Four Steps to Reducing Inventory: Why Working Capital Is a Game Worth Playing

In this episode of Rozmowy Logistyków, Piotr Skobało and Adam Sobolewski discuss inventory reduction and working capital. They cover 4 practical ways to reduce a company's inventory level, developed over years of managing supply chains and advising others.

INVENTORY IS A BIGGER SHARE OF WORKING CAPITAL THAN RECEIVABLES

Working capital is inventory plus sales not yet paid for by customers (DSO — Days Sales Outstanding). In e-commerce and retail, DSO is usually at most 2 days (fast payment processing), and inventory is 30-40 days — so inventory dominates the equation. In manufacturing companies, the relationship can be reversed: in pharma, inventory reaches 70-80 days, but DSO is 60-70 days. Understanding this ratio in your specific industry is the starting point for a conversation with the CFO about real cash needs.

STEP ONE: A RECURRING REVIEW OF PRODUCT STATUS

The foundation of optimization is regularly (not "once in a blue moon") classifying the assortment by status — new, active, being phased out, archived — and calculating inventory value and days of sales in each category. Surprisingly many companies don't have this process in place at all. It's part of the S&OP process, but deserves separate attention, not just as an add-on to future sales planning.

STEP TWO: OPTIMIZING PRODUCTION BATCHES FOR TURNOVER, NOT JUST UNIT COST

Setting production run length purely to minimize technical unit cost ignores the fact that different variants of the same product (e.g. colors) sell at different rates — a uniform minimum batch for every variant leads to excess inventory of slower-moving variants. A real example: Kubota improved inventory turns by 24% in 2021-2022 through deliberate work on its S&OP process, while the fashion sector over the same period saw its inventory cycle worsen by 7%. The decision about priority (lower unit cost or lower inventory) needs to be calculated jointly with finance, not optimized unilaterally by production.

STEP THREE: MANAGE AT THE COMPONENT LEVEL, NOT THE FINISHED PRODUCT

A Make-to-Order (MTO) or Build-to-Order (BTO) strategy — assembling the final product only after an order is placed — lets you manage inventory at the level of thousands of components instead of millions of finished-product combinations. Classic examples: IKEA (cabinet fronts assembled into a specific piece of furniture only on order) and Dell (the legendary business model where the company doesn't commit capital to a component until a customer places an order). Practical advice for companies that say "that won't work for us": distinguish your core assortment (higher turnover, justifies inventory) from your extended assortment (lower turnover, often better suited to a made-to-order model), instead of applying one strategy to the whole portfolio.

STEP FOUR: SERVICE TARGETS MATCHED TO PRODUCT IMPORTANCE

Research (including from the "Big Four" firms) shows that every percentage point of service level above 90% costs logarithmically more inventory to maintain — going from 97% to 99% availability can require up to 40% more inventory, and from 99% to 99.5% another 20%. Setting one service target (e.g. a flat 99%) for the entire assortment, without differentiating by how important a product is to sales, is a common, costly mistake — the decision about where it's worth paying for higher service should be calculated jointly with the CFO.

THE LONG TAIL AND THE AGING RED FLAG

E-commerce companies deliberately keep a minimum stock (2-5 units) of thousands of rarely sold SKUs, so the website can show "delivery in 24 hours" without committing much capital. On the other hand, inventory sitting for more than 180-360 days is a warning sign — the goods systematically lose value, even without a formal expiry date (a new model comes to market, trends change). The real cost of holding inventory isn't just the goods themselves — it's also the warehouse space rental and the cost of cyclically counting the same unsold product year after year, without ever asking why it's still sitting there.

HOW QUICKLY YOU'LL SEE RESULTS

The time to the first visible results depends on how much inventory a company currently holds relative to its lead time. With three months of inventory and a two-week delivery time, effects show up relatively quickly (a month to six weeks); with 9-10 months of inventory and a three-month lead time from Asia, the first results only appear after about six months, regardless of how well-designed the optimization process itself is.