A company operating on the lower end of the maturity scale for both demand and supply planning would find itself at a disadvantage in S&OP. The company would simply be manufacturing to past history in demand planning and would face overblown inventory targets in supply planning. A company in this situation would have inherent waste in its supply chain from buffering against uncertainty. Such a company can improve its demand-planning woes by employing statistical forecasting software and measuring forecast accuracy.
However, improving supply planning to reduce uncertainty is more difficult. Introducing the dynamic calculation of inventory targets optimized for service-level goals is not functionality included in ERP packages. Yet, the complementary business process and software of inventory optimization do address this gap in supply planning. Introducing inventory optimization into supply planning is an opportunity to enhance S&OP. Considering very few companies today use S&OP and inventory optimization together, it is an opportunity waiting to be exploited.
Calculate in inventory optimization
Inventory optimization is a fast-growing capability as companies have focused on working capital reduction in the wake of the economic downturn. It is itself an evolution of inventory target setting. In the past, inventory targets were typically set by a derived static formula such as weeks of supply. Many ERP systems have fields for inventory parameters that are user-defined fields. In other words, the ERP system is relying on the users to specify the safety stock, reorder points, and minimums and maximums.
Inventory optimization is an advancement of this practice because it utilizes software algorithms to plan a service-level goal for each SKU. The software takes into account the service-level goals, demand volatility and lead-time variability for each specific SKU to optimize the inventory levels. The result is an enhanced inventory planning process that reduces excess inventory and improves the service-level performance for SKUs with stock-out occurrences. This scientific approach to inventory planning has produced significant benefits. Companies often claim a 15 to 30 percent reduction in inventory with a 10 to 25 percent increase in service level within the first year.
While inventory optimization and S&OP use the same demand plan, inventory optimization has typically been implemented as a standalone process. In fact, many inventory optimization software packages have built-in demand planning capability. This functional duplication with S&OP further attests to the practical exclusivity of the two processes. Companies tend to implement inventory optimization for use with MRP or DRP and focus its use on the short-term time horizon. So while inventory optimization has driven results for the companies employing it, the process has not been typically integrated into a company's overall S&OP process.
The power of SI&OP
As we discussed above, a common gap in S&OP centers on service-level planning. What if the service-level planning from inventory optimization could be spliced into the S&OP process? The result would be a more robust process to align supply to demand through improved inventory planning. The integration of S&OP and inventory optimization can create a greatly enhanced process known as sales, inventory & operations planning (SI&OP). While SI&OP is most commonly used as a term synonymous with S&OP, its process entails utilizing inventory optimization techniques instead of traditional inventory planning processes.
The power of SI&OP lies in its capability to optimize inventory based on service-level goals. The increased rigor of inventory planning can be applied across the entire S&OP time horizon to drive enhanced supply decisions. Supply decisions can be made to fulfill demand from either finished stocks or further upstream into the production pipeline. Figure 2 depicts the five step process of SI&OP and where inventory optimization integrates.
Get started on your path to SI&OP success
Every company whose goal is to move to an SI&OP process will have a different starting point. The length of the journey and the extent of change depend upon the maturity of the current S&OP process. Companies with robust S&OP will have a quicker path to SI&OP than those companies implementing S&OP for the first time. Regardless of a company's particular starting point, there are three distinct steps that are proven as an effective path to building a SI&OP process.