The Two Levers of Inventory Optimization
When I hear the term “Lever” my mechanical engineering side comes out and I think of the Physics and Mechanical Design courses I took some 30+ years ago. Although I didn’t appreciate it at the time, my engineering education laid a strong foundation that has helped me be as successful as possible in whatever I did. More than anything, I learned how to analyze and solve problems. So when I think of a lever I think of a rigid bar resting on a pivot or fulcrum, used to help move a heavy or a firmly fixed load with one end when pressure is applied to the other.
Back to present day and the supply chain. Two powerful levers a company can use to optimize inventory are “Working Capital” and “Customer Service Levels.” Through the effective use of these levers, you can free trapped working capital while improving service levels.
Your company’s inventory efficient frontier is a tradeoff curve between working capital and service level and represents the currently achievable service level at any corresponding inventory investment. At its most basic, start with a piece of graph paper and plot your current service level on the x-axis and current inventory level on the y-axis. Chances are you are not on the inventory efficiency curve that is theoretically possible given your current operating capabilities. When you remove inefficiencies, failures, etc. and estimate how much your service level will go up and down with changes in inventory investment you end up with a curve — your current inventory efficient frontier curve. Organizations can slide up and down along this curve by manipulating the service and inventory levers (see Figure 1).
However to create real value you have to be able to shift the inventory efficient frontier so that higher service levels can be achieved without increasing inventory or the same service levels can be achieved with less inventory. Multi-echelon Inventory Optimization (MEIO) allows you to truly optimize your inventory across the entire supply chain and enables you to shift to a new efficient frontier for your entire supply chain (Read the eBook: The Inventory Optimization Handbook).
By modeling the end-to-end supply chain, MEIO determines not only the optimal inventory to carry at each location but also at which locations each item should be carried. MEIO looks across sales channels, distribution tiers, and even types of inventory (raw, WIP, FG) to understand how best to minimize total inventory while still providing the desired customer service levels. MEIO can take you into unexplored territory providing reductions in working capital of up to 30 percent or more. For most companies that amounts to millions of dollars in savings annually. That is an impressive use of levers.
What is important to understand is that the supply chain is a living, breathing and constantly changing organism. Your optimal inventory strategy for this month might be suboptimal next month due to changes in demand or supply, changes in competition or market health, or a variety of other factors. Modeling your end-to-end supply chain inventory is not a “one and done” activity and therefore there is always opportunity to shift that efficient frontier into new and undiscovered territory.
Do you understand your company’s service level — working capital tradeoff? Can you model your end-to-end supply chain to determine your optimal inventory locations and levels?
Recently, a colleague recounted a new consulting job he had undertaken a few years back. The client was struggling to make a large enough profit, whic
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