Moving beyond Multi-stage Inventory Optimization

By Sridhar Tayur

Inventory optimization is one of the hottest topics in supply chain circles today — and rightfully so. As a growing number of organizations have proved, astute planning and management can wring 20-30 percent out of current inventories, saving "multiple millions" in direct costs and achieving huge gains in operational performance, all while maintaining — or even improving — product availability and customer service.

Given the enormous benefits at stake, it's no surprise that a recent survey by Aberdeen Group places inventory management software at the top of the list for supply chain technology investments. Within that category, the highest priority is clearly multi-stage inventory optimization, which generates optimal inventory levels for each item across each of the stages or tiers within an organization's supply chain network. More than 80 percent of respondents cited multi-stage inventory optimization as a top priority, nearly twice the number who named any other type of inventory management technology.

The Case for "Multi-stage" Inventory Optimization

This heightened interest in optimizing every step in the supply chain is a function of the increasing size and scope of today's networks. As supply chains grow, often stretching across the globe, so does the complexity of homing in on appropriate, time-varying inventory targets at each point along the way. In fact, because the steps are interdependent, the complexity multiplies. At the same time, the inherent risks and uncertainties at each point virtually ensure that more problems will occur and that when they do, they will send shockwaves up and down the supply chain.

The challenges of managing every type of inventory that an organization maintains — safety, cycle, pre-build, pipeline and merchandising stock — at multiple locations and/or stages in its supply chain are indeed formidable. The complexity of the task has clearly outgrown many of the planning processes and tools that organizations have adopted even in just the past few years. Quite frankly, it outgrew the best efforts of human beings long before that.

Multi-stage or "multi-echelon" solutions provide powerful capabilities for modeling the most complex supply chains and analyzing a staggering number of variables, constraints and "what-ifs." Sophisticated algorithms, combined with a stochastic (probabilistic) approach, enable multi-stage inventory solutions to assess vast amounts of historic and real-time information, considering multiple variabilities and interdependencies.

A case in point is Deere & Company's Commercial & Consumer Equipment Division, which implemented a solution to optimize inventory levels for more than 300 commercial and consumer equipment products held at 2,500 North American dealer locations, plants and warehouses. To do so, the software considers 52 million variables and 26 million constraints. In four hours each week, the system generates optimal targets that have enabled Deere to reduce inventory by more than $1 billion, while significantly improving on-time shipments from factories and maintaining customer service levels at 90 percent or better.

Another example is packaged food giant ConAgra, whose supply chain includes 65 manufacturing facilities and a network of co-located buffer warehouses that feed into 14 mixing centers. Early results from ConAgra's multi-stage inventory optimization project include a reduction in finished goods inventory and significant improvements in case-fill and store in-stock percentages, plus reductions in forecast error and bias. ConAgra recently reported that, after less than one year of implementing its multi-stage inventory optimization solution to set policies governing downstream stocking locations, supply chain savings and productivity gains are ahead of target.

Moving on: Enterprise Inventory Optimization

As more companies implement multi-stage inventory optimization solutions, they'll have their own impressive results to report. They'll also have the opportunity to drive further development and fuller deployment within their organizations, ensuring that the technology yields an even greater return on investment. However, the greatest opportunity — and the greatest reward — lies in taking multi-stage inventory optimization to the next level: the enterprise level.

"Enterprise inventory optimization" (EIO) is a term that encompasses a more comprehensive view of inventory planning and optimization than is commonly held today. It's more than having multi-stage technology in place; it's using inventory optimization as an enterprise asset and shaping it into a core competency that the organization can call upon as it grows, innovates and affirms its leadership in its industry.

Moving inventory optimization to the enterprise level is likely to entail integrating it into other enterprise planning and management systems, including sales and operations planning (S&OP) and systems that support the so-called "demand-driven supply network," a phrase coined by AMR Research. The goal is to create a dynamic, ongoing planning capability that enables the organization to position resources where and when they are most needed and will turn the best profit.

When an organization aligns inventory planning and management with enterprise-wide goals and strategies, it can take advantage of new opportunities, such as winning additional market share in carefully targeted locations or channels, based on greater product availability and enhanced customer service. In this way, the organization can attain top-line revenue increases, despite flat markets and entrenched competitors. It can also improve gross margins, inventory turns and other key metrics for the organization as a whole.

Making EIO Happen

The movement toward a larger, enterprise-wide view of inventory is already under way. Aberdeen reports that, while 63 percent of companies look at inventory in the more traditional way, as a cost-related item, 27 percent now think of inventory as a way of gaining market share through superior service and product availability. Organizations with this vision can leverage their inventory as a competitive weapon and use customer, product or market channel segmentation to achieve a significantly higher return on assets than their competitors.

On the other hand, the same report points out that the use of multi-echelon approaches is still maturing. Approximately 40 percent of companies that report using multi-echelon tools are not taking a purely multi-echelon approach. Instead, they are setting customer service levels for each tier in the supply chain and separately calculating the inventories, rather than obtaining the inventory based on total supply chain cost and service-related calculations.

In addition, depending on their industry (manufacturing intensive or distribution intensive), the majority of companies are currently planning either at their manufacturing and assembly locations or their finished goods regional distribution warehouses. At this time, relatively few are planning at every level in the echelon. While many companies are achieving better performance, thanks to being able to consider variability and focusing on critical levels within their supply chains, they can achieve far more by taking inventory optimization "all the way."

Reaching the enterprise level of inventory optimization may require education targeting greater awareness and understanding of how inventory decisions fit into enterprise goals. It may also require the use of cross-functional teams, deployment of end-to-end inventory managers, development of more enterprise-minded metrics to track performance, or perhaps "just" some additional time for people to get comfortable with a larger, more comprehensive approach to inventory planning and management.

One thing for certain: organizations that are able to take inventory optimization to the enterprise level will reap the greatest benefits.

About the Author: Sridhar Tayur is the Ford Distinguished Research Chair and Professor of Operations Management and Manufacturing at Carnegie Mellon University's Tepper School of Business, as well as the founder and CEO of SmartOps, a provider of supply chain optimization solutions. More information at www.smartops.com.

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