Four Ways to Optimize Inventory

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

Now More than Ever

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Even in quieter times, inventory control parameters like Mins and Maxes may be set far from their best values. We may ask “Why is the reorder point for SKU_1234 set at 20 units and the order quantify set at 35?” Those choices were probably the ossified result of years of accumulated guesses. A little investigation may show that the choices of 20 and 35 are no longer properly aligned with current demand level, demand volatility, supplier lead time and item costs.

The nagging feeling that “We should re-think all these choices” is often followed by “Oh no, we have to figure this out for all 10,000 items in inventory?” The savior here is advanced software that can scale up the process and make it not only desirable but feasible.  The software uses sophisticated algorithms to translate changes in inventory parameters such as reorder points into key performance indicators such as service levels and operating costs (defined as the sum of holding costs, ordering costs, and shortage costs).

This blog describes how to gain the benefits of inventory optimization by outlining 4 approaches with varying degrees of automation.

Four Approaches to Inventory Optimization

 

Hunt-and Peck

The first way is item-specific “hunt and peck” optimization. That is, you isolate one inventory item at a time and make “what if” guesses about how to manage that item. For instance, you may ask software to evaluate what happens if you change the reorder point for SKU123 from 20 to 21 while leaving the order quantity fixed at 35. Then you might try leaving 20 alone and reducing 35 to 34. Hours later, because your intuitions are good, you may have hit on a better pair of choices, but you don’t know if there is an even better combination that you didn’t try, and you may have to move on to the next SKU and the next and the next… You need something more automated and comprehensive.

There are three ways to get the job done more productively. The first two combine your intuition with the efficiency of treating groups of related items. The third is a fully automatic search.

Service-level Driven Optimization

  1. Identify items that you want to all have the same service level. For instance, you might manage hundreds of “C” items and wonder whether their service level target should be 70%, or more, or less.
  2. Input a potential service level target and have the software predict the consequences in terms of inventory dollar investment and inventory operating cost.
  3. If you don’t like what you see, try another service level target until you are comfortable. Here the software does group-level predictions of the consequences of your choices, but you are still exploring your choices.

Optimization by Reallocation from a Benchmark

  1. Identify items that are related in some way, such as “all spares for undercarriages of light rail vehicles.”
  2. Use the software to assess the current spectrum of service levels and costs across the group of items. Usually, you will discover some items to be grossly overstocked (as indicated by service levels unreasonably high) and others grossly understocked (service levels embarrassingly low).
  3. Use the software to calculate the changes needed to lower the highest service levels and raise the lowest. This adjustment will often result in achieving two goals at once: increasing average service level while simultaneously decreasing average operating costs.

Fully automated, Item-Specific Optimization

  1. Identify items that all require service levels above a certain minimum. For instance, maybe you want all your “A” items to have at least a 95% service level.
  2. Use the software to identify, for each item, the choice of inventory parameters that will minimize the cost of meeting or exceeding the service level minimum. The software will efficiently search the “design space” defined by pairs of inventory parameters (e.g., Min and Max) for designs (e.g., Min=10, Max=23) that satisfy the service level constraint. Among those, it will identify the least cost design.

This approach goes farthest to shift the burden from the planner to the program. Many would benefit from making this the standard way they manage huge numbers of inventory items. For some items, it may be useful to put in a little more time to make sure that additional considerations are also accounted for. For instance, limited capacity in a purchasing department may force the solution away from the ideal by requiring a decrease in the frequency of orders, despite the price paid in higher overall operating costs.

Going Forward

Optimizing inventory parameters has never been more important, but it has always seemed like an impossible dream: it was too much work, and there were no good models to relate parameter choices to key performance indicators like service level and operating cost. Modern software for supply chain analytics has changed the game. Now the question is not “Why would we do that?” but “Why are we not doing that?” With software, you can connect “Here’s what we want” to “Make it so.”

 

 

 

 

Volume and color boxes in a warehouese

 

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Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

Share, develop, and manage consensus demand plans

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Gaming Out Your Logistical Response to the Corona Virus

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This short note is about one way your business can develop a plan to adjust to one of the likely fallouts from the virus: sudden increases in the time it takes to get inventory replenishment from suppliers. Supply chains around the world are being disrupted. If this happens to you, how can you react in a systematic way?

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Inventory optimization has become an even higher priority in recent months for many of our customers. Some are finding their products in vastly greater demand. Cloud computing companies with unique server and hardware parts, e-commerce, online retailers, home and office supply companies, onsite furniture, power utilities, intensive assets maintenance or warehousing for water supply companies have increased their activity during the pandemic. Garages selling car parts and truck parts, pharmaceuticals, healthcare or medical supply manufacturers and safety product suppliers are dealing with increasing demand. Delivery service companies, cleaning services, liquor stores and canned or jarred goods warehouses, home improvement stores, gardening suppliers, yard care companies, hardware, kitchen and baking supplies stores, home furniture suppliers with high demand are facing stockouts, long lead times, inventory shortage costs, higher operating costs and ordering costs.

Share, develop, and manage consensus demand plans

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

Share, develop, and manage consensus demand plans to ensure inventory policy matches business strategy.

Smart Inventory Optimization (SIO) creates planning scenarios. SIO starts with a “Live” scenario that shows where you are now. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan that becomes the “Goal” scenario, which drives the ERP system’s replenishment planning.

Leave a Comment

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Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

Share, develop, and manage consensus demand plans

Ensure inventory policy matches business strategy. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan.

Gaming Out Your Logistical Response to the Corona Virus

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This short note is about one way your business can develop a plan to adjust to one of the likely fallouts from the virus: sudden increases in the time it takes to get inventory replenishment from suppliers. Supply chains around the world are being disrupted. If this happens to you, how can you react in a systematic way?

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Gaming Out Your Logistical Response to the Corona Virus

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

​As the world holds its breathe to see how the new corona virus (2019-nCOV) will play out, we cross our fingers for all those currently in quarantine or under treatment and pray that health authorities around the world will soon get the upper hand.

This short note is about one way your business can develop a plan to adjust to one of the likely fallouts from the virus: sudden increases in the time it takes to get inventory replenishment from suppliers. Supply chains around the world are being disrupted. If this happens to you, how can you react in a systematic way?

Reacting to Longer Lead Times

This is a problem that can be solved using advanced supply chain analytics. Presumably, you may have already used this technology to make good choices for the control parameters used in managing all your inventory items, e.g., values for Min and Max or Reorder Point and Order Quantity. The specific technical question addressed here is how to convert an increase in replenishment lead time to changes in those control parameters.

In general, longer lead times require fatter inventories if you want to maintain a high level of customer service. This general rule translates into larger values of Min and/or Max. How much larger depends critically on what new, longer lead time values will appear and their probabilities of occurring.

While many planning software systems assume a fixed lead time, the reality is that almost all lead times have some degree of randomness. Typically, ignoring that randomness increases stockout risk, so having a good estimate of the probability distribution of lead times is important. In normal times, your transactional data can be used to estimate that relationship. But sudden disruptions like 2019-nCOV create unprecedented situations in which you have to make educated guesses about what new delays you will see and how likely they are. We will assume here that you can imagine some such scenarios and want to figure out how to best respond to them.

An Example using Advanced Software

To illustrate this type of prospective planning, consider a hypothetical example. One item, a spare part, has an established pattern of replenishment lead times, with delays of 5, 10 and 15 days occurring with 15%, 70% and 15% probabilities, respectively. Given this distribution and a random demand averaging one unit every 5 days, values of Min = 5 and Max = 10 do a good job. Figure 1 shows a simulation of 10 years of daily operation under this scenario. Fill rate and service level are high, and stockouts are infrequent.

Now suppose that disruptions in the supply chain create a less favorable distribution of lead time, with a 50:50 mix of 15 and 30 days. Figure 2 shows how badly the current values of Min and Max perform in this new scenario. Fill rate and service level plummet due to frequent stockouts. Operating costs more than triple due to penalties for backorders. Only inventory investment (the average dollar value of stock on the shelf) seems to get better, but this happens only because so often there are backorders with nothing left on the shelf. The shift to longer lead times clearly requires new higher values of Min and Max.

Figure 3 shows how the system performs when the Min is increased from 5 to 10 and the Max from 10 to 15. This change compensates for the longer lead times, restoring the previous high levels of fill rate and service level. Inventory investment is necessarily greater, but operating costs are actually lower than before.

Summary

Changes in normal operating conditions require adjustments in the way inventory items are managed. One such change looming large on this date is the potential impact of the 2019-nCOV Corona virus on supply chains, with anticipated increases in replenishment lead times.

Changes in lead times require changes in inventory control parameters such as Min’s and Max’s. These changes are difficult to make with any confidence using pure guesswork. But with some estimate of the increase in lead times, you can use advanced software to learn how to make these adjustments with some confidence.

This note illustrates this point using simulations of the daily operation of an inventory control system.

Figure 1 Simulation of normal operations using current replenishment lead times, Min and Max

Figure 2 Simulation of abnormal operations using longer lead times and current Min and Max

Figure 3 Simulation of abnormal operations using longer lead times and revised Min and Max

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Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

Share, develop, and manage consensus demand plans

Ensure inventory policy matches business strategy. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan.

Gaming Out Your Logistical Response to the Corona Virus

Gaming Out Your Logistical Response to the Corona Virus

This short note is about one way your business can develop a plan to adjust to one of the likely fallouts from the virus: sudden increases in the time it takes to get inventory replenishment from suppliers. Supply chains around the world are being disrupted. If this happens to you, how can you react in a systematic way?

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There is a way your business can develop a plan to adjust increasing Demand. Cloud computing companies with unique server and hardware parts, e-commerce, online retailers, home and office supply companies, onsite furniture, power utilities, intensive assets maintenance or warehousing for water supply companies have increased their activity during the pandemic.Delivery service companies, cleaning services, liquor stores and canned or jarred goods warehouses, home improvement stores, gardening suppliers, yard care companies, hardware, kitchen and baking supplies stores, home furniture suppliers with high demand are facing stockouts, long lead times, inventory shortage costs, higher operating costs and ordering costs. Garages selling car parts and truck parts, pharmaceuticals, healthcare or medical supply manufacturers and safety product suppliers are dealing with increasing demand.

TOP 3 COMMON INVENTORY POLICIES

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

Inventory control policies and strategies for a more profitable business

In this Video Dr. Thomas Willemain, co–Founder and SVP Research, defines and compares the three most used inventory control policies. These policies are divided into two groups, periodic review and continuous review. There is also a fourth policy called MRP logic or forecast based inventory planning which is the subject of a separate video blog that you can see here. These videos explain each policy, how they are used in practice and the pros and cons of each approach.

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Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

Share, develop, and manage consensus demand plans

Ensure inventory policy matches business strategy. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan.

Gaming Out Your Logistical Response to the Corona Virus

Gaming Out Your Logistical Response to the Corona Virus

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How do you know Min/Max policy is working well for you?

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

What is a Min/Max policy? How do you know is working well for you? Smart IP&O gets Min/Max right!

The Min/Max inventory policy is one of four available Replenishment methods in SIO. When the inventory level drops to or below the Min, a replenishment order is generated. The reorder quantity is the number of units needed to raise the stock up to the Max. How do you know your Min/Max settings are working well and triggering replenishment orders at the right time and for the right quantities? If you are like most companies, setting Min/Max levels is based on rules of thumb or simple averaging techniques that don’t expose the trade off curve between service level and inventory cost. This makes it impossible to predict which items are likely to have overstocks and shortages in the future. In this Video Blog we elaborate on this and describe how Smart Inventory Optimization can help.

 

 

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Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

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Ensure inventory policy matches business strategy. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan.

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FORECAST DRIVEN INVENTORY MANAGEMENT

The Smart Forecaster

Pursuing best practices in demand planning,

forecasting and inventory optimization

Improve Forecast Accuracy, Eliminate Excess Inventory, & Maximize Service Levels

In this Video Dr. Thomas Willemain, co–Founder and SVP Research, talks about forecast-based inventory management policy, also known as MRP logic. This is the fourth in our series on major approaches to managing inventory.  We begin by looking at some very simple and then more robust models of inventory dynamics that help us determine how much to order or manufacture and when. We then consider how to calculate lead time and account for lead time variability. Tom concludes by describing the importance of safety stock, it’s role in properly buffering against demand and supply uncertainty, and how best to calculate it. 

 

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RECENT POSTS

Four Ways to Optimize Inventory

Four Ways to Optimize Inventory

Inventory optimization has become an even higher priority in recent months for many of our customers.  Some are finding their products in vastly greater demand; more have the opposite problem. In either case, events like the Covid19 pandemic are forcing a reexamination of standard operating conditions, such as choices of reorder points and order quantities.

Share, develop, and manage consensus demand plans

Share, develop, and manage consensus demand plans

Ensure inventory policy matches business strategy. Various team members can create their own scenarios, perhaps dividing the work by product line or sales territory. One decision maker can then merge these scenarios into a consensus plan.

Gaming Out Your Logistical Response to the Corona Virus

Gaming Out Your Logistical Response to the Corona Virus

This short note is about one way your business can develop a plan to adjust to one of the likely fallouts from the virus: sudden increases in the time it takes to get inventory replenishment from suppliers. Supply chains around the world are being disrupted. If this happens to you, how can you react in a systematic way?

Recent Posts

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  • 3 Prophet 21 p21wwwug Inventory Forecasting Demand PlanningSmart Software to Present at P21WWUG CONNECT 2020
    Smart Software today announced that Dr. Thomas Willemain, co–Founder and SVP Research, will present the Video Session "Top Inventory Policies Explained" at P21WWUG CONNECT 2020 from August 14 - September 11 , 2020. . […]