Aligning APS Functionality to Plan Demand & Manage Inventory

A Point of View
By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Introduction Many large corporations are considering or have implemented Advanced Supply Chain Planning (APS) software. In doing so, the goal is to improve cash flow and minimize inventory investment. Successfully achieving these goals is dependent on a number of factors such as executive sponsorship, resource commitment, data integrity, and process discipline. Another critical success factor is the alignment of software functionality with the needs of the business and the unique characteristics of each item to be planned and managed by the system. Aligned appropriately, an APS will aid significantly in: Improving demand plans; Driving out unnecessary and excessive inventory levels; and Meeting or exceeding service level agreements. Overview of Demand Planning, Inventory Planning & Replenishment Planning Leading APS providers offer a suite of solutions for Demand Planning, Inventory Planning, and Replenishment Planning. Usually, these are highly integrated modules that allow for the seamless flow of data from forecast through replenishment order for each item and inventory location. Exhibit 1: Demand to Replenishment Planning
Forecasts By Item & Location Inventory Plan By Item & Location Recommended PO By Item & Location

Demand Planning

Inventory Planning

Replenishment Planning

Historical Demand & Current Orders

Inventory Rules Service Levels Order Quantity Reorder Points Safety Stock

On Hand Inventory Planned Receipts Planned Orders

In summary form, the process begins by periodically creating a forecast (or demand plan) for each item. Pre-defined inventory rules are attached to each item to determine the system calculations to be used for Order Quantity, Reorder Point, and Safety Stock. Replenishment Planning monitors on hand and projected inventory levels to determine when and how much inventory should be ordered for each item and location to meet anticipated demand. It is relatively simple and straight-forward process. The challenge is determining which parameters or rules to use for each product in attempt to find the optimal balance between service performance and inventory investment. Demand Planning As stated, the process begins by creating a demand plan. A demand plan is the organizations best view of unconstrained future demand. It is derived by creating a statistical forecast from historical data then factoring this with forward looking information from sales, marketing, and finance to create a consensus demand plan. This plan, in turn, is fed as key input into the Sales and Operations Planning (S&OP) process which results in a constrained operations plan.

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Exhibit 2: Demand Planning Process Scope of Leading Practice Demand Planning Process
Core Product Management New Product Introduction Demand & Causal Factor Intelligence Statistical Base Line Forecast Adjusted Forecast (Unconstrained) Consensus Plan (Aligned) S&OP Plan (Constrained)

Demand Planning serves several purposes and therefore often requires a different level of detail and time horizon for each step in the process. Exhibit 3: Demand Planning Time Horizons (Illustrative)
Historical Horizon (12 - 36 months) Forecast Planning Horizon (12 36 months) Telescopic Granularity Daily, Weekly, Monthly, Quarterly

Frozen Period (1 2 weeks)

Time horizon terms to consider in the Demand Planning process include: Historical Horizon: defines the time period for which the historical data will be used and displayed for forecast modeling. This is often comprised of demand history at the item-location level. Forecast Planning Horizon: defines the time period over which statistical forecasts are created and adjustments may be made. Frozen Forecast Horizon: defines the time period for which demand planning processes will not update/change the statistical forecast or adjusted demand plans. Telescopic Planning: defines the level of detail managed and communicated per time period. Near term time periods will be managed at a more granular level of detail. Historical data is stored in its most granular detail. In the statistical forecasting process, this data is rolled up in a hierarchal structure so that forecasts can be created at multiple levels. Lower level forecasts (e.g. by item and location) are used for near term inventory management and replenishment planning. Adjustments can be applied at any level or horizon of the forecast. Creating consensus in the demand plan may require alignment with Sales, Marketing, Finance, or other stakeholder groups. Each group may require a different view and time horizon of an aggregated plan. Sales and Operation Planning (S&OP) generally uses a monthly or quarterly view of anticipated demand summarized for purposes of planning long term operational and resource requirements. At the core of the Demand Planning process is the generation of a statistical forecast. Most Demand Planning modules allow users to consider base (or average) demand, trend, seasonality, cycles, and randomness in developing a forecast. Typically, a number forecast models will be available to use within the application. The following are a few examples from a leading APS provider along with general guidelines on how they are used. Derived: use when past demand data is non-existent or unreliable Inhibited: use to create a zero forecast Life Cycle Planning: use for new or end of life items Moving Average: use for items with very random demand histories or items with relatively flat demand (i.e. no trend or seasonality)

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Non-seasonal: use this model when demand is trending but does not vary seasonally Irregular: use these models for items which are seldom used or if there are zero demand months Seasonal: use this model when demand is often higher or lower during particular times of the year In addition, smoothing factors can be applied to the base, trend, and seasonal components of a forecast. Smoothing factors allow each of these components and/or more recent data history to be weighed more or less heavily in the creation of the forecast. Products in volatile markets, for example, may need to weigh recent demand history more heavily than products with similar year over year trends. Another important feature to consider is the demand planning hierarchy and the application of factoring logic. As an example, leading forecasting systems will plan and forecast at multiple, user-defined levels within a hierarchal pyramid structure. Each level is independently forecasted within the hierarchy, and the initial totals across levels are usually unequal. Since each level must eventually equal, top-down factoring logic is then applied. Generally, forecasts are more accurate when performed at a higher level of detail. Forecasting demand for an entire product group is usually more accurate than the sum of the forecasts for each individual item within that product group. The same is generally true when forecasting across multiple inventory locations for the same item. Therefore, factoring the lower level detail by the higher level totals is considered as a leading business practice which ultimately results in higher overall forecast accuracy and service level performance. Inventory Planning Inventory Planning is the link between Demand Planning and Replenishment Planning. It dynamically computes time-phased inventory levels by item and location based on anticipated demand, replenishment lead times, and required service levels. Inventory Planning is where the business rules and parameters are established for: Reorder Point = Expected demand during replenishment lead time plus safety stock Safety Stock = Quantity held in stock to accommodate variability in customer demand and supplier reliability (where the service level target establishes the amount of variability to cover) Order Quantity = Quantity ordered from supply point when reorder point is hit (may be a fixed or variable quantity) Key inputs include: Demand forecast by item and location: as the forecast changes so does the reorder point (if so configured) Replenishment lead time (and lead time variation): used in determining the reorder point Forecast error: used as input to safety stock calculation Service level target: also used as input to the safety stock calculation Exhibit 4: Demand Planning Hierarchy (Illustrative)

5 4 3 2 1

Super Group Product Group Item Item & Location

Item, Location & Other Attributes

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Exhibit 5: Inventory Reorder Point Logic (Illustrative)

Inventory

Order Qty.

Order Qty.

Order Qty. Reorder Point

Safety Stock Lead Time Lead Time Lead Time Time

The primary output is a time-phased inventory plan used as input to Replenishment Planning. Safety stock is required to meet service levels when variability exists for demand and supply. The higher the variability (or forecast error) and the higher the service target, the higher the safety stock needed to meet demand. This is illustrated by the following normal distribution chart. Exhibit 6: Normal Distribution Chart (Illustrative) All Demand Satisfied

Shortages

Safety Stock = function(K*F,S,LT)

Service Level = 97.7%

K=2 Mean

Lead Time Demand =LT*D

As demand becomes more variable, the curve widens and more safety stock is needed to meet an established service level target. Slower moving items tend to have more variable demand, resulting in more safety stock required on a relative basis.

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Organizations must also consider the diminishing rate of return on investment in safety stock, as depicted in the following illustrative chart of the service vs. inventory trade-off curve. High service level targets require substantially Exhibit 7: Service vs. Inventory Tradeoff Curve more inventory. That is why a leading (Illustrative) 98% business practice is to segment service level 95% 100 90% targets by inventory class. For example, 98% 90 service level target for A items, 95% for B 80 items, and 90% for C items. This 70 concentrates inventory investment in those 60 products with the most importance to the 50 organization. 40 Most leading Inventory Planning solutions 30 offer several methods for calculating safety 20 stock, including the use of a defined service 10 level target for each item. Here are a few 0 examples and a perspective on their Inventory Investment recommended application. Fixed Quantity Use this method to limit investment in high cost items, new items, items with highly variable supply, or items where forecast error exceeds the standard deviation of demand May also be used to maintain an agreed minimal balance for a customer Lead Time (sum of forecast during replenishment lead time): use for dependent demand transfer items (e.g. from RDC to service center) to cover replenishment lead time from WH to WH Periods of Supply (# of days of forecast to cover) Use for items with less predictable demand (high error rate but less than std. deviation in demand), less predictable service level performance (due to erratic demand or supply reliability), but desired minimal balances Potentially good method for slowest moving items May also best used for internal transfer of dependent demand items where forecast days equal replenishment days Service Level (the expected unit demand fill rate) Use to provide a consistent service level (e.g. 95%) for items with predictable demand patterns (i.e. forecast error < std. deviation of demand) For many organizations, this will be the most prevalently used safety stock method Minimize Backorders (the expected order demand fill rate): use if order fill rate is deemed more important than unit fill rate and demand is relatively predictable A reorder point is the point at which a new order is triggered. Generally, it is derived based on expected demand during a specified time period plus safety stock. Five common methods for deriving reorder points and perspective on their recommend application are as follows. Fixed quantity Use for items with unpredictable demand (forecast error > std. dev. of demand), low service requirements, and no minimal balances (or embed safety stock by increasing the fixed quantity) May also be used when tied to a storage unit of measure such as pallet (e.g. reorder when only one pallet is on hand in the warehouse) Fixed quantity + safety stock Use for items with unpredictable demand but required minimal balances (e.g. new items)
Service Level %

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

Similar to above method but allows safety stock to be calculated using a different method Forecast for X periods (Periods of Supply) Use for items with predictable demand, ordered on a periodic basis, but with low service requirements, and no minimal balances (or embed safety stock by increasing the number of periods of supply) Forecast for X periods (Period of Supply) + safety stock Use for items with predictable demand and high service levels but ordered on a predetermined, periodic basis (e.g. weekly orders for high volume items when more than one order may be generated during the replenishment lead time) Allows safety stock to be calculated using a different method Forecast during lead time + safety stock Use for items with predictable demand, high service level requirements, an orders generated on nonperiodic basis For many organizations, this will be the most prevalently used reorder point method. Inventory Planning logic assumes an order will be generated when inventory hits a reorder point. It does not create the supply order, but it does assume an order quantity method will be used when creating an inventory plan. There are several methods for determining an order quantity. Here are a few of the more common methods and perspective on their recommended application. Fixed Quantity: use when the same size order is required every time (e.g. agreed allocations from suppliers); or when demand is highly stable (minimal trending, seasonality or randomness) Fixed Minimal Quantity: use to take advantage of a known price break (however the minimum will be fixed regardless of actual need, so the use of this method may be limited) Economic Order Quantity (EOQ) A fixed quantity determined by [(2*annual forecast*order cost)/(inventory carrying cost per unit)}^0.5 Not recommended unless these costs are known, fixed quantities are desired, and demand is stable Periods of Supply (# of days of forecast to cover) Use when ordering for a period of time rather than a fixed quantity (e.g. weekly or monthly order quantities rather than a fixed quantity), or use when EOQ is not known with confidence For many organizations, this will be the most prevalently used order quantity method.

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

The following exhibit summarizes the recommended application of inventory planning parameters. Since every organizations requirements and product characteristics are unique, it should be viewed simply as general guideline. Exhibit 8: Recommended Application of Inventory Planning Parameters (Illustrative)
Type of Product Order Pattern Inventory Parameters Order Quantity EOQ Fixed Quantity Minimum Periods of Supply (Variable Quantity) Reorder Point Fixed Quantity Fixed + Safety Stock Periods of Supply + Safety Stock Periods of Supply Forecast over Lead Time + Safety Stock Safety Stock Fixed safety stock quantity Sum of forecast over lead time Periods of Supply Service level Minimize backorders Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Use if lieu of fixed quantity when the order cost and carrying costs are known Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes High Cost New End of Life Dependent Periodic Order Non-Periodic Demand Item Frequency Frequency Restriction Handling, Storage, Purchasing Restriction Demand Behavior Predictable by Stable Demand Variable Erratic Highly Limited Trend Demand Demand but Variable or Seasonality error < demand error < demand error > demand Service Level Minimal High Service Balance Level Requirements

Use if lieu of fixed quantity when the minimim quantity is always purchased Yes Yes Yes Yes Yes

Use in lieu of service level if order fill rate is preferred metric to unit fill rate

Replenishment Planning Replenishment Planning links planning and purchase order execution by creating recommend order quantities based on forecasted demand, future inventory positions, and replenishment lead times. Replenishment planning is also often referred to as Distribution Requirements Planning (DRP). Basic features offered within the DRP modules: Automatically reconciles forecasts and customer orders Calculates a time phased (day-by-day) planned inventory (by adding in expected receipts and subtracting the net requirements) Projects when inventory will drop into the safety stock Determines when an order must be released to prevent using safety stock Creates a recommended purchase quantity for authorization. Identifies exception situations where supply and demand are out of balance and expedited orders are needed Exhibit 9: DRP Example and Graphical Depiction (Illustrative)
Periods Beginning Inventory Projected Demand Inventory (if no receipt) Planned Order Planned Order Receipt New Ending Inventory Standard Order Quantity Safety Stock Lead Time Periods Average Demand per Period 200 80 2 100 0 0 1 180 100 80 0 200 280 2 280 100 180 200 0 180 3 180 80 100 0 0 100 4 100 90 10 200 200 210 5 210 110 100 200 0 100 6 100 140 -40 0 200 160 7 160 90 70 200 200 270 8 270 80 190 0 0 190 9 190 110 80 200 200 280 10 280 100 180 0 0 180

300 250 200 150 100 50 0 -50 -100 1 2 3 4 5 6 7 8 9 10 Receipts Demand Inventory on Hand Inventory (if no receipt) Safety Stock

A Point of View

By Tom Tiede

Aligning APS Functionality to Plan Demand & Manage Inventory

This capability is often referred to as time-phased planning. Essentially, it takes a proactive approach to planning orders based on projected future inventory levels. Much like a material requirements planning (MRP) system, it also allows users to define dependent demand relationships, such as in a hub and spoke distribution network. In doing so, it lowers the overall investment in inventory. Summary APS capabilities in Demand Planning, Inventory Planning, and Replenishment Planning enable organizations to reduce inventories and lower operating costs while also raising service level performance. To maximize benefit, it requires careful thought on how best to apply the capabilities of the software to business needs and the unique characteristics of each planned item. Whether selecting a package, implementing the software, or tuning-up the process, organizations must recognize both the importance and challenge in determining which planning models and parameters to use. Several methods are usually available within any leading APS package. This overview has covered many of the more common methods and a perspective on how they may be applied. Appropriate application, in concert with other critical success factors, will aid greatly in helping organizations achieve and sustain desired benefits from their APS investment.

A Point of View

By Tom Tiede