"We are a manufacturing company selling mostly through regional distributors nationwide. We recently organized a distributor convention where we learned that our distributors are usually overstocked with slow-moving SKUs and under-stocked with fast-moving ones. As a result, we were losing about 18% in sales every month while our distributors were at least two weeks overstocked. Our distributors submit their monthly inventory reports to our distributor sales specialists but no one in our office is in charge of collating and analyzing them. We intend to hire someone to monitor inventory reports and were wondering if you have a 'formula' on how to ensure that inventories are just right and that reports submitted to us are accurate." - Dean Carpio
 

Your question brings to mind the Vendor-Managed Inventory (VMI) concept. In a supplier-distributor relationship, VMI is applied when the distributor of your products provides you with information, like how much on average they sell to customers per stock keeping unit (SKU), and you take full responsibility for maintaining your pre-agreed inventory level. For this to work faster and more accurately, companies install an information system which sends and receives information electronically via Internet or Electronic Data Interchange (EDI).

If you don't yet have a centralized system that captures and analyzes inventory and sales data from your distributors, I strongly suggest you consider installing an internet-based information system soon as a tool to better understand your business and customers. It's not as expensive as most people think, but here's the 'formula' that you can use for now.

The agreed inventory level that a distributor must keep at any given time to avoid over or under stocking is the Inventory Control Objective or Target Inventory Level. You can invent your own title, but for now let’s call it the Agreed Inventory Level (AIL).

There are four variables in our AIL:

Frequency of Ordering (FO). This refers to how many times in a selling cycle the distributor places an order from your company. It is important to fix the schedules and frequency of ordering for better planning and inventory management. You may fix the frequency of ordering once a month, every other week, or weekly. The frequency may vary per distributor.

Average Sales (AS). This is the distributor’s actual average sales or off-take computed at cost of goods sold.

Buffer Stocks or Floor Stocks (BS). This is the agreed level of inventory to cover unexpected or abnormal sales surges which is based on historical sales data.

Order-To-Deliver Lead Time (OTD). This is the time from when the purchase order is placed by distributor to the time orders are actually delivered by your company at their doorsteps. The merchandise is still in transit and will eventually form part of the distributor’s inventory count upon receipt.

 

The four variables above may be expressed in number of days, weeks or months. Below is an example of how to compute for AIL using number of weeks supply.

Agreed Inventory Level (in weeks).

Expressed in Weeks:

FO (Once a Month)

FO (2x a Month)
Average Sales

4 Weeks

2 Weeks
Buffer Stocks

2 Weeks

1 Week
OTD Lead Time

1 Week

1 Week
Agreed Inventory Level

7 Weeks

4 Weeks

If the frequency of ordering is once a month, your average sales cover is 4 weeks. If twice a month, 2 weeks. If once a week, 1, and so on. The buffer stocks also change but will largely depend on your agreement. Notice that only OTD does not change regardless of FO.

How do you use AIL to place an order that is just right - not over nor under stock? Get the ending inventory count of the distributor at the time an order is placed and deduct it from the AIL. In the example above (FO once a month), the AIL is 7 weeks. Assuming the ending inventory at the time of ordering is good for 2 weeks, the right order quantity should be enough for 5 weeks (7 - 2).

In my distribution business, my purchasing officer uses this very simple format in the computer using excel which you may copy:

Product (SKU)

A.I.L.

Ending Inventory

Order

       

Lastly, you may include the AIL and all its variables in your distributorship agreement to ensure implementation.

Emilio "Bong" Macasaet III is Partner and Chief Distribution Strategist of Mansmith and Fielders, Inc. (www.mansmith.net), the leading marketing and sales training company in the Philippines. For inquiries, please email info@mansmith.net, call (+63-2) 584-5858 /412-0034 or text (63) 918-81-168-88. Please also send your marketing, sales and strategy questions to mentors@mansmith.net.