AutoZone’s supply chain expansion: A case study

Featuring Josh Bartel and Drew Roth

Guest-at-a-glance

Josh Bartel

CEO

Hydrian Inventory Optimization

Josh graduated from Stanford and previously co-founded Sanitopia.

Drew Roth

Director of Product Engineering

Hydrian Inventory Optimization

Experienced software engineer focused on inventory optimization.

Episode summary

Drew Roth sits down with Josh Bartel to discuss the challenges and opportunities of supply chain expansion. Using AutoZone’s ambitious plan to build 200 new distribution centers as a case study, Josh explores the potential benefits and downsides of multi-echelon networks.

While expanding a company’s geographic footprint can lead to faster delivery and increased sales, Josh cautions listeners about hidden costs. Internal freight costs, outbound shipping expenses, and the complexity of managing inventory across multiple locations can cut into any potential gains.

Josh emphasizes the importance of focusing on local fill rates as a key performance indicator. He advises companies to prioritize optimizing inventory at existing facilities before expanding their network. This episode offers practical advice for any business leader looking to improve their supply chain strategy.

Key insights

Don't confuse network fill rate with success

While expanding your distribution center network might look good on paper — increasing your overall in-stock rate — it can mask inefficiencies. Josh cautions against focusing solely on network-wide fill rates. He stresses the importance of local fill rates, meaning the percentage of orders fulfilled from the DC closest to the customer. A high network fill rate alongside a low local fill rate often indicates an imbalance requiring attention.

Hidden costs can undermine expansion benefits

Before embarking on an ambitious DC expansion project, businesses need to fully grasp the potential hidden costs. Josh highlights internal freight expenses as a common culprit. Moving inventory between DCs to fulfill orders adds up quickly and often goes unnoticed as it’s grouped with general transportation costs. Additionally, increased inventory carrying costs and the added complexity of managing a larger network can significantly impact the bottom line.

Prioritize inventory optimization before expansion

Josh advises companies to exhaust inventory optimization strategies at existing facilities before investing in new distribution centers. Often, companies can achieve significant improvements in delivery speed and customer satisfaction by simply improving inventory management practices at their current locations. This might involve implementing demand forecasting tools, optimizing safety stock levels, and streamlining warehouse operations for greater efficiency.

Test new markets with 3PLs before full expansion

For companies considering expanding their geographic reach, Josh recommends a cautious approach. Instead of immediately investing in new facilities, he suggests partnering with a third-party logistics provider (3PL). This allows companies to test demand and gauge the market’s response to faster delivery times in a new region without the significant upfront costs associated with building or leasing a DC.

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Optimize your offering: Item level net profitability

Featuring Josh Bartel and Drew Roth

Guest-at-a-glance

Josh Bartel

CEO

Hydrian Inventory Optimization

Josh graduated from Stanford and previously co-founded Sanitopia.

Drew Roth

Director of Product Engineering

Hydrian Inventory Optimization

Experienced software engineer focused on inventory optimization.

Episode summary

Josh Bartel and Drew Roth tackle the crucial question: which items should distributors and wholesalers carry? They explore the pros and cons of common inventory strategies including stocking, just-in-time ordering, dropshipping, and removing items from your catalog entirely.

Drew emphasizes the need to analyze factors beyond gross margin when determining true item profitability. Minimum order quantities, vendor performance, shipping costs, and even customer order composition can significantly impact an item’s financial viability.

Discover how one client achieved impressive results by embracing a “SKU diet.” By strategically reducing their product catalog by 40% based on Hydrian’s data-driven analysis, they unlocked revenue growth and increased overall profitability. This episode offers valuable insights and advice for anyone interested in optimizing their inventory.

Key insights

The "SKU diet": Less can be more

Distributors and wholesalers often feel pressure to offer vast product catalogs. However, carrying too many SKUs can negatively impact profitability and customer experience. Josh and Drew advocate for a “SKU diet” – strategically reducing your catalog by eliminating underperforming or unprofitable items. This simplifies operations, reduces inventory costs, and can even lead to sales growth by improving customer focus.

True profitability: Beyond gross margin

Don’t be seduced by a product’s seemingly attractive gross profit margin. Drew emphasizes the importance of considering all costs associated with an item, including inbound freight, storage, outbound shipping, and potential obsolescence. By calculating the true net profitability, businesses can make more informed stocking decisions.

Vendor performance: A key factor in dropshipping

Dropshipping can be an attractive alternative to stocking inventory, but vendor reliability is paramount. Drew and Josh advise carefully evaluating potential dropship partners on factors like shipping speed, packaging quality, and inventory accuracy. Inconsistent vendor performance can damage customer relationships and negatively impact your brand.

Data-driven decisions: The key to inventory optimization

Making sound inventory decisions requires more than intuition. Josh highlights the power of data analysis in identifying underperforming SKUs, optimizing inventory levels, and ultimately improving profitability. By leveraging tools and insights, businesses can move away from gut feelings and towards objective, data-supported inventory strategies.

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Navigating inventory management challenges for SMEs

Written by Michael Jones

Running a small to medium-sized enterprise (SME) is no easy feat. You’re constantly juggling priorities and resources, all while trying to stay ahead of the competition. One area that’s become increasingly complex is supply chain management, particularly inventory management.

While powerful inventory software tools are available, they often come with a learning curve and require specialized skills. This leaves SMEs with a tough decision: invest in training, hire new talent, or outsource?

This article explores the challenges SMEs face and offers potential solutions for navigating the evolving landscape of inventory management.

The rise of inventory software tools

Inventory management software has come a long way from basic spreadsheets. Today’s solutions offer a range of advanced features designed to streamline and optimize inventory control:

Real-time tracking: Provides a constant view of inventory levels, allowing businesses to track stock movements, identify low-stock items, and monitor incoming shipments. This real-time visibility helps prevent stockouts and ensures timely replenishment.
Predictive analytics: Leverages historical data, market trends, and other variables to forecast future demand. This empowers businesses to anticipate customer needs, optimize inventory levels, and minimize the risks of overstocking or understocking.
Automated reordering: Simplifies the replenishment process by automatically generating purchase orders when inventory levels fall below predetermined thresholds. This automation saves time, reduces manual errors, and ensures a consistent flow of inventory.

The skill set dilemma

The availability of advanced features is undeniably beneficial but presents a new set of challenges for SMEs. Implementing and using these sophisticated tools requires a skilled workforce. This leads to a critical decision-making point for SMEs: should they train their current staff, hire new talent, or outsource specific functions?

Training existing staff

Training existing employees is often the most cost-effective option, but requires significant time investment and may impact productivity. SMEs must consider if their team has the bandwidth to learn the new software while managing their current responsibilities. Can existing workflows be adapted to incorporate new systems without overburdening employees?

Hiring new talent

Recruiting specialized talent for complex inventory management presents significant hurdles. Finding individuals with expertise in data analysis, forecasting, and supply chain management is challenging and costly. SMEs must weigh the financial implications of expanding their workforce against the potential benefits of a dedicated inventory management team.

The case for outsourcing

Given the challenges of training and skill development, outsourcing certain supply chain functions can be an attractive option for SMEs. By leveraging the expertise of third-party providers, companies can mitigate the time and cost associated with implementing and maintaining complex inventory systems. Outsourcing can also provide access to cutting-edge technologies and best practices that may be beyond the reach of smaller firms.

However, outsourcing is not without its challenges. Companies must carefully select partners who understand their specific needs and can deliver consistent, high-quality service. Additionally, outsourcing can lead to a loss of control over certain aspects of the supply chain, which can be risky if not managed properly.

The complexity of forecasting and demand planning

Accurately forecasting demand is crucial for effective inventory management, regardless of the chosen software or approach. Inaccurate forecasts can lead to costly imbalances in inventory levels. Overstocking ties up capital, increases storage costs, and carries the risk of obsolescence while understocking results in missed sales opportunities and dissatisfied customers.

Effective demand forecasting goes beyond basic calculations and relies on sophisticated algorithms, statistical modeling, and the ability to analyze large datasets. SMEs need to ensure they have access to the right tools and the ability to interpret data to generate accurate forecasts and align inventory levels accordingly.

Managing lead times and price changes

In addition to demand forecasting, SMEs must also manage varying lead times and supply-led price changes. Lead times can fluctuate due to a variety of factors, including supplier reliability, transportation issues, and geopolitical events. Companies must have systems in place to monitor lead times and adjust their ordering practices to avoid disruptions.

Similarly, price volatility in the supply chain can impact cost management. SMEs need to be agile in responding to price changes, negotiating with suppliers, and adjusting pricing strategies to maintain profitability. This requires a deep understanding of both fixed and variable costs and the ability to react quickly to market changes.

Conclusion

Successfully navigating the complexities of today’s supply chain environment demands a strategic and adaptable approach, especially for SMEs facing resource constraints. While advanced inventory software tools offer significant potential benefits, implementing them effectively requires careful consideration.

Balancing the need for specialized skills with available resources is crucial for optimizing supply chain operations and maintaining a competitive edge in the market. By carefully evaluating their options — whether investing in training for existing staff, hiring new talent, or outsourcing specific functions — SMEs can leverage the right tools and expertise to navigate inventory management effectively.

Ultimately, the chosen approach should align with the specific needs, resources, and long-term goals of each SME to ensure efficient, cost-effective, and adaptable supply chain management.

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AutoZone’s push for more distribution centers: When does expanding your DC network have diminishing returns?

AutoZone's push for more distribution centers: When does expanding your DC network have diminishing returns?

AutoZone has recently made headlines with its aggressive construction of new distribution centers (DCs) referred to as “mega hubs.” These mega hubs are designed to replenish nearby stores more efficiently and enhance inventory availability, and the retailer intends to build 200 of them over the next few years. While expanding a distribution network offers numerous benefits, it also raises the question: When does this expansion start to yield diminishing returns?

Benefits of expanding distribution centers

Improved delivery speed: By having more DCs closer to retail locations and their end users, AutoZone can reduce delivery times, leading to faster replenishment and order fulfillment, with higher customer satisfaction.
Increased inventory availability: Single, large locations can afford to stock a longer “tail” of lower-volume items, allowing each AutoZone store to offer a broader selection of products.
Sales growth: As delivery speed and availability improve in new geographic markets, there is almost always a corresponding increase in sales.

Downsides of expansion

Operational costs: As the number of DCs increase, so do the operational costs, particularly internal freight costs as material is shuttled between hub locations and retail stores. Each new DC also requires investment in infrastructure, staffing, and various carrying costs. All of these costs can be very hard to quantify.
Inventory management complexity: Managing inventory across a larger network of DCs becomes increasingly complex. For each location, for example, supply chain planners must decide whether or not each supplier should replenish directly into a facility, or use a hub- and- spoke system. This complexity can lead to inefficiencies and higher costs.
Market saturation: There is a point at which adding more DCs does not significantly improve market coverage. Beyond this point, the additional benefits of new DCs are minimal.
Complexity in demand routing: If a customer places a multi-line order and one item is out of stock at the nearest shipping location, the order may need to be split and shipped from different locations. This increases outbound transit costs and affects the customer experience, as parts of the order may arrive on different days.

Global vs local fill rates

Many companies focus on their network-wide or “global” fill rate. For example, if a customer in California orders a product that is out of stock at a nearby DC but has availability in a DC across the country, you might think that you have successfully filled that order from stock. However, the customer experience (having to wait several days for a separate shipment) and the financial implications (an added shipment, with a high transit time or zone count) likely mean that the order didn’t add much to your bottomline.

Moreover, some sales channels, such as Amazon, won’t even display a product to customers (or will significantly downgrade its ranking) if it isn’t available at a location that can deliver within a target timeframe.

Keeping a focus on local in-stock rates is critical — and as those rates rise, network-wide in-stock rates will naturally increase as well.

Hub-and-spoke vs direct replenishment

With multiple facilities, you now have the option to replenish one location from another, larger location, rather than the supplier. Such a hub-and-spoke relationship can create substantial savings, especially for suppliers with high order minimums or incentive requirements.

However, internal freight and labor costs will increase, and the marginal change in these costs due to hub-and-spoke replenishment can be tough to isolate. Furthermore, high order or free freight minimums can make it impractical to use this model for some suppliers/facilities.

Ideally, you constantly monitor these factors and update your direct buy vs hub-and-spoke settings for each supplier in each facility.

Testing the waters

Before committing to a new facility, it may make more sense to use a 3PL or other non-owned infrastructure to test the impact of stocking products in new locations. If the program is successful, a more substantial investment (in inventory, facilities, staff, etc.) can be scaled up over time.

Conclusion

A strategic, data-driven approach is essential for distributors looking to optimize their distribution networks. Hydrian has several tools to assist in network planning, transition into new facilities, and ongoing operation and replenishment.

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Shelf life: How to avoid losing money to expired or obsolete parts

Managing shelf life and obsolescence is a significant challenge in the automotive parts industry. Without proper strategies, distributors can face substantial financial losses due to expired or obsolete inventory. This article explores the specific product categories most prone to these issues, effective risk management strategies, and actionable advice for optimizing inventory.

Financial impact of expired or obsolete parts

Expired or obsolete parts result in direct costs such as disposal and replacement. For hazardous products with relatively short shelf lives, disposal costs can be inordinately high. Additionally, there are indirect costs like lost sales opportunities and the storage costs of keeping unsellable inventory. These financial burdens underscore the importance of effective shelf life management. If obsolete inventory finds its way to your customers, additional costs for return or customer disposal come into play as well.

Product categories prone to shelf life issues 

Batteries

Batteries have a limited shelf life due to chemical degradation. Improper storage conditions, especially extreme cold, can accelerate this process, leading to early expiration. Certain batteries may also be prone to leakage or evaporation.

Fluids (oils, coolants, brake fluids)

These fluids are prone to degradation over time and exposure to environmental factors. They require proper storage conditions to maintain their efficacy. Hot and cold temperature cycles, in particular, can accelerate this degradation.

Rubber components
(belts, hoses, seals)

Rubber components can age and crack over time, even if unused. High humidity, high temperature, exposure to water, and particularly exposure to sunlight will all dramatically shorten the shelf life of rubber products. These products are also often subject to volatility in demand based on vehicle models and maintenance schedules.

Electronic components
(sensors, control modules)

Rapid technological advancements can render electronic components obsolete quickly. They have shorter product life cycles and higher risks of obsolescence. This is truer of consumer products (e.g. USB chargers) than OEM electrical components.

Filters (air, oil, fuel)

Filters are affected by packaging integrity and environmental conditions, especially moisture and humidity. Despite generally higher turnover rates, they are at risk of excess stock if not managed properly. Filters, especially those made of paper, can be particularly prone to mold.

Strategies for managing shelf life and obsolescence

Effective management of shelf life and obsolescence involves proactive strategies and close collaboration with suppliers. Here are some actionable approaches:

Set lower service level targets

For items with shelf life or obsolescence risk, set lower service level targets relative to other items with similar sales volume. This helps mitigate the risk of excess stock aging into expiration before it can sell. Regularly review and adjust these targets based on market demand and inventory performance.

Dynamic pricing and promotions

Use dynamic pricing strategies to move older inventory before it becomes obsolete. This could involve discounting products nearing the end of their shelf life to encourage sales.

Plan promotions and discounts specifically for items at risk of expiring. This helps clear out old stock and makes room for new inventory.

FIFO fulfillment

Ensure that the oldest product is always picked first. If lot tracking is not being used, basic rules (e.g. new product coming into stock is placed behind or above existing product) can be effective.

Planned, recurring, systematic stock rotation with vendors

Establish agreements with suppliers to rotate stock systematically. For instance, unsold inventory within the first 90 days can be exchanged for newer products without restocking fees. This ensures that your inventory remains fresh and minimizes the risk of obsolescence.

Regularly review and update stock rotation policies to keep up with market trends and inventory performance. This collaborative approach with suppliers can significantly reduce the financial burden of obsolete inventory.

Set lower service level targets: For items with shelf life or obsolescence risk, set lower service level targets relative to other items with similar sales volume. This helps mitigate the risk of excess stock aging into expiration before it can sell. Regularly review and adjust these targets based on market demand and inventory performance.
FIFO fulfillment: Ensure that the oldest product is always picked first. If lot tracking is not being used, basic rules (e.g. new product coming into stock is placed behind or above existing product) can be effective.
Dynamic pricing and promotions: Use dynamic pricing strategies to move older inventory before it becomes obsolete. This could involve discounting products nearing the end of their shelf life to encourage sales. Plan promotions and discounts specifically for items at risk of expiring. This helps clear out old stock and makes room for new inventory.
Planned, recurring, systematic stock rotation with vendors: Establish agreements with suppliers to rotate stock systematically. For instance, unsold inventory within the first 90 days can be exchanged for newer products without restocking fees. This ensures that your inventory remains fresh and minimizes the risk of obsolescence. Regularly review and update stock rotation policies to keep up with market trends and inventory performance. This collaborative approach with suppliers can significantly reduce the financial burden of obsolete inventory.

Conclusion

Managing shelf life and obsolescence is critical in the automotive parts industry. By focusing on specific product categories prone to these issues and implementing effective risk management strategies, distributors can avoid significant financial losses.

Setting lower service level targets for volatile items, establishing stock rotation agreements with suppliers, and leveraging technology for inventory management are all essential steps. By adopting these strategies, you can optimize your inventory, enhance customer satisfaction, and drive business success.

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How to improve seasonal forecast accuracy for better customer outcomes

Seasonality is a core consideration when you’re forecasting how much stock you’ll need to purchase to meet expected demand. For example, in the auto industry, the demand for batteries typically spikes in winter, while wiper blades see higher sales during rainy seasons. However, there are a number of seasonal considerations, not all related to weather, which can seriously impact the effectiveness of your forecast.

In this article, we’ll go over some key concepts:

Exploring the reliability and utility of weather forecasts in purchasing

Isolating promotional activities (e.g. Black Friday sales) from seasonal effects

Ensuring that seasonal purchasing plans take into account supplier lead time

Comparing year-over-year vs recency weighted (i.e. “momentum”) demand models

Exploring the reliability and utility of weather forecasts in purchasing

Weather is a significant factor in seasonal demand for many products. While any good forecast should account for sales changes during each season, we’ve seen some clients try to incorporate real time weather forecasts into their sales predictions. This can have utility in certain situations, but can also be more trouble than it’s worth.

Short-term accuracy

Weather forecasts are generally reliable for short-term planning (up to 10 days). For items with very short leadtimes, it may be possible to use near term weather forecasts to make adjustments to immediate inventory needs.

Long-term predictions

Long-term weather forecasts are less reliable. While patterns like El Niño can indicate general trends, they should be, at most, a small influence on your overall demand plans. The Farmer’s Almanac and other long term forecasts are notoriously unreliable.

Isolating promotional activities (e.g. black friday sales) from seasonal effects

Promotional activities can skew your seasonal forecasts if not properly accounted for. It’s crucial to isolate these effects to maintain forecast accuracy.

Historical adjustment

Adjust historical data to remove the impact of past promotions, so that your system doesn’t over-forecast coming out of a big promotion. At Hydrian, we have automated ways of doing this, but manual review of promotional sales periods is fine, too.

Future planning

Add expected promotional activities to your future forecasts to ensure adequate stock levels. This is the flipside of historic correction — if you don’t load in future increases in demand due to promotional activity, you will not have the inventory necessary to support the promotion. You might even be spending extra marketing dollars to send traffic to items that aren’t available.

Lead time cycles

For example, if your sales and marketing team doesn’t pass along estimates for promotional sales increases at least one supplier lead time cycle before the promotion starts, you will be unable to move extra inventory into your DC in time to support the promotion.

Ensuring that seasonal purchasing plans take into account supplier lead time

One critical aspect of seasonal forecasting is aligning your purchasing plans with supplier lead times. Seasonal demand spikes are predictable, but if you fail to account for the lead time required by your suppliers, you might find yourself with stockouts during peak demand periods. Order too much stock too early, however, and you’ll needlessly hold excess inventory.

Early seasonal orders

Place large seasonal buy orders roughly one lead time cycle ahead of expected demand, with a reasonable buffer.

Calculate lead time buffer

To estimate an adequate lead time buffer, you could take the 75th percentile of each supplier’s historic lead time and then add a month.

Consider holiday variances

Make sure to account for holidays and other exceptions that may change the lead time of a particular order.

Year-over-year vs recency-weighted (i.e. “momentum”) demand models

When forecasting seasonal items, it can be tempting to use the prior year’s peak demand in order to predict this year’s peak demand. For extreme seasonal items (e.g. ice scrapers, which may not sell at all during the off season) this can make good sense, especially before the high season begins. But for items with at least some sales during off-peak seasons, it’s important to incorporate that recent data into your forecast.

In any event, revising your forecast during the peak season based on actual recent sales is critical. Using a seasonally normalized model, where recent demand is first adjusted for seasonal effects before passing into your forecasting model, is usually the best approach.

Key strategies:

For extreme seasonal items, simply using last year’s sales as your baseline forecast can be a good starting point, especially before the start of the season.
For items with at least some off-peak sales, and for all items once the peak season begins, seasonally normalize historic data by dividing each past period’s sales by a “seasonal factor” (the expected sales during that period vs the annual per-period average). Run your chosen forecasting model on this data.
To “re-seasonalize” the data, multiply each forecast period’s demand in your output by that period’s seasonal factor.

Conclusion

Effective seasonal forecasting requires a nuanced approach that considers supplier lead times, the right mix of demand models, the utility of weather forecasts, and the isolation of promotional activities. By choosing the right forecast frequency and approach, you can significantly improve accuracy and ensure better customer outcomes. Implementing these strategies will help you stay ahead of demand fluctuations and maintain optimal inventory levels throughout the year.

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Is it time to go on a SKU diet? When to dropship, stock, order as needed, or stop selling a part altogether

Offering a large, diverse inventory of items is a huge source of value in the OEM aftermarket. Stocking the complete maintenance catalog for a product, for example, or allowing customers to find everything they need in one place, can be a major source of competitive advantage.

However, over time, the associated costs and complexity can weigh heavily on a business. A “SKU diet” — streamlining your inventory by deciding which items to dropship, stock, order as needed, or discontinue — can improve efficiency, reduce costs, and enhance customer satisfaction. In this article, we’ll outline a strategy for achieving these benefits.

Dropshipping

Dropshipping is when a supplier directly fulfills orders on your behalf, meaning you don’t hold inventory yourself. This reduces holding costs and the risk of overstock, but has downsides as well.

Dropshipping considerations

Availability: Does the supplier even offer direct shipping to your customer? Most overseas suppliers rarely offer dropshipping, and it might be impractical.
Delivery performance: How long does the supplier take to deliver compared to your DC? If suppliers have long dropship processing times, that would be a reason to avoid using their service. Ditto if the supplier’s packaging and presentation is not up to your own standards.
Freight cost + fees: Any multi-item customer order that involves a dropshipment will now have at least two total shipments per order, likely arriving to the customer on two different dates. This increases your total freight cost and also inconveniences the customer. Any dropshipment fees charged by the supplier are also a factor.
Unit cost / bulk: Large or expensive items can be a great fit for dropshipping since stocking those products has such a high cost.
Sales demand: When you stock a low-volume product, inventory turns, service levels, and the risk of excess stock are all worse than they are for strong sellers. Slow sellers are thus often a better fit for dropshipping.

Just-in-time shipping (i.e. “order as needed”)

Ordering a product only when demand occurs allows you to avoid the cost and risk of holding inventory. You are effectively cross-docking the product from your supplier to your customer, through your DC receiving dock. Just-in-time is a good solution for products you would otherwise dropship, but are a bad fit for dropshipping.

Considerations for just-in-time shipping vs dropshipping

Availability: Unlike dropshipping, assuming that you allow customers to backorder product, you always have the option to sell an item that is bought from the supplier only as needed.
Lead time: Compared to dropshipping, lead time is longer, since the order has to arrive at your DC before it is shipped to the customer. And both options are of course slower than if you stock the product in your DC. As with dropshipping, imported items are usually a poor fit for just-in-time, due to lead time.
Cost: Labor costs in your DC increase, since every sale also results in a receipt. Also, like dropshipping, freight costs will be higher, since you have to pay inbound and outbound shipping on a second shipment.

Stocking a product in your DC

Stocking a product usually provides the best customer experience. Lead time is minimized, you have the most control over packaging and presentation, and if all lines are in-stock, you can deliver the order in a single shipment. Of course, this option carries the most inventory risk.

Good attributes for stock products

High sales demand: Items with high sales volumes and consistent demand.
High affinity: Items that are commonly part of large customer orders should be prioritized for stock, to reduce the chance that multiple shipments will be required, or that an order will be held up by one out-of-stock item.
Reasonable size / cost: Pricey or bulky products are less appealing as stock items.
Lack of alternatives: All else being equal, items with long supplier leadtimes or high dropshipping costs are better suited for stock.

When to stop selling a product altogether

At some point, it simply isn’t sensible to sell an item. Even if gross margins are good on paper, removing it from your offering may be more economical if the fully loaded cost of selling the item is too high.

Qualities of candidate SKUs for discontinuation

Equivalent Products: If you offer another product that can fulfill the same application, it becomes less important to offer an equivalent item.
Low Demand: Items with minimal sales history or declining demand, especially if demand is sporadic (which increases the risk that a period of high activity could lead you to overstock).
Low Margin: The lower your gross margin is, the harder it is to sell an item at a profit, especially if it exhibits other attributes on this list.
High Holding Cost: Expensive, bulky, and hazardous items are all more expensive to handle, stock, and sell.
Long Lead Time: Long leadtimes basically multiply the cost of forecast error, since you are effectively predicting sales (and purchasing inventory) to cover longer and longer periods into the future. Since dropshipping and just-in-time are generally not a good fit for long lead time items, discontinuing becomes more attractive.

Case study: Successful SKU optimization

In 2022, Hydrian implemented a SKU rationalization program (i.e. “SKU diet”) for a long-time client, a $150MM revenue aftermarket and OEM parts distributor. After working with the client to establish parameters for deciding how to classify their existing catalog, the following was achieved over the course of the next year:

Stocking SKUs went from 14,500 to 8,250.
The number of products offered on dropship (9,000) remained stable, with around 2,000 products being removed from dropship programs and another 2,000 items being added.
Just-in-time products went from 4,500 to 5,500.
Over 4,000 products were discontinued.
Fill rates increased from 86% to 94%.
Inventory turns increased from 3.3 to 5.5.
Gross profit increased from 34% to 36%.
Revenue increased 8%.

Conclusion

SKU management is crucial for businesses looking to improve efficiency and profitability. By strategically deciding which items to dropship, stock, order as needed, or discontinue, businesses can reduce costs, streamline operations, and enhance customer satisfaction. Implement these strategies to ensure your inventory is aligned with market demand and your business goals.

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Overseas suppliers, gray markets, and the age-old question: Do you want it cheap or fast?

Overseas suppliers, gray markets, and the age-old question: Do you want it cheap, or fast?

Finding the right balance between cost and speed is crucial in every supply chain, especially in the OEM and aftermarket auto parts market. Distributors often face the dilemma of choosing between cheaper parts from overseas and faster, more reliable, yet more expensive domestic options. In this article, we’ll discuss how to set up a supply chain that balances these competing interests.

Gray market suppliers

The gray market refers to the trade of genuine parts that, while legal, may not be authorized by the manufacturer. While these parts are often sourced from legitimate manufacturers, they bypass official distribution networks, resulting in lower prices.

Advantages

Cost: Prices can be as much as 70% below manufacturer wholesale rates.
Rare or discontinued parts: These channels can provide access to parts that are otherwise difficult to source.

Risks

Availability: Gray markets often have large surpluses of a particular item in one month and then may not offer that item at all for the next several months. Having a secondary supplier is crucial when utilizing gray markets. For this same reason, it’s important to price gray market items carefully. If you lower your sell price dramatically due to low sourcing cost, customers may be displeased if you have to reverse that decision a month later due to gray market availability concerns.
Lead Time: Gray markets often have extended lead times, even in comparison to other overseas options. This can significantly impact service levels and safety stock requirements.
Quality Issues: There is a risk of receiving parts that do not meet quality standards, as gray market suppliers may not adhere to strict quality control measures. Be willing to pay a premium to buy from sources that come from authorized vendors.
Lack of Certification: Parts purchased through gray market channels often do not come with warranties or the same certifications as they do when purchased directly from the manufacturer. Remaining shelf life, when applicable, may be shorter. Worst case, the parts you buy on the gray market may not even be legal to sell in your local market.
Relationship Risk: If manufacturers and key approved suppliers find out about your utilization of gray markets, they may view it unfavorably, which could impact your future relationship with them.

Gap sourcing

Gap sourcing is the strategy of purchasing from a domestic, higher-cost supplier to cover a shortage while waiting for overseas or gray market materials to arrive. This approach helps maintain service levels and avoid stockouts during periods of extended lead times at the expense of gross margin. Having a secondary gap source —- even if they are a competitor — is a must when utilizing import suppliers and gray markets in your supply chain.

Setting up an effective gap sourcing program

Accurate ETAs: Knowing delivery dates for outstanding gray market/import orders is crucial. Communicate with suppliers about open orders and regularly audit the accuracy of their delivery estimates (both the initial estimate at the time of PO placement and at later stages). Good delivery estimates will allow you to predict future stockout periods and how long they will last.
Expediting: Sometimes, free expediting (i.e. simply asking the supplier for earlier delivery) may be adequate to cover a future inventory gap, with no need to find an alternate source. Failing that, a paid option (e.g. expediting shipping) may still be more economical than paying a competitor or other domestic source for a gap-covering, low-margin buy.
Gap lead time: The lead time of your gap source will determine how far out you need to forecast inventory shortages. If you expect to run out of stock in a month and can gap source in a week, you should wait until you are down to roughly one week of stock before placing the gap buy. If demand is lower than expected, or the import order arrives earlier than expected, you may not need to gap source at all. For the same reason, it is recommended to buy no more than a week or two of expected demand at a time from your gap source; you can always place another order next week.
Profit margin: Regular audits of your gap source margin vs your import margin may justify changing your primary source to the domestic supplier. Typically, if the domestic cost is within 25%, we recommend at least exploring the option of making them your primary supplier. When the cost of holding inventory, spilled demand due to stockouts during long import lead times, and dead stock are taken into account, it can often be more profitable to give up gross margin in exchange for speed.

Conclusion

Balancing the cost and speed of your supply chain requires a strategic approach that incorporates various sourcing options, including gap sourcing. By understanding when to use domestic suppliers to cover shortages and how to set up an effective gap sourcing program, you can maintain high service levels and customer satisfaction while managing costs. Implement these strategies to navigate the complexities of the parts supply chain and achieve a competitive advantage.

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Navigating inventory management challenges for SMEs

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