Inventory Optimization: Five Steps to Improve Process Effectiveness

Amidst the recent continued economic volatility, C-level executives’ focus has shifted from revenue growth to profitable growth, and hence global supply chain performance has gained a great deal of attention. As global supply chains are devising ways and means to respond to unpredictable customer demand and increased competition, one of the greatest challenges they face is achieving inventory optimization while maintaining higher customer service levels and reduced variable costs.

In my experience of working with a number of clients in the energy and chemicals market within manufacturing, in addition to some in the consumer packaged goods (CPG) and pharmaceutical markets, I have observed some common challenges facing these industries, including:

Ineffective Master Data Management: Data definition and data quality are common pain areas across industries, driven by acquisitions (multiple disparate systems) and lack of data management practices. These organizations are sitting on a pile of data, without being able to use this data for effective decision making. For example, almost all of the clients I worked with had inaccurate procurement and manufacturing lead times in their transactional systems, leading to judgment-based inventory planning. Inaccurate planning leads to frequent expediting and de-expediting and the resources were constrained by available capacity. To free up capacity, each component in the value chain buffers the lead time component and this lead to excess ordering and stocking to meet customer service levels.
Individual goals not aligned to overall objectives: While all of the clients I worked with believed that cycle time reduction would bring a competitive edge to their business, and had an overall objective of reduced order-to-delivery cycle time, individual elements of the overall cycle time did not have any goals around lead time adherence. Similarly, procurement and logistics functions were measured on cost savings only, while CXOs’ objective was to improve customer service levels and working capital. There were no processes around supplier or freight forwarder performance management on fulfillment or lead time adherence, or the processes were so ineffective that it didn’t drive any actions or behavior.
Lack of communication and collaboration: Whether it’s within the organization or between supply chain partners (customers and suppliers), lack of communication and collaboration was one of the top three challenges across industries. Here’s a typical example: New product development or R&D developed a new product without involving procurement, which resulted in procurement of customized parts from specialized suppliers, resulting in higher total cost of ownership. In some cases procurement was involved during new product development, but quality control were not informed of the raw material testing requirements. This resulted in material rejections and a poor supplier relationship.

To address these challenges, I recommend a five-step structured approach to set up an effective global inventory planning and control process, as follows:

1. Take a business assessment

Assess business functions and processes in their current environment. Start with an understanding of the current order-to-delivery (OTD) process. Devising a future state while identifying gaps and improvement opportunities will set the momentum to accelerate change acceptance among the cross-functional teams involved, including sourcing, planning, commercial operations, stockroom and manufacturing. Key activities in this stage should include:

Study “As-Is” planning and execution process within the OTD process. Aim to have an unbiased assessment of current processes and practices. Start by interviewing a representative set of stakeholders who perform the same job within each function of the OTD process. Follow up with brainstorming sessions that involve key stakeholders from each function, which will help them understand their upstream and downstream process and address any issues arising out of lack of clarity of roles and responsibilities. These stakeholders should also voice their opinion on the desired “As-Is” state to establish a baseline against which improvements can be measured, and to effectively manage change through shared responsibility among their teams. Organizations should also consider conducting lean workouts among a cross-functional team of subject matter and Six Sigma process experts to understand redundant and non-value-added steps in the process due to multiple hand-offs between various functions within the OTD process.
Summarize findings and gaps in data, process and practices. One of the ways to effectively capture the gaps in material planning and execution practices is through self-evaluation score sheets. A score sheet typically enlists the various planning and execution categories, and asks the functional owners to score according to the importance and effectiveness of each practice. Typical scoring criteria used is 1 (low), 5 (medium) and 9 (high) to clearly differentiate high impact gaps from lesser ones. For a more robust and objective view, third party service provider can also assist with benchmarking current processes against some of the best run companies in the industry.
Devise “To-Be” planning and execution OTD process. Resource and system limitations may warrant a “To-Be Intermediate” state before moving to the ideal state. The objective is to outline a streamlined, robust and sustainable process that is aligned to the overall objective of optimizing inventory, customer service levels and variable costs. Organizations then begin to migrate to ideal state once resource and system limitations are addressed.
Communicate to the whole group the identified improvement opportunities and goals. One of the biggest challenges faced during assessment is change resistance. Data-based inferences and identification of change catalysts is the key to driving fast adoption of more easily implemented improvements. By seeing immediate results, stakeholders will be better engaged to support additional and more sweeping process changes.

2. Develop the inventory plan

Complete and accurate data is fundamental to developing an inventory plan. Start with the data gaps identified during the assessment phase. Next, determine data availability and data quality along with their operational definitions for effective inventory planning and control. Having clear operational definitions is extremely important for process standardization and improvements, specifically if the business has grown through acquisitions and has multiple data sources and nomenclatures. Inventory planning is driven by accurate data pertaining to:

On-hand inventory
Open orders (sales, production and purchase)
Lead time
Standard or average cost
Bill of material (BOM)

Developing an overall inventory plan should involve the following steps:

Classify parts into three segments: raw, work-in-process or sub-assembly, and finished goods.
Categorize each segment into stock and non-stock categories (purchase to order or make to order).
Plan for each segment, independent of the other others involved in the process.
Classify raw material stock using multi-criteria inventory classification to lay a good foundation for success.
Calculate safety stock and minimum order quantities by part to optimize inventory and transaction costs while achieving service targets. Develop a theoretical raw material inventory plan based on calculated safety stocks and order quantities.
Repeat the exercise for other segments and come up with an overall inventory plan to meet the desired service levels.
Identify initial inventory impact and planned inventory investment.
Once a plan is developed, upload the planning parameters into transactional systems.

3. Execute according to the plan

Once the inventory plan is developed, it is important to execute to the set plan. Any exceptions to deviate from the set plan needs to be approved by management to ensure discipline. Executing to the plan involves the following steps:

Ensure tight adherence to inventory planning and ordering policies at part level.
Establish process controls to ensure data quality and consistency.
Synchronize production schedules to the materials plan.
Establish a robust supplier performance management process that captures effective contract management, performance measurement and metrics, performance review and control mechanisms, and recognition systems. Timely raw material availability is the key to optimal inventory planning, as poor quality of materials could lead to poor yields and costly reworks.
Simplify, standardize and digitize the process globally to minimize efforts in routine execution.
Set up a process around Delegation of Authority (DOA) to ensure disciplined and consistent practices.

4. Measure performance against the plan

Organizations can’t improve what they don’t measure. Ongoing monitoring and control is key to sustain improvements, organizations should focus on near real time visibility into supply chain performance measures to proactively root cause for deviations from plan, and to take corrective actions. This step should involve:

* Establishing key performance indicators (KPIs) and metrics for each process. For example:

(a) Planner metrics provide visibility into a planner’s performance on service levels: safety stock investment, ordering costs and total excess inventory value.

(b) Supplier scorecards with delivery, costs, quality, responsiveness and reliability related metrics highlight top and poor performing suppliers.

(c) Workforce productivity to drive “first time right” culture and to minimize rework and associated wastes that would consume quality time of workforce.

(d) Production span measures overall production variations and identifies root cause variations in each work-center.

* Establishing process controls through periodic monitoring and reports.

* Empowering and encouraging people to document and share best practices and recognizing people delivering exceptional results.

5. Ensure continuous improvement

To meet complex and volatile customer demands, while ensuring profitable growth, organizations should focus on continuous improvements leading to faster movement of materials and information. This step should involve devising a mechanism or practice in order to:

Capture root causes for variations in the plan.
Conduct periodic reviews to discuss impact areas, assign ownership and establish timelines to facilitate resolution.
Run continuous improvement programs such as Vendor Managed Inventory (VMI) and consignment stock agreements with key suppliers.
Reduce cycle times and lead times within the order to deliver cycle, to minimize forecasting errors.
Minimize the ordering quantities and safety stocks.
Establish a data-driven decision making process.
Enhance and retain workforce materials knowledge.

Mani Iyer is Senior Business Manager at Genpact. He is an APICS certified CPIM and CSCP professional, a supply chain consultant and Green Belt-certified Six Sigma champion and has over ten years of rich experience in inventory planning and optimization, sourcing, business process management and project management.