Inventory Optimization: Trying to Manage a Business Conundrum

Stephen DeAngelis

June 7, 2016

Inventory management continues to be a business conundrum. Lora Cecere (@lcecere), founder and President of Supply Chain Insights, recalls a heated debate about inventory that took place on stage at a company-sponsored summit. One panelist called inventory a “waste” that needed to managed and another panelist believed inventory was an “asset” that needed to be managed. Reflecting on this debate, Cecere wrote, “Inventory is both. Companies need to carefully manage the asset and mitigate the waste. The successful answer depends on supply chain strategy and the building of strong processes to manage supply. Each company is different.”[1] Three associate professors from the University of North Texas, Wesley S. Randall, David R. Nowicki, and Shailesh Kulkarni, add, “Having the right amount of inventory when and where it’s needed is a key element of corporate success. After all, losing control of inventory eats away at corporate profit margins and costs a firm its customers.”[2] In another article, Cecere admits, “Right sizing inventory is easier said than done. … Inventory is the most important buffer of supply and demand volatility.”[3] That fact alone should make inventory optimization high on the priority list for most businesses.

 

Inventory Considerations

 

Jeff Bodenstab, from ToolsGroup, explains inventory optimization is challenging because so many variables are involved. For example, he notes that businesses need to answer basic questions like, “In what form should I hold my inventory; as raw material, finished goods, or something in between?”[4] Then you need to decide where you are going to hold that inventory (e.g., “at the factory, in a centralized distribution center, at regional network, or some combination of the above”). Then you need to set an inventory policy (i.e., “inventory optimization should be quite dynamic, considering issues such as seasonality, changing demand patterns or fluctuating order lead times”). Next, Bodenstab notes, a company needs to consider “mix Optimization (also called Service Optimization or Service Level Optimization) [which] allows the business to position the inventory across the distribution network to meet high customer service level objectives in a much more efficient manner than simply creating a homogeneous mix of ‘one size fits all’ inventory.” Then you need to consider lot size optimization. “Optimal lot sizes are a function of the targeted service levels, safety stocks, set-up cost (for manufacturing) or the handling cost (for replenishment) versus the inventory holding cost and other factors.” Finally, Bodenstab asserts that production capacity needs to be factored into optimization planning. When production capacity is limited, “prebuilt inventory should be carefully planned to cover the excess demand in the period of inadequate supply.” In addition to inventory related to production, you can’t ignore inventory related to maintenance, repair and operations (MRO) of equipment used during production. You get the picture — it’s complicated. Whenever a large number of variables need to considered, I recommend leveraging cognitive computing capabilities, like the Enterra Enterprise Cognitive System™ (ECS) — a system that can Sense, Think, Act, and Learn®. Cognitive computing systems can deal with many more variables, drawn from both structured and unstructured data, and provide insights that may not always be obvious.

 

Best Practices

 

Andy Hill, CEO and co-founder of Oniqua, reports there are good reasons to leverage “technology tools, automated processes and inventory management best practices.”[5] He claims “asset-intensive organizations can consistently produce results like these”:

 

  • 15-25 percent reduction in funds invested in safety stock
  • 5-20 percent decrease in write-offs of surplus and obsolete stock
  • 10-25 percent fewer stock-outs, for improved availability and productivity
  • 10-25 percent drop in administrative costs for replenishing inventory
  • 33-66 percent less resource time spent managing inventory.

 

Hill offers a list of a dozen inventory optimization best practices businesses should consider adopting. They are:

1. Criticality Analysis (i.e., business impact analysis).
2. Demand Forecasting. Cecere cautions that forecasting alone won’t improve inventory optimization (“it requires a holistic look at inventory”).
3. Lead Time Forecasting (to determine optimal safety stocks).
4. Issue Size Forecasting (“the number of units typically required for an application”).
5. Economic Modeling (“what if” scenarios).
6. Optimization of Reordering Parameters (“minimum and maximum levels (MIN/MAX) used by the ERP materials management system”).
7. Exception Management (to focus on high value or problem items).
8. Inventory Segmentation (not all items can be handled in the same way).
9. Spares Risk Assessment (to determine “spares that are high cost, critical, have little or no expected usage and require long lead times to receive.”).
10. Spares Pooling across multiple sites.
11. Knowledge Capture (“Capturing organizational knowledge relating to inventory items is an important business process in preventing mistakes and re-investigation.” Cognitive computing systems are particularly adept at capturing “tribal knowledge.”)
12. Reporting Inventory KPIs (the old adage “that which is measured improves” still applies).

 

Hill concludes, “Competitive advantage requires a positive mindset towards innovation and technology.”

 

A New Strategic Approach

 

Randall, Nowicki, and Kulkarni claim to have created a new inventory strategy they call the science of theoretical minimums, or STM. They developed this new strategy as a way to manage inventory without affecting customer service levels or shifting cost to other supply chain partners. They explain:

“STM provides a simple and elegant framework to reduce cost and increase customer service levels by monetizing time delays across the extended supply chain. Unlike other strategies, managing to theoretical minimums reduces the total supply chain cost instead of simply pushing costs onto weaker suppliers. This means that STM reveals how much profit is being left on the table in the end-to-end supply chain. This monetization of delay cost provides supply chain executives with a clear picture on where to focus their efforts. More importantly, we contend that STM is an idea whose time has come. In the last decade, the task of managing inventory flows in ways that drive out informational delay has been a sort of alchemy that has alluded the major supply chain technology companies. … The concept is not new. In the hard sciences, theoretical minimums have been used as a bench mark for years. Information technology strategists, for instance, often discuss the theoretically achievable bandwidth of a particular configuration. That is used to understand bottle necks and the opportunities to invest to reduce those bottle necks. Theoretical minimums have a similar value in the supply chain. Here, they provide an idea of what is possible by increasing visibility, attacking latent activities, and synchronizing supply chain processes. Attacking these latencies mitigates the negative costs associated with lead times and variability. STM accomplishes this by providing the basic logic for accounting for inventory and inventory costs in terms of physical and informational delay. This simplicity removes the ambiguity that often clouds inventory related decision-making.”

They conclude, “Our results convince us that STM is a leap forward in the way extended supply chain partners visualize the cost of information delay and represents a new and efficient frontier for extended supply chain inventory management.” If their thoughts pique your interest, I recommend you read their article in full.

 

Conclusions

 

“Inventory management is a complex subject,” Cecere writes. Fortunately, cognitive computing systems can deal with complexity. But Cecere insists technology alone is not the answer. “More and more companies are purchasing inventory technologies,” she writes, “but fail to give planners time to plan. This is a mistake. With the rise of the global multi-national, there is more and more need for an inventory planning role to manage the form and function of inventory and develop inventory strategies. Buying the technology and not having clear processes and accountability does not help. … What is … important is the design of inventory strategies in the supply chain and the management of form and function of inventory.” For the foreseeable future, inventory optimization will remain as much art as science; but, as the above discussion indicates blending the right technologies with the right people can dramatically improve the process.

 

Footnotes
[1] Lora Cecere, “Is Inventory Waste or an Asset?Supply Chain Shaman, 3 September 2015.
[2] Wesley S. Randall, David R. Nowicki, and Shailesh Kulkarni, “The Perfect Formula for Determining the Right Amount of Inventory,” Supply Chain 24/7, 28 March 2016.
[3] Lora Cecere, “Does Better Forecasting Improve Inventory? Why I Don’t Think So Anymore.Forbes, 29 November 2015.
[4] Jeff Bodenstab, “Five Types of Inventory Optimization You Should Know,” ToolsGroup, 10 November 2015.
[5] Andy Hill, “12 Best Practices Of Inventory Optimization,” Industrial Distribution, 13 November 2015.