Inventory Planning & Optimization: Extending Your ERP System Part Two: How It Works

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Inventory Planning & Optimization Solutions

Inventory optimization software is the most recent addition to the suite of Supply Chain Management (SCM) solutions. Software companies like JustEnough and i2 have emerged as leaders in this space. These solutions establish the optimal mix between inventory investment and service levels for each inventory item at each location within an organization.

Inventory Planning and Optimization solutions do not process transactions. Rather, they use the data from the existing ERP or Transaction system to allow managers to make better operational decisions and then execute against them.

These solutions are strategic planning and initial execution process tools that analyze all necessary information, past, present and future to build the ideal working inventory model. Users are then also given the ability through the solution to operate against the model, making dynamic adjustments along the way, to recover profit from inventory.

Advanced functionality typically includes:

  • Supply Analysis & Planning

  • Demand Planning & Forecasting

  • Inventory Modeling

  • Replenishment

  • Distribution and Re-Distribution

  • Collaboration

  • Analysis Tools

What does an Inventory Optimization solution do?

Inventory Optimization software finds the optimal level of inventory investment, for a given customer service level for each item of inventory at each location within an organization. Optimization balances supply to meet demand at the lowest possible cost (investment in inventory), using the least company resources, for a given service level, for each item at each site within the entire supply chain.

This is Part Two of a three-part note.

Part One contained an Executive Summary and discussed ERP Systems Today.

Part Three will present the Business Case for implementing these solutions and detail The Bottom Line.

Why are Inventory Optimization solutions so important?

Organizations today realize that although strategies focusing on outsourcing transportation, e-business and new distribution models are important, these are all secondary in relation to what lies at the heart of any supply chain: INVENTORY. Although firms have invested significantly in ERP and MRP systems in the last decade, overall inventory levels within the extended supply chain remain relatively unchanged.

"Inventory optimization software recovers profit from inventory by making it easier to eliminate excess stock, reduce lost sales and minimize the cost and time in doing so." (Source: )

Inventory management solutions free up company resources to focus on managing the business more efficiently and addressing other business challenges.

Inventories typically comprise 40-50% of a manufacturing or distribution organization's capital investment. Right-sizing this investment, without compromising service levels, provides management with a beneficial way of increasing ROI. Again this goes against conventional wisdom, which states that inventory reductions will not provide the same profitability increase as that of increasing sales.

"While sales are obviously important, ongoing inventory optimization practices actually afford the single largest opportunity to have a direct impact on profitability. Optimization of inventory can result in an inventory reduction of 30%, while also reducing out-of stock situations and ensuring that the correct stock is available to satisfy demand. These are benefits that can't be realized by increasing sales." (Source: J.Healy, Profit from the inside out,, 2002)

Traditionally, inventory management was measured by way of the number of times stock was turned. However, by focusing exclusively on this measure, organizations failed to take advantage of things like volume discounts and customer service levels.

To avoid simply getting more efficient at moving the wrong stock around, the trend is for Retailers, Distributors and Manufacturers to leverage their ERP investment by implementing relatively inexpensive and rapidly deployed Inventory Planning and Optimization solutions.

Characteristics of Inventory Optimization systems include

  • Lead time forecasting forecasts the most appropriate supplier lead time for any item or supplier.

  • Service level analysis information monitored includes demand history, demand variation, profit margins and lost sales.

  • Demand forecasting includes seasonality and life cycles, promotional filters, demand spikes, trend analysis and item profit margins.

  • Order frequency correct order frequency analysis can reduce inventory by 10 15%

  • Replenishment takes into account timing of the order, order point, potential overstock/under stock situations, promotional information, and production changes. Purchasing and inventory management established as a profit center.

  • Network aware inventory planning is done taking into account the requirements of the entire supply chain network including suppliers and customers.

  • Collaboration - new browser-based technology allows for planning through the participation of the entire supply chain community. This was previously not possible in the past, where systems were not open to integration. CPFR and VMI are now becoming commonplace.

Forecasting and Algorithms are an Important Element as part of a Complete Solution

Many of the ROI measurements below and the characteristics above rely on a key factor Forecasting. Any solution needs to have an excellent forecasting solution under the hood.

Forecasting is not to be confused as being used only in calculating demand. In fact, any good software will use forecasting for lead-time analysis as well, as this presents a key factor in replenishment decisions and hence proper inventory modeling. Forecasting should be used on a group level as well as individual SKU levels and exploded and collapsible respectively. Some innovative solutions use best fit forecasting by allowing different forecasts to compete with each other with the winning forecast being applied. Forecasts must be able to handle promotions and events, various causals from internal and external sources, and lost sales in order to be effective.

Another important area where forecasting and other algorithms are used is in safety stock calculations. One cannot stress enough the importance of safety stock calculations. Some vendors will do simple averaging, others some forecasting. Certainly a most innovative approach has been the adoption by JustEnough of neural network based algorithms that factor in a whole set of variables into the final calculation.

JustEnough emerges as a leader in the forecasting domain and related algorithms with its competitive approach of automated forecasting algorithm selection and neural network approach. i2, Manugistics and SAP's APO all require advanced programming and customization as part of implementation when doing forecasting. This is good in certain instances but is a very involved and specialized task. E3 copes adequately with some aspects of forecasting, its forecasting solutions do not always address complex environments.

How is the ROI of Inventory Optimization measured?

Inventory optimization systems add value by recovering profit from inventory in the following areas:

  • Increased profitability by avoiding markdowns and obsolescent write offs.

  • Lowered working capital cost of holding excess stock through redistributing excess

  • Better purchase order management.

  • Better cost management associated with space utilization, both at warehouses and stores.

  • Lower transportation costs through network planning

  • Eliminating excess stock by accurate forecasting of demand.

  • Increased s customer service levels.

  • Increased Customer spending based on increased availability.

  • Improved product mix.

  • Dynamically reduced safety stock and therefore holding costs.

  • Lost sales reduced.

  • Slow moving items treated accordingly.

  • Exception management and event management.

  • Lead time is critical and is better understood, with business managed better accordingly.

Other savings that organizations make, which are more complex to measure, but never-the-less can make a significant contribution include but are nor limited to automated functions that some software solutions will execute and leave managers to manage through exception, efficiencies within the organization, better planning and related shorter planning cycles, and the freeing up of cash flow.

This concludes Part Two of a three-part note.

Part One contained an Executive Summary and discusses ERP Systems Today.

Part Three will present the Business Case for implementing these solutions and detail The Bottom Line.

About the Author

Dirk Hooiman is a respected and successful consultant with over 28 years of industry experience in the areas of business process consulting, quality and strategic planning. He is currently a Senior Consultant with the Solutions Group, a business process consulting company. Mr. Hooiman is accomplished in Kaizen, PS 9000, Lean Manufacturing, and Six Sigma as well as working to install ISO 9000 and develop strategic plans in both manufacturing and technology companies.

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