When is enough inventory enough—or too much? That’s the challenge in these days of rising fuel costs, labor shortages and depressing economic conditions in general.
For years, we’ve been reading about and living with just-in-time inventory. It was all neat and tidy: the right amount of stuff in the right place at the precise moment it’s required. While JIT is still a good idea, it’s become a burden for managers dealing with suppliers who refuse to send less-than-full truckloads; truckers who refuse to hit the road because of the cost of diesel fuel; global supply chains that stretch from here to— well, to China.
What has this to do with material handling? A whole lot. It requires new approaches inside the building as well as outside. Is having adequate stock in reserve the best way to prevent a shortage? Does having reserve stock, however, make economic sense?
One common approach to inventory management, according to Gregg St. John, former director of professional services at Cornerstone Solutions, a supply chain management services company, is called economic order quantities. A company attempts to set lot sizes by balancing order costs and carrying costs.
“This approach is flawed for a few reasons,” says St. John. “Carrying costs are usually underestimated, and order costs are assumed to be variable or are not reduced. The incorrect assumption is made that all inventory will be sold, shortage costs may not be considered, and finally, safety stocks are often set arbitrarily or by trial and error.” Safety stock, he adds, puts undue stress on financial resources.
Another approach is to let software drive purchases and increase or decrease inventory accordingly. That, too, has its faults, says St. John. “ERP/DRP systems will drive inventories according to their planning parameters and often generate data based upon incorrect data input.” He adds that one has to be careful because systems do as they are told. Forecasts are incorrectly assumed to be correct when they are not, ‘fudge factors’ are often built in but are not recognized, and parameters are often incorrect or conservative.
Finding a Solution
A more appropriate approach is to model ‘should be’ inventories for your operation based on inventory drivers (as mentioned above), says St. John. “These include factors such as forecast accuracy, service-level targets, lead times and supply reliability, supply chain capacity and lot sizes. Data is often maintained on each of these variables by most companies,” he says.
Inventory models can provide a comparison of ‘should be’ vs. actual and will highlight problem areas. Another benefit of inventory models is once they are built, the variables in the models can be changed to perform ‘what if’ analyses.
“Inventory models should be used primarily for two reasons,” says St. John. “First, to further the organization’s understanding of the factors influencing its inventory investment. And, second, to help focus inventory reduction efforts on the root causes that will provide the best results.”
However, he adds, the use of inventory models is not effective when the most important root causes of excess inventory are already known. “It is safe to say that the appropriate amount of inventory can be determined analytically, and sustainable inventory reduction is possible by addressing inventory drivers. Remember that better tools are available to help you optimize your supply chain.”
In a white paper prepared for Marsh, the supply chain risk management practice of Marsh & McLennan Companies, Beth Enslow tells how CFOs and supply chain managers can employ a new approach to global inventory that will boost customer responsiveness while removing redundant inventory. The result can be millions of dollars of workingcapital improvement and compressed cash-to-cash cycles. (See the note at the end of this article to obtain a full copy of this white paper.)
No CFO would imagine managing cash reserves separately for each individual facility. This would build unnecessary cash buffers at each location to deal with local cash-flow volatility. Rather, cash management is done across the entire enterprise.
In the supply chain world, however, local inventory policy setting has been the norm. Each facility or level in the supply chain acts as its own island and creates local inventory policies, leading to unnecessary inventory buffers.
By comparison, global inventory management acts like global cash management. It creates policies that meet customer-service requirements and minimize stockouts without unneeded, redundant inventory. Companies discover they can remove multiple days of inventory and experience the resulting working-capital and cash velocity benefits. From a financial perspective, this is an attractive way to save money in a difficult economy.
Boost Financial Performance
The interests of CFOs and treasurers are closely aligned with those of the supply chain manager when it comes to switching from local inventory management to global inventory management. Yet the vast majority of companies have yet to adopt this approach.
Although this approach requires a new mindset, companies adopting global inventory management find it is one of the least disruptive and best ROI initiatives a company can undertake. For CFOs, global inventory management represents a way to drive financial improvement during economic downturns as well as upturns; cash velocity and working- capital metrics can be improved, regardless of economic conditions.
Global inventory management is a way to increase inventory turns and reduce stockouts, while minimizing excess and obsolete inventory and associated costs.
By transitioning to a global inventory management approach, companies have improved their balance sheets significantly. These savings come from globally calculating the optimal inventory levels and locations for raw materials, work in process and finished goods across the supply chain. The approach also institutionalizes inventory policies and processes to ensure working-capital requirements don’t creep back up over time.
Traditional Methods Fail
In the world of cash management, having greater transparency into actual cash reserves, currency exchange-rate trends and accounts- payable and accountsreceivable requirements gives the treasury department the confidence to hold less cash. Likewise, in the world of inventory management, greater transparency of end-to-end inventory requirements and supply and demand volatility enables a company to buffer itself with less inventory.
Unfortunately, traditional inventory policy setting methods— such as those found in ERP or advanced planning and scheduling (APS) systems—do not take an end-to-end view of inventory. At best, they sequentially set inventory targets for one level in the supply chain (say, your local warehouses), then the next level (say, your regional distribution centers) and so on. They also fail to account for supply and demand variability, artificially assuming variability has a ‘normal distribution.’
These faults are tremendous weaknesses in today’s environment of outsourcing and global sourcing, which drive up the number of ‘inventory piles’ in the supply chain and typically result in drastically longer lead times and more supply variability that must be buffered by more ‘just-in-case’ inventory. At the same time, most industries are seeing faster-changing customer preferences, increasing the excessinventory risk of ‘guessing wrong’ about product demand.
Ingredient for Success
In this new environment, what is needed is a global inventory approach that simultaneously considers all the inventory across your supply chain when setting inventory polices and robustly accounts for supply and demand volatility.
Six Good Reasons to Rethink Your Inventory Approach
The critical enabler for global inventory management is a breakthrough technology known as a multi-echelon inventory optimization tool. This technology, commercialized from the academic world over the past decade by a handful of solution providers, delivers the brains to do three things that past inventory systems could not:
- Calculate inventory targets globally across the echelons, or levels, in your supply chain (e.g., where and how much inventory to hold across manufacturing facilities, assembly plants, packaging facilities, regional distribution centers and local warehouses);
- Better account for business volatility, including customer demand fluctuations, supplier on-time issues, shipping lead times, manufacturing yield rates and seasonality;
- Help make your inventory investment work harder for you through strategies like postponement, inventory risk pooling and service-level mix optimization.
At Ground Level
Theory is one thing; reality can be something else. Jon Petticrew, vice president operations, ODW Logistics, Columbus, Ohio, describes the 3PL business as a daycare center for inventory. It seems that definition is changing.
“More customers are asking us for inventory-management type functions,” says Petticrew. “Customers are now asking, ‘How can you help me turn my inventory faster? Because that means cash.’”
Toward that end, he says he’s now generating a lot more reports for client companies. “We produce reports telling them what is moving fast, slow, etc. From our standpoint, we try to associate a cost with everything. The customer might have something fully reserved on his balance sheet, so it’s not a big cost right now.”
What Petticrew means is that the customer has already taken a hit for a slow-moving SKU on the balance sheet. His job, then, is to show the customer how that item, sitting in the back of the warehouse, for example, is costing money because it’s taking up space.
“We show them how to save money by getting it out of the building and turn some money just by getting rid of something, even by holding a warehouse sale,” he says.
Petticrew says, rather than build inventories, companies are asking if his company can do other functions in the supply chain. “Clients want one-stop shopping,” he says. “They want us [a 3PL] to handle all the hand-offs, etc.”
And, clients want the 3PL to be more asset based. “By being more asset based, the 3PL has more control over the entire process, and that’s what our clients are looking for. They want one person to go to with a problem.”
Petticrew says other inventorymanagement schemes he’s seeing more of are kitting and postponement, or deferring of inventory. Examples are things like the OEM sending the 3PL basic inventory and having the 3PL affix different labels on the product, then move it to the specific client.
As companies worry less about what the competition is doing and more about how to save money, co-mingling of freight has become more important. The impact of higher fuel costs has made companies focus on trailers leaving the yard half full. Petticrew says it used to be a tough sell (to his client companies) to put the same product going to different customers on the same load. Now, they’re saying, whatever you have to do to lower the cost, do it. And, virtually everything, or anything, a 3PL can do involves material handling.
Handling the Last Mile
Russ Marzan, executive vice president, 3pd, Atlanta, says the biggest difference he’s seen in the last 18 months or so, when talking with customers about inventory management, is speed. 3pd is a 3PL specializing in that last mile of the supply chain: delivery to the consumer’s door or to a job site.
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Cornerstone Solutions Inc.
“Our customers are reacting much faster,” Marzan says. “Everybody is watching costs.” He says, with customers that have global supply chains, what used to take months to reach fruition, now happens much faster. The reason, he says, is that people are more willing to listen because they want to reduce or keep inventories moving more than ever.
“It used to be, when we saw inventory start to back up in our facilities,” he says, “we’d go to the customer to address the issue. Today, especially the global customers, those that receive imports, they’re saying, ‘Hey, we want to prevent that back up.’”
The window within which a company has to work is from the time of order to the time of delivery. People are looking at what they can do to manage that time more efficiently.
Even though Marzan’s company deals primarily with the last part of the supply chain, he says his customers are asking for a broader view of inventories and where things are. “They want us to start by analyzing the manufacturing process,” he says. “We begin by asking if they track freight in the facility because often they have only the space to manufacture the product then ship it out.”
He says he also has to look at the length of time inventory will sit at the port and the time it will take to travel across the water or across the country. “So, if we’ve timed it all correctly, we can just crossdock it through our facility to the end customer.” Much easier said than done, he admits.