Who Is Spending Your Cash?

“Cash is king,” we hear.  I have seen this in the core values of major, multi-national corporations.  If you travel for your company, you likely face restrictions on the amount and/or cost of travel which you can book without very senior level approval.  I know of one company with revenues of about $15 billion in which the CFO has mandated approval of any air fare over $500, even for employees who routinely must book and re-book travel on short notice due to the nature of their duties.  I do not debate the wisdom of such policies.  I only use them to illustrate how carefully the expenditure of cash is scrutinized in many cases.  Capital expenditures require even greater examination and multiple approvals, perhaps even from the board of directors.  Despite these procedures, I pose this question:  “Do you really know who his spending your cash and how they are doing it?”

Consider where most of the cash is spent and who spends it.  In most manufacturing firms, the largest single expenditure of cash is for the acquisition of raw materials and their transformation and distribution, namely, the cost of goods sold.  What is not sold remains on the balance sheet as inventory.  A manufacturer with 40% gross margin is doing very well in most industries, although there are notable exceptions in pharmaceuticals and a few other manufacturing industries.

A 40% gross margin would mean that 60% of the cash inflow from sales is spent on inventory – inventory that is either sold or stored.  In fact, manufactured product (or at least the raw materials, components or intermediates/work-in-process) in every manufacturing operation is stored at some point before it is shipped to a customer.  That is why inventory turns or days in inventory (both relating inventory to sales through the cost of goods sold) are the most appropriate kinds of metrics for inventory rather than the absolute amount.

So, given the relative proportion of cash flow in the majority of manufacturing firms that is spent on inventory of one kind or another, compared to, say, the proportion of cash flow spent on travel, one might assume that the level of scrutiny and approval required for spending on inventory would be extraordinary and performed at the most senior level of the firm.  Is that true in your company?  Of course not.  Manufacturing and distribution operations would be paralyzed, and servicing customers effectively would be precluded by such a bureaucratic approach.

Supply chain planners or buyer/planners are people who must determine how much should be procured, when, and where.  Purchasing or sourcing professionals, whose mission is to make sure that the purchase price is minimized, support the planning function, but purchase orders are issued by buyer/planners.

Even if “buying” is separate from “planning”, it is the planner who decides how much is needed when and where.

Planners do not rank among the highest paid employees, yet they are pulling the lever to spend the majority of the company’s cash flow.

Most planners today have access to advanced planning and scheduling (APS) tools which embed material requirements planning (MRP – I know this should be “little mrp”, as opposed to “big MRP” for manufacturing requirements planning, but allow me this convention here for visual ease) and distribution requirements planning (DRP) calculations to aid them in determining how much to purchase.  These tools are very helpful.  They are particularly helpful if the forecast is exactly right, if forecast error is always normally distributed, if stated transit lead times are always reality, if yields are constant, if service from one internal manufacturing or distribution point to another is always constant and known.  However, almost none of these conditions are ever true, and they are never true all at the same time.

So, not only do planners have to ultimately determine what to move, make and buy for every item in the bill of material (or formula/recipe) at every location in every future time period in the planning horizon, they must do so in an environment with many unknown inputs.

(At this point, I will include a plug for recruiting, training and retaining the very best planners – not vp’s of planning or directors of planning, but planners themselves since they are likely spending most of your cash!)

This problem is called multi-echelon, inventory optimization (MEIO).   MEIO is fast becoming a best practice requirement.  MEIO optimizes the answer to the very challenging problem of how much extra inventory a planner should plan to have at each location, for every item, at every level, given the many other unknown factors as well.  Put differently, “What is the inventory safety stock level that should be targeted for every item at every location, such that the cost of holding inventory for achieving a given service level for the end customer is minimized.”  This question must be answered across all nodes while considering all of the unknown factors mentioned above.

When solved, the result is a lower required buffer inventory than could be planned with just MRP or APS in order to achieve an optimal service level.  That means more available cash and more revenue and profits.

Solving the MEIO problem remains a massive challenge for which many planners still do not have sufficient tools at their disposal.  However, algorithms have been developed and can be implemented through commercially viable software.  It’s also increasingly possible to build your own on an advanced analytics platform.  As MEIO continues to be adopted, more planners can go about their normal planning process of determining what to move, make and buy, but with a much better starting point, namely the amount of inventory buffer required at each item, location.  This buffer, or safety stock, already a standard row in a supply planner’s gross-to-net calculation in his or her advanced planning system, allows planners to perform their work without disruption while achieving significantly better results for the cash management of their firm – when populated through MEIO.

Questions:

1)      How do your planners account for the unknown factors in determining how much cash to spend on which inventory in which locations and when?

2)      Are you thinking about evaluating MEIO?  If not, why not?

3)      Can you afford not to pay more attention to where the majority of your cash flow is going?

Advertisement

The Time-to-Action Dilemma in Your Supply Chain

If you can’t answer these 3 sets of questions in less than 10 minutes (and I suspect that you can’t), then your supply chain is not the lever it could be to drive more revenue with better margin and less working capital:

1) What are inventory turns by product category (e.g. finished goods, WIP, raw materials, ABC category, etc.)?  How are they trending?  Why?

2) What is the inventory coverage?  How many days of future demand can you satisfy with the inventory you have on-hand right now?

3) Which sales orders are at risk and why?  How is this trending?  And, do you understand the drivers?

Global competition and the transition to a digital economy are collapsing your slack time between planning and execution at an accelerating rate.

 

You need to answer the questions that your traditional ERP and APS can’t from an intelligent source where data is always on and always current so your supply chain becomes a powerful lever for making your business more valuable.

 

You need to know the “What?” and the “Why?“ so you can determine what to do before it’s too late.  

 

Since supply chain decisions are all about managing interrelated goals and trade-offs, data may need to come from various ERP systems, OMS, APS, WMS, MES, and more, so unless you can consolidate and blend data from end-to-end at every level of granularity and along all dimensions, you will always be reinventing the wheel when it comes to finding and collecting the data for decision support.  It will always take too long.  It will always be too late.

 

You need diagnostic insights so that you can know not just what, but why.  And, once you know what is happening and why, you need to know what to do — your next best action, or, at least, viable options and their risks . . . and you need that information in context and “in the moment”.

 

In short, you need to detect opportunities and challenges in your execution and decision-making, diagnose the causes, and direct the next best action in a way that brings execution and decision-making together.

 

Some, and maybe even much, of detection, diagnosis and directing the next best action can be automated with algorithms and rules.  Where it can be, it should be.  But, you will need to monitor the set of opportunities that can be automated because they may change over time.

 

If you can’t detect, diagnose and direct in a way that covers your end-to-end value network in the time that you need it, then you need to explore how you can get there because this is at the heart of a digital supply chain.

As we approach the weekend, I’ll leave you with this thought to ponder:

“Leadership comes from a commitment to something greater than yourself that motivates maximum contribution from yourself and those around you, whether that is leading, following, or just getting out of the way.”

Have a wonderful weekend!

Resilience Versus Agility

Just a short thought as we move into this weekend . . .

Simple definitions of resiliency and agility as they relate to your value network might be as follows:

Resiliency:  The quality of your decisions and plans when their value is not significantly degraded by variability in demand and/or changes in your competitive and economic environment.

Agility:  The ability to adjust your plans and execution for maximum value by responding to the marketplace based on variability in demand and/or changes in your competitive and economic environment.

You can take an analytical approach that will make your plans and decisions resilient and also give you insights into what you need to do in order to be agile.

You need to know the appropriate analytical techniques and how to use them for these ends.

A capable and usable analytical platform can mean the difference between knowing what you should do and actually getting it done.

For example, scenario-based analysis is invaluable for understanding agility, while range-based optimization is crucial for resiliency.

Do you know how to apply these techniques?

Do you have the tools to do it continuously?

Can you create user and manager ready applications to support resiliency and agility?

Finally, I leave you with this thought from Curtis Jones:  “Life is our capital and we spend it every day.  The question is, what are we getting in return?”

Thanks for stopping by.  Have a wonderful weekend!

Ten Key Questions for Spare Parts Planning

1)      How does demand behave?  To answer this, you must ask yourself the following:

a) How often do you expect to receive a demand for a given spare part?

b) What is the expected magnitude of a demand transaction when it occurs?

c) Are  failures based on age, or use, or both?

d) How large is the installed base of a given spare part?

(Technical note:  Historical data on the time interval between demands (inter-demand interval) and on the order of magnitude of demand transactions (demand order sizes) can be used to estimate the likelihood of a demand occurring in a given time interval and its transaction size using statistical techniques such as Croston’s method or a compound Poisson distribution[i].  If failure of a part (and the subsequent need for replacement or repair) is time-dependent (as many are), then the combined use of a type of Erlang distribution to estimate the interval and a Poisson distribution to estimate the quantity may be more appropriate.[ii])

2)      Are some spare parts much more important than others?  Some of the key questions here include the following:

a)  How expensive is the item?

b)  What does it cost to store and transport the item?

c)  What are the consequences when the part fails?

d) Do the consequences of a failure compound with time?

Factors like these are used to determine a part’s “criticality”.  For more critical parts, you usually need to have more safety stock.  That buffer stock may need to be geographically distributed near potential sources of demand and/or expedited delivery may be necessary.

(Technical note:  Where the answer to “d.” above is “yes”, then the use of an Erlang distribution may be helpful to estimate the duration of the wait time for the customer.)

3)      Is demand affected by the conditions in which the part is used and/or the level of preventative maintenance that it receives?  In cases where the answer is “yes”, then the algorithms and statistical approaches that are used to calculate demand and inventory requirements may need to be tailored for different situations.

4)      Are the magnitude and sources of demand such that requirements can be modeled as a trend over time with appropriate adjustments for seasonality?  If so, then this simplifies the planning considerably in that the requirements for such a spare part may be able to be modeled in a way that is similar to non-spare parts.

5)      Is the supply network composed of a single stage or multiple echelons?  The calculations for safety stock are different for each structure.

6)      Are the failed parts scrapped (consumed) or repaired and used again?  Where parts to be replaced are repaired and used again, a determination must be made as to whether the failed part is beyond repair and should be scrapped.  When new replacement parts should be purchased must also be determined, and tracking by serial number is required.

7)      Are the purchase, or manufacturing, batch sizes significantly larger than the expected demand quantities in a period?  If so, then this should be taken into account when planning resupply and safety stock.

8)      Is the supply constrained by a budget?  If so, you should take this into consideration when planning supply as well.

9)      Will requirements be reviewed periodically or continuously?  Continuous (or nearly continuous) review systems are quite feasible with modern communications and computing technology, and in many, if not most cases, they can yield better results.  A continuous review system reevaluates supply requirements each time an actual demand is generated.  Where a large number of spare parts must be monitored by a limited number of planners, however, it may be more practical to periodically review requirements (once per inter-demand interval or some multiple/fraction of inter-demand interval) for non-critical items and plan safety stock to account for demand variability over lead-time and the review period as well as variability in lead-time for those non-critical items.  Critical items, particularly expensive ones, should probably be evaluated continuously.  It may be useful to segment spare parts by levels of criticality and treat each group of parts accordingly.

10)   How many time periods of inventory do I currently have on hand for each spare part and for each category of spare parts?

A fundamentally sound approach to spare parts management can be summarized as follows:

1. Understand your demand patterns
2. Classify your parts (e.g. by criticality, by demand pattern, and/or cost, etc.)
3. Apply the appropriate forecasting model and statistics
4. Employ an efficient algorithm to find inventory targets and purchase quantities that meets the specific needs, constraints, and goals of your business including the structure of your value network, requirements of your customers, and the costs and risks/uncertainties that you face.  Keep the approach as simple as possible within those conditions.

(Note:  Many formal statistical approaches require assumptions that may not hold in your business.  In most cases, a heuristic that searches for a high value solution that conforms to real-world constraints, leveraging statistical theory where appropriate, is the most useful approach. )

5.  Deploy this algorithm through an easy-to-use, fast, visual and interactive tool that functionally meets your specific requirements, but  doesn’t “break the bank”.

As we enter this weekend, I leave you with one more thought — this time, from Socrates:  “The wisest man is he who knows his own ignorance.”

Have a wonderful weekend!

---

[i] Lengu, D., Syntetos, A., Babai, M., “Spare Parts Management:  A Distribution-based Approach”, Salford Business School Working Paper Series, 342/11.

[ii] Saidane, S., Babai, M., Aguir, S., Korbaa, O., “Spare Parts Inventory Systems under an Increasing Failure Rate Demand Interval Distribution”, Proceedings of the 41^st International Conference on Computers and Industrial Engineering,  2011.

How Much To Buy And When?

I want to bring your attention to an important basic and “best” practice that is often neglected.

Once your advanced planning, DRP or MRP system runs and creates recommendations for purchase or manufacture at lead time such that the right amount of material is supplied when it is needed in your time-phased plan, the recommendations are likely approved and executed.

While there may have been a batch or lot size calculation (or estimate) at some point in the past that was used to set a minimum lot size (or maybe even an incremental lot size) parameter in your item master, I suspect that there is no check to see if you would be better off buying or making two, three or four or more periods of material, given the total cost of ordering, manufacturing, and receiving, etc., as well as the available quantity discounts balanced against the cost of holding any additionally purchased material.

The counter argument is that you have used “lean thinking” to minimize setup and ordering costs and therefore, should only replenish what is immediately required by the next link in manufacturing or distribution.  Hopefully, it is even delivered “just-in-time” during that week.  That is a very worthy effort.

However, the ability to drive toward a lot size of one and immediate changeovers can go farther in some industries than in others.  There are also other economic realities that need to be considered (i.e. quantity discounts, handling costs, fluctuating material costs, etc.) and which should never be ignored, not to mention the opportunity to intelligently hedge for any value network risks that may be spiking at any given point.

If you are able to put this into practice – the explicit consideration of this kind of “look ahead” calculation to optimize a purchase or work order by minimizing setup costs like ordering and handling and to take advantage of quantity discounts, but not to the point of incurring unnecessary carrying costs or obsolescence, keep in mind that your safety stock for the period in which the new material arrives should probably be much less than the calculated amount, if not actually zero.

One way of dealing with this challenge lies through the path of collaboration.  If you can reliably share your requirements, costs and goals with your suppliers, they can then leverage the processes under their control in order to make sure you have what you need at the lowest total cost and risk.  This places the burden on the party who can most effectively address these considerations, but it will only work if the collaborative arrangement provides for shared risks and rewards that drive both parties toward mutual benefit.

Some serious thought should go into the process of managing the collaboration, including what tools and metrics will enable efficient communication and management by exception.

You also need to quantify the potential benefit before entering into a collaborative arrangement.

In those cases where a mutually vested partnership is not, or not yet, possible, there are analytical approaches that your organization can take internally to address this challenge.  

These analytical approaches are likely outside of the core functionality of your planning system, but complimentary capabilities can be developed leveraging heuristics or optimization that will add the necessary value.

In fact, the presence of a collaborative partnership with mutually vested interests simply means that you can strengthen your analytics and make them more comprehensive.

Thanks for taking a moment to read Supply Chain Action this week.

Malcolm Forbes once said, “The best vision is insight.”  Let’s make sure we have done the analysis necessary to acquire the insight necessary for our vision.

Have a wonderful weekend!

Two Thoughts on Safety Stock

Jean-François Baril, Senior Vice President, Sourcing and Procurement for Nokia Corporation, based in Espoo Finland, commented this week in a panel discussion hosted by SCM World and moderated by Kevin O’Marah, that “risk management is embedded in everything we do,” pointing out that supply chain managers not only have to manage what they see, but also what they do not see. 

As we move into a shortened work week that launches the holiday season, managers of value networks face multiple risks including currency fluctuations, money supply, uncertainties about the future of sluggish economic growth, the directions of regulatory efforts, and lagging consumer confidence, to name a few.  Just as the management of information cannot be the sole purview of the IT department, so the management of risk in the value network must go beyond an executive or department that is designated by that name.  Management of risk in the value network will always remain a cross-functional endeavor. 

More exotic risk management approaches such as those I have touched on previously (Supply Chain Matters and Supply Chain Action 7 October) will be much more effective if some of the less exotic “blocking and tackling” is in place to deal with more regular volatility in your business.

Inventory decisions and decisions regarding supply chain flexibility rank among the most important that your company will make and are significant drivers of enterprise value or lack thereof (Journal of Enterprise Resource Management).  One the inventory side, safety stock or buffer inventories are key decisions to help deal with volatility in demand (and hopefully supply).  On this Friday, here are two ideas to consider in this regard:

1)      Since safety stock is calculated and intended to compensate for historical variability in demand and supply, you probably should not update it every time you rerun your supply plan (e.g. Oracle ASCP or SAP APO) unless there is reason to believe that there will be a step change one way or the other in that variability in the future over lead time (plus the review period).  Updating safety stock too often can create additional noise in your supply plan that will only cause excess expediting costs.

2)      I tend to be a purest when it comes to getting a mathematically rigorous answer for safety stock, even in a multi-stage, stochastic environment (Supply Chain Action 29 September), because I don’t want to leave any money on the table.  However, you can sometimes reach unanticipated diminishing returns if planners do not use the “rigorous” answer because they do not understand it.  So, consider the need for planners to understand and interact with the safety stock calculation and its result when you decide how “pure” the calculation needs to be.

Thanks for stopping by this Friday.  I won’t be making a post (or at least a full one) next Friday since we will be celebrating Thanksgiving in the US, so as you go into short week ahead, remember the words of one, W.T. Purkiser, who said, “It’s not what we say about our blessings, but how we use them, that is the true meaning of our thanksgiving. “

Have a wonderful weekend and a terrific Thanksgiving.

Who Is Spending Your Cash?

“Cash is king,” we hear.  I have seen this in the core values of major, multi-national corporations.  If you travel for your company, you likely face restrictions on the amount and/or cost of travel which you can book without very senior level approval.  I know of one company with revenues of about $15 billion in which the CFO has mandated approval of any air fare over $500, even for employees who routinely must book and re-book travel on short notice due to the nature of their duties.  I do not debate the wisdom of such policies.  I only use them to illustrate how carefully the expenditure of cash is scrutinized in many cases.  Capital expenditures require even greater examination and multiple approvals, perhaps even from the board of directors.  Despite these procedures, I pose this question:  “Do you really know who his spending your cash are how they are doing it?”

Consider where most of the cash is spent and who spends it.  In most manufacturing firms, the largest single expenditure of cash is for the acquisition of raw materials and their transformation and distribution, namely, the cost of goods sold.  What is not sold remains on the balance sheet as inventory.  A manufacturer with 40% gross margin is doing very well in most industries, although there are notable exceptions in pharmaceuticals and a few other manufacturing industries.

A 40% gross margin would mean that 60% of the cash inflow from sales is spent on inventory – inventory that is either sold or stored.  In fact, manufactured product (or at least the raw materials, components or intermediates/work-in-process) in every manufacturing operation is stored at some point before it is shipped to a customer.  That is why inventory turns or days in inventory (both relating inventory to sales through the cost of goods sold) are the most appropriate kinds of metrics for inventory rather than the absolute amount.

So, given the relative proportion of cash flow in the majority of manufacturing firms that is spent on inventory of one kind or another compared to, say the proportion of cash flow spent on travel, one might assume that the level of scrutiny and approval required for spending on inventory would be extraordinary and performed at the most senior level of the firm.  Is that true in your company?  Of course not.  Manufacturing and distribution operations would be paralyzed and servicing customers effectively would be precluded by such a bureaucratic approach.

Many firms, today, have a position called buyer/planner.  These are people who must determine how much should be procured, when, and where.  Purchasing or sourcing professionals whose mission is to make sure that the purchase price is minimized support the planning function, but purchase orders are issued by buyer/planners.

Even if “buying” is separate from “planning”, it is the planner who decides how much is needed when and where.

Planners do not rank among the highest paid employees, yet they are pulling the lever to spend the majority of the company’s cash flow.

Most planners today have access to advanced planning and scheduling (APS) tools which embed material requirements planning (MRP – I know this should be “little mrp”, as opposed to “big MRP” for manufacturing requirements planning, but allow me this convention here for visual ease) and distribution requirements planning (DRP) calculations to aid them in determining how much to purchase.  These tools are very helpful.  They are particularly helpful if the forecast is exactly right, if forecast error is always normally distributed, if stated transit lead times are always reality, if yields are constant, if service from one internal manufacturing or distribution point to another is always constant and known.  However, almost none of these conditions are ever true, and they are never true all at the same time.

So, not only do planners have to ultimately determine what to move, make and buy for every item in the bill of material (or formula/recipe) at every location in every future time period in the planning horizon, they must do so in an environment with many unknown inputs.

(At this point, I will include a plug for recruiting, training and retaining the very best planners – not vp’s of planning or directors of planning, but planners themselves since they are likely spending most of your cash!)

This problem is called multi-echelon, inventory optimization (MEIO).   MEIO is fast becoming a best practice requirement.  MEIO optimizes the answer to the very challenging problem of how much extra inventory a planner should plan to have at each location, for every item, at every level, given the many other unknown factors as well.  Put differently, “What is the inventory safety stock level that should be targeted for every item at every location, such that the cost of holding inventory for achieving a given service level is minimized.”  This question must be answered across all nodes while considering all of the unknown factors mentioned above.

When solved, the result is a lower required buffer inventory than could be planned with just MRP or APS in order to achieve an optimal service level.  That means more available cash and more revenue and profits.

Solving the MEIO problem remains a massive challenge for which many planners still do not have sufficient tools at their disposal.  However, algorithms have been developed and can be implemented through commercially viable software.  It’s also increasingly possible to build your own on and advanced analytics platform.  As MEIO continues to be adopted, more planners can go about their normal planning process of determining what to move, make and buy, but with a much better starting point, namely the amount of inventory buffer required at each item, location.  This buffer, or safety stock, already a standard row in a supply planner’s gross-to-net calculation in his or her advanced planning system, allows planners to perform their work without disruption while achieving significantly better results for the cash management of their firm – when populated through MEIO.

Questions:

1)      How do your planners account for the unknown factors in determining how much cash to spend on which inventory in which locations and when?

2)      Are you thinking about evaluating MEIO?  If not, why not?

3)      Can you afford not to pay more attention to where the majority of your cash flow is going?

Careful, Comprehensive Inventory Management (Part 4)

As a memory aid, I use A⁵6σ to represent such a careful, comprehensive, and corporate approach to inventory management.  Each component of A⁵6σ is essential for achieving sustainable, continuous improvement in inventory efficiency.  There are five concepts which I will alliterate with the letter “A” combined with the tools of six sigma.  Below, are the final points.  Please see my previous posts for earlier points.

Access – information and use it instead of inventory

Data is now more available than ever.  However, there are two key challenges in making use of it.  The first is the acquisition of data.  For everything, from where a particular serial number of an item is currently located in a supply network to syndicated data of leading indicators of demand, methods, technologies and markets exist for the acquisition of data.  Once you have the data, you must then organize, summarize, and analyze the data into information in such a way that better decisions can be made in less time.  As an example, knowing more about your customer’s demand sooner may help you operate your operations more effectively and efficiently to meet that customer’s demand when it actually comes to fruition.  Knowing the exact location of inventory as it transits and is transformed through your value network can, in some cases, help you respond more quickly to the changes in the market without adding more inventory.

Accelerate – continuously reduce lead-times and lot sizes

Whether you consider yourself a “lean” operation or a “six-sigma” shop or both (“lean six-sigma”), the reality remains that all manufacturers are obliged to constantly search for ways to reduce lead times and run times (batch or lot sizes) during which variation can occur.  This sometimes requires analysis of fixed versus variable cost such as the fixed cost to modify equipment so that change overs can be completed more quickly against the variable cost of carrying inventory for a longer time, or perhaps indefinitely.

6 σ – leverage techniques of process control reduce variation

In conjunction with continuously reducing lead-times and lot sizes, a careful and comprehensive approach to inventory management requires that you make use of what we have known for decades about statistics to identify variation (the reason for safety stock) and its sources, so that you can work continuously to reduce it.  As with the “Anticipate” process, you will reach diminishing returns, but your progress may not be linear or only incremental, and it will be difficult to anticipate when a step-function improvement will occur, so this is an ongoing responsibility.

So, there you have it, the A⁵6σ approach to inventory management.  In summary,

1. Anticipate market requirements
2. Account for your actions
3. Accurately calculate safety stock
4. Access information and use it instead of inventory
5. Accelerate by continuously reducing lead times and lot sizes
6. Leverage the 6σ techniques of process control to reduce variation

You need to do all of these in order to manage your inventory carefully and comprehensively.  I suspect you are careful and comprehensive in your approach to cash management.  Since you spend so much of your cash on inventory, it’s time to take an equally intelligent approach to managing inventory.

Careful, Comprehensive Inventory Management (Part 3)

As a memory aid, I use A⁵6σ to represent such a careful, comprehensive, and corporate approach to inventory management.  Each component of A⁵6σ is essential for achieving sustainable, continuous improvement in inventory efficiency.  There are five concepts which I will alliterate with the letter “A” and the tools of six sigma.  Below, is the third “A”.  Please see my previous posts for earlier points.

Accurately – calculate safety stock

We cannot know for certain what demand will be tomorrow.  Even organizations dedicated to consumption-based replenishment of “true demand” cannot know exactly how much will be required of which products, at which locations at which times.

Make-to-order businesses have an easier time of this, but, even then, orders can change and often do.

This is not only true of the demand, but also the lead time to meet the demand which is affected by variation in the ability of manufacturing to respond in a timely and accurate fashion (driven by batch sizes and setup times, by variation in the conversion process, and by other factors), and variation in the transportation operation (caused by traffic volume or accidents, road construction, weather, illness, and any number of other factors), not to mention the capability of warehousing to know what is exactly where and pick, pack and ship it in a timely way.

For these reasons, you must have more inventory than you will actually be needed if everything goes perfectly.

Any other approach implies the intentional loss of revenue.  Done poorly, this can put you out of business.

Fortunately, there are techniques for doing a good job of this through optimization.  Do a bit of research to identify the technique that fits the structure of your operations (single-tier distribution or multi-tier manufacturing, for instance) and get the analytical and software support (if necessary) to embed that technique into the normal planning process.  This can often yield a step-function improvement in both reducing the necessary investment of working capital in inventory as well as in improving customer service.

Combined with the set of decisions around supply chain flexibility with which inventory decisions are interdependent, decisions around inventory are essential to increasing the value of your enterprise.

You can find more on this in my published article, “Don’t Manage a Supply Chain, Lead a Value Network”, just published by the Journal of Enterprise Resource Management (http://www.apics.org.au/Default.asp?page=363).

Careful, Comprehensive Inventory Management – (Part 2)

As a memory aid, I use A⁵6σ to represent such a careful, comprehensive, and corporate approach to inventory management.  Each component of A⁵6σ is essential for achieving sustainable, continuous improvement in inventory efficiency.  There are five concepts which I will alliterate with the letter “A” and the tools of six sigma.  Below, is the second “A”.  Please see my previous post for the first “A”.

Account – for your action

This is perhaps the simplest, but yet most difficult aspect of careful, comprehensive inventory management.  When different functions of the business such as sales and manufacturing do not have harmonized goals, then inventory efficiency will suffer.  For example, if manufacturing is rewarded only for efficiency and overhead absorption, while sales is only rewarded for volume or even total margin dollars, and purchasing is rewarded for lowering per unit costs, then inventory is left to someone who does not have the ability to really influence it.  This is one of the benefits of a functional Sales and Operations Planning process that is supported by shared and consistent metrics across business functions.