It seems that everyone these days agrees about the importance of inventory optimisation. You cannot open a business book or magazine without being reminded that although inventory appears in the accounts as an asset, it is in reality nothing of the sort.
Unnecessary inventory is a major liability for business, and generates several kinds of costs. There are the hard costs of the capital employed in the inventory itself, of course. Then there are the soft costs of storage, handling, transport, losses and insurance. With product life cycles becoming shorter, there is also a problem with obsolescence – will tomorrow’s model render today’s stocks redundant?
But these are only scratching the surface. If inventory is not optimised, then all the physical elements of the supply chain become sub-optimal. Too much stock in a warehouse, for example, not only increases space costs, but means that product is likely to be incorrectly configured – generating higher operational and handling costs. Of course having the wrong stock can also lead to stoppages in production and unfulfilled orders – resulting in dissatisfied customers and lost sales.
Essentially an imbalance of inventory in the warehouse or distribution centre leads to duplication of sales order processing, which has an impact on every subsequent node in the supply chain – from outbound transportation through to cash collection.
No company deliberately sets out to tie-up cash and capital in inventory that is not producing any competitive advantage. They do so in order to keep production flowing and to maintain quality of service to their customers.
Creating a risk profile
The problem is that, in our experience, European manufacturers tend to take a very broad-brush approach to inventory policy – for example, they will hold six weeks’ or three months’ stock. What they will not do is create a risk profile for each line item that takes into account things like errors in forecasting and lead-time, and the replenishment cycle.
Of course, manufacturers need to strike the right balance between improved product availability and reduced inventory. But it is important that they recognise that the inventory/service-level trade-off exists not within the business as a whole, but at line item or SKU level at every node in the supply chain.
The trade-off is not simply about reducing inventory; it is about enabling manufacturers to meet targeted availability levels in a balanced way. Manufacturers need a methodology and processes in place to manage inventory at a line item level at every point in the chain.
A risk profile needs to be built up using measurable factors for each line item. It is only by doing this that manufacturers can answer the fundamental question: ‘how much inventory do I need to hold, versus what service levels do I need to achieve?’. Inventory should be aligned with service and marketing strategies – such as product availability levels. Is a 95 per cent service level acceptable, for instance, or should it be 75… or 99 per cent?
Manufacturers must understand that the risk within the business lies at line item level. There is variability of demand, and variability in the ability to accurately forecast that demand. There is also variability of supply, and variability in the supplier’s ability to deliver on time. These dynamics exist at a line item level, and so they must be managed at that level, according to a risk profile that is built from the bottom up. However, most manufacturers do not possess the tools and skills necessary to measure and manage such variability in demand and supply.
ERP systems are very good at establishing a base set of business rules, but they lack the functionality – and in particular the flexibility – to manage inventory day-to-day, by exception, in a dynamic environment. Even the most sophisticated ERP systems are not going to tell a manufacturer which components or assemblies in its stock profile of, say, 25,000 line items are going to cause the most lost sales or stock-outs in the production environment that day. Companies certainly need inventory management software, but more importantly they also need a methodology that is underpinned by the software.
The fact is that inventory optimisation is a people-based process. Clearly software is an important enabler – if you are managing 25,000 line items then obviously you are going to need some good systems support. Software might tell you, for example, that you are not very good at forecasting a particular item. And if it has a forecasting engine built-in, then it might even help you forecast it better in future. What it will not do is implement a meaningful forecasting process… and it won’t pick up the telephone and negotiate with a supplier to collapse lead times when necessary.
More and more manufacturers (as well as retailers) are now sourcing offshore, and this also has important implications for inventory management. Clearly if the supplier of a particular component is now located in China rather than the next town, then it is no longer a one-day lead-time, but six weeks at least on a ship – unless the company is prepared to incur additional airfreight costs.
Globalisation is creating a critical need for long-range forecasting and efficient international supply systems, and again inventory optimisation is a central part of the solution.
As lead-times lengthen, so the risk of stock-outs increases and more safety stock needs to be held. What we are finding is that many manufacturers are ill-equipped to deal with complex international planning, and don’t fully understand the supply chain implications of offshoring.
This is confirmed in a recent study by leading management consultants, McKinsey, which found that customers across all sectors serviced from Asia were being let down by shortages of the right product 40 per cent more often than world best practice – in spite of inventory levels often 30 per cent higher than the global benchmark.
The answer is to create integrated supply chains that use technology to join up the links to provide visibility of demand, supply and progress across and between every element, so that production and the physical elements of the chain are more closely aligned to demand. In this way global inventories can be dramatically reduced without compromising service levels.
Determining what’s most important
Manufacturers need to review the things that are most important to them more regularly, and must prioritise them in terms of their criticality to the business – whether by value, volume or other factor. Item classification is a very important part of Exel’s supply chain management methodology, and is, in fact, where our process begins. It means determining the most important line items and creating meaningful categories for them – which will then suggest how inventory should be managed.
In our experience, manufacturing enterprises need help with this. Ask any manufacturer to name an item that they can forecast 100 per cent correctly, where the supplier also delivers 100 per cent of the time on time in full, and most would struggle to find one. The fact is that every business has issues with supply and demand – otherwise they wouldn’t be holding stock.
The solution for the majority of manufacturers is to combine the power of appropriate IT systems with the expertise of a supply chain management specialist, in a process of outsourcing. The approach should be holistic, integrated and collaborative.
When supply matches demand, and inventory is reduced, then supply chains become not only leaner but also more agile – ie better able to respond to customers’ changing demands.
The paybacks for getting inventory optimisation right can be immense. By adopting just this kind of approach, Exel helped one British FMCG manufacturer to slash its raw materials stockholdings by more than 60 per cent, at the same time as increasing product availability in the plant by over six per cent to 99.9 per cent.
James Hurrell is business development manager for Inventory Management at Exel’s Industrial Sector, part of DHL: firstname.lastname@example.org
- The inventory/service-level trade-off is not just about inventory reduction
- Manufacturers must understand that the risk within the business sits at line item level
- Companies need a methodology, and software to underpin it, that lets them focus on the issues causing the most pain at any point in time
- Inventory should be managed by exception, but in a knowledge-led way, based on measured risks
- Only in this way can manufacturers achieve the biggest prize in the shortest timeframe with the least amount of