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Inventory Planning & Optimization: Extending Your ERP System

Written By: Dirk Hooiman
Published On: April 4 2003

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Executive Summary

Enterprise Resource Planning (ERP) systems are developed primarily for transaction processing, data collection and data reporting. By design ERP systems are designed to broad in their breadth of offering which results in being shallow in depth of specialized functionality such as Inventory Planning and Optimization.

Often there is a misconception that Inventory Planning & Optimization software performs the same functions as the MRP (material requirements planning) module, the Item Master modules and ordering module of an ERP system. Some of these differences between an ERP and the value of Inventory Planning and Optimization Solutions are explained in this document.

A good way to introduce Inventory Planning and Optimization (Inventory management) may be by quoting a well known Supply Chain book: "Competitive advantage will increasingly stem from a firm's ability to deliver the right product to the right place at the right time, at the right price. Recent studies show that customers are increasingly substituting brand loyalty for availability" (Source: M. Christopher, Logistics and Supply Chain, 2nd Ed, Prentice Hall).

The implication is that companies with superior supply planning and execution systems will end up getting the lion's share of the market. As Forrester Research notes, "As the flow of goods more closely matches demand conditions, companies are able to trim inventories, improve customer satisfaction, and avoid nasty surprises" (Source: C. Mines, Six New Technologies to Boost Business Results, Forrester Research, May 2002)

In addition current trends around inventory management are:

  • Manual inventory reduction policies These crude policies have come at a cost to customer service levels.

  • Mass customization - The range and variety of products available to customers is unprecedented.

  • Shorter product life cycles When demand does not meet forecasts, inventory write-offs are the result.

  • Market leaders invest heavily in technology and advanced planning systems - Leading companies like Wal-Mart and Dell, who make use of advanced SCM solutions have higher inventory turns than their industry competition.
Leader - Inventory Turns Laggard Inventory Turns
CPG Suppliers Procter & Gamble - 6.43 Johnson & Johnson - 3.07
Technology Dell - 64.34 Compaq/HP - 14.84
Contract Manufacturers Flextronics - 8.86 Solectron - 4.92
Retailer Wal-Mart - 7.29 K-Mart - 4.39

Sources: Zacks investment Services and Forrester Research Figure 1 Inventory Turns widely Differ in Industries

Since 1998, Retailers, Distributors and Manufacturers having been introducing supply chain management (SCM) software, specifically designed to enable firms to better manage the planning (SCP software) and execution (SCE software) of supply chain functions. Figure 2 shows the various functional options available in the SCM market. The black eclipse shows the area of Inventory Planning and Optimization.


click on image

(Source: SCM applications marketplace source: Piper Jaffrey Inc.)

Main vendors in this space, such as SAP APO (Advanced Planning & Optimization), i2 Technologies, JustEnough, E3, and Manugistics are referred to in this document. Whilst some of the above companies provide tools in other aspects of SCM, the document limits its scope to the Inventory Planning and Optimization area.

This is Part One of a three-part article. Part Two will discuss Inventory Planning & Optimization Solutions. Part Three will present the Business Case for implementing these solutions and detail The Bottom Line.

ERP Systems Today

ERP systems were developed in the 1970's to allow large companies to automate the processing of transactions related to business functions like finance, order processing, human resources and material requirements planning. Companies like SAP, Baan and JD Edwards were among the first to explore these opportunities. ERP systems were designed to allow a single software package to replace disparate and obsolete software within the corporation.

The late 1990's saw a huge growth in the adoption and implementation of supply chain planning systems. ERP vendors have added new SCM modules onto their core product suites and are aggressively marketing this new functionality.

AMR Research recently estimated that through 2006, ERP revenue growth rates would be 10% compounded annually. However, of this, the majority of revenue will come from SCM and CRM (customer relationship management) modules. The SCM market on the other hand has been growing at close to 50% annually since 1998 (Source: J.Surmacx, Mix and Match ERP, cio.com June 2002). Where SCM was once viewed as a means to gain competitive advantage, companies now see it as a necessary extension of an ERP system.

As Forrester Research recently stated, there were a six "ripening technologies" that they noted would "intersect with business technologies". The 1st mentioned was "Coordinating Supply and Demand Chains", wherein it was stated that "smart agent software would become event driven and self-regulatingnew continuous demand management applications and practices that predict, manage and reduce variability on the demand side." (Source: C. Mines, Six New Technologies to Boost Business Results, Forrester Research, May 2002)

The following reasons outline why ERP vendors have added SCM functionality to their product:

  • Execution Focus
    ERP systems were developed for transaction processing, data collection and data reporting. Users who accessed the ERP database looking to make critical supply chain decisions where overwhelmed by the sheer volume of content.

  • Poor Flexibility
    Assumptions regarding operating constraints such as lead times and safety stock are often hard-coded in ERP systems. Inflexible plans created under these conditions are not favorable to optimizing results for a Customer's particularly unique complexities.

  • Planning is One-Dimensional
    ERP systems normally employ some flavor of MRP (Material Requirements Planning) or MRP-II (Manufacturing Resources Planning) for internal supply chain planning. Unfortunately these methodologies are sequential in nature, which makes them unsuitable for considering multiple dynamically changing constraints such as varying lead times and incorporating real demand into their equations.

Plans created by sequential techniques are rarely optimal on the first attempt. Because organizational requirements change consistently, sequential planning can never produce a truly optimal plan for any useful period of time.

This concludes Part One of a three-part article.

Part Two will discuss Inventory Planning & Optimization Solutions.

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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