Charlie Munger, renowned investor, advises: “To become wise, you’ve got to have a latticework of models in your head.”
WHY MULTIPLE MODELS?
Research proves our evolutionary brains are riddled with “cognitive biases.” This is good for species survival but bad for innovating service value.
We don’t know what we don’t know. And, thanks to “confirmation bias,” we prefer to listen to people who share our data-free beliefs. Willful ignorance is common, as we humans struggle to cope with the reality of too much math.
Because models are simplifications of reality, they are flawed with blind spots, but they’re not as flawed as our thinking. And, multiple models can offset the others’ blind spots. Let’s look at some fill-rate models.
THE DOMINANT FINANCIAL LENS
Inventory is your biggest asset, so the faster it turns, the better the return on investment (ROI).
To do this, you coul focus on improve two related financial ratios:
GMROI= Warehouse Gross Margin Dollars (divided by) average Inventory Investment.
Turns x Earns (GM%)
- But, slimming inventory reduces fill rates. What’s the optimal target fill-rate percentage that balances declining service value to customers with increasing ROI?
- To accomplish this, graph your inventory investment vs. your fill rates. Find the sharp bend in the graph where diminishing returns set in. In a classic, hard goods-distributor case, at 92 percent fill rates inventory would need to double to improve fill rates to 95 percent. So, should you target all SKUs for 92 percent?
- And, fill rates increase with knowledgeable substitutions; inter-branch transfers; and back-ordering, non-urgently needed stock outs.
COST-TO-SERVE LENS AT THE LINE-ITEM/SKU LEVEL
- Completing orders with inter-branch transfers and back orders creates significant operational activity expense. Fatter inventory improves fill rates, transactional costs for both the distributor and its customers, and productivity of your people. All of these are positive trade-offs.
- About 5 percent of SKUs are extremely net-profitable. Why not target those for especially high fill rates?
- Another 5 percent of SKUs are very popular yet unprofitable, small-dollar picks. Target these for higher fill rates, but also pursue a blend of other profit-improving moves for these SKUs.
HIGHER FILL RATES FOR TARGET CUSTOMER NICHES
Having best fill rates for all types of customers is tough. But, what if you have historically strong sales and fill rates for a peculiar niche of customers? Or, do you want to target a specific niche? Then, model what the niche buys and beef up those SKUs. The best fill rates will both retain and win more niche customers. Increased fill rates also boosts average gross margin dollars per order and employees, which, in turn, cranks profit dollars per employee.
Financial ratios for inventory don’t see any of my underlinings. A cost-to-serve model at the line/SKU model is a surefire way to find success.
Publication date: 02/01/19