Supply chain processes designed using world class principles

Within any supply chain, inventory is a necessary evil.  While it may sit on the financial balance sheet as an asset, to the business it is often a liability; financing costs, storage costs, possible damage, obsolescence and write-off, IT systems and management time to control.

Often this inventory is held to buffer inflexibility in the supply chain in order to maintain product availability and customer service.  There is general belief that, other things being equal, the higher the inventory the higher the service.  While this may be true in theory, the practical reality is quite the opposite.  All our experiences, both pre and post supply chain transformation programmes, point to the fact that the businesses with low levels of inventory deliver high service provided, of course, that their supply chain processes have been designed using world class principles.  By contrast, those with high inventories find their supply chains filled with half built products they cannot sell and not those they can, leading to poor service. 

Too many businesses, when addressing a service shortfall  increase inventory levels in the expectation of following the correct theoretical path.  In practice the reverse will happen and service will further decline along with increase in costs and unnecessary investment.  Given that we live in a practical world what can a business and its supply chain as a who do to move in the other direction?  Cutting inventory is the end result, but not the starting point.  So where should we start?

World Class Planning and Control
The starting point is to understand why inventory is held at all.  If the supply chain can respond within the leadtime the customer requires, then finished goods inventory is not required and the product can be made to order, like a Dell computer.  However, in order to respond the manufacturer may well have to hold inventory as their suppliers cannot also respond in time.  While some stages of a supply chain may be stockless, invariably at several stages inventory will be required.  But how much should be held?

To determine this we need to know what drives the levels.  This will be a function of:

1. Demand: in terms of absolute level, its volatility and uncertainty, trends and seasonality, promotions and one-off events.
2. Supply: in terms of response lead time, both absolute and variability and batch size of order quantity.

At any stage in the supply chain inventory holding will be made up of a number of sub elements.

For the vast majority of products with some level of repeatability, the size of each can be calculated.  The level of required inventory, both maximum and minimum, then becomes a simple mathematical function of:

1. Average rate of sales
2. Volatility of demand, measured by the normalised standard deviation
3. The supply replenishment lead time in days
4. The batch size or order quantity

Inventory should not be set according to a number of weeks holding.  This is a retrospective measure on the business performance, but should never be used as a basis for setting the quantity to be held, especially when suggested by sales people saying "our customer wants us to hold four weeks stock."  The customer does not actually care how much you have as long as you can meet their requirements.  The level you hold is you decision.

Once inventory is set and replenished according to these parameters the business is then in a position to start taking action to reduce required inventory by reducing the variables:

1. Volatility: This may just be an underlying factor of the nature of customer demand, particularly in the B2C environment.  However, in B2B this is often something that the business can address.  Are customers ordering infrequently in large quantities because of price break points?  Are customers ordering at quarter end as a result of sales push to meet reported results?  These are both measurable and controllable and can be used by the business to reduce inventory.

2. Lead Time: This is a measure from the time a part requirement is triggered until it arrives and is available for use.  It will tend to be driven by a combination of the planning process and the flexibility of the supply organisation.  The latter is, in turn, a function of not just the direct manufacturing activity but of the support activities around it such as logistics and quality control.  These are certainly all measurable and responsibility for their reduction can be allocated.

3. Batch Size: This is similar to lead time reduction, but tends to focus on the flexibility of the direct production equipment and is resolved primarily through the reduction in change over times.

Clearly the implementation of the required processes is not a simple one.  The business will need a Sales and Operations Planning process with appropriate levels of collaboration with its partners.  The use of MRP and kanban pull replenishment will be essential.  Improved forecasting and the use of Advanced Planning Systems (APS) may play a part in the solution, but are never the answer themselves.  The direct operations will have to embrace the principles of world class and lean manufacturing techniques.

Whatever the process changes required, the principles remain unchanged:

1. Determine and quantify the drivers of inventory
2. Set inventory according to these factors
3. Take action to reduce these drivers and re-set the inventory accordingly

These factors can invariably be halved - and so can your inventory!