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Why operations need to change the way they approach inventory management

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article image Mike Reed

Mike Reed, Managing Partner at business improvement consultancy, Oliver Wight International discusses the need for organisations to manage their inventory better to ensure effective supply chain management.

A typical situation would involve the business stopping production until inventory is cut to an acceptable level, only to find a few weeks later that customers are unhappy they can’t get hold of the products they want. Production is restarted and run flat out for the next few months to try and recover the supply position resulting in more inventory than it started with.

Mike Reed argues it doesn’t have to be like this; by properly analysing its decisions on service levels, cycle times, utilisation of production capacity and safety stock, an organisation can ensure it is always carrying the right amount. Though it may sound straightforward, getting to such a position requires more integrated processes and behaviours, as well as some thinking outside of the box.

A company first needs to define its optimum inventory level. All too often organisations rush straight in to remove visible inventory (cycle stock, safety stock, pre-stocking and hedging stock), when efforts need to be concentrated on the rest, which can be as much as 25 per cent. Simply removing unknown inventory at a stroke is also not the answer. Trying to remove inventory without tackling the root cause is like tackling the symptoms of an illness before the diagnosis.

Inventory is generally a consequence of one of three things: variation between supply and demand; the inefficiency of people, process and tools; or tactical company decisions. The inventory held by an organisation is typically a consequence of the decisions made months, years, even decades ago. When they make these decisions, companies fail to recognise the long-term impact they have on inventory, and instead arbitrarily set targets on the basis of a certain number of weeks’ coverage leaving those involved in day-to-day inventory decisions with no understanding of, or control over, the levers affecting inventory targets.

Organisations need to look beyond the immediate execution window and consider all supply variables before making critical decisions. An integrated management process, such as Integrated Business Planning (IBP) can help to achieve this. IBP puts great emphasis
on assumptions management and scenario planning, to ensure decision-makers consider all the available alternatives. The integrated overview IBP provides, coupled with the rolling 36-month horizon, allows greater understanding of the impact overriding business goals have on inventory levels, thus empowering the management team to change them.

One such business goal is service target levels. Increasing service levels means carrying more safety stock to avoid letting the customer down. In an ideal world every organisation would have 100 per cent service levels; the reality is many have to settle for 95 per cent at best. To determine an acceptable service level the company should benchmark itself against the competitors and consider what the market expects. For many a small drop in service levels will have a significant positive effect on inventory levels.

Safety capacity is another option often overlooked by businesses. Most organisations see inventory as their
only option to buffer poor supply performance and provide the flexibility to satisfy unforecast demand. But in fact, investing in safety capacity, as part of the supply strategy, can be a cheaper option. Rather than maximising asset utilisation, reducing planned capacity slightly and having the ability to ramp it up when demand requires can provide a good alternative.

Even managing the details of safety stock can have a substantial impact on inventory levels. Many businesses carry a generic two-week safety stock for every product in their portfolio, but it’s important to consider the significance of each individual product. By understanding the true variation of demand and supply one can make strategic decisions over where inventory is needed and where it can be reduced. Customer requirements may demand three weeks’ worth of safety stock for some products, while others, particularly those with little demand variation, may need only one or perhaps even less.

The key to gaining a better understanding of true variation of demand lies in demand and supply taking joint ownership, which for most organisations will involve a huge cultural change wherein departmental barriers need to be broken down, the blame culture eliminated, and a team-based environment created.

Integrated Business Planning helps tackle these paradigms because it demolishes traditional organisational barriers and creates a structure based on integrated processes. But to realise the full advantages of having integrated processes and teams, a change management programme needs to be implemented in parallel.

As supply chains become longer and more complex, and global economic volatility remains, taking control of inventory is essential to cost-effectively meet the demands of today’s consumer. Effective inventory management involves strategic thinking, integrated processes and a team culture, but if an organisation can truly change the way it thinks about inventory it has the power to become far leaner and more agile, ultimately providing a massive competitive edge. 

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