Recently, we sat down with Peter Schram, founder and advisor at Breakthrough Advisory, during the webinar, How to Improve Inventory Decisions in Uncertain Times to Balance Opportunity and Risk. As we noted, when everyone involved with inventory has their own perspective, and those perspectives are not aligned, we all know the result: too much of what we don't need and not enough of what we do need. In this post, we take a look at a few of the key points discussed during the webinar.
It's a common dilemma and entirely understandable. Companies are in constant unrest around the priorities of their different business functions. Supply Chain Planners want more buffer stock to cushion the inevitable mismatch between demand and supply. Product managers want to introduce multiple product variants, features, and options. Sales teams want to keep enough in-stock availability to achieve short lead times. Sourcing wants order quantities big enough to qualify for the best price. Manufacturing optimizes capacity by running fixed batches. Logistics wants to reduce shipping days to optimize transportation resources.
And alongside all these stock increasers—and others—Finance just called for a 20% reduction in total inventory.
Thus, we should take inventory decision-making very seriously over all our stock types and time horizons. And we need to address this vital process as a coordinated team.
Why do we have inventory?
It's useful to view inventory as arising from three major decision processes. Design decisions have a structural impact on our working capital. These decisions shape the product portfolio, minimize lead times in manufacturing and order fulfillment, and optimize supplier relationships. Design decisions produce inventory termed work-in-process, in-transit, and cycle stock. Business decisions determine inventory held as anticipation stock and hedging stock created to cover demand peaks, support new product launches, and mitigate production risk over the product lifecycle. This decision category produces as much as 60% of total inventory. Finally, inventory held as safety stock throughout the multiple tiers of the supply chain results from operating trade-off decisions made around areas such as replenishment planning and others.
Many companies focus primarily on operational trade-off decisions, but significant improvement opportunities are achieved through better design and business decisions. In an era when only about 10% of companies are constantly redesigning their supply chains, stakeholders need to understand that it's not only operating trade-offs that impact inventory. Strategic decisions have a huge impact on working capital and inventory. On the revenue side, having the wrong inventory (or insufficient) results in lost sales and lower topline revenue. On the expense side, operating costs increase as large amounts of excess inventory consume more warehouse space and internal logistical resources until ultimately becoming obsolete waste. Vital cash flow is interrupted when dollars are trapped in excess inventory.
Integrated inventory decisions.
Inventory is not a standalone aspect of a business. Inventory has a "triangular" trade-off relationship with two other major facets of the business: services level and operating costs. It's crucial to integrate
supply chain decisions with the financial planning function, so that invested capital and inventory-related costs serve the company's goals for revenue and key business metrics.
While linking inventory management decisions to financial plans is a big challenge for many companies, it's essential to make the connection. Cross-functional teams are understandably obsessed with the operational sales and operations execution (S&OE) time horizon of 90 days. To deal with today’s operational disruptions, supply constraints, and global uncertainty, allocation decisions are driven by priorities around profitability, key customer satisfaction, contractual obligations, and other factors. But the connection between inventory management and Finance is just as crucial over the tactical S&OP horizon of three months to two years and beyond that it is to the strategic horizon stretching to five or ten years.
Insights and techniques to optimize inventory.
During the online event, Peter noted it’s helpful to divide total inventory into three types that can be improved through different actions. First, classify the percentage of inventory that is “efficient” inventory—stock that is structurally and operationally well aligned. This type of inventory can be optimized through familiar process improvements. For instance, shortening production cycle times to free up working capital. “Situational” inventory is a second grouping. It is governed by decisions regarding sales and marketing events of the business. Right-sizing situational inventory improves risk/opportunity transparency. The third classification is “inefficient” inventory due to deviations from normal operations. The cure for this excess is eliminating as much of it as possible by removing process inefficiencies.
All actions should be taken under executive sponsorship with a growth mindset from senior leadership. Finance involvement helps all stakeholders take a broad perspective that includes root cause analysis and a business-goal perspective on improvements. For instance, to look not only at forecast accuracy but also at production plan attainment and other factors. The approach should combine small projects with quick impacts and carefully chosen, bigger initiatives that, while more complicated and requiring higher effort, can yield greater strategic results.
John Galt Solutions’ Atlas Planning Platform is an advanced supply chain planning technology that has helped hundreds of companies redefine their inventory network strategy and master the interconnectedness of their multi-enterprise supply chain ecosystems. Let's take a look at how your business goals can be realized through intelligent orchestration