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Overcoming Chemicals Industry Challenges through Optimization of Distribution and Inventory

Written By: Predrag Jakovljevic
Published On: May 11 2006

Optimizing Distribution and Rationalizing Inventories

Most chemical companies are still unable to profitably respond to highly variable demand, or to execute predictable product supply strategies. A previous note, So What's the Big Deal with Chemicals?, presented the current state of the chemicals industry, including a discussion of the challenges the industry faces.

Part Two of the series So What's the Big Deal with Chemicals?

Optimizing the distribution network and rationalizing inventories at each point in that network are hence the keys to an efficient supply chain and smoother operations. An optimal inventory targeting capability that calculates all the components of inventory at every point in the supply chain, and that then compares historical forecasts to actual sales data, and models all the processes that contribute to inventory, should allow users to quickly identify problem areas and make adjustments that decrease inventory without reducing customer service. As for maximizing inventory efficiency, at each point in the supply chain one should get the information needed to determine optimum inventory levels, and redeploy the excess to improve service at high-priority locations.

Additionally, some optimization tools should help companies minimize the combined costs of manufacturing and holding inventory, without necessarily sacrificing service. These tools must allow users to examine all the factors that contribute to inventory and production costs, such as cycle times and cycle stock levels, production line transition costs, inventory tradeoffs, and so on. By using the cycle optimizing tool, production planners should be able to determine optimal policies for product frequency, cycle length or production campaign length, as well as target levels for cycle and safety-stock inventories. In this way, it might be possible to set realistic inventory policies that support both good service and good profit margins.

Furthermore, industry roles are fluid and ever-changing, given that nearly 30 percent of chemicals sales are to other chemical companies. The largest players are typically basic life science (pharmaceuticals and agrochemicals), industrial gases, and specialty chemicals (perfumes and cosmetics, paints and ink, soaps and detergents, dyes and pigments, and so on) producers. The rest are critical middlemen, who process and add value to basic commodities, and resell the still unfinished products for further processing. Some large companies might sell the product of their commodity division to their specialty division (thus becoming their own major customer), or they might sell basic commodities to an intermediary and then buy back the finished product for further use by the specialty division.

On the other hand, the manufacturing process is often the weakest link in the supply chain as a whole, since component products and semi-finished materials require long lead times that impede quick-acting demand-driven principles. Manufacturers can do very little to accelerate the subassembly processes, since the laws of chemistry (in other words, the processing times) are largely inflexible, posing challenges for manufacturers who want to integrate their demand forecasting, sales teams, plant floor personnel, and so on. It is thus not that uncommon for fierce competitors to temporarily partner so as to reduce costs: they will often swap a commodity in one location for the same one in another location. Tracing these complicated transactions is very difficult, the more so because of the fluctuating prices of these commodities.

Production Planning and Scheduling

In addition to inventory management, effective production planning and scheduling is the other required core competency of competitive chemical supply chains. But, as in the aforementioned case of inventory management, the growing complexity of the chemical industry has made achieving this goal more challenging, due to the need for long-term upstream scheduling with short-horizon finished product plans. Accordingly, savvy production planners should know how to reshape plans smoothly and responsively, without breaking the rhythm of the plant, and they should be able to visualize the impact of a planning decision on the entire supply chain. Competent scheduling software has to be built on a production model unique to chemical operations, with features like product-to-product transitions, lot quality variability, cycle and campaign simulation, tank farm and complex storage modeling, available to promise (ATP), capable to promise (CTP), and sales monitoring, all in a production environment that runs at maximum capacity.

One should be able to obtain aggregated and detail views of the supply chain model for decision support during sales forecasting, production scheduling, and product distribution. Also, there is often the need to stabilize production cycles in a "make to inventory" business, through calculated inventory target levels based on planned customer service levels. These levels typically must calculate inventory target levels at the product, package, and location level, and show the aggregate inventory levels required for a business to support a given service level.

Management of inventory at customer and other consignment locations, with customer specifications of quality, packaging, and transportation, is also often required. Additional intricate features that the system should support include variable scheduling horizons (to decouple packaged from bulk material); rate-based production (long batches); the handling of flow rates from feedstock to bulk (rail cars and barges); pipeline versus "on-hand" inventory management; the modeling of unprocessed materials (including recycles and multiple produced items) from a single feedstock; the ability to find equivalent products, locations, and packages; and so on.

Producing chemicals typically involves all of the three common physical states of ingredients, namely, solids, liquids, and gases. From a formula and mixing perspective, this necessitates an impeccable unit of measure (UOM) conversion engine. Whether the formula requires conversion of US measurements to metric or imperial measurements, liquids to solids, or gases to liquids, such conversions should be transparent to the production of the finished goods; in some instances free form conversion tables can be extremely useful. The aforementioned ATP capability comes in handy here for providing a tool to almost instantly analyze and commit customer orders while keeping an eye on profitability; users can also instantly determine if an order is within forecast, and see the best way to fulfill the order (whether from existing inventory, planned production, or alternate sourcing locations).

Furthermore (principally in specialty chemicals), customer service is increasingly becoming the differentiating lever, since beyond the trend toward consignments or vendor-managed inventories (VMI), customers are demanding services that go far beyond mere delivery and replenishment. For instance, a sanitation chemicals maker might sell, procure, manage, and ultimately dispose of its products on behalf of its hospital customers, while a paint producer might oversee and operate spray painting facilities within auto assembly plants of customers.

Research and development (R&D) is steadily becoming more about customer service than about mere product and process innovation, and might include developing unique products for preferred customers. New product development, at least for specialty chemicals, is often more about a one-to-one relationship with the customer and understanding its need than it is about building a better molecule, since in this industry, brands matter much less than in, say, the retail or automotive sectors. Brand loyalty is not what keeps customers, but rather the right price, along with an accommodating relationship (for example, consignment inventories), and, especially for specialty chemical manufacturers, special customer care and service, bundled with the ability to develop proprietary ingredients.

Consequently, defining and formulating recipe-based products requires industry-tailored solutions to adequately allow product development. Effective recipe management is a must, which means developing, perfecting, and protecting franchise products, their potential successors, and the failed prototypes that preceded them. Many specialty chemical producers, for example, are still struggling to compare development and production costs (factoring in the impact of manufacturing capacity and supply chain speed) against the potential value of a new product. Combining process-industry-oriented product lifecycle management (PLM) capabilities with counterpart process-manufacturing-oriented enterprise resource planning (ERP) capabilities can produce a unified sample management solution that would allow free-of-charge product samples (for evaluation purposes) to be shipped in the same manner as commercialized products.

Combining these PLM solutions with process-manufacturing-oriented supply chain solutions could further provide unique recipe optimization capabilities for evaluating current inventory to develop least-cost or best-fit product formulations or recipes, and thereby accelerate the process of new product development and introduction (NPDI) or new product development and launch (NPDL). This will help achieve globally compliant products with lower R&D costs and a shorter time-to-market.

In the domain of specialty chemicals in particular, the NPDI process wins more business by recognizing and exploiting a customer need for more (for example) adhesives, flavoring or scenting agents, polymers, and so on, than from trailblazing a new market with a purely technological innovation. Faster time-to-market and time-to-volume means a greater advantage for these companies over their peers—and a greater chance to gain market share, since in many chemical companies (and particularly in specialty chemical companies) every order may represent a new product. For example, it might suffice to tweak an existing formula, or to replace one chemical ingredient with another chemical ingredient, but this places three demands on the functioning of the software.

First, since the resulting chemical is being produced for the first time, a quote would normally be required; consequently, the software needs to have the ability to easily convert prospective quotes into firm orders and trigger an event in the production schedule. Second, since new formulas will be needed, the maintenance and management of formulas needs to be streamlined and responsive to customer inquiries, possibly while the customer is still on the phone. Templating ("copy from/to") would be a useful tool in this regard; one would start with an existing formula as a template for the new formula, and make ingredient changes as warranted. And third, to complement the templating concept (and because many chemical properties are interchangeable), a suggested ingredient substitution would facilitate the production process. Automated or suggested ingredient substitution could allow the user company to fulfill customer orders that otherwise would have to be abandoned or, at best, delayed.

Lagging in Data Integration

However, the chemical industry customarily lags behind other manufacturing sectors in terms of data integration and reconciliation, in terms of creating comprehensive and accurate customer profiles. Consequently, there has been a lack of ability to prioritize customers and answer the basic question of whether the customer is worth keeping after all. There is an increasing awareness of the need for a customer segmentation that would grant a high degree of attention for the most profitable customers, while using more efficient means (such as an e-commerce Web site, price increases, or additional surcharges) for high-cost, less profitable customers—and even abandoning the worst ones. Many rightfully wonder about the point of squeezing costs out of the manufacturing and upstream supply chain, if the company cannot manage its transaction margins (see Applications Giants Bolster Their Pricing Management Capabilities).

Thus, savvy chemical companies are using sales and operations planning (S&OP) processes to better anticipate and more profitably respond to demand, but they are also prioritizing the use of price optimization to develop price elasticity (customer sensitivity) curves to outline price or volume tradeoffs, linking these to sales contract and raw material purchase contract compliances and risks. Also, given their fluid and often competitive relationships with other players, they also try to develop plans to sell excess capacity in sluggish times, profitably allocate capacity in boom times, and identify which products need to be manufactured and which need to be bought as finished goods (outsourced) from other chemical suppliers. This last need may be driven by the requirement to satisfy contractual elements, which often make up the majority of sales volume, and constrain opportunities to change product mix.

Of paramount importance is an efficient optimization engine that can map the demand forecast across the supply chain, and provide sales and production plans that accommodate capacity limitations while maximizing profitability. Product and customer mix can then be analyzed interactively to find a business blend that improves equipment use, and alternative scenarios can be easily run to assess the impact of various customer and production options.

Don't Forget Environmental Regulations

Environmental regulations impose strict monitoring and production restraints; the manufacture and use of hazardous chemicals requires strict adherence, especially in North America and the European Union (EU). The chemical industry (and companies that rely on chemicals within their plants) must address a myriad of new regulations, including the Restrictions of Hazardous Substances Directive (ROHS), and other regulations that require compositional analysis, the development of material safety data sheets (MSDS), environmental analysis, and hazards identification.

The chemical industry faces particular scrutiny from a regulatory perspective. Companies have been discussing the impacts of various programs, including European Classification and Labeling Inspections of Preparations including Safety Data Sheets (ECLIPS); Registration, Evaluation and Authorization of Chemicals (REACH); Science, Children, Awareness, Legislation and Evaluation (SCALE); and Global Harmonized System for the Classification and Labeling of Chemicals (GHS). For more information, see Process Manufacturing: Industry Specific Requirements; Part Two: Chemical.

Mission-critical processes that contribute to the cost of doing business include implementing (and ensuring compliance with) employee safety guidelines; implementing food contact rules; monitoring emissions (this is often delineated by regulatory permits); and even validating the origin and composition of products. In other words, the introduction of hazardous materials and dangerous goods (which are closely regulated and must be reported) constitutes a new complexity for chemical industry process manufacturing: this creates two conditions that can be greatly simplified by software.

First, when creating a new formula or modifying an existing one, the formula must be analyzed for the presence of hazardous materials. This check requires a continuously updated and current list of regulated materials that are considered hazardous. Also required is the percentage of these materials relative to the other ingredients. Secondly, the reporting of hazardous materials must comply with a specific format, namely MSDS; these sheets will usually accompany the customer's bill of lading (BOL), and therefore must be integrated with the billing process. While MSDS copies can be kept on file and manually matched with the BOL, most companies will not want to risk noncompliance and would rather seek an automated remedy. Companies who like to haphazardly "live on the edge" will rely on manual procedures to determine when a formula or product requires an updated MSDS.

More prudent companies, however, will seek to have update notification incorporated in their enterprise-wide software, along with a new, automatically generated MSDS, as needed. The programming of hazardous material compliance is not trivial, particularly when one considers that it involves list processing and matching, percent of total analysis, scheduling, and formatting. Bolt-on solutions do exist, but because of the requirement for tight integration, it is hard to argue against an enterprise-wide software solution that includes this functionality straight out of the box. Depending on the importance of formula analysis and MSDS reporting within the user organization, the inclusion of this functionality in a software offering could be a deal maker or, at the very least, a tie breaker. Also, each mode of bulk chemical transportation, including rail, truck, and marine transportation, must comply with regulations and safe-handling specifications.

About the Authors

Predrag Jakovljevic is a principal analyst with Technology Evaluation Centers (TEC), with a focus on the enterprise applications market. He has nearly twenty years of manufacturing industry experience, including several years as a power user of IT/ERP, as well as being a consultant/implementer and market analyst. He holds a bachelor's degree in mechanical engineering from the University of Belgrade (Yugoslavia), and he has also been certified in production and inventory management (CPIM) and in integrated resources management (CIRM) by APICS.

Olin Thompson is a principal of Process ERP Partners. He has over twenty-five years of experience as an executive in the software industry, and has been called the "father of process ERP." He is a frequent author and award-winning speaker on topics such as gaining value from ERP, SCP, e-commerce, and the impact of technology on industry. He can be reached at Olin@ProcessERP.com.

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