Inventory Optimization: Where to Focus and How?

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Traditionally, it has been understood that to improve customer service you have to have high levels of inventory. This ensures that orders are filled quickly. But it also means that the value of your inventory is high, to the detriment of your organization as it ties up cash and warehouse space that could be put to other and better uses. Managing inventory can be a daunting task for an enterprise with tens of thousands of products that are located in hundreds of locations. The fact that different functions in the organizations have different objectives and often conflict of departmental or sub-business interest adds another hurdle in inventory reduction.

Typically, the sales & service head of the organization will want the order fill rate, customer service and the order fulfillment lead time to be the best. This person will never want to lose any sales or for that matter do not want to see customer satisfaction going down just because the organization either could not supply the new product or the service parts at right time. This department will want that the organization should:

• Keep enough inventory of all product models or variants at multiple locations so that there are no stock outs, minimum transit time for product shipping and no unit down (production stopped) cases for their customers
• Make manufacturing operations flexible enough to respond quickly to changing market demand for a particular product model or variant so that they do not lose sales of a single unit for want of timely supply
• Ensure that the procurement & sourcing functions have quick replenishment efficiency with low supplier lead times or procurement starting at high safety stock levels

All of the above will lead in increase of inventory and will contribute towards what I call as reverse optimization of inventory.

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Let us see now, what will a manufacturing leader want to make sure, so that the success KPIs for the shop-floor are met and the production team increase production efficiency in terms of producing more units in same time, less over time is required and rejection rates are at the lowest ebb. Simple logic suggests that if the same model or variant is produced for a longer time, the jigs and fixtures will not need to be changed; the operations sequence will remain same and transition between production shifts will take minimum time – all this contributes to better productivity or efficiency in the production line but at the same time, producing not based on demand but to stock so that the production efficiency targets are achieved, will inflate the inventory.

Both the above examples are not bad practices and in-fact these are seen as best practices in industry if we see them in isolation, as they deliver value for independent business functions. The negative impact of these practices is that they make the job of the inventory owner more difficult.

The inventory owner’s main objective is to reduce the inventory to the lowest possible level so that more working capital is available for operations. This objective, as we saw above, conflicts with the manufacturing and sales/service business function’s objectives and this is the reason why inventory optimization and not reduction is the activity where we should focus on.

If the inventory owner decides to reduce the inventory in isolation based on some fuzzy logic which might be the best, keeping in mind different demand variations and patterns, it is highly likely that it will hit the objectives of other business functions negatively and the whole purpose will be lost. But, if the focus is inventory optimization in such a way that there is a trade-off between service levels and inventory level, production efficiency and order fill rate and so on, only then we can it a real win-win situation where organization as a whole, can gain substantially.

It is not that compromise between different business functions is the only way to optimize inventory. There are more factors that drive this initiative and can substantially impact the result. These are:

• Forecast accuracy – More is the accuracy of forecast, better will be inventory planning vis-à-vis market demand. So with less inventory, you will be able to maintain or increase your order fill rate and service levels
• Supply Chain Visibility – If, it is known to all stakeholders that the required material is in the way and will reach in a day or two, it will help in correct promises to the customer and while customer satisfaction will improve with better delivery performance, the inventory will also get optimized as no unnecessary panic buying will happen for emergency orders. Also, supply chain visibility means visibility of goods in the distribution centers or warehouses and other channels so that fastest and most economical way of shipping can be achieved which will again make sure that double inventory is not being purchased for a product that is available in some other warehouse or distribution center
• Supplier Lead Times – Less time to get supplies from supplier means faster replenishment and less time an inventory will stay in the warehouse. This also means that you will need to keep lower safety stock levels and thus overall inventory will be reduced
• Inventory turns – More is the number of times you sell and replenish your inventory in a given period, more will be available working capital and less will be obsolescence. The inventory carrying cost will reduce as a result, which is a key KPI of Inventory optimization
• Inter warehouse transfer – An analysis of inventory movement across warehouses might tell you that there is some inventory lying in couple of the warehouses for long with no demand for them in last 6 months and very low forecast in next 6 months. If this process can be automated to do the analysis and transfer the slow moving or dead inventory from one warehouse to another where it can be consumed faster, the inventory can be optimized considerably
• Field returns process – Lot of field engineers get the inventory (mostly service parts) issued from warehouse to service customer(s) and at least 40% of the time all issued parts are not consumed at the location. These parts are either kept at customer location or in the service van of the field engineer and either becomes obsolete/expire or are not visible at all for supplying against other demands. This results in duplicate buying and hence more inventory than required. A proper process around this, can not only ensure lesser inventory but will also reduce scrap (obsolete) inventory
• Accuracy in Bills of Material – Incorrect bills of material often increase inventory. For example, after a design change a casing will need only 5 bolts instead of 7 earlier but since the BOM was not changed after design change was approved and implemented, it still shows 7 bolts and every-time 2 extra bolts are getting issued as part of the back-flush which results in excess unused inventory in WIP. The production in-charge will return the excess parts to inventory as and when the priorities allow and till that time, more procurement of same part will be done based on the available visibility which results in inflated inventory. Correcting the bills of material will help in controlling this inflation of inventory
• Lot Sizes Review – Since the safety stock, demand and lead times that impact the inventory level requirements, keep on changing, a regular review of the lot sizes of items for procurement will always help in making sure that the procurement is as per the finalized strategy of stocking and will in inventory optimization
• Inventory accuracy – Lastly, if we are optimizing something but do not know the exact picture, then it is obvious that where will we reach. We need to make sure that the physical inventory matches the inventory in system as all the calculations on service levels, order fill rate etc. will be based on it only.
  

So, we saw that while it is important to iron out the conflicting interests between different business functions by discussing and finalizing the service levels, production efficiency and other KPIs along-with the inventory levels so that all business functions work as a team on one strategy and with same objectives in mind, there are other ways too that can help you in achieving optimized inventory without impacting other functions operations.