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Home : Articles : Inventory : Inventory Management

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INVENTORY MANAGEMENT

When dealing with inventory, many companies mistakenly believe that centralization will cost them more in the long run. They can't imagine that maintaining their inventory in a variety of warehouses instead of just one would really save them money in the long run. But those businesses might be well served to do a few minor mathematical calculations.

The formula is known as the Square Root Law of Inventory. This formula has been around for five decades and was proven to be a mathematical actuality way back in the 1970's by business expert D. H. Maister. Essentially, the Square Root Law of Inventory states that the number of warehouses a company has will cause a specific increase in certain costs. Likewise, the less warehouses the businesses uses will result in a specific increase in savings. This increase, either in a positive or negative direction, can be mathematically computed using the Square Root Law.

For example, if Company A uses 15 different warehouses for their inventory then their costs would be likely be almost 75 percent greater than if they only used a single warehouse. Also, if Company B originally had 5 warehouses and decided to centralize their inventory, they would see a savings of just over 50 percent.

Of course, savvy organizations don't need a mathematical formula to recognize the savings of having a single warehouse. The costs of paying taxes on or of renting the facility are extensive on their own, but those costs must also be added to the expenses of maintaining those buildings, paying for warehouse staff, adding security features, etc. Basically, all of the costs of having one warehouse double when a company adds another warehouse.

Besides costs, multiple warehouses are also more difficult to manage. Keeping track of the inventory at several locations, watching stock amounts, handling orders, and planning distribution are all more complicated when a company has to deal with more than one or two warehouses. Not to mention that it can also complicate the addition of technology, such as supply chain management software or ERP systems.

Switching to a more centralized warehouse system may not seem possible to many businesses, but the change is possible, especially in companies that already have effective supply chain management in place. With modern supply chains, vendors are able to monitor inventory and to replenish the stock on an as needed basis. As a result, companies no longer have to fill warehouses with stock just to make sure they have what they need for the future. Likewise, collaboration with logistics vendors can help keep finished products moving so few need to accumulate in the warehouse. The combination of savings from the efficient supply chain and the centralized warehouse are significant.

However, companies can also make some other changes with their warehouses to also save money. One of the most common methods involves the Slow Moving Goods (SMG) strategy. According to this strategy, a company can boost productivity by achieving a better balance in their warehouse between SMGs and Fast Moving Goods (FMG). A division of 80% FMGs and 20% SMGs is ideal for warehouse arrangements and prevents overcrowding in the warehouse since the majority of goods being stored there will be almost constantly on the move.

Before making a decision on the appropriate strategy, businesses must also take in mind factors other than the Square Root Law of Inventory. Transportation costs, for example, must be considered, as well as lead time, availability, and warehouse proximity. In some cases, businesses may opt to centralize their network by reducing their number of warehouses to only two strategically located facilities. However, those types of decisions should only be made when all of the factors have been weighed and given thorough consideration.

While the convenience of having multiple warehouses may seem worth the extra cost, the reality is that those warehouses are not only more expensive but more difficult to manage and maintain effectively. Centralizing inventory is the ideal solution for most businesses.

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