Supply Chain Comments

By Karin L Bursa

December 12, 2011
Supply Chain Digest

What Do We Mean by “Inventory Optimization?”

Depends on Perception of the Scope of the Challenge, Complexity of your Network, and Even the Role of your ERP Systems


The term Inventory Optimization can mean several things, depending on how you perceive the scope of the challenge, complexity of your network, and even the role of your ERP system.

If your organization has dramatically slashed inventories “across the board,” you need to address potential new imbalances between supply and shifting demand. While excess buffer stock may have been eliminated, now the imperative is to meet demand fluctuations with scientifically derived inventory targets to avoid expediting and stock-outs.

What is the extent of your commitment to optimize? In a survey conducted by Logility and Consumer Goods Technology, more than 50 percent of companies claim they optimize inventory across several stages of their supply chain. But do they really? We find the majority of companies are at one of three levels of inventory optimization sophistication:

 

 

1. Basic Math. Inventory targets are not managed. Instead, the supply chain team nets out all future demand and maintains stock for it. Here, “safety stock” is only the additional amount above what is in the plan beyond the next 18 months. This approach to inventory can only work when demand and supply are both deterministic: a highly unlikely prospect.

 

 

2. Rule of Thumb. This is the oldest and most common method of setting inventory levels. Based on the forecast, a company will hold inventory sufficient to meet a specific number of forward weeks of supply. This approach neglects the primary drivers of excess inventory: demand uncertainty, lead-time variability and product velocity.

 

 

3. Single Stage Inventory Optimization. This is usually the first good step a company takes towards optimization. Single stage models are calculators, perhaps in the form of fancy spreadsheets. Localized optimization can improve service levels and free up working capital, but the single stage approach ignores the fact that excess inventory buffers are produced by interrelationships between stages.

 

Do you treat inventory optimization holistically across your network? Multi-Echelon Inventory Optimization (MEIO) is a progression from the single stage model in which software models the inter-dependent, end-to-end supply chain and derives optimal inventory targets for the entire network. Extending optimization to multiple tiers of the supply chain produces significantly greater improvement. To do this, MEIO provides both tactical and strategic components:

 

1. Tactical MEIO identifies how much inventory is needed for every product at every location. Once targets are set, the process should be managed by exception, so that planners are alerted to deviations from the plan and optimize their time as well as their inventory.

 

 

2. Strategic MEIO policy setting is critical to an effective S&OP process. It enables higher level improvements, by allocating the right inventory amounts to the right locations to achieve desired service levels at the lowest cost. It creates step-change improvements through powerful supply chain modeling, manufacturing postponement strategies, customer-specific service level goals, what-if scenarios, and more.

 

Do you consider inventory optimization to be a separate discipline from traditional ERP? More than 60 percent of respondents to our recent survey indicated that they expect their ERP or APS solution to optimize inventory. In reality, ERP and APS systems do not optimize inventory. They are operational, transactional systems that do not provide guidance on setting better inventory policies and targets. A MEIO system independently feeds recommendations into the ERP environment: MEIO is to ERP what a steering wheel is to a car.

So, to view inventory optimization at its fullest “multi-echelon extent,” inventory optimization is a mature supply chain discipline that frees up millions of dollars in working capital by reducing inventory end-to-end without negatively impacting service levels. Unlike traditional “binge-and-purge” cycles of overproduction followed by brute-force reductions, MEIO enables companies to continually improve savings, increase inventory turns and drive more profit to the bottom line. To gain these advantages you have to move beyond spreadsheets and rules-of-thumb, accept the fact ERP and APS systems are not inventory optimization solutions, and look at the supply chain as a network of interwoven stages in which buffer inventory impacts every node before and after it.

That’s what world-class supply chain leaders mean when they say “inventory optimization.”