Measuring sludge stock

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By Tony Dear, Director, IMA.
The theory is that products continuously flow through the supply chain. Sometimes they don't. They slow down or stop moving. This is Sludge Stock.
Results of poor inventory operations management
As a mathematician I came into supply chain planning and management because I thought I had some unique knowledge or a few smart algorithms that might be of value. After a few years it dawned on me that my maths was of peripheral use but that the main problems in supply chain planning were much more basic. Some examples:
The Australian pirate spares operation that ended up with more Alfa Romeo exhausts than there were cars of that model in the whole of Australia.
The health food company which had two piles of leaflets in the office of the sales director. The first was a lavish leaflet advertising a promotion of a coffee substitute. The second pile was a less fulsome note apologising for running out of this product so soon in the campaign.
The bearing company that defined any stock in excess of four months demand as excess. Excess stock was 45% of total stock.
The chain effect in internal supply chains. A local mechanic in helicopter support in Nigeria orders 2 oil pumps. His supervisor in Lagos receives his requirement and doubles it. The central stock controller in the UK does the same so that an order for 8 pumps is placed on the supplier.
The fastener company with 8000 products in three warehouses which were controlled by Reorder Points which were set manually. These tended to be updated only when a crisis occurred usually when a product went out of stock the ROP was raised. As a result the Reorder Points bore little relation to demand but they remained the sole source of order suggestions.
Two companies and two systems. In the first the Managing Director told me what a great Inventory System they had minimal investment, low obsolescence, and good service. When I investigated I found the system suggestions were inappropriate and the good results came only because the stock controller changed 80% of the suggestions from the system. In the second the system had a bad name because the results were bad but this was because the stock controllers constantly overruled the system suggestions which were in fact quite sensible.
It is very easy in stock operations to end up in a situation which you never wanted to develop.  Perhaps the worst scenario for most operations is the accumulation of sludge stock.
Sludge stock
Sludge stock is show-moving or non-moving stock. The problem is that most warehouse operations tend to accumulate more of it than they would like. Investment in stock is an investment in customer service; excessive investment in sludge stock is often not the best way to use the company's money.
There are three primary issues with sludge stock.
INSIDIOUS ACCUMULATION: Sludge stock accumulates insidiously and under the radar.  In part this is because of the manner in which most inventory systems calculate Reorder Points and other inventory parameters which generate the order suggestions. For example the common approach of setting different target service levels for A, B, and C products often contributes directly to sludge stock accumulation. Less sophisticated approaches to setting parameters including the option of setting them all individually, item by item are even more likely to result in sludge stock accumulation. The problem is focus; traditional approaches to setting stock parameters do not pay attention to -  or attempt to quantify  - the implications of particular stock parameter settings in terms of sludge stock accumulation.
IMPACT ON SERVICE: Sludge stock impacts service. The more money that is invested in sludge the less that is available to invest in the products the customers actually want. Sludge stock is necessary but it should be planned and managed and not just allowed to happen. It should be an aid to customer service rather than as something that impedes it.
DIFFICULT TO CORRECT: The most difficult problem with sludge stock is getting rid of it once it accumulates. Often the only option is to write it down and this is an extremely expensive option. Many companies are constantly held back by sludge stock accumulation; they suffer the worst of both worlds poor service coupled with excessive investment in stock. One company plagued with sludge stock decided to bite the bullet and get rid on it which they did at considerable expense. Three years later they had just as much as previously. Nature fills a vacuum.  
There are two key points about sludge stock.
Sludge stock is necessary to ensure an acceptable level of service.
Sludge stock accumulation should be planned - not just allowed to happen.
If we want to plan and manage sludge stock then we must have some way of measuring it. Over the years I have found very few companies that have any systematic measure of sludge much less an approach to its management. This article looks at a methodology for measuring sludge stock accumulation using deciles.
The companion article "Controlling Sludge Stock"  sets out an approach based on deciles which expands and builds on traditional approaches to stock management to monitor and control the ongoing accumulation of sludge.
Using deciles to monitor sludge stock accumulation
Here is a situation we recently came across. The company imported electrical accessories and they had a little too much stock just under 2m compared with a budget of 1.8m.  It didn't look too much out of line. So the usual injunction was issued to reduce stock. We felt it was worth analysing in a little more detail using deciles.
The idea of deciles is not at all complex and works like this. List the products in decreasing order of sales value (or margin) and then divide these products into deciles ie the top 10% are the first decile, the next 10% are the second, and so on. The results for this operation are displayed below.

The sales value and stock value are both calculated using standard cost. The other columns show the number of products, the percent of sales, the percent of stock and the weeks of stock in each decile. The last row is stock that has not moved in the past year which it is often useful to display separately.
The amount of sludge becomes immediately apparent; 63% of stock yields 20% of sales. Conversely the cover for the stuff that is moving is very low 37% of stock to cover 80% of sales.  Telling people to reduce stock is totally counter-productive in this situation; the problem is not overstock but survival.
There is a further point here. We have found across a wide variety of warehouse operations that in the top 7 or 8 deciles the investment in stock tends to be quite reasonable. It is the investment in the lower 2 or 3 deciles that is the issue.
Measuring sludge stock investment: SSI
The usual KPIs in any warehouse model is investment in stock. This is constantly measured and is available in every report on the warehouse. It can be very illuminating to measure this investment by decile.
We would suggest a further measure of importance. Given the tendency to accumulate sludge stock and the great difficulty in remedying the situation once it occurs it is well to consider a single measure of sludge stock accumulation that can be monitored by management. This may be done using the KPI of Sludge Stock Investment (SSI).
Let us consider our investment in stock. To achieve the optimal return on investment from an accounting viewpoint it is logical to invest equally in each decile.

Unfortunately this is mostly not possible. The lower deciles have many more products in each decile and the demand for these products tends to be more erratic. To maintain even a reasonable service in these deciles it is often necessary to invest more in them. The situation tends to be more like that shown below.
The investment in the lower deciles must come at the expense of investment in the upper deciles; it is a necessary movement of investment into less productive areas.
From this we can work out a simple indicator of the extent of the sludge accumulation. This is the Sludge Stock Investment (SSI) and it is the amount of investment in the lower two deciles; in the graph above it is 34%. This means that in the upper deciles 66% or stock accounts for 80% of sales This is probably quite acceptable; any SSI above 35% should raise alarm bells.
Given that the accumulation of sludge stock is so often the main issue with many warehouses, coupled with the difficulty of rectifying excessive accumulations, it is logical to have a measure of this and to keep a constant eagle eye on it. The Sludge Stock Investment is a good measure of this. It enables the sludge component of stock to be both planned and closely monitored.
Excessive sludge stock accumulation is the most common problem in warehouse operations with many products.  It accumulates under the radar, impacts overall service, and is extremely difficult to resolve without incurring very considerable expense.
The accumulation of sludge stock should be both planned and monitored.
Measuring stock in terms of deciles provides a very precise method of monitoring sludge stock accumulation. In addition the KPI of Sludge Stock Investment (ASSI) the investment to cover the lowest 2 deciles of sales - provides a simple measure for management both to set the amount they wish to invest in sludge and to monitor performance against this standard.
Once the sludge component of stock is defined and valued it is possible to develop ongoing stock management policies that ensure it is contained within planned limits and so the investment in stock is used to service customers and not to support a mound of expensive stuff that no one wants.

Article by Tony Dear, principal of Inventory Management Associates.
Inventory Management Associates (IMA) specialises in demand forecasting, supply chain planning & inventory management solutions both through sophisticated software & technical expertise. IMA has been helping companies improve their supply chain in many countries for over 30 years and in a wide variety of industries including retailing, merchanting (paper & steel), automotive spares, fashion, music and food & beverages. IMA's software & support compliments legacy & enterprise software to deliver improvements to clients key supply chain metrics.

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