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First Thoughts
  By Dan Gilmore - Editor-in-Chief  
     
   
  August 28, 2008  
     
 

Supply Chain News: What is Inventory Optimization?

 
 


OK, so just what in the heck is Inventory Optimization?

A mindset, a strategy, a goal, a software category? Yes, yes, yes and yes.

The term obviously means a lot of things to different people. We can probably all agree that “optimizing” inventory levels across the enterprise sounds like a very good thing.

In the end, in fact, the entire construct of “supply-demand balancing,” that is at the heart of what supply chain management is, gets down to optimizing inventory levels. The ultimate goal: having the right amount of inventory, in just the right places, to meet customer service and revenue goals - but no more than that.

Gilmore Says:
Maybe the right way to say it, to borrow from a historic political quote, is to consider that “The price of inventory optimization is eternal vigilance.”

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So that’s the quest, but it’s more of a journey rather than a destination. Or rather, maybe the right way to say it, to borrow from a historic political quote, is to consider that “The price of inventory optimization is eternal vigilance.”

It’s not easy. As we noted on these pages, in 2006 Wal-Mart began its Inventory Deload program, after finding that total inventory levels had been rising at a much higher rate versus the company’s sales growth than its historical performance. In fact, in 2004, inventory levels at Wal-Mart grew at almost 90% of sales growth, and just under 90% in 2005.

About that time, Wal-Mart’s Johnnie Dobbs (now Executive VP of Logistics and Supply Chain) noted that part of the challenge was that even for Wal-Mart “there were so many paths that could lead to inventory in the DC.”

As an update, the Inventory DeLoad program has started to pay big dividends. In 2007, for example, the Wal-Mart Stores division reversed the inventory trend, with inventory growth of just 0.7% versus a sales increase of 5.8%.

Another quote I like on this topic, from a meeting I attended 3-4 years ago with a very large consumer goods company: “Our CEO says if we’d attained the objectives from all these inventory reduction programs and investments we’d made over the past few years, we should have negative inventory by now…” said the VP of Logistics, “… but we have more inventory than ever.”

And of course, many companies still swing between “eras” of high inventory, when customer service concerns top the priority list, and low inventories, when business slows and suddenly someone looks at the cost of holding all that inventory. Many companies have tamed these inventory cycles to an extent, but many others have not. I saw the inventory rollercoaster play out first hand a few times earlier in my career.

Inventory has also been at the top of Wall Street’s concerns as analysts look at many companies; therefore, it has naturally also become a top concern for CEOs and CFOs. It seems to me the attention really started in 2001, when network giant Cisco announced a staggering $2.1 billion inventory write down, as the tech bubble burst and it was caught holding the inventory bag.

Wall Street analysts tend not to focus so much on the working capital reduction aspects that supply chain thinking often does with regards to the benefits of lower inventory, but rather on the more basic risk of potential write-offs due to obsolescence (e.g., high tech industries) or big mark downs that will hit margins (e.g., retail and apparel).

Given all that, it’s surprising that often companies just can’t find the time for the basics, such as regularly reviewing safety stock levels and policies. There are a number of consultants who make a good living simply serving as a catalyst to help companies update safety stock decisions across their SKU base.

A few other interesting developments in this area:

  • There is strong anecdotal and quantifiable evidence that the rise in offshoring is adding to overall inventory levels.
  • The rise in transportation costs inevitably leads to decisions that increase inventory to reduce logistics spend in that trade-off equation.
  • The rise we’ve seen in commodity prices can also cause companies to “stock up” to avoid for awhile future price increases.
  • The so-called “Long Tail” phenomenon, under which the power of the Internet (Amazon.com) and/or increasingly narrowcast market segments (e.g., something like Caffeine Free Diet Coke with Lime) are causing a greater percentage of total sales for many companies to come from products with low total sales velocity – a very tough inventory management challenge.

Inventory Optimization is also a comparatively new and fairly hot category of software that has been adopted by a growing number of companies. I learned a lot more about it as we put together our latest Supply Chain Digest Letter on the topic (to download an e-copy, or to access other resources, please visit our Inventory Optimization Resources page.)

In a nutshell, Inventory Optimization software seeks to do three primary things:

  • Look at inventory levels holistically across the entire supply chain, considering the impact inventories at any given level or “echelon” have on other upstream or downstream levels. This includes raw materials and component inventories through internal channels and nodes and, in some cases, all the way down to the retail shelf. Most companies and traditional software solutions look at this problem more discretely, in effect “optimizing” inventories at each level without well considering the big picture.
  • Optimize and continually update safety stock levels across these echelons.
  • Take into better account the impact of variability in demand or supply plans in recommending inventory levels. As with many things in the supply chain, use of “averages” in planning inventories can lead to problems.

Given the market dynamics cited above, and the increasingly brutal level of global competition, gaining even a small edge in inventory management efficiency can pay huge customer and financial dividends.

Many companies are now also embracing an extension of S&OP called Sales, Inventory and Operations Planning (SIOP). While at one level, inventory always should have been a part of S&OP, it was hard enough just to develop a consensus demand plan, let alone targeting the right inventory levels to meet that forecast. But as companies evolve, this is the next level of S&OP (see our upcoming videocast The Role of Inventory Optimization in Sales and Operations Planning.)This is the first in a series of pieces SCDigest is doing on inventory management, including an updated look at how different sectors and companies did last year coming soon.

I am not sure if inventories can ever truly be optimized for more than a nanosecond, but supply chain leaders are getting closer all the time.

What’s your perspective on “Inventory Optimization?”  Do you have experience with this software category? Why don’t more companies do a better job with safety stock policy management? Is it time for SIOP? Let us know your thoughts at the Feedback button below.

 
 
     
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