Inventory is much more complicated than many stakeholders outside the supply chain organization realize. Factors such as business complexity, supply disruption risks, network constraints and competing economic drivers impact both requirements and performance.
Without sufficient rigor in planning and evaluating inventory performance, supply chain leaders leave themselves exposed to drama and directives from disappointed leadership when inventory is different from their expectations.
We have been advising on the adoption of an integrated approach for increased transparency that incorporates scenario review and conscious plan selection, performance measurement against plan and variance diagnosis for learning and improvement. Here’s a closer look at each aspect.
Select from Various Supply and Inventory Scenarios
The best time to consider financial inventory targets is during evaluation and selection of an operating plan for each finite time period, such as a month or quarter. This allows balance sheet considerations to be calibrated against commercial and operating realities.
Supply chain planning provides options to decision makers by providing various scenarios, anchored from a baseline reference plan that fulfills expected demand while controlling inventory near the minimum operating requirement (MOR). This MOR enables efficient operations and effective service delivery for the desired customer experience.
For example, financial desire to increase book profitability often results in pressure to maximize absorption of manufacturing fixed cost. Reference to the baseline scenario allows this request to be framed as a choice between cash and margin. Increasing production in advance of future demand is a form of anticipation stock that requires alignment between financial and commercial stakeholders. The final decision should be documented for future reference.
Stakeholders will also want to understand how possible inflation, supplier risk and manufacturing reliability issues are being addressed. The baseline supply and inventory scenario should have already been optimized around demonstrated manufacturing reliability and any projected increases in raw material costs. If there are opportunities for pre-buying raw materials, these should be escalated, reviewed and approved so that cash and risk considerations are balanced with the margin opportunity. Concerns about supplier failures and delivery disruptions can be covered with hedging stock if approved as part of a risk mitigation plan.
Measure Performance Against the Selected Operating Plan
An approved operating plan that is balanced, feasible and documented sets the stage for transparency that eliminates the mystery and mutes the shock and horror of surprise variances.
If changes are made to the plan, it’s important to document those changes. By doing so, you can quantify their impact on suppliers, network performance and stakeholder perceptions of planning credibility.
It’s also important to quantify the percentage variation of actual inventory from the plan projection. Financial processes often ask for inventory projections within the current month and quarter. While these may satisfy cash flow management needs, they are not fully reflective of the system’s capability to predict and control stock levels across the effective network lead times (typically several months or quarters) consistent with the making of supply commitments.
The appropriate offset between plan projection and actual would be related to decision timing for supply commitments. For example, global supply networks and others with long product supply lead times would measure inventory variance based on a timing offset consistent with the stock turnover rate and critical path lead time, taking conversion and transportation into account (three months or more). By contrast, parts and components with very long lead times could require separate measurement of inventory plan variance based on an offset of nearly a calendar year.
Diagnose and Quantify Top Variance Drivers to Learn and Improve
Supply chain planners have no reason to be defensive about the measurement and sharing of inventory plan variance. This is a measurement of system capability that establishes the current level of precision for prediction and control. If anything, stakeholder interest in the topic can be embraced as an opportunity to drive learning and improvement.
Measurement of actual stock value against the plan projection requires disciplined recording of the assumptions, projections and operating details behind the approved scenario. Once actual performance has been measured and reported, detailed analysis will generate a multitude of variances (large and small).
This rigor reveals patterns across time about persistent variance drivers requiring either management attention (such as canceled orders) or planner escalation during future decision cycles (such as forecast bias).
For example, overbuying is an issue frequently cited by planning leaders, often related to disparate incentives and lack of visibility between operations and procurement. By quantifying this challenge, supply chain leaders can have a higher-level conversation with stakeholders to foster alignment and help address the challenge.
This approach helps leaders move away from narratives and perceptions to documented evidence of the most impactful drivers for inventory variance. For organizations dedicated to learning and improvement, this sets the stage for prioritized analysis and corrective action.
By taking a rigorous approach to inventory performance management, supply chain leaders create transparency that enables informed conversations with stakeholders for more aligned expectations and effective supply-demand balancing decisions.
