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).

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Careful, Comprehensive Inventory Management (Part 1)

Manufacturers and distributors usually spend most of their cash on inventory.  In fact, many service organizations like utilities and health care delivery organizations spend lots of money on materials.  But in the case of manufacturers and distributors, just look at the cost of goods sold as a proportion of sales, compared to any other item.  Given that reality, the better part of wisdom mandates a careful and comprehensive approach to managing inventory.

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.  Here is the first “A”.

Anticipate – anticipate market requirements

The more you are able to accurately anticipate the demand by your end customer in the marketplace, the more you will be able to move, make, buy and store the inventory that will sell quickly.  This may seem like a self-evident axiom, but this is not easy and the benefits of incrementally better anticipation go directly into additional revenue as well as more efficient inventory and use of cash. Large bodies of knowledge have been built around this subject from rigorous quantitative models for forecasting to methodologies for collaborative forecasting, both within an organization and across organizations.  The point of diminishing returns can be reached fairly quickly, but if you are not there, it may be your most significant leverage for improved supply chain performance.

Sales, Supply and Operations Planning

If you read much on this topic, you have started to see an increasing number of articles, columns, and presentations about Sales, Inventory and Operations Planning, or SIOP for short.  This is particularly true if you read some of the collateral from some software firms, some consultancies (e.g. Accenture, I believe), and probably some of those self-declared omniscient ones, the industry analysts (I will leave the potential examples to your imagination).  For a moment, I would like to examine why that emphasis makes sense in a way that has not been adequately represented (as far as I know) to date.

Sales planning, broadly speaking, is about determining which customers to serve, through which channels, for what they will demand, at what price (strategic pricing strategy).  The execution of this plan results in revenue.  Operations planning, focused on making, storing and transporting product, determines where to place what manufacturing capacity, from where to distribute to where, and how to transport product in service to the sales plan.   The result is operational costs.  Sometimes missing from this equation is supply planning and management which determines how much stock to position where and when, for each level in the bill of material (or formula/recipe), as well as where and from whom to source, when and how to execute strategic purchases, and how to structure contracts for minimal risk and maximum flexibility.  The result of the supply plan directly affects cash because most manufacturing companies spend the majority of their cash flow on inventory, most of which, hopefully, is sold and appears on the income statement as the cost of goods sold.  What is not sold (always more than planned) appears as inventory on the balance sheet.  Inventory is one of the key drivers (along with cash, accounts payable, and accounts receivable) of working capital requirements.  If working capital requirements can be reduced, then cash flow can be spent on innovation, capital equipment, and other opportunities.  The supply plan also manages the risk from the supply base and creates opportunities for the business through strategic supply management.

So, then, S&OP is really more about Sales and Supply and Operations Planning (SS&OP anyone? . . . I know that sounds like an industry “analyst” making up another redundant acronym, but it sounds better and is more descriptive than SIOP).  Anyway, my point is supply planning, including planning for safety stock to account for uncertainties in both demand and supply, as well as how to minimize risks from the supply base and leverage opportunities with suppliers has a disproportionate impact on working capital, operational risk and flexibility within your value network.  Typical S&OP often omits these interdependent variables and decision sets and their huge potential impact on the value of the company.  This decision set which I am calling supply planning and management is interdependent with both sales planning and operations planning so that no one of these decision sets can be properly considered without incorporating the other two.

Find more of my thoughts on S&OP here:  http://www.apics.org.au/Default.asp?page=343 or here:  http://arnoldmarkwells.com/images/Sales_and_Operations_Planning_The_Key_to_Continuous_Demand_Satisfaction.pdf

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