Inventory Optimization (IO) is a loosely used term in the industry. You’ll see it used to describe tactical inventory management, warehouse operations  and strategic network assessments as well as used to describe single stage as well as multi-echelon environments. Inventory optimization is so much more and impacts the supply chain at all levels. Recently, I had the pleasure to speak with Dr. Sean Willems, Ph.D. MIT Sloan School of Management, Associate Professor of Operations Management at Boston University to clarify what inventory optimization is, why it is important and how it can drive innovation through/change the velocity of your supply chain.

Karin: What is Inventory Optimization?

Sean: At its core, inventory optimization is based on a set of mathematical algorithms that help establish optimal inventory levels at locations across a supply chain. In business terms, it is about reducing the amount of working capital tied up in safety stocks and other buffers.  Inventory optimization does some very complex things, like take into account interdependencies among all stages of the supply chain and mitigate the effects of demand uncertainty. It is not about changing the physical aspects of the supply chain infrastructure; it’s about maximizing the velocity of inventory to achieve desired customer service levels.

Karin: Why should companies look at leveraging inventory optimization within their supply chains?

Sean: Where to begin? For one thing, it is common to see a 20 percent or greater reduction in inventory across an optimized supply chain. Inventory optimization calculates the correct (optimal) inventory targets to support business goals and customer service level requirements for the lowest inventory cost. When you know how much inventory you should carry, and where it should be located, you can be confident about how much it will cost to achieve a specific service level.

Karin: Doesn’t my APS, ERP or MRP system already do this?

Sean:No! It’s a common misconception that transactional systems do optimization. They don’t. Traditional ERP and APS (Advanced Planning and Scheduling) systems only provide deterministic planning. MRP does requirements planning and APS takes capacity into account, but they work from given targets; neither can recommend what your inventory targets should be for the best bottom line results. Inventory optimization starts by modeling and monetizing the supply chain as a multi-tiered network, from suppliers and raw materials through finished goods and distribution. Inventory optimization then takes into account variability in demand and supply, and many other factors such as lead times, and discovers ways for companies to free up working capital while maintaining—or improving—their customer service levels.