Seven Challenges of Inventory Management

Inventory is a necessary evil in modern supply chains. Identifying and maintaining the right amount of inventory is one of the biggest challenges that supply chain managers face. Inventory sits as a trade-off between customer satisfaction and material availability vis--vis increasing inventory holding costs and working capital. With the globalization of organizations, Indian companies are matching their international peers in terms of sophistication and maturity of supply chains. However, maturity of supply chains and the supporting technology does not complete eliminate the aforesaid trade-off completely. It is essential to look at inventory as good inventory and bad inventory. Good inventory is the key to good customer service and positive cash flows while bad inventory, too much of the wrong items, clog warehouses and distributioncenters.IBM in partnership with IW Custom Research undertook a value chain survey, the results of which have been published in early 2008. This article draws from the report and IBMs vast experience in handling inventory related strategic and operational projects across industries. The article highlights the top 7 challenges that are critical but no he article highlights the top 7 challenges that are critical but not obvious, to retain a balanced inventory in the supply chain, preventing unproductive working capital and lost sales opportunities.

Parameter updates are only made when the resultant impacts of the semis alignments become evident as large inventory excesses or frequent stock-out occurrences. The untracked accumulation of excess inventory leads to inventory write-downs and lost working capital.

Solution: Periodic review of the key planning parameters is required for ensuring proper inventory management. Tools and applications are effective enablers of such reviews. IBMS proprietary application for inventory management and rationalization Dynamic Inventory Optimization Solution or DIOS, provides for simulation engines that determine safety stocks optimal levels and expected service levels. The solution also has IBM-patented adaptive methods for safety stock calculation.

Seven Challenges of Inventory Management Inventory is a necessary evil in modern supply chains. Identifying and maintaining the right amount of inventory is one of the biggest challenges that supply chain managers face. Inventory sits as a trade-off between customer satisfaction and material availability vis--vis increasing inventory holding costs and working capital. With the globalization of organizations, Indian companies are matching their international peers in terms of sophistication and maturity of supply chains. However, maturity of supply chains and the supporting technology does not complete eliminate the aforesaid trade-off completely. It is essential to look at inventory as good inventory and bad inventory. Good inventory is the key to good customer service and positive cash flows while bad inventory, too much of the wrong items, clog warehouses and distributioncenters.IBM in partnership with IW Custom Research undertook a value chain survey, the results of which have been published in early 2008. This article draws from the report and IBMs vast experience in handling inventory related strategic and operational projects across industries. The article highlights the top 7 challenges that are critical but not obvious, to retain a balanced inventory in the supply chain, preventing unproductive working capital and lost sales opportunities.

1. Infrequent Parameter Reviews: The parameters that are used for managing inventory - such as safety stock quantity, replenishment order quantity, reorder point in a Continuous Review policy, or review period in a Periodic Review policy - use factors such as service levels, demands, and supplier replenishment lead times as inputs for their calculation. However rapidly changing markets, competitors, and product lifecycles have made review periods that worked in calmer times unsuitable for todays speed of business execution. Failure to monitor the environment and update these inputs on a frequent and detailed basis is a recipe for inefficient inventory investment. Companies set these parameters on a one-time basis, often at the start of a new process improvement initiative or an ERP implementation. However, failure to monitor the values fixed to the parameters and the parameters themselves, leads to their ineffectiveness in the long-term.

2. Days of Supply: When faced with unpredictable demand and pressures to ensure supply availability, a seemingly logical approach is to declare a quantity of supply to be held at all times for each SKU. Typically, this quantity is expressed in terms of 'days of supply', or 'days coverage'. The approach reasons that if it takes on average two weeks to receive replenishment from the an order is placed, then adding a safety cushion and calculating average daily consumption will be fine. Many inventory managers concede that by taking this approach, they may be giving up inventory reduction (and cost saving) opportunities in order to' guarantee' availability. However, this approach isnt completely suitable to determine an efficient supply quantity. This approach fails in three areas: first, it does not take into account the daily, seasonal, and lifecycle variations in demand that may be inherent for each SKU; second, it does not take into account variations in supplier replenishment lead time; and

third, it does not seek a cost-efficient balance between inventory held as safety stock and inventory being replenished (cycle stock). Solution: Monitor and understand the variations in demand and supplier lead times, and frequently recalculate safety and cycle stock for each stock keeping unit. The IBM/IW Custom Research Value Chain Survey showed that sharing real-time demand and inventory data and continuous replenishment programs for customers help in facing this challenge. Other programs like collaborative demand planning, forecasting and replenishment also offer great support. Respondents using collaborative forecasting reported an average monthly forecast error of 10 while the average for the larger surveyed group was 15

3. Volume-based Classification Method: With tens, and in some cases hundreds of SKUs to manage, some classification and prioritization is a required first step. However, classification based only on quantity sold is not the most optimal way. What may seem intuitive may not be the most effective approach for managing inventory at the lowest overall cost. With the advent of ERP systems and other high-computation enablers, it is now possible for a more fine-grained approach to material classification beyond simple methods like FSN. Imagine instead an approach that classifies SKUs by the relative magnitude of value and costs required to order and hold them in stock. For example, SKUs with a similar ratio of value and ordering costs to holding costs would be grouped together and ordered with a similar frequency. This approach seeks to minimize the overall costs - ordering plus holding plus transportation, etc. - by addressing the manner in which SKUs are grouped.

Solution: Consider alternative classification techniques that incorporate multiple costs and parameters to optimize inventory investment. In an earlier DIOS-based engagement, using the ratio of ordering costs to handling costs for material classification led to the number of orders/year reducing from 230,000 to 70,000. 4.Top-down Forecasting: High-level forecasts generated by sales teams are vital for effective demand and supply planning. In many cases, the method for generating the forecast is set by company division or product type. Thus, a single method of forecasting is cascaded down to product lines and perhaps even to the individuals/location level. Although an aggregate forecast approach is necessary for manufacturing and procurement capacity planning and for supplier negotiations, it is not the most effective means for optimizing the investment in inventory. Such top-down approaches do not account for the local variations in demand that can be significant at the individual SKU level. Even within a single product type, some SKUs are relatively new in their lifecycle, others are soon to be retired; some are affected by seasonality, others are not, but may be very sporadic in both time and relative quantity between sales. Since these forecasts will be used for setting the inventory parameters that are needed in the future, only an approach that takes into account the anomalies of demand for individual SKUs at the stocking point will be effective. Solution: Create forecasts at the SKU stocking level to generate reliable models of demand variation. While implementing an ERP for an Indian Pharma major, IBM suggested a bottom-up approach to forecasting, with inputs from the area sales managers being aggregated along the hierarchy, after reviews. Any changes at the highest level of forecasts could be disaggregated to the lower levels

through pre-determined ratios or manual overruns. The suggestion led to reduced forecasterrors and better planning. 5. Misaligned Service Level Measurement: The service level target is a key factor in the determination of inventory levels. Yet despite its influence, rarely is enough attention paid to how this measurement is calculated. Implicit in most service level discussions is that poor service levels result in lost sales and vice versa. Therefore an effective service level measurement should reflect customers' performance expectations and buying behavior and should be agreed to by key internal functions. For example, a manufacturing organization may track quantities of product shipped and quantities ordered over a specific time period, so a fill rate calculation is used for serviceability. However, this calculation provides no insight into the probability of a stock-out occurrence, or how long it takes until supply is replenished when that stock-out occurs. One of these approaches is no better than the other. However it takes a consensus from the manufacturing, marketing, sales, and sometimes finance teams as to which approach is best suited for measuring the performance that is most relevant to customers. In addition understanding the link between service level and customer satisfaction also opens the door to segmenting the customer base to further differentiate service levels by customer segment. Our experience shows that the squeaky wheel service level tends to get applied to all customers and items because rule of thumb policies do not lend themselves to defining and maintaining segment specific services levels. The result is more inventory than is really needed to provide the optimal service level. Solution: Create an approach to service level calculation that can provide multiple differentiated measurements of serviceability and include all functions in determining which measurements and values should be used when developing inventory plans.

6. Failing to address the underlying causes of variability: We have often found that when science is applied to understanding service levels, supply variability, demand variability, and various stocking policies, the result, though technically optimal, still holds opportunity for improvement. This is because variability in both supply and demand can often be self inflicted or turn out to be easily addressable. Examples are: promotion practices that create spikes, suppliers with erratic shipping patterns, and ordering policies that create bottle-necks in shipping and receiving. The right inventory level for a given level of service is highly sensitive to the variability around supply and demand. Most inventory stocking policies assume a normal distribution of variability around these key parameters. Our experience has shown that a normal distribution is often not the case, and beyond measuring and accommodating for the variability, taking actions to address the variability, focusing on the most volatile and expensive fluctuations, can drive even better inventory productivity. Solution: Understand the sources of high variability on both the demand and supply sides of your stock and take actions to reduce the variability. While working on statistics-based forecasting, outliers have to be removed from the historic data. Similarly, future production planning and inventory management must factor in promotional plans. Cross-functional teams involved in the planning process offer a solution to the above. Simultaneously collaboration and integration among customers and suppliers, as shown by the IBM/IW Custom Value Chain Survey is important (65.3% of respondents who collaborate, said it is somewhat effective to highly effective

Failure to align inventory policies Reduced inventory helps in greater working capital productivity. However, resistance from sales and marketing, due to the risk to service levels is high. We have found that an approach that

simulates various inventory policies and parameters can bring transparency to the decisions and their impacts. Simulations allow companies to compare the impacts of different parameter choices on expected stock-outs, service level, and inventory costs. Also, by simulating under different demand and supplier response scenarios, a firm may be able to anticipate the correct level of inventory to hold to minimize its exposure to risk. The ability to see how a companys inventory will fluctuate next week and months into the future is imperative for reducing the fear around change and helps to align the organization on priorities. A time worn and Edelman award winning example of the power of simulation is the case of IBMs use of its Supply Chain Analyzer to simulate the impact of changing our inventory policy to individual retailers in the personal computer supply chain. Sitting with each retailer and showing them the impact of our holding the inventory higher up in the supply chain, using their data, allowed IBM to take two months worth of inventory out of its retail channel and reduce price protection expenses by over $100 million. This is a classic example of supply chain collaboration facilitated by simulation. Solution: Invest effort in building organizational alignment around inventory policies, potentially using simulation capabilities to anticipate the expected results of your inventory parameter decisions.

Over the last decade our supply chain practice at IBM Global Services has conducted well over 200 supply chain transformation engagements that focused on improving the effectiveness and efficiency of our clients inventories, finished goods, raw materials, and work in process. As a result of these engagements and supported by cutting edge proprietary solutions and tools, we have developed an approach that blends data analytics, optimization algorithms, and discrete event simulation. This approach allows us to quickly analyze a given clients unique inventory

management challenges and evaluate literally thousands of policy parameters, provide transparency to the organization on the trade-offs involved, and arrive at the right combination that delivers optimal inventory efficiency. This approach lets us accurately and efficiently diagnose a clients inventory and pinpoint which items are clogging the arteries and which ones need increase in inventory. About the authors: Clifford Patrao is an Associate Partner with IBM India and is the lead for their Consultancy Services division. He has widespread experience in successfully leading supply chain transformational engagements across industries. Clifford can be reached @

clifford.patrao@in.ibm.co Suresh Chivukula is a consultant in the supply chain area with a focus on process improvement engagements. Suresh can be reached atsuresh.ch@in.ibm.com