An Optiant White Paper

The Executive Guide to Maximizing Working Capital without Crippling Your Supply Chain
How to stop brute-force inventory reductions and position your company for the coming economic recovery

Slashing Inventory Now May Cripple Your Supply Chain—and Your Business.
The Importance of optimization, rather than brute-force cutting, to free up working capital now while enhancing responsiveness during the recovery
The severity and rapidity of the economic downturn caught just about every business by surprise. Although it’s normal for demand changes to cause inventory to “overshoot” the demand curve, this sharp and deep cycle has pummeled those who did not have the necessary disciplines and competencies in place to proactively managing their process,. Not surprisingly, the crisis-management reaction has included brute force reductions in inventory, headcount, sourcing and production capacities. Unfortunately, the continued need for working capital during the downturn creates perfect conditions for potentially disastrous decision-making. Mandates such as “cut inventory by 20%” can indeed produce liquidity—while leaving the supply chain less able to function efficiently and unable to meet higher customer demand during the recovery. Bad inventory management today makes the company less competitive during the upswing and amplifies the damage caused by the economic crisis. By contrast, market leaders work these cycles to gain share and strengthen their people, process, and technologies. Competency. Corporate performance during today’s volatile economy, credit crunch, and financial crisis is intrinsically connected to supply chain competency. Successful companies will analyze all the factors that led them to hold inventory in the first place, such as supplier lead times, demand fluctuations and uncertainty, production capacity, sales forecast errors, etc. The smart move is to enhance supply chain infrastructure through intelligent decisions about where to cut inventory and by how much, right down to the SKU-by-location level. To do this, the organization needs to enable its people, process, and technology around inventory management. Consider the impact of inventory management on availability of working capital. In a business that can’t control inventory, any time demand falls the supply chain will keep building when it shouldn’t. The result is excess inventory that sits until discounting or obsolescence finally moves it off the shelf, which causes a drop in the balance sheet and a loss on the P & L. For a company in need of working capital, this is not a preferred strategy for “converting” inventory to cash. In today’s uncertain economy demand is harder to forecast than ever, yet somehow the supply chain must deliver the working capital that is key to the company’s short-term health and long-term strategic vision. As modern business cycles become faster and more severe, winning companies depend on inventory efficiency to provide investment dollars during the down cycle. “Inventory optimization is now among the top three priorities for many supply chain organizations as they seek to create increased efficiencies during the continued global recession..”
Manufacturing Insights, June 2009

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The Recessionary Economy’s Double-edged Sword
While too much inventory traps and diminishes working capital, too little results in missed sales, lost revenue, and lost customers. Both scenarios can occur during the business cycle. A plunging-and-recovering economic cycle poses double danger to complex, vertically integrated businesses. First is the cost of sluggish reaction to dropping demand. Many manufacturing 70 teams are measured on building Plan vs. Demand Drop 60 products and using resources as 50 efficiently as possible. This can 40 Original Build Plan lead to a supply chain strategy 30 Excess that is “determined” to keep Inventory 20 building to the plan long past the logical stopping point. Excess Demand 10 inventory builds up during the 0 lag period and saps working capital at the time it is most scarce. The potential arises for massive channel-stuffing and obsolescence as overstock sits for months. When the inventory cuts do come, they take the form of brute-force mandates rather than intelligent decisions.
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“Most companies have mastered the basics of Supply Chain execution. Where they struggle is designing supply chains that are as flexible as their market requires.”
Senior Manager, Accenture

Unprepared. After the effects of across-the-board cuts set in, we come to the second danger. Eventually demand recovers, leaving organizations that manage inventory by “rule-of-thumb” completely unprepared to take advantage and rebound quickly. Forecasts change rapidly and unpredictably. “Gun-shy” managers are slow to ramp up. Suppliers who not long ago were shut off are now unable to quickly revive themselves. Some suppliers and contract manufacturers will go bankrupt. When demand 70 recovers, having fewer suppliers Manual Response 60 can create a bottleneck in Rule‐of‐thumb 50 capacity, especially in cases of inventory adjustments long international lead times. 40
30 What is a 90-to-120-day lag in response costing your business? 20 Way too much. The cost comes 10 Excess Inventory in many forms: lost revenue, 0 poor return on assets, bad cash position during a crucial time, inability to take market share away from slower competitors. Sep Oct Aug Dec Nov Jan Feb Jul Mar Lost  Revenue

“Increasing the productivity of assets has taken on more importance because of its direct relationship toward maximizing working capital and improving the bottom line.”
Simon Ellis Supply Chain Practice Dir. IDC Manufacturing Insights

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Although you can’t manage the economy to create more demand, you can chart a “course of lowest cost” by successfully managing inventory. To navigate this difficult passage, the supply chain must minimize its costly tendency to overshoot changes in the demand curve. Someone has to balance out the uncertain demand
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and inaccurate sales forecasts. But how can they know what to cut, what to keep, what to order, what to postpone? Where is it smart to reduce and where is it suicidal? Where does the confidence come from to ramp up manufacturing, take maximum advantage of increasing demand, and grab more market share? The key lies in reacting to demand signals early enough and positioning sufficient buffer inventory in the right locations. Bouncing back. Rules of thumb and spreadsheet calculations are not up to the job, but there is a higher level of analytical power available that has proven over and over that it can minimize the “overshoot” effect both during the plunge and the ramp-up. Optiant’s inventory optimization technology applies proven mathematical algorithms to model the overall supply chain and map the interdependencies of its components. The analysis predicts exactly how different supply chain configurations will behave in 70 response to possible changes in Optimized Response 60 the demand curve. Greater Rule‐of‐thumb  50 inventory competency lets the Optimized  Avoidable 40 organization respond with Lost  confidence—quickly adjusting Revenue 30 inventory targets and policies to 20 minimize costs, maximize profit, 10 and maintain required service Avoidable Excess Inventory 0 levels. This means the avoidance of excess inventory and obsolescence during a demand drop and very little missed sales revenue during an upswing. Faster response improves competitive advantage during the recovery and a growth in market share. In an exaggerated plunge-and-recover cycle, good inventory management means the difference between bouncing back from the downturn and being run over by it.
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“A multi-echelon inventory optimization application can be a powerful lever in optimizing overall supply chain performance.”
AMR Research

Becoming Recovery-Ready and Uncertainty-Proof
Great demand uncertainty breeds little confidence in how to get back on top of the demand curve. Normally, when demand exceeds the safety stock, managers resort to tactics such as expediting, subcontracting, premium freight transportation, or overtime to accommodate the 70 Demand Uncertainty demand windfall. But in a plunge- 60 and-recover scenario, if vital inventory is not on hand at multiple stages of the supply chain, sales will be lost at the precise time they are most crucial. Even as demand changes over time, the degree of uncertainty is

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predictable and can be managed. Using existing demand data, a smooth demand curve can be generated, with variability shown as high and low bounds: in effect, uncertainty forms an envelope around the demand signal. Inventory planners can choose how wide an envelope to plan for, given their service level requirements and business goals. Managers can confidently hold more raw materials and subassemblies at lower-cost stages, ready to produce high-cost finished goods in multiple variants quickly when needed. Selected long-lead-time items can be stocked at higher levels than other SKUs so as not to impair response to a sudden increase in demand. The SKUs associated with high-profit goods can be given preferential treatment while low-value stock gets lesser priority. Optiant inventory technology is uniquely focused on handling uncertainty. It is the leading—and only—decision support solution that creates confidence and predictability in the face of both demand and supply volatility and uncertainty.

The Difference Between Operations and Optimizations
It’s a common misperception that operational supply chain tools such as ERP and Advanced Planning Systems somehow improve the strategy and tactics of inventory management. This is not the case. Operational tools in a deterministic planning system actually amplify inventory overshoot because operational and transactional systems do not address the issues of how much inventory is optimal or where it should be held within the overall supply chain. For instance, inventory is often located using the same structure defined in the ERP/APS system, even when these stock-holding locations are physically close to one another. Pooling inventory could reduce runs between the stock-holding positions and improve fill rates. Optimized stock pools are an excellent technique to maintain consistently high service levels while saving between 30%-50% of safety stock cost—but stock pooling is beyond the scope of ERP and APS systems. In another example, simple "days-of-supply" inventory targets often cause stock to build up earlier in the supply chain than needed, causing a tendency to miss highdemand peaks where maintaining fill rates is a crucial task. Inventory optimization maintains fill rates by intelligently allocating the right amount of stock to each location, week by week and month by month (whether the inventories are pooled or not). ERP and APS systems do not address uncertainty. Instead, ERP systems should be used as a source of supply, demand, forecast and production data for an inventory optimization solution such as Optiant’s PowerChain suite, which models, analyzes, and recommends smart inventory targets and policies. Optiant technology models the complex supply chain as a multi-stage network, incorporating production lead-time at each stage and “dollarizing” the impact of different supply chain decisions (such as how much buffer stock should be held and where it should be located). The analysis takes into account transaction data
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Optiant’s advanced mathematical optimization technology—nonlinear, integer programming originated at the MIT Sloan School of Management—provides strategic and tactical decision support, versus the operational support provided by ERP systems.

as well as uncertainty in demand, volatile supply costs and delivery timetables, inaccurate or inconsistent forecasts, and more. Trying out alternative what-if scenarios helps planners see clearly which decisions will produce a successful outcome (service levels met or improved) while minimizing costs across the entire supply chain. Optiant’s technology is flexible and easy-to-use, focusing planners’ attention on “exceptions” from the norm that should be corrected. It can feed updates to the ERP system on a regular basis so that inventory is optimized routinely.

Alignment Must Begin at the Top
Supply chain mandates come from the senior staff, and supply chain leadership needs to come from the same place. The questions senior executives should be asking of their supply chain teams include:    What’s the most profitable way to bring inventory back into alignment with the demand curve? How should we position inventory and capacity throughout the chain to be ready for a recovery while handling demand uncertainty? How can we position our people and competencies to take full advantage of increased demand while minimizing losses during future downturns? “People in the functions are usually busy with their own business and don’t take time to understand and focus on how they impact inventory in the overall supply chain. There is nothing like simple, visible data to bring people together in problem solving, agreement and decisions.”
Senior supply chain exec

Supply chain managers should be able answer to these questions based on hard data and facts. If they can’t, it’s because wise inventory decisions (that minimize costs while maximizing customer service levels in spite of uncertain demand) require a specialized decision support system that provides one accurate picture of the entire supply chain and pulls managers together in understanding its efficient operation. While manufacturers should ideally design, model, and optimize their supply chains in a collaborative environment, many decisions are in fact made in silos of Sourcing, Manufacturing, Distribution, and Customers. In many companies, these teams have directly conflicting systems of goals and rewards. Taken individually their decisions may be justified, but the totality creates massive overstocks and lag times (as well as other inefficiencies), and these contribute directly to the company’s inability to dig its way out of a deep demand trough as quickly as it must. An end-to-end optimization solution (such as Optiant’s PowerChain suite) allows companies to take a “cross-silo,” holistic approach to designing and optimizing their supply chains, rather than viewing them as a series of local decision points. Led by a broad initiative from senior management, collaborative decisions can be made from the perspective of what’s best for the overall supply chain, rather than individual sites striving to “have enough on-hand so we won’t have to expedite.” For instance, Optiant may recommend replacing safety stock held at each and every stage in the supply chain with a decoupled approach to lower total safety
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One Optiant client was able to reduce finished goods Inventory by 36%, raw materials & WIP by 47%, and improve delivery performance by 17%.

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stock while maintaining service levels. Armed with one, fact-based representation of how the supply chain works, the executive staff can provide confident leadership that cuts across the silos. Cross-functional cooperation and vision regarding the end-to-end supply chain should be a game-changing initiative driven by senior management.

Preparing for Change—and Greater Profitability—in Just 90 Days
A time of uniquely low demand is like an auto race running under the yellow flag: it is an opportunity to prepare both the supply chain and all of its stakeholders to prosper when full-speed competition resumes. The perfect time to implement a more efficient decision-support solution is as early as possible in the plunge-and-recover cycle. Optimization tools set in place now will create a lean inventory environment that responds to demand— especially volatile demand—with speed and confidence. Inventory optimization solutions are much easier to implement than, say, an ERP system, and can quickly create savings in the millions. Optiant routinely implements in just 90 days, with no disruption to existing ERP and APS systems (the independent Optiant solution feeds optimal recommendations to supply chain managers and the enterprise systems). The goal of any inventory management system is to provide the best possible customer service within the constraint of the lowest practical inventory cost. This improves company performance during any business cycle, but sharp downturns provide a special opportunity for excellent companies to free up working capital, become stronger, and gain market share during the recovery. Here are the key guidelines:    Reform your inventory rather than slashing it through brute-force reductions. Free up working capital by intelligently reducing excess inventory—but avoid cuts that hurt your ability to gain market share during the recovery. Correct the tendency for inventory to badly “overshoot” the demand curve. Become able to react to demand changes faster than your competitors can. Provide supply chain stakeholders with one accurate overview that helps them understand the big picture. Empower managers to follow recommendations that strengthen the entire supply chain and improve the company’s ability to compete and win. Exercise senior leadership to drive inventory improvement during “yellow flag” period. “With quite reasonable acquisition cost and attractive ROI, inventory optimization applications are quite compelling…the level of benefit may surprise you!"
IDC Manufacturing Insights

“The ability to optimize inventory across multiple echelons, with global visibility of customer service commitments, costs, and demand and supply variability, is an inherent need in every complex supply chain.”
AMR Research

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Optiant’s PowerPoint Suite of Inventory Optimization Solutions
Optiant provides an innovative solution for determining optimal safety stock locations and levels in a complex supply chain. Using the PowerChain platform, a user can design and model a supply chain as a network, where the nodes of the network are the stages of a supply chain. Each stage uses a base-stock policy to control its inventory levels and quotes a service time to its customers, both internal and external. The PowerChain optimization engine then determines optimal safety stock locations and levels for minimal cost of the safety stock of the supply chain. The benefits include lower investment in safety stocks, higher return on assets, lower on-going inventory holding cost, higher customer service levels and increased revenue. In addition, the PowerChain suite serves as an effective communication tool across the many functional and geographical divisions within a typical supply chain, enabling collaborative decision-making.

For more information on how inventory strategy and tactics can be improved within your organization, email chris.russell@optiant.com or visit www.optiant.com

Optimizing Supply Chains. Maximizing Results.

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