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Inventory optimization: How to develop a multi-channel approach


September 20, 2010
By Joe Kislowicz

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Manufacturers and their supply chain partners have been much more concerned with overall inventory levels over the past decade. The tech bubble recession in 2001 and the credit crunch recession in 2009 both led to large inventory write-offs. As a result, financial and credit analysts have become extremely sensitive to companies carrying what is perceived as too much inventory. Furthermore, there is growing evidence that levels are increasing due to a number of factors, including:
• The lead times necessary for offshore production necessitate larger order quantities;
• Set-up costs dictate the need for large run sizes;
• The rise in transportation costs necessitates large order quantities; and
• Market volatility is pushing purchasers to buy and store in order to eliminate market uncertainty.

Managing inventory in a multi-channel network presents major challenges. One is the failure to achieve true network inventory optimization, because replenishment strategies are applied to one channel without regard to its impact on the other channels. A 30,000-foot view of inventory usage across the chain is absent. Another possible pitfall is basing replenishment decisions on inaccurate demand forecasts. These errors will result in negative consequences, including:
• Excess inventory in the form of overly high safety stock or reorder quantities;
• Adequate inventory exists in the network, but is not ready to be shipped because the inventory is not in a completed stage or it’s in the wrong location;
• Customer delivery locations experience stock-outs even though service between channels is accurate;
• Erroneous allocation decisions are made for products with long replenishment cycles; and
• Suppliers’ deliveries are over/under because they have received inaccurate demand projections.

The key to managing all of this is inventory optimization – the application of technology and techniques across the supply chain to improve visibility, management and control of inventory levels. And the key to planning for inventory optimization is a profit-driven analysis.

Planning
Pareto analysis is applied to classify the profit levels of each item and to rank them based on their individual contribution to the overall profit of the enterprise. Policies are then put into place designed to lower the inventory levels of the low contributors and raise the levels of the high contributors, all with the objective of lowering the overall levels.

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The core of optimization technology is the engine whose function it is to analyse inventory across the supply network, and to concretize fluctuations in lead time and demand uncertainty. Inventory optimization allows for interaction with variable policies, which are now date and time-period sensitive. Seasonal demand fluctuations and supplier reaction time are provisioned for, as evidenced by lead time to order fulfillment. Re-order points and safety stock levels are no longer fixed, but are variable along the time continuum. Furthermore, inventory policies are directed at the most basic element – the item/warehouse level.

A multi-channel approach
The true value of inventory optimization is the ability to properly handle a multi-channel enterprise. The primary goal in this situation is to minimize inventory in all channels, while customer service meets customer demands. In this situation, inventory is the main focus, while at the same time warehousing costs, minimum order sizes and transportation costs are kept in line because these costs form part of the optimization policies. With a multi-channel approach, demand forecasting and inventory replenishment decisions are made at the top level in a single optimization iteration, rather than in a series of iterations for each channel. A multi-channel approach should:
• Account for all lead times and any discrepancies;
• Monitor and manage the bullwhip effect, which causes variations between nodes and distribution centres;
• Avoid multiple independent forecast updates in each channel;
• Enable visibility up and down the demand chain;
• Synchronize order strategies;
• Offer differentiated service levels; and
• Correctly model the interactive effects of alternative replenishment strategies of the different levels.

Benefits
By using a multi-channel approach, the enterprise is able to make optimal replenishment decisions for every item across every channel. This enables the enterprise to attain or exceed service goals while keeping inventory requirements in the total network in line. Inventory is properly balanced between the channels to reduce total levels without sacrificing customer satisfaction. Reduced inventories equal reduced costs. Working capital for the enterprise is freed up. Plus, cash flow is increased, leading to better earnings performance and an increased level of customer satisfaction.

A multi-channel distribution network, although complex to manage and distill, provides opportunities for inventory optimization that offset potential increases in transportation, warehousing and run size costs. To achieve these savings, it is imperative to use a fully integrated inventory optimization, multi-channel strategy. The multiplicity of factors and constraints on inventory make this strategy complex to put into place and follow, but certainly worth the effort. The results are better customer service, with less inventory.

Joe Kislowicz, M.B.A., is a senior partner with Alyson Software Solutions Inc., a supply chain partner with SYSPRO ERP software in Toronto, Ont. Kislowicz has more than 25 years of experience in automated computer-based inventory control systems. He can be reached at jkislowicz@alysonsoftware.com.