Inventory Chain Optimization: The Next Dimension for Supply Chain Management

by William Benton

April 14, 1999

Many firms have invested time and money in a variety of technologies to increase corporate return on investments. These systems have enabled management to make better and more timely decisions, but this has still in many cases resulted in only modest reductions in inventory levels. The ability to quickly reduce such inventories gives management a great opportunity to quickly increase ROI.

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Inventory
Chain Optimization (ICO) technology is rapidly being introduced to supply chain
executives and is resulting in immediate and significant benefits well beyond
those expected and received from traditional supply chain systems installations.
ICO is a new approach being applied to inventories in the supply chain that employs
management sciences and modern information technology to raise inventory service
levels up to 99.9%, reduce total operating and financial expenses by up to 50%,
and drastically reduce workload. Actual ICO results obtained from a variety of
industries indicate that this automated process can be installed quickly and easily
into existing ERP and planning systems. This allows for significant benefits to
be realized in a fraction of the time required for traditional supply chain improvement
projects. ICO achieves what executives require: an automated process that provides
optimized inventory management, increased service levels, and ultimately increased
ROI.

What
is Inventory Chain Optimization?

In supply chain management,
specific policies and procedures are implemented to manage inventories at specific
locations (links) in the chain. Depending on where inventories are located in
the chain, inventory is classified as either supply or demand. The key to optimizing
supply chain management is to both optimize the information flow across the
chain and optimize the total inventory in the supply chain to meet customer
service level goals.

Click for larger image.
Figure
1.

Inventory Links in
the Supply Chain


Because the supply chain is
made of one or more links, the products flow only one way through the links from
the sources of raw materials to finished goods for the customers. The product
flow is controlled by the demand and supply transaction information flowing both
ways, back and forth, between customers, distributors, manufacturing raw material
sources, etc. Therefore, a supply chain actually consists of two fundamental and
functional flows: (1) The flow of transaction information and (2) the flow of
material and product.

Traditional supply chain
solutions, such as Materials Requirement Planning (MRP), Enterprise Resources
Planning (ERP), Inventory Control, and Supply Chain Management (SCM), typically
focus on implementing more rapid and efficient systems for reducing time and
costs for communication of information, between and across the inventory links
in the supply chain (see figure 1).

ICO focuses on optimizing
the total investment of material, costs, and workload for every inventory item
throughout the supply chain’s links, from the source of raw material to the
final customer finished goods inventory. Optimization means providing a “balance”
of supply to meet demand at a minimum total annual cost, minimum inventory level,
and minimum workload to meet customer service level goal for each item in each
link in the inventory chain. ICO ensures that the level of inventory planned
and held at each location link, given lead times and actual costs, are algorithmically
calculated to be at the optimal quantity and costs to meet the service levels
strategically selected by management for each item at each location link in
the supply chain. Figure 2 shows the balance needed to optimize an item in inventory
at each location. In such an optimal relationship, on-time delivery is defined
as delivery of the specific item, at the specified quantity to meet the customer’s
request date (see Figure 2).

Click for larger image.
Figure
2.

The Goal – An Optimized,
Balanced Inventory

Why is Inventory
Chain Optimization Important?


Considerable
capital has been invested in MRP, ERP, SCM, Inventory Control and other systems
with the intent of increasing corporate Return On Investment (ROI). Though these
systems have increased ROI through inventory reduction caused by more efficiently
expediting inventory movement and improving management decision making through
faster and more accurate information flow, there still remains additional improvements
which can be made by optimizing the inventory levels, costs and workload at
each link in the chain. It is interesting to note that during this past period
of corporate investment in such systems, inventory levels on a national basis,
as a percent of demand, have seen only a modest reduction. With inventories
comprising 40-50% of the average manufacturing or distribution company’s capital
investment, the ability to significantly reduce such inventories and their associated
costs and workload provides management with a great opportunity to quickly increase
corporate ROI.

The challenge lies in how
to reduce inventories without reducing service levels or increasing associated
costs, which may offset the benefits obtained through inventory reduction. ICO
meets this challenge and reduces inventories while simultaneously increasing
service levels and lowering costs and workload. Optimization is attained for
each item, at each location, by determining the optimized inventory and cost
per item to meet the most profitable service level in a systematic way (see
figure 3).

Click for larger image.
Figure
3.

Inventory Chain Optimization
Benefits

How
was ICO Developed?

ICO was professionally developed
after years of evaluating inventory and business management policies, practices
and procedures throughout many industries. From this extensive analysis, four
critical issues with traditional inventory management methods and processes
were identified as inherently inadequate if applied to today’s dynamic market
environment:

Management
Theory

With the advent of client/server
computer technology, corporations and international software companies went
forward with developing inventory planning and management systems by fitting
traditional inventory policies, processes and methods to run on computers. It
was rarely recognized that management sciences coupled with advanced computer
power laid the foundation for a significant paradigm shift in reengineering
the actual methods and processes used for managing, planning, and optimizing
the inventory chain. Therefore, these advanced MRP and ERP systems evolved using
traditional management theory.

Inventory
Management

Traditional
inventory management methods were driven from financial decisions in a top-down
management environment. This top-down approach drove management to focus on
such variables as inventory turns and targeted inventory investment levels.
These management rules rarely considered such issues as customer service levels
and their inter-relationship with lead times, total annual costs and workload.
In some cases, such top-down methods actually resulted in increased corporate
costs due to the extra effort to meet customer demands. Major costs were incurred
in operating advanced ERP and SCM computer systems to support the expediting
of replenishments because of inadequate inventory policies.

Demand Forecasting

Traditional
demand forecasting, used by management to plan inventories, had four inherent
over-simplifications that exacerbated the errors in forecasts:

  • Forecasting
    methods seldom dealt with the actual lead-time of an item.
  • Forecasting techniques
    were based on ad hoc calculations, which did not effectively deal with the
    volume of data required for a production environment.
  • Forecasting techniques
    relied on human judgement for forecast model technique selection.
  • Because of the complexities
    of the task, most forecasting policies dealt with aggregate data. Since demand
    patterns can differ for individual items at different locations, aggregate
    forecasting compounded forecast error.

Implementation

Even
though inventories typically account for 50% or more of a product intensive
company’s total assets, the typical senior manager had a limited understanding
of the actual impact inventory management decisions had on corporate earnings
and customer service levels. This was partially due to the inability of inventory
systems to provide senior managers with executive information that showed the
actual impact of business decisions on all links in the inventory chain.

Click for larger image.
Figure
4.

Inventory Chain Optimization

By recognizing the shortcomings
in traditional inventory management methods and the software used to support
them, ICO was developed. ICO not only resolved the major issues identified in
traditional inventory management and demand planning, but also fully exploited
the power of management science techniques in optimizing inventories. ICO differs
from traditional approaches to inventory planning by using the computer as a
powerful tool for deploying optimization techniques and expert systems technology.
ICO provides corporate management with an effective tool to better manage and
optimize the financial and operational performance of their inventory investment.
Utilizing ICO’s algorithm optimization processes, executive management is provided
with a powerful system to increase profits by simultaneously maximizing customer
service levels, minimizing total annual costs, reducing workloads and reducing
inventories.

When
Should Inventory Chain Optimization Be Considered?

The
major objective in managing a company’s inventory chain is to ensure the chain
has the optimum level and mix of inventory required at every link in the supply
chain to meet strategically targeted customer service levels. The targeted service
level must be met through identifying optimum inventory policies to ensure the
lowest possible cost with the least amount of workload. To do this, an effective
supply chain management system requires an ICO engine that optimizes all related
costs, workload, and inventory investment against the service level that management
has targeted for each customer and/or product line at each location in the supply
chain. When management’s focus is on optimizing all resources ­ costs,
workload and inventory ­ to meet targeted service levels, the traditional
control concepts of fixed safety stock and inventory turns must be replaced
by dynamic policies recognizing total costs and adapting to variability in both
supply and demand (see Figure 4).

Click for larger image.
Figure
5.

Dynamic Benefits of
Inventory Chain Optimization

Business leaders have begun
to recognize that traditional inventory management methods are inadequate to
meet the dynamic needs of today’s marketplace. They have recognized that to
reduce costs and improve ROI, they need to optimize inventories throughout the
supply chain. Although most existing SCM systems can leverage today’s computer
and networking power to enable processes to run faster, ICO has achieved major
success in increasing the accuracy of inventory levels, costs and workloads
through more accurate demand and supply planning methods. ICO systems are driven
by customer service levels. They create optimized demand and supply plans based
on optimized planning policies that consider the realistic and dynamic interaction
of all costs and other resources throughout the inventory chain to ensure customer
service levels are achieved as directed by management (see Figure 5).

Inventory
Chain Optimization Should be Considered When:

  • Business
    goals require greater service levels, lower costs, or lower inventories
  • Inventories and service
    levels can be used as a strategic tool (weapon) to maintain or increase market
    share
  • Customers demand higher
    (faster) customer service
  • Inventories are significant
    and not transitory
  • All data needed is available
    in the automated supply chain system
  • An evolutionary improvement
    process is sought for further investment in the business to obtain higher
    ROI

Where
Should Inventory Chain Optimization Be Utilized?

ICO
is being used in many product intensive industries, e.g. Aerospace, Telecommunication,
Computer, Electronic, Automotive, Chemical, Footwear, Apparel, Fashion Goods,
Government, Paper, Machinery, Medical and other product intensive businesses.
Several types of inventories are good candidates for Inventory Optimization
such as:

  • Raw materials
    at supplier
  • Finished components
    at supplier
  • Raw materials at plants
  • Finished components
    at plants or resale points
  • Finished goods at plants
  • Finished goods in master
    warehouses
  • Finished goods at distributor
    warehouses
  • Finished goods in vendor
    managed inventories (VMI)
  • Packaging supplies,
    labels, etc…
  • Service and repair parts
    (MRO)

Corporate
Successes from ICO

Companies have taken advantage of the flexibility of implementing
ICO for selected inventories that maximize profitability across the supply chain.
The following examples are representative of corporations benefiting from ICO.

Example
1: A Global Supplier of Consumer Appliances

This
manufacturer of water coolers and dispensers supports a dealer-distributor network
of almost 5,000 companies in 14 countries. To meet the demands of these dealers
and distributors this company was using traditional ERP and demand planning
systems. However, these systems were unable to fulfill up to 30% of customer
orders in three days (the industry standard fulfillment time). To improve business
performance, the company front-ended its ERP system with the ICO solution. Through
using ICO, the company was able to optimize service levels to 99.9% fulfillment
in 48 hours or less. Due to the consistent reliability of ICO to balance inventories,
this manufacturer was able to announce to its customers that it would deliver
in “48 hours or the product was free.” This ICO-based market strategy enabled
the manufacturer to increase market share by over 34% in an 18 month period.
This significant increase in service levels was achieved while simultaneously
reducing inventories 40% in the first 10 months and by reducing operating costs
by 28%.

Example
2: An International Distributor of OEM Engines and Engine Parts

This
distributor was faced with a significant challenge: in order to maintain and
grow their market share in North America, it needed to significantly increase
its customer service levels. The distributor had already invested a significant
amount of time and resources in an ERP solution, but was not seeing significant
improvements in service levels or inventory reductions. Less than 12 months
after implementing the Inventory Chain Optimization solution, the company saw
a 22% increase in customer service levels as measured to the standard of “on
unit, on quantity, to the customer’s initial request date.” This increase in
customer service level was accompanied by a 17% increase in sales revenue. While
achieving these benefits, the company was also able to reduce operating expenses
associated with expediting and materials management by 23%.

Example
3: A global Supplier of

Service Parts

This
international provider of paper manufacturing equipment previously required
very large inventories of service parts to ensure a high level of maintenance
service to their installed equipment base ­ in hundreds of locations world-wide.
Inventory Chain Optimization allowed the company to reduce its spare parts inventories
by over 60% while increasing and maintaining exceptional service levels to its
customers. Total costs were reduced over 50% and workload for planning and expediting
were cut in half.

About
the Author

Mr.
Benton
is Chairman and Founder of GAINSystems and has over twenty years
of professional business and consulting experience. He is recognized as an international
speaker and the author of Inventory Chain Optimization. He maintains consulting
relationships with many Fortune 1000 companies and government organizations.

Mr. Benton has extensive
experience in developing and managing improvement programs in several major
functional areas, including strategic, tactical, and organizational planning,
business systems development, data processing, inventory and manufacturing management,
supply chain management, logistics, inventory distribution, telecommunications,
budgeting, and business controls.

In the area of inventory
management, Mr. Benton has management expertise in the fields of inventory control,
procurement and distribution systems development, and order processing systems.
Through working with over 400 companies in the past twenty years, he has earned
recognition as a pioneer in developing optimal processes for demand management,
supply management, multi-level forecasting, inventory management, and distribution,
and is the author of the General Adaptive INventory System (GAINS®) for
optimizing management of inventory chains. GAINS embodies a concept that employs
management sciences and expert systems technology to maximize service levels,
optimize costs, reduce inventories, and reduce workload.

Mr. Benton holds a Bachelor
of Science degree in Industrial Engineering from Purdue University, a Master
of Science degree in Industrial Engineering Operations Research from the Illinois
Institute of Technology, and is a registered Professional Engineer. Previous
professional experience includes the position of Managing Principal and Director
of Management Information Services for a major international consulting firm.
He also directed the Systems Development and the Operations Research departments
for a leading international manufacturer. Prior to that, he worked for several
years as an Industrial Engineer in the steel industry, and as Assistant Professor
of Technology at Purdue University.

Mr. Benton has served as
a member of several professional societies, including the American Management
Presidents Association, the Institute of Management Sciences, the American Production
and Inventory Control Society (APICS), the Council for Logistics Management,
and was appointed an officer with the Institute of Industrial Engineers. He
is a frequent speaker before business groups and professional societies.

GAINS®
is a wholly owned proprietary system by GAINSystems, headquartered in Naperville,
IL USA

GAINS and GAINSystems
are registered trademarks of GAINSystems

Copyright© GAINSystems
1971-1999

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