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Inventory is a necessary evil in modern supply chains. Identifying and maintaining the right amount of inventory is one of the biggest challenges that supply chain managers face. Inventory sits as a trade-off between customer satisfaction and material availability vis-à-vis increasing inventory holding costs and working capital. With the globalization of organizations, Indian companies are matching their international peers in terms of sophistication and maturity of supply chains. However, maturity of supply chains and the supporting technology does not complete eliminate the aforesaid trade-off completely. It is essential to look at inventory as “good inventory” and “bad inventory”. “Good inventory” is the key to good customer service and positive cash flows while bad inventory, too much of the wrong items, clog warehouses and distribution centers. IBM in partnership with IW Custom Research undertook a value chain survey, the results of which have been published in early 2008. This article draws from the report and IBM’s vast experience in handling inventory related strategic and operational projects across industries. The article highlights the top 7 challenges that are critical but not obvious, to retain a balanced inventory in the supply chain, preventing unproductive working capital and lost sales opportunities. 1. Infrequent Parameter Reviews The parameters that are used for managing inventory - such as safety stock quantity, replenishment order quantity, reorder point in a Continuous Review policy, or review period in a Periodic Review policy - use factors such as service levels, demands, and supplier replenishment lead times as inputs for their calculation. However rapidly changing markets, competitors, and product life cycles have made review periods that worked in calmer times unsuitable for today’s speed of business execution. Failure to monitor the environment and update these inputs on a frequent and detailed basis is a recipe for inefficient inventory investment. Companies set these parameters on a one-time basis, often at the start of a new process improvement initiative or an ERP implementation. However, failure to monitor the values fixed to the parameters and the parameters themselves, leads to their ineffectiveness in the long-term.
forecasting and replenishment also offer great support. The solution also has IBM-patented adaptive methods for safety stock calculation. and lifecycle variations in demand that may be inherent for each SKU. . Other programs like collaborative demand planning. then adding a safety cushion and calculating average daily consumption will be fine. this quantity is expressed in terms of 'days of supply'. seasonal. and third. Respondents using collaborative forecasting reported an average monthly forecast error of 10 while the average for the larger surveyed group was 15. However. IBM’S proprietary application for inventory management and rationalization – Dynamic Inventory Optimization Solution or DIOS. Solution: Monitor and understand the variations in demand and supplier lead times. or 'days coverage'. a seemingly logical approach is to declare a quantity of supply to be held at all times for each SKU. This approach fails in three areas: first. provides for simulation engines that determine safety stocks’ optimal levels and expected service levels. 2. Tools and applications are effective enablers of such reviews. it does not seek a costefficient balance between inventory held as safety stock and inventory being replenished (cycle stock). The IBM/IW Custom Research Value Chain Survey showed that sharing real-time demand and inventory data and continuous replenishment programs for customers help in facing this challenge. and frequently recalculate safety and cycle stock for each stock keeping unit. Days of Supply When faced with unpredictable demand and pressures to ensure supply availability. they may be giving up inventory reduction (and cost saving) opportunities in order to 'guarantee' availability. this approach isn’t completely suitable to determine an efficient supply quantity. The approach reasons that if it takes on average two weeks to receive replenishment from the an order is placed.Parameter updates are only made when the resultant impacts of these misalignments become evident as large inventory excesses or frequent stock-out occurrences. Many inventory managers concede that by taking this approach. second. it does not take into account the daily. Typically. The untracked accumulation of excess inventory leads to inventory write-downs and lost working capital. Solution: Periodic review of the key planning parameters is required for ensuring proper inventory management. it does not take into account variations in supplier replenishment lead time.
Volume-based Classification Method With tens. etc. some classification and prioritization is a required first step. the method for generating the forecast is set by company division or product type.3. In an earlier DIOS-based engagement. Solution: Consider alternative classification techniques that incorporate multiple costs and parameters to optimize inventory investment. However. others are not.by addressing the manner in which SKUs are grouped.000 to 70. For example. Although an aggregate forecast approach is necessary for manufacturing and procurement capacity planning and for supplier negotiations. using the ratio of ordering costs to handling costs for material classification led to the number of orders/year reducing from 230. In many cases.000.ordering plus holding plus transportation. but may be very sporadic in both time and relative quantity between sales. and in some cases hundreds of SKUs to manage. Even within a single product type. This approach seeks to minimize the overall costs . What may seem intuitive may not be the most effective approach for managing inventory at the lowest overall cost. only an approach that takes into account the anomalies of demand for individual SKUs at the stocking point will be effective. Since these forecasts will be used for setting the inventory parameters that are needed in the future. IBM suggested a bottom-up approach to forecasting. Any changes at the highest . With the advent of ERP systems and other high-computation enablers. Thus. Imagine instead an approach that classifies SKUs by the relative magnitude of value and costs required to order and hold them in stock. some SKUs are relatively new in their lifecycle. Such top-down approaches do not account for the local variations in demand that can be significant at the individual SKU level. others are soon to be retired. classification based only on quantity sold is not the most optimal way. . Top-down Forecasting High-level forecasts generated by sales teams are vital for effective demand and supply planning. after reviews. Solution: Create forecasts at the SKU stocking level to generate reliable models of demand variation. some are affected by seasonality. 4. it is not the most effective means for optimizing the investment in inventory. While implementing an ERP for an Indian Pharma major. it is now possible for a more fine-grained approach to material classification beyond simple methods like FSN. SKUs with a similar ratio of value and ordering costs to holding costs would be grouped together and ordered with a similar frequency. with inputs from the area sales managers being aggregated along the hierarchy. a single method of forecasting is cascaded down to product lines and perhaps even to the individual SKU/location level.
6. Failing to address the underlying causes of variability We have often found that when science is applied to understanding service levels.level of forecasts could be disaggregated to the lower levels through predetermined ratios or manual overruns. However it takes a consensus from the manufacturing. Examples are: promotion practices that create spikes. marketing. so a fill rate calculation is used for serviceability. Therefore an effective service level measurement should reflect customers' performance expectations and buying behavior and should be agreed to by key internal functions. a manufacturing organization may track quantities of product shipped and quantities ordered over a specific time period. Solution: Create an approach to service level calculation that can provide multiple differentiated measurements of serviceability and include all functions in determining which measurements and values should be used when developing inventory plans. though technically optimal. suppliers with erratic shipping patterns. and various stocking policies. this calculation provides no insight into the probability of a stock-out occurrence. For example. rarely is enough attention paid to how this measurement is calculated. demand variability. The suggestion led to reduced forecast errors and better planning. Our experience shows that the “squeaky wheel” service level tends to get applied to all customers and items because rule of thumb policies do not lend themselves to defining and maintaining segment specific services levels. and ordering policies that create bottle-necks in shipping and receiving. or how long it takes until supply is replenished when that stock-out occurs. Yet despite its influence. the result. One of these approaches is no better than the other. supply variability. sales. Most inventory stocking policies . This is because variability in both supply and demand can often be self inflicted or turn out to be easily addressable. The result is more inventory than is really needed to provide the optimal service level. still holds opportunity for improvement. The right inventory level for a given level of service is highly sensitive to the variability around supply and demand. However. In addition understanding the link between service level and customer satisfaction also opens the door to segmenting the customer base to further differentiate service levels by customer segment. and sometimes finance teams as to which approach is best suited for measuring the performance that is most relevant to customers. 5. Implicit in most service level discussions is that poor service levels result in lost sales and vice versa. Misaligned Service Level Measurement The service level target is a key factor in the determination of inventory levels.
Simulations allow companies to compare the impacts of different parameter choices on expected stock-outs. said it is ‘somewhat effective’ to ‘highly effective’. While working on statistics-based forecasting. 7. Solution: Invest effort in building organizational alignment around inventory policies. Our experience has shown that a normal distribution is often not the case. focusing on the most volatile and expensive fluctuations. Failure to align inventory policies Reduced inventory helps in greater working capital productivity. Solution: understand the sources of high variability on both the demand and supply sides of your stock and take actions to reduce the variability. as shown by the IBM/IW Custom Value Chain Survey is important (65. Cross-functional teams involved in the planning process offer a solution to the above. due to the risk to service levels is high. a firm may be able to anticipate the correct level of inventory to hold to minimize its exposure to risk. and beyond measuring and accommodating for the variability. Summary . resistance from sales and marketing. potentially using simulation capabilities to anticipate the expected results of your inventory parameter decisions.assume a normal distribution of variability around these key parameters. Similarly. However. by simulating under different demand and supplier response scenarios.3% of respondents who collaborate. outliers have to be removed from the historic data. The ability to see how a company’s inventory will fluctuate next week and months into the future is imperative for reducing the fear around change and helps to align the organization on priorities. future production planning and inventory management must factor in promotional plans. Simultaneously collaboration and integration among customers and suppliers. We have found that an approach that simulates various inventory policies and parameters can bring transparency to the decisions and their impacts. taking actions to address the variability. A time worn and Edelman award winning example of the power of simulation is the case of IBM’s use of its Supply Chain Analyzer to simulate the impact of changing our inventory policy to individual retailers in the personal computer supply chain. using their data. Sitting with each retailer and showing them the impact of our holding the inventory higher up in the supply chain. service level. This is a classic example of supply chain collaboration facilitated by simulation. can drive even better inventory productivity. Also. allowed IBM to take two month’s worth of inventory out of its retail channel and reduce price protection expenses by over $100 million. and inventory costs.
He has widespread experience in successfully leading supply chain transformational engagements across industries. we have developed an approach that blends data analytics.ibm. Suresh can be reached at suresh. About the authors: Clifford Patrao is an Associate Partner with IBM India and is the lead for their Consultancy Services division.ch@in. and work in process. optimization algorithms. provide transparency to the organization on the trade-offs involved.ibm. As a result of these engagements and supported by cutting edge proprietary solutions and tools. and discrete event simulation. raw materials. and arrive at the right combination that delivers optimal inventory efficiency. This approach allows us to quickly analyze a given client’s unique inventory management challenges and evaluate literally thousands of policy parameters.com Suresh Chivukula is a consultant in the supply chain area with a focus on process improvement engagements. This approach lets us accurately and efficiently diagnose a clients’ inventory and pinpoint which items are clogging the arteries and which ones need increase in inventory.Over the last decade our supply chain practice at IBM Global Services has conducted well over 200 supply chain transformation engagements that focused on improving the effectiveness and efficiency of our clients’ inventories. Clifford can be reached @ clifford.com . finished goods.patrao@in.
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