Root Causes of Inventory Pain
Root Causes of Inventory Pain
Inventory Executives are faced with the daunting task of maximizing service while keeping inventory investments at a minimum. In order to ensure that the return on your inventory asset is maximized, the planning process must be in concert with the business strategy, and the planning team must play the role of an arbiter to the rest of the organization by clearly communicating the tradeoffs the organization will have to make between service and inventory investment. Shortages, overstocks, and conflict over stocking levels are symptoms of a suboptimal or disconnected planning process. In Smart Software’s experience, this results from the following 3 root causes:
Highly variable & intermittent demands make consistently accurate projections all but impossible. Countless hours are spent trying to anticipate what will come next rather than calibrating the organization’s risk tolerance and harnessing that information to determine required levels of supply. Intermittent demand – also known as lumpy, volatile, variable or unpredictable demand – have many zero or low volume values interspersed with random spikes of demand that are often many times larger than the average. Intermittent demand makes it difficult to accurately forecast demand and inventory requirements because there aren’t any inherent patterns. And any patterns that may exist are overwhelmed by the random spikes in demand. Many companies make the mistake of “chasing the forecast” insisting that sales or technicians provide better estimates of demand or turn to unreliable forecasting techniques in a quest to predict the next spike. Many resort to forecasting inventory requirements such as Min/Max levels and Reorder Points relying primarily on subjective business knowledge and simple “rule of thumb” estimates. The result is that billions of dollars are wasted every year because of either excess inventory costs or poor customer service due to stock-outs
Rule of Thumb
Safety stock levels, reorder points, lead times, and order quantity directly influence the service vs. cost relationship. Every day, the ERP system makes purchase order suggestions and manufacturing orders based on these drivers. Ensuring that these inputs are understood and optimized will generate better returns on inventory assets. Organizations that are able to do so will see improvements in service and reductions in inventory costs. Unfortunately, the specific inventory policy being utilized is often unclear to many management teams. In absence of a clearly defined and communicated policy, planners are forced to develop their own unique approaches. These self-developed approaches are most often a combination of simple rules of thumb and institutional knowledge. Inventory executives are simply ill equipped to shape inventory according to the changing needs and priorities of the business. Inventory costs balloon and service performance suffers when unable to answer questions such as: “What is my current reorder point and reorder quantity policy, what level of service and inventory cost will this policy yield in the future, and how will performance and costs be influenced by specific changes to the policy.” Rule of thumb approaches don’t answer these questions. In fact, they ignore the critical role of of demand and supply uncertainty. This results in excess inventory for predictable items and more frequent stock outs on less predictable items.
Ad Hoc Process
The failure to establish common metrics makes it difficult to adjudicate conflicting priorities. For example, Finance may prefer to conserve cash, while Sales and Maintenance insist that they never stock out. The result is often a test of wills. An objective, quantifiable performance measure such as service level changes the discussion, putting a dollar valued on a negotiable level of service.
Thousands of parts potentially stocked at dozens of locations means planners don’t have the bandwidth to proactively review inventory drivers. This results in outdated reorder levels and order quantities further leading to large stockouts and inventory write offs. This often leads to a pain avoidance response. For example, order quantities will often go up immediately following a stockout to ensure the outage never recurs. This tends to be a one-way ratchet until inventory carrying costs become an obvious drain of much needed cash.
When inventory is out of balance, finger pointing often results. Operations is often stuck in the middle between sales and finance. Without a clear direction from the executive team on service goals, inventory budgets, and an insistence that sales and finance come to the table knowing that tradeoffs will have to be made, the planning team becomes disempowered and the cycle continues.
Introducing Service Level Driven Planning
Smart Software has developed a methodical approach to address these pain points. “Service Level Driven Planning” (SLDP for short), powered by SmartForecasts and Smart Platform, extends beyond demand planning to deliver inventory policy decision support and the means to make it so. Its impact unfolds in three steps:
Step 1. Benchmark current service level performance and costs. “Stress test” your current inventory stocking policy by utilizing probabilistic forecasting to simulate future demand and replenishment cycles. Projected performance against proposed stocking policies is measured and reported across several key metrics including service levels, fill rates, costs, turns, orders per year and more. Metrics are reported at the item level across thousands of part x locations and as a whole, helping establishing where you are overstocked and understocked.
Step 2. Collaborate and Assess – Compare current policies and metrics against system generated optimized policies that consider ordering costs, holding costs, stockout costs and prescribe a recommended service level. Engage feedback from stakeholders. Is the optimized policy pragmatic? Where is stockout risk not acceptable? Where it is acceptable and to what degree? What is the inventory budget and service level targets that must be maintained? Make modifications to the policy via “what if” and develop organizational consensus on the plan.
Step 3. Make it so. Empower the planning team with the knowledge and tools it needs to ensure that the agreed upon service vs. cost plan is adhered to and your ordering process receives the resulting optimized inputs (forecasts, reorder points, safety stocks, order quantities). Track results and utilize underlying tools to identify and address exceptions.
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