The Need for Inventory Optimization in Today’s Market
August 5, 2015

Picture the following circumstances:

You walk into an apparel store and find a design to your liking. However, you are unable to get your choice of color or your size of fit. What was the result? The store lost out on a potential sale. Similarly, at some point you decide to buy something online, and the store near you does not have the product in stock. The same retail chain has this product at some other outlet, but it cannot be shipped to you anytime soon. Again, another opportunity is lost. It’s not so rare that a customer turns to a competitor’s product because the business at hand did not stock what he or she was looking for. Are incorrect inventory decisions to blame for these situations?

Organizations may have the most sophisticated planning tools and yet may not be able to fulfill all their demands. In a competitive and dynamic landscape, companies need to find smarter ways to increase their margins while meeting customer expectations. Constraint planning was meant to achieve this goal and yet not all demands are fulfilled while executing a plan. Advanced Planning & Scheduling (APS) tools address this problem set.

Components of APS, include Sales & Operations Planning, Forecasting & Demand Planning, Inventory Planning & Optimization, Supply planning and Production Planning. Inventory Planning & Optimization is a key process in which optimal Safety Stock levels in the Supply Chain Network are calculated to cover demand and supply variability and meet organizational Service Level policies. The word “optimal” does not mean maintaining the lowest costs of On Hand stocks. Rather, it means maintaining a correct product mix at the right places in order to meet the expected customer service level.

Why should inventory be optimized? Is this process different from Supply Chain Constrained Planning?

The purpose of Inventory Optimization is to determine the Target Stock levels at the stocking points in supply chain – such as manufacturing plants, depots, and warehouses. The organizational inputs that impact the target stocks include service levels, frequency, and lead-time to replenish the inventory and inventory carrying costs. These decisions are combined with demands, variabilities in demands, and variabilities in constraints to suggest Optimal Safety Stocks.

On the other hand, the objective of supply chain optimizer planning is to find the most feasible solution to manage constraints. These constraints could be production or storage capacities, transportation lead times, or cost of not meeting demands on time.

Constraint planning is dependent on the manual input of Safety Stocks in order to calculate total demand and create a plan that addresses all constraints. The inventory positions are time-bucketed as it moves along planning periods. It does not calculate the inventory positions based on variability of demand and supply.

So why do we need Inventory Optimization?

We require inventory optimization to balance out the variability. There will always be some sort of variability in the supply chain world, introduced through changes in demands and fluctuations in supply lead times. These variabilities should be balanced in order to maintain service levels, which goes on to determine the customer expectations.

At the same time, maintaining safety stock means increasing the inventory holding cost. Hence, we need to optimize the target stock levels to reduce the cost.

We need visibility across the supply chain. On the downstream side, customers influence demand variations as being part of the supply chain. The changes at the point of consumption should be captured. On the upstream side, components and raw materials should be covered in the inventory decisions. For example, rush orders from preferred customers may disrupt an entire plan because raw materials or components could not be received within a shorter lead-time. In other words, variability in demand is not tied back to supplier.

The number of product variants to the market is widening in order to meet customer expectations. With frequency of new product introductions to the market going up, the risk of On Hand Inventory obsolescence goes up in tandem. A critical raw material that was stocked due to longer lead-times could be worthless if the engineering department changes the design. Planning and optimizing inventory will minimize such losses, thus reducing cycle time and the overall cost of a new product Introduction.

It is much easier to calculate Safety Stock at each stocking point in supply chain network – when planned in isolation. In reality, complexity increases due to the multi-echelon structure of supply chains. Safety Stocks for such networks need to be determined by considering the service levels and variabilities at global levels – in correlation with one another.

Good inventory planning means less working capital locked. Inventory provides insight on not only the health of an organization, but also on the efficient functioning of a company’s management direction. Wise inventory decisions mean lesser amounts tied up on shelves, which in turn means the capital could be wisely utilized somewhere else in more productive ways.

Multi-echelon supply chains are fairly complex in nature. An efficient business process should be backed by an equally efficient technology. A technology that calculates suggested Safety Stocks at minimal time taken, allows users to change the variabilities and simulate the scenarios. It also provides integrated analytics of end-to-end supply chain, collaborative review of planning performances, and streamlined reporting.

SAP has now enabled these functionalities in their Cloud Solution through IBP for Inventory. For more details on IBP, please refer to the Intrigo white paper.

–Bipin Umarale, Solutions Consultant, Intrigo Systems