Supply chain executives worldwide face an ongoing imperative: improve customer service levels. They also face an ongoing risk: don’t create excess or obsolete inventory at the same time.
It’s a double-edged sword for supply chain performance. Because of variability in demand and supply, increasing customer service levels can lead to higher levels of safety stock. Improving cash flow by indiscriminately reducing working capital Rands can result in slashing the wrong inventory, resulting in lower customer service levels.
While many leading supply chain teams have conducted inventory optimization (IO) initiatives to raise service levels while lowering inventory cost, others worry that they won’t be successful in the effort. Two common barriers that can prevent an organization from reaping inventory optimization benefits are:
• Technology Barrier: IO success can be undermined by reliance on limited tools (such as modules built into, or bolted onto, existing ERP systems) or inadequate ones (e.g. error-prone, hard-to maintain spreadsheets). These tools are unable to effectively analyze and model the required amount of inventory.
• Complexity Barrier: An internal perception that understanding and implementing proven mathematical tools and business processes in order to streamline the creation of optimal inventory policies and targets is too difficult for the team to take on.
Overcoming these barriers is easier than you think. Companies that embrace multi-echelon inventory optimization (MEIO) achieve, on average, a 28% increase in inventory turns. This paper presents a simple three step approach that helps remove barriers to inventory optimization success and shows how leading supply chain organizations use powerful business process and technology enablers to achieve and sustain improved inventory performance.
A simple three-step approach can remove barriers to achieving a successful MEIO initiative.
First, assess your organization’s capabilities from the perspectives of:
• Inventory performance
• Business process and inventory management expertise
• Technology and organizational readiness.
Understanding your current state on these critical dimensions lays the foundation for a solid business case that delivers real-world benefits.
Second, create a future state inventory optimization capability - process, technology, organization – that provides your supply chain team with a roadmap to success.
Finally, continue to drive fundamental strategic changes that create greater resiliency and agility throughout the supply chain and establish a cycle of continuous improvement for years.
Starting Small: Assess MEIO Readiness
Helping an organization begin the MEIO journey starts with a small-scale assessment that captures the current state of the organization’s inventory performance, process, technology and organizational capabilities, as well as profiling existing inventory, and analyzing key business and supply chain drivers.
Questions to be asked at this stage are:
• What is our current inventory performance? Use key metrics such as inventory days on hand, service levels, and responsiveness levels to identify how large a gap separates the current state from industry leading performance.
• What is our business process for planning inventory levels? This lays the groundwork to move from simple rules of thumb that are manually entered into ERP systems to advanced inventory optimization processes that are integrated into a broader Supply Chain Planning capability.
• How does our inventory plan fit within our sales and operations planning (S&OP) process? Analyze the inventory plan as it relates to operational, tactical and strategic horizons.
• What technology do we use to enable inventory planning? Traditional operational systems use techniques such as min/max, single echelon safety stock, Kanban, etc. Advanced inventory optimization techniques consider demand uncertainty, supply variability, service level targets, and supply chain network constraints to create robust inventory plans that can be fine-tuned for an organization’s risk and agility profile. Additional considerations include integration, and application architectures that may introduce additional constraints.
• What does our inventory planning organization look like? Multiple organization models can be leveraged (COE, centralized planning, planning within the business). Understanding your organization’s human resources strategy (career path strategy to keep top performers) helps you build a highly capable and engaged team.
Figure 2. MEIO achieves higher service levels at lower safety stock levels
After capturing the organization’s current state capabilities, a business case is developed to document the reasoning behind the inventory optimization initiative and the expected benefits. In addition to estimating cost, it outlines the key value proposition, including both one-time improvements, reductions and savings, as well as long-term recurring benefits gained from having a strategic platform for modeling inventory scenarios.
By spanning immediate tactical benefits and strategic wins, this document provides both a justification and a blueprint for all stakeholders and senior management to work from. Components of the business case include demonstration of a return on investment, expected gains in working capital, and benefits flowing from service level improvements.
Building and Sustaining Your MEIO Capability
The ultimate success of your MEIO effort depends on more than implementing the right software tool. An effective and sustainable inventory optimization capability must become a core competency of the organization. There are several important steps you can take to begin developing it as an intrinsic “supply chain way of life.”
Start by creating a future state inventory optimization process that provides your supply chain team with a roadmap to steer them through five activities:
• Prepare data for inventory planning (inputs and outline to inventory planning policies)
• Define inventory drivers based on inventory strategy (and corporate goals)
• Conduct inventory modeling and scenario analysis
• Finish and publish
• Monitor inventory management performance
Figure 3. Inventory optimization process
Prepare data for inventory planning
Action: Review all elements of master and transactional data on a regular basis. Ensure that inputs to the Inventory Optimization tool are accurate.
Why it is important: Inventory optimization results are driven by accurate data. It is important that key elements such as item, location, time-phased sourcing, bill of materials, demand forecast, inventory on hand, lead times and holding costs are accurate and up-to-date.
Understanding the form and function of inventory will help define policies and model alternative scenarios. After the causes, amounts, and locations of existing inventory are discovered (finished goods, raw material, work in process, cycle stock, pipeline stock, pre-built, etc.), the stage is set for optimizing where to hold inventory and when to postpone product differentiation.
Technology enabler: A best of breed solution should allow for easy viewing of all master and transactional data.
Define inventory drivers based on inventory strategy
Action: Define specific inventory drivers for the type of business your organization operates.
Why it is important: Various drivers, or causes, of inventory rise and fall as an organization makes changes to:
• Manufacturing and supply strategies
(Make-To-Order or Make-To-Stock, frozen/ slush/liquid production horizons, postponement strategies, off shore and near shore suppliers)
• Customer service strategies
(Segmentation strategies, service level requirements, precision by division, product family or geographic needs)
• Distribution strategies
(Cargo and truckload considerations, VMI, customer replenishment requirements)
Technology enabler: A best of breed solution should feature attributes that segment inventory optimizations, creating the appropriate inventory response for each channel and sub-channel. Simplifying the management of groups of items lets planners focus on important inventory drivers and strategies.
Figure 4. Drivers of inventory
Conduct inventory modeling and scenario analysis
Action: Generate a multi-echelon safety stock plan based on the inputs and parameters defined in Step 1 and 2. Use scenario modeling and “what-if” analyses to determine the best course of action. Use sensitivity analyses to evaluate the robustness of various scenarios.
Why it is important: The multi-echelon safety stock plan sets optimal targets for inventory buffers across the entire multi-tier supply chain network. By modeling the end-to-end supply chain and taking into account how changes in inventory levels affect multiple tiers, MEIO provides real tactical benefits.
Technology enabler: A best of breed solution should allow planners to review safety stock targets and manage inventory levels based on exceptions, focusing efficiently on deviations from plan. It should make it easy for planners to understand policy recommendations and monitor results. Built-in advanced analytics should provide monitoring and visualization of KPIs and plan performance. “What-if” scenario modeling explores and evaluates the benefits of alternate approaches, changes to network nodes, changes to lead times between nodes, policy changes based on new manufacturing/ service/ distribution strategies, and more.
Figure 5. Explore alternative inventory scenarios
Finalize and Publish the Inventory Plan
Action: Inventory Planners endorse the final plan, accepting or revising optimized inventory targets where required after reviewing the safety stock recommendations, and then review and gain consensus with the broader team of supply chain planning, customer service, and logistics stakeholders. The deployment process is specifically paced to achieve a controlled release of optimization results, ensuring user acceptance.
Why it is important: Consensus is critical, as inventory targets impact multiple stakeholders when the consensus plan is published into downstream supply chain processes (distribution requirements planning, production planning, materials requirements planning) to be executed. Ease of publishing the plan is also important—if the act of updating safety stock targets is difficult it will lead to adoption issues.
Technology enabler: A best of breed solution should allow for easy and seamless native integration between inventory planning, demand planning, and supply planning.
Monitor inventory management performance
Action: Automate the ongoing balancing between service and inventory by monitoring via dashboards and reports. Employ exception alerts to focus attention when high-priority KPIs deviate from accepted ranges (combine built-in metrics with custom-defined KPIs in line with specific business needs). Adjust inventory parameters and targets as necessary.
Why it is important: Using key metrics to monitor the on-going performance of inventory optimization helps easily determine where root cause analysis is required for issues that arise.
Technology enabler: A best of breed solution should offer easily customizable views to allow you to add data streams for inventory, and calculated arrays based on these data streams, to determine Days on Hand, Turns, etc.
Drive Strategic Value
After process and technology have been implemented, the supply chain team can assess the immediate tactical gains produced by MEIO. Near-term improvements are seen very quickly in key metrics such as service level, reduced inventory costs, improved working capital, and improved raw material availability for production requirements.
Inventory optimization can also deliver many broader, long term supply chain improvements. Structural changes such as implementing postponement strategies can reduce finished goods inventory risk and increase supply chain agility. Opportunities range from the ability to identify and analyze the impact of reducing procurement lead times from vendors to reducing manufacturing and transportation lead times between DCs. Inventory optimization can also provide a simple network modeling tool to identify total costs with different plant or DC locations based on different costs of transportation, inventory holding and inventory handling.
Over time, the trade-off between customer service and inventory cost (known as an efficient frontier) can be adjusted to meet the risk profile of the organization. Again and again, MEIO creates new, previously unavailable trade-off curves that deliver higher levels of service at lower inventory cost. This “virtuous cycle” drives continuous improvement for years.
When the imperative is to reduce working capital trapped in excess and obsolete inventory while also raising service levels, leading supply chain management teams turn to MEIO.
But companies often face barriers to adopting a game-changing IO initiative. Perhaps they previously fell short using the limited IO facilities offered by ERP vendors. Some teams are stymied by reliance on error-prone spreadsheets that cannot scale to support an enterprise-wide optimization effort. Or perhaps there is a management-held conviction that inventory optimization is too complex and the organization is “not ready” to pull it off.
These barriers can be overcome by adopting a powerful three-step approach that takes a clear and easy-to-follow path to successful inventory optimization:
1. Assess your inventory performance and deliver optimal inventory targets, along with a business case for change.
2. Design and implement a world-class inventory optimization capability that encompasses people, process, and technology to achieve the business case.
3. Extend the capability beyond tactical safety stock targets to encompass strategic supply chain improvements.
Contributed by: Steve Barker, Senior Account Executive, EMEA, Logility