What is inventory optimization?
Inventory management is the practice of overseeing and controlling the ordering, storage and use of a company’s inventory, which includes all of its raw materials, components and finished goods. A company’s inventory is often the single largest asset on its balance sheet, so the importance of managing it intelligently cannot be overstated.
While inventory managers have a variety of responsibilities, one of the most important ones is ensuring that the company has enough product to satisfy customer demand, but not so much that it risks becoming obsolete or that the carrying costs associated with it create a cash flow shortfall.
The process of striking this balance is referred to as inventory optimization. It’s a systematic and statistical technique that helps mitigate supply chain risks by allowing inventory managers to make informed, data-driven decisions related to trade-offs between service targets and inventory levels. Effective inventory management results in optimal stock levels throughout the supply chain, which reduces costs of storage and warehousing, ensures on-time delivery to customers, increases customer satisfaction and improves cash flow.
What are the benefits of inventory optimization?
Finding the sweet spot between supply volume and customer demand can be extremely difficult, especially for large organizations with complex global supply chains, but the companies that excel at it can realize a variety of key benefits, including:
- Preventing shortages that make it challenging to fulfill orders in a timely manner
- Avoiding excess stocks that erode revenues
- Improving delivery times to increase customer satisfaction levels
- Freeing up working capital during periods of economic growth
- Reducing costs and ensuring liquidity during an economic downturn
- Reducing supply chain risk by leveraging real-time data
- Improving inventory turns and reducing inventory holding costs
- Reducing waste within the supply chain
What are some of the key challenges of inventory optimization?
Some of the specific challenges companies have to overcome to achieve inventory optimization within their supply chains include:
Lack of inventory visibility
As with many other aspects of modern supply chain management, accurate and up-to-date data is crucial for any effort to optimize inventory. For companies with manufacturing facilities and warehouses located around the globe, it can be challenging to determine inventory stocks across all the nodes in the supply chain, especially without the right processes and systems in place. When inventory is hard to find, the results are increased costs, decreased customer satisfaction, and lost revenues.
Supply chain complexity and volatility
Today’s supply chains are more complex than ever before. Because they are global, they are subject to any number of unforeseen economic, environmental and political factors, which can create sudden volatility. Increased volatility and the uncertainty that comes along with it can lead to stock outs and dissatisfied customers.
Outdated tools and processes
Despite the importance of effective inventory optimization to the bottom line, many companies still use manual processes and outdated, non-purpose-built tools, such as Excel to manage their inventory. These generic tools are error-prone and lack automation, analytics and other features that provide real-time insights and visibility into inventory levels across the different nodes in the supply chain.
Demand for a company’s products is constantly changing based on a variety of factors. Carrying too much product can result in obsolete inventory and carrying too little can leave the company unable to fulfill orders. Inventory planners must take many factors and variables into account to determine the optimum amount of inventory to carry to account for fluctuating demand. Doing so without the right software tools is a major challenge.
In their own words: Lessons from supply chain planners
What are the different inventory optimization techniques?
When it comes to implementing inventory optimization, there are two widely recognized techniques: single-echelon inventory optimization (SEIO) and multi-echelon inventory optimization (MEIO).
The first of these, SEIO, balances inventory one part at a time, determining the safety stock required to overcome constraints like variability lead-time and demand volatility. With SEIO, inventory managers typically focus on either incoming material flow or outgoing material flow – not both. It’s a sequential approach with forecast demand determining the required inventory for each level separately.
MEIO approaches the problem in a different way, examining the entire value chain holistically and determining the correct inventory levels across the network based on demand variability at various nodes and the performance at higher layers or “echelons” in the supply chain.
For example, if a retailer receives a product from a distribution center, both the retailer and the distribution center represent different echelons of the supply chain. With this technique, inventory managers focus on incoming and outgoing material flow simultaneously, working to minimize inventory costs while maintaining service levels. In MEIO the goal is to continue to update and optimize inventory levels across all echelons.
Which inventory optimization technique a company chooses largely depends on the nature of the business. For companies building highly customized, one-off products, like ships, SEIO will likely be the best option. For companies dealing with large volumes of similar stock across multiple distribution nodes, such as those in the consumer electronics space, MEIO is almost a must.
How does inventory management software help with inventory optimization?
Successfully optimizing inventory across global supply chains is not possible without the help of inventory management software. The leading solutions are cloud-based and include advanced tools specifically designed to help inventory managers with the complexities of optimization.
Inventory management capabilities are sometimes offered as a standalone software solution. More often, they are integrated into a comprehensive end-to-end software solution designed to handle multiple supply chain management functions, including supply planning, demand planning, fulfillment, transportation management, warehousing, customer service, and manufacturing, among others.
Inventory optimization in an end-to-end system
Many companies find the integrated approach beneficial because it gives them end-to-end visibility across the supply chain and across all the different functional areas. It also gives them the ability to share data in real time to achieve better alignment among the groups and people involved. Armed with this data, the supply chain professionals involved in the optimization process can collaborate more effectively.
Like other areas of supply chain, inventory optimization depends on participation from a variety of roles in the organization in addition to inventory managers. For example, while the inventory planner defines ordering policies and minimizes the costs associated with inventory, the material planner manages the detailed plan for all materials, and the distribution planner ensures the availability of stock for the distribution network.
When inventory management capabilities are bundled as part of an end-to-end supply chain planning software solution, advanced optimization features and techniques, such as MEIO, can be combined with concurrent planning capabilities to help maximize efficiencies and enhance customer service.
Key inventory optimization activities
The leading inventory management software solutions provide deep insight into a company’s inventory position and policies and make it easier for inventory managers to perform the range of activities required to optimize their inventory. Some of these key activities include:
- Calculating optimal inventory targets and safety stock settings
- Continuously monitoring lead times and changes to parts performance, so policy adjustments can be made as needed
- Ensuring inventory is always aligned with the rest of the business through connected, end-to-end management
- Improving performance and monitoring changes with inventory quality ratios
- Monitoring and understanding trends and exceptions with intuitive, interactive dashboards
- Proactively identifying risks and opportunities with visibility into cross-site inventories
What are some key best practices for successful inventory optimization?
When it comes to inventory management, there isn’t a one-size-fits-all formula to follow. Industry pressures, business priorities and numerous other factors make each company’s inventory profile unique. But there are a number of key best practices that are helping mature companies succeed in this area:
- Have a dedicated inventory manager: Having a dedicated inventory manager with clearly defined responsibilities related to inventory optimization and other inventory practices can act as a critical driver of profitability, sustainability and growth.
- Foster collaboration: Inventory management and inventory optimization are continuous value-driven activities that must include all key stakeholders in the process to collaboratively plan, monitor and respond to changes to inventory plans as they happen. The leading software end-to-end software solutions are designed to facilitate high levels of collaboration among stakeholders.
- Use the right tools: Achieving inventory optimization within an organization requires the entire team to be equipped with the best tools available. Inventory management and optimization software that’s tightly integrated as part of an end-to-end supply chain management solution helps everyone leverage inventory assets more efficiently and make more effective inventory management decisions.
- Manage metrics: It’s important for inventory managers to establish a clear set of metrics and objectives so that inventory management and optimization efforts are closely aligned with the goals of the business, such as revenue and profitability targets and customer satisfaction levels. For example, when tracking the Inventory Turns metric, a combination of higher turns and strong customer service usually means reduced cycle times and is often a good measure of process improvements.
- Plan and optimize: Choosing the right inventory optimization technique for the business, whether it’s SEIO or MEIO, is critical for achieving the financial objectives of the business.