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The business intelligence challenge

Inventory and supply chain management is an untapped profit and service level enhancer

by Howard Coleman

Fashions change, seasons change, and so does your supply chain. So, when was the last time you looked at your entire supply chain process to determine if it is keeping up with the times? Recent supply chain management developments have dramatically changed how your business can compete, supply chain versus supply chain.

Yes, your supply chain can be a competitive advantage and a source of business value to your company. But, if you have not examined your inventory and supply chain drivers in some time, and have not fully recognized the value of new “business intelligence” applications, then maybe it’s time to take a look at how some new innovations can impact profit, service level and working capital improvement. Fortunately, even small companies can look and act big, challenging their thinking about their supply chains and implementing practical and realistic solutions.

A Business Intelligence Approach
You may be familiar with the pricing and gross margin analytical software available today that allows you to drill down into how you price products, customers, etc.,
develop “what if” scenarios, see the potential results of your pricing policy decisions and their impact on the goal of maximizing gross margin.

If so, consider this: What margin is to pricing optimization, service levels is to inventory optimization. Inventory Optimization (IO) is a subset of business intelligence. In the process of collecting, storing and analyzing data, inventory optimization enables more intelligent supply chain decisions to unlock working capital while maintaining or improving your desired service levels. IO views inventory as a strategic asset, not as a problem.
IO is a hot new area of software and supply chain discussion right now. If your goal is to have the right inventory – at the right place and at the right time – you are trying to optimize your inventory investment. No one I know intentionally orders too much or too little inventory as a strategy. But sometimes you have to find some other unique, new and different ways to conserve working capital and maybe even gain some other benefits too!

IO software, applied to your inventory and supply chain decisions, is meant to perform a rigorous analysis to your inventory, then uses this analysis – the business intelligence you obtain – to identify specific changes to inventory stocking and replenishment processes and decisions, changes to the distribution network, and correlate inventory investments to product revenue and profit generation opportunities.

I recently heard IO defined in a few different ways that make a lot of sense:

• In simple terms: “Aligning your company’s inventory with your go-to-market strategy.”

• In broader terms: “For multi-location distribution networks (known as multi-echelon), the inventory level in one location can affect the ability to achieve inventory and service level goals in another. For instance, if you set inventory levels at location A to X, what do you need to set inventory levels at location B to achieve Y, when B is the source of inventory for A? The only way to correctly answer this question is to determine the total inventory for all locations simultaneously, taking into account all the various dependencies and sources of variability within the distribution network. In other words, identifying smarter inventory replenishment policies and holding rules.

The word “simultaneously” is a key word. Consider the impact that inventories have at any given level, or echelon, on upstream locations (a distribution center or your
supplier) and downstream locations (your stocking branches). Advocates of IO say, “look at the total distribution network,” whereas traditional ERP systems often just look at the inventory requirements at each location, or echelon, separately, in a transactional based look.

IO is an interesting proposition considering that there are so many companies that can’t seem to find the time to review and/or update basic safety stock decisions
(lots of money tied up there!), review their demand and lead-time supply variability on a regular basis, or are still ball-parking their inventory buying decisions related to paying freight or hedging against commodity price increases and what the cost versus inventory trade-offs really are.

So, maybe a more scientific approach has merit and can enhance and leverage your ERP investment without replacing your ERP system.

The Rationale
Additionally, through IO analytics, you can drill down to specifics and discover many things you didn’t know before. Suppose you need to provide differing service levels, by product or group or location, or add a branch or two, or use different approaches in different markets. All of this serves to increase the complexity of supply chain management decisions. So, your stocking strategies become very important, particularly if you relate it to your business objectives and to specific item/product attributes (such as fast movers, slow movers, new products, critical products), demand expectations and supply characteristics.

In today’s environment, it’s not enough just to monitor inventory control efforts by running reports from your computer system to measure inventory turns. Why? These actions are not directly concerned with transforming inventory management into a profit and
service level enhancer. This is where the inventory optimization concept enters the picture.

The Inventory Drivers
The challenge of Inventory Optimization can be even more daunting in multi-echelon distribution networks (Figure 1), where you have product stored at a central point (a distribution center or hub) and the DC is the internal supply to your branches (the customer-facing locations). We know this as the “hub-and-spoke” distribution model.
The nuts and bolts of inventory optimization involve carefully setting and monitoring the specific drivers of inventory management that are interrelated, and use information gathered from each other. These drivers are:

• Desired Service Levels
• Forecasting
• Replenishment
• Order Frequency
• Lead Time

Consider desired service level. This involves setting and monitoring the desired service level performance of the inventory itself, down to each SKU. Most ERP systems don’t provide service level analysis and reporting. Rather, you must peer into demand history, demand variation, GMROI and lost sales.

Next, demand forecasting requires that you have an understanding above and beyond recent sales history. It requires an understanding of “demand-pull” and “continuous flow” concepts (see our White Paper, “Lean Thinking in Wholesale Distribution Supply Chains – Do You Pull or Push? available at www.mcaassociates.com) and their use, to develop appropriate target inventory levels for each and every product.

Replenishment order frequency is another critical aspect of inventory optimization. Replenishment is not just reordering. It’s not just about the cost to generate a purchase order, but rather “how much we order each time we order.” That’s where each order costs your company money. More accurately pinpointing an optimum or best order frequency can, by itself, account for significant inventory reductions and service level enhancement.

Next is lead-time. Anticipating lead-time with accuracy goes beyond simply determining a supplier’s lead-time from past averages. It not only requires an in-depth assessment of the supplier’s overall performance, but also requires an understanding of its impact on all locations within the distribution network, to minimize or eliminate those self-defeating practices such as having to over order or over transfer in an attempt to compensate for variations in supplier performance.

The Multi-Echelon Distribution Network
A hub-and-spoke distribution network can have some major pitfalls because stocking and replenishment strategies are often applied to one echelon without regard to the other(s). There are some potential negative consequences:

• Excess inventory in the form of redundant safety stocks (at both hub and spoke)
• Stockouts, at a spoke, even though adequate inventory exists in the distribution network.
• There may be a minimal relationship between what you order and the actual demand you are experiencing, due to demand variability.

Going back to Figure 1, there is often a split in replenishment approaches, kind of like a sequential approach (one for the DC, and then one for the spoke). This poses problems:

• Lack of visibility up the demand chain. When a spoke seeks to replenish itself, it’s “blind” to suppliers beyond the DC. The spoke ignores any lead-times other than its own lead-time from the DC. The spoke may also assume that the DC will completely fill its replenishment orders each and every time. And depending on your ERP system, the spoke may not have any visibility into the DC’s inventory balances.

• Lack of visibility down the demand chain. Similar to the case above, when the DC seeks to replenish itself, it may be oblivious to customer demands beyond those of individual spokes and/or have no visibility into the spoke’s inventory balances.

• Demand distortion. Because the DC and spoke create independent demand forecasts (based on their own immediate customers’ demands), distortions in demand and peaks and valleys often result.

• Total distribution network costs. If one or more of the spoke’s inventory drivers are modified, the cost implications may be readily apparent at the spoke but not readily visible to the DC. The impact becomes strictly focused on one single echelon.

• No linkage between safety stocks. Each DC and spoke protect themselves independently, so any desire to optimally balance inventory is made more problematic.

Overall, this lack of cohesiveness is caused by independent decisions as to how inventory will be managed, either at the DC or at the spoke.

A Call To Action
If any of this seems familiar to you, then committing your organization to realizing the benefits of inventory optimization will require a change in philosophy and thinking. It also requires a solution, or tool, to realize that objective, making IO something that you should consider as a source of real supply chain management business value to your company and a competitive advantage (your supply chain vs. your competitor’s supply chain).
Distribution focused companies must view inventory and supply chain management as an untapped profit and service level enhancer, as well as a cash saver. By making these concepts a reality, you can truly reduce your total supply chain costs, generate additional capital and increase service levels in a meaningful way. This is your call to action!

Howard Coleman is principal of MCA Associates, a management consulting firm that works with wholesale distribution companies. Reach him at (203) 732-0603 or hcoleman@mcaassociates.com or at www.mcaassociates.com. Howard will lead a Webinar on this topic, entitled “Is it Time to Update Your Supply Chain?” on Sept. 20 at 1 p.m. EST. Click here to register.

This article originally appeared in the July/August 2011 issue of Industrial Supply magazine. Copyright 2011, Direct Business Media.

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