Inventory Planning & Optimization — July, 2007

Sponsored By:

Sign up today to begin receiving this FREE e-mail newsletter.

Advanced Inventory Optimization Five-Year Market Analysis and Forecast
From ARC Advisory Group
Advanced Inventory Optimization (AIO) solutions deliver targeted customer service levels with the minimum amount of network inventory. AIO solutions differ from traditional replenishment solutions that only contain a single stage inventory calculator designed to determine inventory targets for a single node in the supply chain at a time. In contrast, AIO solutions simultaneously calculate where and how much inventory should be held across multiple echelons of a supply chain. There are two types of AIO solutions. Regular Inventory Optimization solutions calculate target inventory levels for raw material, work-in-process, and finished goods. Parts Inventory Optimization is focused on calculating stocking levels for service parts in a multi-echelon supply chain.

This is still a young, small market that requires educating potential customers of the significant benefits AIO offer over competing types of solutions. Statistically, the optimization is complex and as a result ARC is forecasting that Knowledge Based Outsourcing will be a key driver of market growth. Knowledge Based Outsourcing involves outsourcing all or some portion of a planner's job to an outside party.
In ARC's interviews with users of AIO systems, a high proportion of references reported either a quick payback period or a high Return on Investment. A key challenge will be getting this message to the market. Other key issues include:
1. How can suppliers convince potential customers that their form of optimization is superior to traditional forms?
2. How can suppliers leverage Knowledge Based Outsourcing and Software as a Service to gain new customers?
3. Will new distribution channels will be required?
4. How will entry of ERP suppliers affect the dynamics of this market?

Demand-Driven Inventory Management Strategies
Industry Directions/Julie Fraser & William Brandel
According to a survey of companies across a broad spectrum of manufacturing, distribution, and retail by Industry Directions, traditional supply chain management practices make it a challenge to create a truly demand-driven supply and distribution network.

Most respondents to this study state that improving service levels is the primary driver to their inventory management strategy. Yet, most are still doing things in a relatively traditional fashion. They review processes and performance, inventory and service level targets infrequently. A majority have planning software, but not other applications that support dynamic, demand-driven response. Top performing companies in the study are more likely to use these practices and software.

Spreadsheets are the dominant method for setting both inventory targets and customer service targets. While many companies have developed excellent calculations in spreadsheets for managing targets, there are inherent limitations to spreadsheets and the classic deterministic inventory theory commonly used. One is that they become far more challenging to manage at a more detailed SKU-level and another is that they are single-user systems that limit truly dynamic collaboration.

Most respondents believe that application-based solutions are more effective than spreadsheets or rules of thumb. Inventory optimization software is growing in popularity, and many products provide mechanisms to optimize both inventory and service parameters on the efficient frontier and make tradeoffs for each SKU.

Inventory planning and optimization software that uses algorithms to account for uncertainty are recognized by over 30% of respondents as the most effective, with another 27% feeling than an application that includes an inventory target calculation would be the most effective mechanism.

For customer service levels, 30% believe an application with a calculation would be most effective and 23% believe an optimizing algorithm for the customer service level would be best. Still, fully 20% believe that an expert using rules of thumb is the most effective way to set customer service levels, and another 27% selected spreadsheets. Some companies may be very effective with these mechanisms, but we suspect many respondents are not acquainted with application-based opportunities to improve customer service and inventory targets.

Joint Supply, Demand and Pricing Optimization
From Accenture/Arjun Mukherjee
To make informed forecasting and replenishment decisions, many companies bring together operational elements of production and distribution with sales and marketing, executing sales and operations planning (S&OP) collaborative improvement processes. As cross-functional and consensus-based processes, S&OP activities create value by keeping supply and demand in balance.

But most S&OP arrangements fail to consider or fully account for the effects of pricing and promotional strategies on the upstream supply chain. How does the use of sales and marketing instruments affect upstream replenishment capabilities and overall profitability? How do capacity, lead times and production status relate to the company's ability to react to pricing- or promotions-induced demand swings?

This point of view illustrates the need to extend the traditional S&OP process to include joint pricing and operational tactics. Accenture's research and client experience confirms that this combined effort can help maximize a company's profitability and accelerate its journey to high performance. Among other benefits, coordinating dynamic pricing, promotional and operational decisions will help reduce the costly bullwhip effect. In the bullwhip effect, small variations in orders get amplified up the supply chain, causing
anything from inventory shortages, to lengthened lead times and lost sales, to decline in customer service. A synchronized approach also helps improve both the revenue and cost sides of the profit equation.

Extending the footprint of S&OP processes provides an opportunity to link and share pricing and promotional information with supply chain constraints. This extended forum can also help organizations ascertain the responsiveness of their supply chains when prices are adjusted. The following five key questions can help supply chain managers assess how well they are jointly optimizing supply, demand and pricing.

1. How do you ensure that your pricing and promotional activities do not adversely affect the upstream supply chain?

2. How do you link your sales and marketing instruments with critical supply chain factors such as lead times, inventory and capacity constraints?

3. How do you measure the impact of sales and marketing decisions on upstream
replenishment capabilities?

4. How flexible are your production and distribution strategies with regards to
fluctuating customer demand?

5. How do you adjust your sourcing strategy and inventory rules to take into account the effects of dynamic pricing and customer margins?

How To Keep the Supply Chain Logistics Wheels Turning
From AMR Research/Lora Cecere
With logistics costs outpacing growth of the US Gross Domestic Product (GDP) for the past three years, AMR Research lays out nine actions accompanies can take to lessen the impact. Two of these steps involve inventory and network optimization:

1. Don't take inventory for granted: For the third consecutive year, inventory carrying costs have risen faster than transportation costs. In 2006, total business inventories rose 6.2% with a continued push of inventories back into the supply chain. The idea was to move inventory responsibilities from the channel to the manufacturer and from the manufacturer to the supplier. Inventory carrying costs also rose 13.5% to represent 3.4% of the nominal US GDP.

Reversing this trend requires continued focus on inventory management. Make inventory management part of the S&OP, use demand shaping strategies to run out excess inventory, and consider the implementation of technologies with deeper statistical modeling, such as those from LogicTools, a division of ILOG, Optiant, SmartOps, and Terra Technology, and ToolsGroup, for multi-tier supply chain environments. Our 2004 analysis showed an average of three months to return on investment (ROI) for these technologies. With the rise in inventory levels and inventory carrying costs, now may be the time for your organization to evaluate these technologies.

Additionally, if inventory responsibility shifts backwards in the supply chain, be sure that your organization is not lulled to sleep. Transferring inventory ownership is a quick way to shift costs off of your books, but it is a real cost of doing business. A lack of attention to the buffer inventories between supply chain tiers, if not managed, will increase total costs. In AMR Research studies, we see that when companies shift inventory responsibility only 20% improve supply visibility and reduce demand translation and latency. These are important abilities but you may be caught with unwanted inventory in the case of an economic downturn.

2. Face reality, redesign your network: One of the shocking pieces of data we see consistently in quantitative research is the lack of focus on network design optimization. Even in the face of these changes in supply chain logistics for distribution-intensive industries like CP, only 7% of companies analyze their logistics networks more frequently than yearly, with 67% evaluating their networks annually and 36% redesigning every two years or more.

Action Item: Leaders are reevaluating network strategies systemically as part of their quarterly S&OP processes. They recognize that each of their supply chains requires a unique design and fine-tune networks as supply chain parameters change.


Inventories: Time To Restock The Warehouses
From Business Week
Businesses made a concerted effort during the past couple of quarters to keep their warehouses from getting any fuller. Now that inventories relative to sales look a lot leaner, the adjustment is winding down. If demand holds up, the economy should get a boost as companies allow inventory growth to keep pace with demand.

In March, business inventories fell 0.1%. The unexpected decline will translate into a bigger hit to first-quarter economic growth. The originally reported 0.3% drag on first-quarter real gross domestic product from the smaller rise in inventories were close to 1% when the revised numbers came out on May 31, according to JPMorgan Chase economist Bruce Kasman. That comes after shaving 1.2% off of fourth-quarter real GDP.

The recent clampdown, combined with resilient consumer and business demand, have left stockpiles at more comfortable levels. March's inventory-to-sales ratio fell back to a seven-month low of 2.7 months. In addition, the Institute for Supply Management's April factory activity report showed the largest share of respondents reporting customer inventories were too low since July, 2006. And fewer nonmanufacturers in April thought they were carrying too much inventory.

Starting in the second quarter, inventory growth should turn modestly supportive. Kasman expects an average positive contribution to real GDP of about 0.5% during the rest of the year. The boost to growth in the second quarter will likely come from autos as inventories climb on an upswing in production. A restocking of retail stores after a sharp March decline should be a plus.

But businesses will add to inventories only if they believe business and consumer demand will hold up. Right now the picture looks positive. Factory orders and output are growing at a good clip, and early data on May chain-store sales were positive. If that trend persists, Kasman expects manufacturing inventory growth will pick up in the second half of the year as the drag from housing diminishes.

Multi-Echelon Supply Chains Require Revamped Inventory Management
From Aberdeen/Nari Viswanathan
The pressure is on for companies to revamp traditional inventory management practices with technology and processes that are better suited to today's global, multi-echelon supply chains. In a recent survey by Aberdeen Group, Boston, more than two-thirds of respondents said they have been asked in the past six months to provide recommendations on how their company can improve inventory management technology; 83 percent have been asked to recommend process improvements.

While the majority of the 160 companies surveyed cite cost-reduction as the primary goal of better inventory management, 27 percent are looking to use inventory as a means of gaining market share, through superior service and market availability.

Instead of trimming inventories across the board to reduce cost, these best-in-class companies segment their customer channels and products and then optimally position supply when and where it is most needed and most profitable, he says. Through this approach, they are able to increase their overall customer service levels while also reducing total inventory costs, which leads to improvement in other key metrics like customer retention, gross margin and inventory turns.

Aberdeen defines best-in-class companies as those that have achieved customer service levels of 96 percent or better, while at the same time reducing inventory carrying costs. Just over 11 percent of respondents were in this category. About 55 percent of these were distribution intensive companies and 45 percent were manufacturing intensive. Roughly 38 percent were large enterprises, with the rest being mid-sized.

Best-in-class companies have a number of differentiating characteristics. They are about twice as likely as their competitors to:

1. use network design technology to support business growth and outsourcing decisions;

2. use multi-echelon inventory optimization technology;

3. have an existing supply chain visibility system;

4. have a forecasting system that supports customer-level forecasts;

5. use cross-functional product teams; and

6. update their inventory policies multiple times a year.

Moments of Truth In the Retail Supply Chain Are All About Return on Inventory
From Global Logistics & Supply Chain Strategies/Jean V. Murphy
In today's retail environment it is vital to maximize return on inventory investment. To do that, retailers and their suppliers need to understand and respond to consumer desires in a more precise way than ever before. New technology is helping them succeed. Retailers and consumer goods manufacturers like to talk about “moments of truth.” Most famous are the two that Procter & Gamble defines as crucial to its entire business: the moment when a consumer stands in front of a store shelf and decides whether to buy a product and the moment when he or she uses the product and decides whether it meets expectations.

For these decision-making opportunities to ever occur, however, the supply chain must first deliver on its own moments of truth: Is the desired product on the shelf or store floor when the consumer comes in to shop? If so, did the product arrive within a time window and cost basis that allows it to be sold at a healthy margin?

Nailing these defining moments, which can separate winners from losers in the highly competitive retail market, is more challenging than ever, thanks to a changing consumer base that is far less predictable than in the past. “A significant demographic shift is occurring in the first world,” says Chuck Kramer, vice president of retail at i2 Technologies, Dallas. “We are a much less homogeneous society than we have ever been before. There is a wider distribution of ethnicity, of wealth and of lifestyle, and that has made consumer taste much more of a moving target.”

In addition, today's consumers are a demanding lot. They are tech-savvy, astute shoppers who expect an array of new and innovative products, an enjoyable shopping experience that includes transparent transactions across multiple channels, and everyday low prices. Otherwise known as the Wal-Mart effect, this last element drives companies to increasingly supply their stores from low-cost countries, resulting in much longer lead times and less predictability. It also turns up the pressure to contain supply chain costs and to maximize return from every inventory dollar.
“Return on inventory means one thing: getting the most profit out of every case of inventory that you put in front of the customer,” says Danny Edsall, director of worldwide solutions for retail supply chain and merchandising at IBM, Armonk, N.Y. “The fundamental way you do that is by making sure you have the right product in front of the right customer. That's the biggest driver of returns.”

Until recently, however, the emphasis at most companies has been on cost efficiency. “I don't think we are done lowering costs yet, but we are pushing the envelope on that,” says Edsall. “We are already a long way up that slope and it becomes harder and harder to squeeze more out.” What hasn't yet been done effectively, he says, is “really figuring out how to create a merchandising plan and assortment to make sure the right products are in front of the customer in the first place.”

The work IBM and its partners are doing now is all about finding new ways to get deeper insight into what customers really want, he says. “It's about getting behind the demand patterns so can understand not just what a customer bought, but what he really wanted to buy. Then start using that to drive the supply chain.”

The key is to use not only general demographic data provided by third-party services like Nielsen, but to proactively mine data from loyalty programs, customer surveys and previous buying history. “Some categories of retail businesses are very rich in that data, especially warehouse clubs that require memberships,” Edsall says. “They know exactly what members have bought in the past. The thing is not to use this information just to create incentives to buy more, but to plan the entire supply chain around it.” IBM Business Intelligence for Retail enables this type of analysis and is part of the company's comprehensive range of retail solutions.

Back to top