When I visit with customers or potential clients, they often ask, "Where should I start in order to get a handle on my supply chain?" There is no clear and concise answer, but I usually say "Follow the inventory!"
Inventory is a result of decisions made, not the cause. When you look into where your inventory is bloated you tend to find where the decision making or process structure is out of tolerance. Be careful not to assign blame too hastily, though. One of the major impediments to inventory reduction is the mistaken notion that improved inventory management alone is all that is required to get the job done.
The real culprits are the inefficient business processes that cause excessive inventories to exist in the first place. What do I mean by inefficient business processes? And how can you fix it? Start by following these tips:
- Don't always blame inventory control and purchasing! Most inventory management and replenishment systems have been built using 30 year-old rule-of-thumb metrics based on days of supply. In my book, Demand Driven Inventory Optimization and Replenishment, I discuss the "The Goldilocks Effect" in supply chains. The effect indicates that only about 10 percent of your products have the correct inventory, 70 percent are at different degrees of overstock and 20 percent are under stocked. You need to examine your inventories to uncover the Goldilocks Effect in preparation for a process and technology change. For example, inventory optimization solutions can overcome the days-of-supply problem. From a process perspective, change management needs to look at conflicting metrics in the replenishment system so that fill rate requirements do not overly bloat inventory levels and reduce inventory turns.
- Develop flexible manufacturing. When a manufacturer is rigidly set up for long production runs, there is a tendency to maintain higher than necessary production levels even in the face of reduced demand. The “inflexible” manufacturer maintains high production to absorb overhead. While raw material and work in process inventories are critical, they're often subject to production scheduling and spot market purchases. A shift to an outwardly focused vision of what the customer is willing to buy helps temper the production schedule so product is only being produced to the foretasted demand and not simply to insure efficient production runs. Many companies find their finished goods inventory is where the bloating is most evident. The distribution chain is where bad decisions get amplified. Faulty forecasting, disrupted supply and incorrect inventory mixes can wreak havoc on the distribution chain. Look closely at your performance against your peers!
- Use effective performance metrics. It’s surprising that many companies actually reward behavior that tends to bloat inventory levels. For example, focusing on manufacturing utilization to absorb overhead can result in production (that go into inventory), even when there is no other rational reason to do so. The inevitable result is more inventory in manufacturing or finished goods and lower customer service due to bad product mix management.
When I say "follow the inventory", not every company is the same. However, in my travels I tend to see two schools of thought:
Production is extremely important and virtually all sales and operations planning processes go back to the idea that efficient production is at the foundation of a solid company. However, there is a natural hand off in the management of production and distribution based on scheduling versus demand. Production tends to be based on "operational efficiencies". In essence, do it better than your competitors. Production is based on long-term, deterministic demand. The schedule is based on baseline demand plus or minus "x" from prior year. Over time this evaluation is increased or decreased depending on how sales come in. Production inventory is positioned in a "just in time" manner Unless the company goes into a full blown build-to-order mode, production inventories are going to remain relatively stable.
On the flip side is distribution. Distribution inventory is the elastic band between the customer and production. Distribution is based on random or stochastic demand. Moreover, it is based on projections or "bets" on what the customer wants. One wrong decision here will negate months of production efficiencies. Because of this decision amplification the distribution segment is the true measure of supply chain efficiency. Indeed, measuring the distribution chain tells a company not only how efficient they are, but also how effective they are in being demand-driven and outwardly focused in their decision making.
Companies today must be fast and nimble enough to react quickly to changes in customer demand and do it with little inventory. Gone are the days when companies could stockpile large quantities of raw materials, load up the shop floor with work-in-process and pack warehouses with finished goods. The old ways caused erratic and long lead times, high costs and require too much cash for working capital. Today’s customers are demanding short lead times, quality products, on-time delivery, good customer service and a good price, or the business will be lost. Compliance or non-compliance with these customer demands depends on how well you follow the inventory.
For more in-depth supply chain efficiency advice, order the book Demand Driven Inventory Optimization and Replenishment.