due to rising interest rates and an increased reluctance to finance. There’s a shift happening: people buy less goods and more services, which results in shorter order books. And while we were quickly building stocks to recover from post-COVID material shortage, those efforts have come to a sudden stop.

Optimization: the classic approach to inventory reduction

Standard net working capital reduction has three workstreams: debtors, creditors, and inventory. As supply chain and operations strategists, we’re usually called in for the latter.

The classic approach to inventory reduction is a straightforward one. It revolves around optimization: you try and secure availability and lead times for markets while reducing stock. Depending on the situation, you might also want to add a portfolio rationalization to increase stock turn.

This playbook approach is as valid as ever. It quickly pays off to cut slack from the actual stock abundance, which was caused by loose stock policies during a low capital cost era followed by post-COVID material shortage.

One company, one goal: a more transformative approach

Although there’s nothing wrong with the classic approach, there are two types of companies that can reduce stock in an even more transformative way. We’ll discuss them below!

1. Decentralized companies

These organizations typically have a range of operating companies, which are run as profit centers. Local MDs have used inventory to boost availability and maximize  growth. New value-over-volume strategies create a strong trigger to challenge the status quo. In terms of governance, decentralized companies can choose two routes:

We recommend that you choose both routes if you can. It allows you to secure the entrepreneurial culture that operating companies thrive on, while keeping an eye on the companywide allocation of cash and stock.

2. Vertically integrated industrial companies

These companies need to adopt a through-chain approach to balance WIP (work in progress) against market demand. The complexity is mainly driven by long lead times between raw materials (upstream) and finished product (downstream). This causes substantial WIP along the way.

In such cases, two approaches provide a solution — and ideally, companies implement them in the following order:

Once implemented, managing WIP versus availability means you’re (re)setting the ideal parameters that feed the algorithm. You’ll use a hands-off approach with the least possible manual interventions in WIP and order book — apart from major disruptions in flow.

Embracing a value-over-volume strategy

Whether you adopt the classic approach or the more transformative one, working capital reduction is a powerful trigger to implement parts of a value-over-volume strategy. Rather than just reducing capital employed, it’s a powerful way to eliminate waste in product portfolios, make customer centricity more efficient, and ensure higher returns on invested capital.