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02/01/2012 | Channel: Manufacturing
How multi-echelon inventory optimisation can help business success in uncertain markets. By Karin Bursa
With the global financial crisis behind us, but an uncertain economy ahead, supply chain teams are receiving loud-and-clear executive mandates - grow the top line, improve customer service and don’t increase costs. ‘No problem,’ you say, as your eyes roll.
When the economy flopped it caught companies off-guard - as two months of supply quickly became four months, then six months, manufacturing was halted and inventories cut with all the precision of a sledge hammer. Organisations adjusted to meeting the market’s needs with bare minimum stock. Now the environment may have stabilised, demand has started a slow ascent - and uncertainty has become the new norm, leading to increased complexity and the need to manage dynamic supply chains more efficiently.
The easy answer might seem to be increased inventory, however this is counter to the latest supply chain mission: improve service level to high 90’s, increase inventory turns by double digits and decrease obsolescence by 50 per cent. Recommending an inventory increase is sure to bring a lot of scrutiny from executives who are still feeling the sting of the global economic crisis. The smart answer is to artfully and scientifically increase inventory in certain locations and reduce it in others.
To determine how much inventory to remove, executives have been examining the micro-economics of service level versus inventory - but usually only at a single instance in the supply chain (a distribution centre for example). Balancing inventory and service at one location doesn’t make the game-changing impact companies need as they grapple with the new-normal economy. The answer? Multi-Echelon Inventory Optimisation. Here are some smart, hard-hitting best practices that have proven successful through the latest downturn and slow-motion rebound.
Optimise on multiple levels
In many companies, raw material (RMI), work-in-process (WIP) and finished goods (FGI) inventories are managed by entirely different functional groups. These inventories should be viewed as an organic backbone of the supply chain, rather than separate silos in which one team may be motivated to buy in bulk, another to minimise the number of production set-ups and a third to hold enough FGI to ensure 99 per cent customer service.
Because the availability of RMI impacts production lead times for WIP and consequently FGI, inventory policy for all three must be synchronised. For instance, managers may attempt to minimise production costs by instituting longer frozen periods, thus creating relatively low raw material inventories and high finished goods inventories. Raw materials inventory is generally less expensive and typically has lower demand uncertainty (due to risk pooling across multiple end products). In practice, increasing RMI and some WIP buffers strategically can decrease overall FGI and WIP dramatically, typically producing net savings of ten per cent to 30 per cent of total inventory.
Takeaway: Organisations that focus optimisation efforts on their finished goods stockpiles find it difficult to increase turns and stay competitive in the market today. Multi-echelon supply chain modelling is required to reveal the full costs of policies that result in long frozen periods, extended lead times, excess safety stock, chronic expediting, and more.
Tame SKUs with postponement
New products, packaging, styles, bundling, promotions, and many other factors cause SKU counts to increase relentlessly. A silo organisational structure where multiple groups have different KPIs leads to a lack of ‘big picture’ visibility and contributes to the problem. This causes each department to focus on their metrics, concerns. Instead, as a group, the organisation must understand the working capital that is required for a new product.
As SKUs proliferate, so do inventory buffers. Smart postponement strategies are a best practice for avoiding the runaway costs of FG and WIP inventories. Postponement pools WIP and FG inventory to retain more flexibility in meeting demand while lowering manufacturing, packaging and distribution costs. Pooling inventory can lower safety stock levels by aggregating demand signals that partially cancel each other out.
Takeaway: Postponement cuts obsolescence rates by delaying differentiating steps and late product fan-out until closer to the customer. Everyone from executive management to the supply chain team should make postponement an area of expertise.
Analyse inventory based on form and function
In order to optimise inventory levels, it is necessary to recognise that inventory is not a single entity; it is multiple components in several categories. These can include cycle stock (inventory due to production frequencies), early arrival stock (uncertainties in co-ordinated delivery times), marketing stock (inventory placed at customer locations to stimulate demand), obsolete stock (unsalable product that is often left on the books for accounting and finance purposes), prebuilt stock (inventory built ahead of demand due to capacity limitations), and safety stock (several classes specific to types of variability - forecast, supply or manufacturing).
Breaking inventory into categories is important for three reasons.
1. Not all inventories are of equal importance to the business. If inventory is not broken into its components, it cannot be monitored and improved upon. It would not be uncommon for a mid-sized company to have in excess of 100 million dollars in inventory. If this is viewed as one inventory there are little to no improvements available
2. The business drivers of the different categories of inventory differ so they cannot all be improved the same way or with the same speed. Different math is required for each category. In particular, the safety stock component, because it is driven by variability in both demand and supply, is the hardest component to solve without a proven multi-echelon inventory optimisation model
3. If a management edict comes down on the first day of the quarter to cut inventory by ten per cent within a month, only safety stock (and possibly cycle stock) can be reduced quickly. All of the other categories (such as prebuild, marketing or obsolete stock) are driven by other factors that cannot be easily or quickly changed - if they can be changed at all. So a ten per cent inventory reduction initiative could translate into a 30 per cent safety stock reduction requirement
Takeaway: Not all categories of inventory are of equal importance, nor are they equally available for reduction. When the right categories are addressed effectively, a ten per cent to 30 per cent overall inventory reduction is typically possible.
Karin L. Bursa
Karin L. Bursa is vice president of marketing at Logility, a provider of collaborative supply chain management solutions. Ms Bursa has more than 24 years experience in the development, support and marketing of software solutions to improve and automate enterprise-wide operations.
Logility
Logility is a leading provider of collaborative, best-of-breed supply chain solutions to companies of all size. Logility Voyager Solutions provides supply chain visibility; demand, inventory and replenishment planning; S&OP; supply and inventory optimisation; manufacturing planning and scheduling; transportation planning and management; and warehouse management.
For more information visit: www.logility.com
When the economy flopped it caught companies off-guard - as two months of supply quickly became four months, then six months, manufacturing was halted and inventories cut with all the precision of a sledge hammer. Organisations adjusted to meeting the market’s needs with bare minimum stock. Now the environment may have stabilised, demand has started a slow ascent - and uncertainty has become the new norm, leading to increased complexity and the need to manage dynamic supply chains more efficiently.
The easy answer might seem to be increased inventory, however this is counter to the latest supply chain mission: improve service level to high 90’s, increase inventory turns by double digits and decrease obsolescence by 50 per cent. Recommending an inventory increase is sure to bring a lot of scrutiny from executives who are still feeling the sting of the global economic crisis. The smart answer is to artfully and scientifically increase inventory in certain locations and reduce it in others.
To determine how much inventory to remove, executives have been examining the micro-economics of service level versus inventory - but usually only at a single instance in the supply chain (a distribution centre for example). Balancing inventory and service at one location doesn’t make the game-changing impact companies need as they grapple with the new-normal economy. The answer? Multi-Echelon Inventory Optimisation. Here are some smart, hard-hitting best practices that have proven successful through the latest downturn and slow-motion rebound.
Optimise on multiple levels
In many companies, raw material (RMI), work-in-process (WIP) and finished goods (FGI) inventories are managed by entirely different functional groups. These inventories should be viewed as an organic backbone of the supply chain, rather than separate silos in which one team may be motivated to buy in bulk, another to minimise the number of production set-ups and a third to hold enough FGI to ensure 99 per cent customer service.
Because the availability of RMI impacts production lead times for WIP and consequently FGI, inventory policy for all three must be synchronised. For instance, managers may attempt to minimise production costs by instituting longer frozen periods, thus creating relatively low raw material inventories and high finished goods inventories. Raw materials inventory is generally less expensive and typically has lower demand uncertainty (due to risk pooling across multiple end products). In practice, increasing RMI and some WIP buffers strategically can decrease overall FGI and WIP dramatically, typically producing net savings of ten per cent to 30 per cent of total inventory.
Takeaway: Organisations that focus optimisation efforts on their finished goods stockpiles find it difficult to increase turns and stay competitive in the market today. Multi-echelon supply chain modelling is required to reveal the full costs of policies that result in long frozen periods, extended lead times, excess safety stock, chronic expediting, and more.
Tame SKUs with postponement
New products, packaging, styles, bundling, promotions, and many other factors cause SKU counts to increase relentlessly. A silo organisational structure where multiple groups have different KPIs leads to a lack of ‘big picture’ visibility and contributes to the problem. This causes each department to focus on their metrics, concerns. Instead, as a group, the organisation must understand the working capital that is required for a new product.
As SKUs proliferate, so do inventory buffers. Smart postponement strategies are a best practice for avoiding the runaway costs of FG and WIP inventories. Postponement pools WIP and FG inventory to retain more flexibility in meeting demand while lowering manufacturing, packaging and distribution costs. Pooling inventory can lower safety stock levels by aggregating demand signals that partially cancel each other out.
Takeaway: Postponement cuts obsolescence rates by delaying differentiating steps and late product fan-out until closer to the customer. Everyone from executive management to the supply chain team should make postponement an area of expertise.
Analyse inventory based on form and function
In order to optimise inventory levels, it is necessary to recognise that inventory is not a single entity; it is multiple components in several categories. These can include cycle stock (inventory due to production frequencies), early arrival stock (uncertainties in co-ordinated delivery times), marketing stock (inventory placed at customer locations to stimulate demand), obsolete stock (unsalable product that is often left on the books for accounting and finance purposes), prebuilt stock (inventory built ahead of demand due to capacity limitations), and safety stock (several classes specific to types of variability - forecast, supply or manufacturing).
Breaking inventory into categories is important for three reasons.
1. Not all inventories are of equal importance to the business. If inventory is not broken into its components, it cannot be monitored and improved upon. It would not be uncommon for a mid-sized company to have in excess of 100 million dollars in inventory. If this is viewed as one inventory there are little to no improvements available
2. The business drivers of the different categories of inventory differ so they cannot all be improved the same way or with the same speed. Different math is required for each category. In particular, the safety stock component, because it is driven by variability in both demand and supply, is the hardest component to solve without a proven multi-echelon inventory optimisation model
3. If a management edict comes down on the first day of the quarter to cut inventory by ten per cent within a month, only safety stock (and possibly cycle stock) can be reduced quickly. All of the other categories (such as prebuild, marketing or obsolete stock) are driven by other factors that cannot be easily or quickly changed - if they can be changed at all. So a ten per cent inventory reduction initiative could translate into a 30 per cent safety stock reduction requirement
Takeaway: Not all categories of inventory are of equal importance, nor are they equally available for reduction. When the right categories are addressed effectively, a ten per cent to 30 per cent overall inventory reduction is typically possible.
Karin L. Bursa
Karin L. Bursa is vice president of marketing at Logility, a provider of collaborative supply chain management solutions. Ms Bursa has more than 24 years experience in the development, support and marketing of software solutions to improve and automate enterprise-wide operations.
Logility
Logility is a leading provider of collaborative, best-of-breed supply chain solutions to companies of all size. Logility Voyager Solutions provides supply chain visibility; demand, inventory and replenishment planning; S&OP; supply and inventory optimisation; manufacturing planning and scheduling; transportation planning and management; and warehouse management.
For more information visit: www.logility.com