If Inventory Optimization was Easy, People would Stop Writing about It

Stephen DeAngelis

August 01, 2019

Every supply chain professional understands inventory is a necessary evil. Carry too little inventory and you can miss out on sales and anger customers. Carry too much inventory and you increase handling costs and cut into profits. Like Goldilocks, supply chain professionals are looking for the “just right” solution to their dilemma. If the solution was easy, there wouldn’t be so many people continuing to write about supply chain optimization. Alexa Cheater (@Alexa_Cheater), Product Marketing Manager at Kinaxis, explains, “From designing, sourcing and manufacturing, to distribution and consumption, your supply chain is at the heart of your customer satisfaction levels. It has become a competitive weapon that could help you win the consumerism war. But the sheer complexity of supply chain networks, and the impact design decisions have on operational performance, makes supply chain inventory management aligning inventory investments with on-time customer delivery and margins a major challenge.”[1] Toby Brzoznowski, co-founder and executive vice president of LLamasoft, adds, “For any organization, inventory inefficiencies can be disastrous to the business.”[2]

The inventory optimization challenge

The basic concept for inventory optimization is simple: Find the right balance between supply and demand to meet customer needs without having too much inventory on hand. According to Cheater, “The equivalent of 7% of America’s GDP is tied up in inventory, and accounts receivable and payable. … It’s no wonder that number is so high with a lot of companies still struggling with inventory optimization, trying desperately to find that sweet spot between supply volume and customer demand.” Finding such a balance requires both supply- and demand-side visibility. Brzoznowski explains, “Optimizing inventory requires finding the elusive balance between cost and service — overstocks and lost sales in retail-speak. Unfortunately, many organizations are challenged with an incomplete view of their supply chain, which leads to an inability to quantify all stages of inventory (safety stock, cycle stock, in-transit inventory, work-in-process, pre-build and promotional positioning) and difficulty understanding SKU-level demand behavior. What compounds the problem is that most traditional inventory management applications are limited in scope, only focusing on safety stock settings, and even then, without proper segmentation of demand. In order to reach desired service levels at the lowest possible cost, companies must step back and attain a holistic view of their inventory policies.”

In the best of times, getting inventory right is a challenge. These are not the best of times. Current trade wars have added a dimension of complexity to an already complex situation. Some companies increase inventories to avoid anticipated tariffs or potential loss of access to suppliers. Myriad things can affect the inventory optimization equation. In flush times, demand can outstrip production. Although that sounds like a great situation for manufacturers, customers are not so thrilled. Jeff Bodenstab, a marketer at Toolsgroup, writes, “When supplies get tight, inventory optimization can help focus production around the most critical products while reducing requirements for other items.”[3] The point is, inventory optimization is a continual requirement demanding continuous attention.

Inventory optimization approaches

There are a number of different inventory optimization schemes — all of them rely on having the best possible supply chain visibility. Thomas Willemain recommends Service Level Driven Planning (SLDP).[4] He explains, “[SLDP] prescribes optimal service level targets continually identifies and communicates trade-offs between service and cost that are at the root of all wise inventory decisions. When an organization understands this relationship, they can communicate where they are at risk, where they are not, and effectively wield their inventory assets.” Cheater agrees that inventory optimization must be intimately tied to supply chain planning. She explains, “The first step in navigating [inventory optimization] obstacles is integrating inventory management into the rest of your supply chain planning processes, and the technology solution(s) powering them. Why? Because inventory management will be the backbone of your inventory optimization processes, and has strong interdependencies with sales and operations planning (S&OP), master production schedule (MPS) and supply action management (SAM).” Cheater goes on to discuss two inventory optimization schemes: single-echelon inventory optimization (SEIO) and multi-echelon inventory optimization (MEIO).

  • Single-Echelon Inventory Optimization: “SEIO balances inventory one part at a time, determining the necessary safety stock to overcome constraints like lead time variability and demand volatility. Location problems typically focus on either incoming material flow, or outgoing material flow — not both. It’s a sequential approach with forecast demand determining the required inventory for each level separately.”
  • Multi-Echelon Inventory Optimization: “MEIO takes a more holistic approach, looking at the entire value chain and determining the correct inventory levels across the network based on demand variability at various nodes and the performance at higher echelons. The focus is on minimizing inventory costs while maintaining a target service level. Location problems deal with both inbound and outbound material flow simultaneously. You need to factor in constraints related to both.”

According to Cheater, the selection of which scheme to use depends wholly on your business model. She explains, “If you’re building highly customized, one-off products, like ships, SEIO will likely suit your needs best. If you deal with large volumes of similar stock across multiple distribution nodes, like those in the consumer electronic space, MEIO is almost a must. … The goal is to continually update and optimize inventory levels across all echelons.” Bodenstab believes, for most companies, MEIO is the right choice. Like Cheater, he indicates companies need to be keenly aware of current supply chain constraints. He writes, “MEIO allows a company to position the inventory to meet financial and marketing objectives in a much more efficient manner than ‘one size fits all’ inventory.” He goes on to suggest four ways inventory optimization can help alleviate a constrained supply chain.

1. Postponement for Inventory Configuration: “Postponement for inventory configuration optimizes the trade-off between upstream and downstream inventory to identify the most globally efficient balance. Allocating inventory upstream where it has the broadest range of possible uses (i.e., ‘risk pooling’) is traded off against positioning it downstream near the demand. It addresses the issue of ‘in what form should I hold my inventory; as raw material, finished goods, or something in between?’ It can automatically suggest the right ‘decoupling points’ and the adequate levels of materials, components, subassemblies and finished goods in any location of the entire supply chain.”

2. Stage Optimization: “Stage optimization applies the same postponement principles, but to the distribution part of the network, where the form of the inventory usually does not change, only its place in the network. For instance, it addresses decisions about whether to stock inventory at the factory, in a centralized distribution center, at regional network, or some combination of the above.”

3. Prebuild Analysis: “Prebuild analysis aligns inventory requirements with build ahead capabilities. In a finite capacity environment with reduced supply, prebuilt inventory can be carefully planned to cover the demand in the period of inadequate supply. An inventory optimization system can dynamically define the prebuilt inventory requirements on the basis of time-phased forecasts.”

4. Lot Size Optimization: “Lot size optimization is the simultaneous optimization of safety stock and cycle stock values. Inventory analysis identifies the optimal trade-off between either the set-up cost (for manufacturing) or the handling cost (for replenishment) versus the inventory holding cost.”

Brzoznowski asserts companies are foolish if they don’t leverage cognitive technologies to help them optimize inventory. Cognitive technologies take into account “all variables and scenarios to help companies create effective strategies for inventory, along with improved customer service levels.” He adds, “Without a way to digitally model supply chain operations and inventory policies, companies would need to experiment in the real world, which is time-consuming, risky and cost-prohibitive. Supply chain design enables companies to create living models of the end-to-end supply chain, encompassing physical infrastructure, policies, demand and inventory. These models provide a true holistic view of all the interdependencies and trade-offs throughout the supply chain.” My company’s offering in this area is the Enterra Intelligent Inventory Management System™, which can help provide end-to-end supply chain visibility and analytics, can help enterprises deal with inventory challenges. Cheater adds, “Optimizing inventory isn’t easy, but it can help you free up working capital in times of growth, and reduce costs and ensure liquidity in times of economic downturn. It’s also the key to meeting those all important customer satisfaction levels. It provides a systematic and statistical way to effectively cover supply chain risks. It provides the ability to make informed tradeoffs between service targets and inventory levels to maximize corporate performance. Ultimately, it leads to improved inventory turns, reduced inventory holding costs and higher customer service satisfaction levels.”

[1] Alexa Cheater, “Supply chain inventory optimization – Beyond the analytics,” Kinaxis Blog, 22 March 2017.
[2] Toby Brzoznowski, “The Key to Holistic Inventory Optimization: Supply Chain Design,” Supply & Demand Chain Executive, 11 September 2017.
[3] Jeff Bodenstab, “Four Ways Inventory Optimization Can Address Tighter Supply Constraints,” Toolsgroup Blog, 8 May 2018.
[4] Thomas Willemain, “Want to Optimize Inventory? Follow These 4 Steps,” The Smart Forecaster, 2 July 2019.