For too many companies, a critical piece of data fact-finding ― the measurement of demand uncertainty ― is handled by simple but inaccurate rules of thumb.  For example, demand planners will often compute safety stock by a user-defined multiple of the forecast or historical average.  Or they may configure their ERP to order more when on hand inventory gets to 2 x the average demand over the lead time for important items and 1.5 x for less important ones. This is a huge mistake with costly consequences.

The choice of multiple ends up being a guessing game.  This is because no human being can compute exactly how much inventory to stock considering all the uncertainties.  Multiples of the average lead time demand are simple to use but you can never know whether the multiple used is too large or too small until it is too late.  And once you know, all the information has changed, so you must guess again and then wait and see how the latest guess turns out.  With each new day, you have new demand, new details on lead times, and the costs may have changed.  Yesterday’s guess, no more matter how educated is no longer relevant today.  Proper inventory planning should be void of inventory and forecast guesswork.  Decisions must be made with incomplete information but guessing is not the way to go.

Knowing how much to buffer requires a fact-based statistical analysis that can accurately answer questions such as:

• How much extra stock is needed to improve service levels by 5%
• What the hit to on-time delivery will be if inventory is reduced by 5%
• What service level target is most profitable.
• How will the stockout risk be impacted by the random lead times we face.

Intuition can’t answer these questions, doesn’t scale across thousands of parts, and is often wrong.  Data, probability math and modern software are much more effective. Winging it is not the path to sustained excellence.

Do MRO companies genuinely prioritize reducing excess spare parts inventory? From an organizational standpoint, our experience suggests not necessarily. Boardroom discussions typically revolve around expanding fleets, acquiring new customers, meeting service level agreements (SLAs), modernizing infrastructure, and maximizing uptime. In industries where assets supported by spare parts cost hundreds of millions or generate significant revenue (e.g., mining or oil & gas), the value of the inventory just doesn’t raise any eyebrows, and organizations tend to overlook massive amounts of excessive inventory.

Consider a public transit agency.  In most major cities, the annual operating budgets will exceed $3 billion.  Capital expenses for trains, subway cars, and infrastructure may reach hundreds of millions annually. Consequently, a spare parts inventory valued at $150 million might not grab the attention of the CFO or general manager, as it represents a small percentage of the balance sheet.  Moreover, in MRO-based industries, many parts need to support equipment fleets for a decade or more, making additional stock a necessary asset. In some sectors like utilities, holding extra stock can even be incentivized to ensure that equipment is kept in a state of good repair.

We have seen concerns about excess stock arise when warehouse space is limited. I recall, early in my career, witnessing a public transit agency’s rail yard filled with rusted axles valued at over $100,000 each.  I was told the axles were forced to be exposed to the elements due to insufficient warehouse space. The opportunity cost associated with the space consumed by extra stock becomes a consideration when warehouse capacity is exhausted. The primary consideration that trumps all other decisions is how the stock ensures high service levels for internal and external customers.  Inventory planners worry far more about blowback from stockouts than they do from overbuying.  When a missing part leads to an SLA breach or downed production line, resulting in millions in penalties and unrecoverable production output, it is understandable.

Asset-intensive companies are missing one giant point. That is, the extra stock doesn’t insulate against stockouts; it contributes to them. The more excess you have, the lower your overall service level because the cash needed to purchase parts is finite, and cash spent on excess stock means there isn’t cash available for the parts that need it.  Even publicly funded MRO businesses, like utilities and transit agencies, acknowledge the need to optimize spending, now more than ever.  As one materials manager shared, “We can no longer fix problems with bags of cash from Washington.”  So, they must do more with less, ensuring optimal allocation across the tens of thousands of parts they manage.

This is where state-of-the-art inventory optimization software comes in, predicting the required inventory for targeted service levels, identifying when stock levels yield negative returns, and recommending reallocations for improved overall service levels.  Smart Software has helped asset intensive MRO based businesses optimize reorder levels across each part for decades. Give us a call to learn more. 

I can’t imagine being an inventory planner in spare parts, distribution, or manufacturing and having to create safety stock levels, reorder points, and order suggestions without using key performance predictions of service levels, fill rates, and inventory costs:

Smart’s Inventory Optimization solution generates out-of-the-box key performance predictions that dynamically simulate how your current stocking policies will perform against possible future demands.  It reports on how often you’ll stock out, the size of the stockouts, the value of your inventory, holding costs, and more.  It lets you proactively identify problems before they occur so you can take corrective action in the short term. You can create what-if scenarios by setting targeted service levels and modifying lead times so you an see the predicted impact of these changes before committing to it.

For example,

• You can see if a proposed move from the current service level of 90% to a targeted service level of 97% is financially advantageous
• You can automatically identify if a different service level target is even more profitable to your business that the proposed target.
• You can see exactly how much you’ll need to increase your reorder points to accommodate a longer lead time.

If you aren’t equipping planners with the right tools, they’ll be forced to set stocking policies, safety stock levels, and create demand forecasts in Excel or with outdated ERP functionality.   Not knowing how policies are predicted to perform will leave your company ill equipped to properly allocate inventory.  Contact us today to learn how we can help!

​When you should use traditional extrapolative forecasting techniques.

With so much hype around new Machine Learning (ML) and probabilistic forecasting methods, the traditional “extrapolative” or “time series” statistical forecasting methods seem to be getting the cold shoulder.  However, it is worth remembering that these traditional techniques (such as single and double exponential smoothing, linear and simple moving averaging, and Winters models for seasonal items) often work quite well for higher volume data. Every method is good for what it was designed to do.  Just apply each appropriately, as in don’t bring a knife to a gunfight and don’t use a jackhammer when a simple hand hammer will do. 

Extrapolative methods perform well when demand has high volume and is not too granular (i.e., demand is bucketed monthly or quarterly). They are also very fast and do not use as many computing resources as probabilistic and ML methods. This makes them very accessible.

Are the traditional methods as accurate as newer forecasting methods?  Smart has found that extrapolative methods do very poorly when demand is intermittent. However, when demand is higher volume, they only do slightly worse than our new probabilistic methods when demand is bucketed monthly.  Given their accessibility, speed, and the fact you are going to apply forecast overrides based on business knowledge, the baseline accuracy difference here will not be material.

The advantage of more advanced models like Smart’s GEN2 probabilistic methods is when you need to predict patterns using more granular buckets like daily (or even weekly) data.  This is because probabilistic models can simulate day of the week, week of the month, and month of the year patterns that are going to be lost with simpler techniques.  Have you ever tried to predict daily seasonality with a Winter’s model? Here is a hint: It’s not going to work and requires lots of engineering.

Probabilistic methods also provide value beyond the baseline forecast because they generate scenarios to use in stress-testing inventory control models. This makes them more appropriate for assessing, say, how a change in reorder point will impact stockout probabilities, fill rates, and other KPIs. By simulating thousands of possible demands over many lead times (which are themselves presented in scenario form), you’ll have a much better idea of how your current and proposed stocking policies will perform. You can make better decisions on where to make targeted stock increases and decreases.

So, don’t throw out the old for the new just yet. Just know when you need a hammer and when you need a jackhammer.

Inventory Control concerns the management of physical goods, focusing on an accurate and up-to-the-minute count of every item in inventory and where it is located, as well as efficient retrieval of items. Relevant technologies include computer databases, barcoding, Radio Frequency Identification (RFID), and the use of robots for retrieval.

Inventory Management aims to execute the inventory policy defined by the company. Inventory Management is often accomplished using Enterprise Resource Planning (ERP) systems, which generate purchase orders, production orders, and reporting that details current inventory on hand, incoming, and up for order.

Inventory Planning sets operational policy details, such as item-specific reorder points and order quantities, and predicts future demand and supplier lead times. Important components of an inventory planning process include what-if scenarios for netting out on-hand inventory, analyzing how changes to demand, lead times, and stocking policies will impact ordering, as well as managing exceptions and contingencies.

Inventory Optimization utilizes an analytical process that computes values for inventory planning parameters (e.g., reorder points and order quantities) that optimize a numerical goal or “objective function” without violating a numerical constraint. For instance, an objective function might be to achieve the lowest possible inventory operating cost (defined as the sum of inventory holding costs, ordering costs, and shortage costs), and the constraint might be to achieve a fill rate of at least 90%. Using a mathematical model of the inventory system and probability forecasts of item demand, inventory optimization can quickly and automatically suggest how to best manage thousands of inventory items.