Inventory – can’t live with with it, can’t live without it. Let’s talk about how to balance the competing trade-offs of high service levels, the need to control costs, and freeing up cash – and how to make managing your inventory a whole lot easier.

We want to have sufficient inventory on hand to service customers and maximize sales, especially in a make-to-stock environment. Inventory, is of course, necessary. And there are plenty of reasons to hold lots of it.

Why Inventory is Good

By committing to higher levels of inventory we can optimize batch sizing to lower production costs and cost per item. By ordering more stock/materials we can optimize transportation costs. We can get price breaks by ordering higher volumes on a monthly basis vs lower volumes on a weekly basis.

Having inventory on hand limits fines for late delivery in the case of retailers like Walmart and Amazon. And a high level of inventory limits costs for expediting delivery for stock we didn’t have readily available. Having inventory ahead of a sale is cheaper than having to source it last minute.

The flipside is the cost of tying up cash in stock that isn’t selling. Right now we have a perfect storm of rising inflation where inventory/materials are more expensive to source, debt is more expensive to service, and sales are going down. In such an environment your CFO will be on your back to reduce inventory.

Why Inventory is Bad

Beyond the hard cost of dollars being tied up in assets sitting in storage, there is an opportunity cost associated with tying up capital in inventory. With that extra cash your company could shore up the balance sheet, service debt or deploy it for new initiatives. Storage is also a cost, not just in terms of the space but in terms of people and equipment required for warehousing.

Inventory also comes with damage and pilferage. What’s more, companies with short lifecycles face obsolescence, never being able to shift stock for certain items which have to be disposed of (another cost). Insurance is yet another cost, the premium being paid on the total assets your company holds.

So there are advantages to holding inventory and disadvantages to holding inventory. Finding a balance between the two that is right for your company is the holy grail of planning.

Lean Into Your Company’s Priorities

If you’re thinking I want on-time, in-full to be 99%, I want to have 24 turns a year, I want to have less than one week’s worth of inventory in stock, and I want to maximize my margin – wonderful, everybody wants that! One of those objectives, one is going to win, and it is up to you to decide which is most important. What are your company’s objectives? In the Cost-Service-Cash triangle, your company will naturally lean into one dimension more than the others, and it’s up to you make the trade-offs that support enterprise strategy.

Prioritize customer service, and your costs will increase and cash will be tied up. Prioritize cash, and you’ll have to accept that customer service will suffer and costs will increase. Prioritize lower costs, and service will decrease and cash gets tied up. Which dimension you need to prioritize most will inform your safety stock levels.

Stop Self-Inflicted Uncertainty Now!

There are certain things companies do that unintentionally introduce demand uncertainty, making it more difficult to know the required safety stocks. There are certain supply planning actions we can take to make inventory management more effective.

Beware Demand Shaping: IBF research reveals that a 1% reduction in uncertainty equals a 6% reduction in my safety stock. Dynamic pricing and promotions shift demand, causing uncertainty that has makes inventory management more complicated. While promotions may be necessary, there are consequences to adding in that demand variability.

Reduce your lead times: It’s not just about demand forecasting; proper supply management pays dividends when it comes to reducing the cost of holding inventory. On average, every 1% reduction in lead time results in a 0.95% percent reduction of safety stock.

More SKUs equal more inventory: I can’t believe that some people don’t understand that logic. More SKUs serving the same demand adds uncertainty without increasing the top line. A 10% reduction in SKUs represents a  5% reduction in safety stocks.

Lower your service levels for a given customer: Some customers won’t necessarily need the service level you’re providing, meaning that you can afford to carry less inventory. What does customer X really need, and what can you reasonably get away with?

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Using history to predict the future is the most basic assumption that underlines demand planning processes and activities. This assumption presupposes that there is inherent demand variability in sales and, by analyzing sales data, the variability can be identified and managed – that is a given. But it’s not only demand planners who must understand variability; Supply Planners also need to be proficient in identifying factors that impact supply and then manage them to mitigate risk.

Not All Risk Comes From Demand

Supply planners must look internally and understand that not all risks come from demand. Risks and variability in the supply chain are often viewed as a forecast problem but the forecast isn’t the only part of the supply chain that features variability, and demand assumptions aren’t the only assumptions driving our supply chains and S&OP. 2020 has been a year that has really highlighted the need to manage assumptions across the entire supply chain and not just for demand.

Understanding Supply Chain Variables

Assumptions exist outside of demand. They impact our ability to serve our customers and need to be identified and managed, just as we do with demand assumptions. Attribute data (data relating to those things that cause variability in supply) related to an item’s characteristics, distribution network, manufacturing process, purchasing terms, and even general planning settings, all contain variables that impact the supply chain.

We have an opportunity to introduce previously unrecognized uncertainty into the supply process.

Typically, these factors aren’t considered to impact supply. Often these attributes are poorly managed and unvalidated unless persistent and serious issues make them impossible to ignore. When we input this data into the master data of planning systems, we have an opportunity to introduce previously unrecognized uncertainty into the supply process. When we do this, we get visibility into supply constraints and are in a position to manage them.

Failure to understand these supply assumptions results in either a growth of excess and obsolete inventory or in a shortage of good inventory,

This data (or attributes) should be regularly reviewed for accuracy, tracked for performance, and actively managed and maintained. For example, we must understand the impact on supply performance when lead times, run rates or process times change, or minimum order quantities and lot sizes are greater than our total annual forecast, or when any other supply constraint appears. Failure to understand these supply assumptions results in either a growth of excess and obsolete inventory or in a shortage of good inventory creating customer dissatisfaction and service failures.

Variability In Demand Is Often In Fact Variability In Supply

When things don’t work out as planned from a supply chain perspective, we often assume it’s due to a random, non-repeating event that could not be prevented when in fact there were indicators in the data that could have alerted us to it ahead of time. Key attributes impacting our supply chains should be identified to reduce unplanned variability and poor performance. They should be measured for accuracy and adherence to bring about best supply results. Unfortunately, when this is not done it shows up as variability in demand! 

We know there are many circumstances that can change the results of attribute values both internally (labor availability, repairs, inaccurate inventory) and externally (weather, transportation limits, vendor capacity). Measuring supply performance and communicating this performance and its drivers back to demand can help demand planners better manage forecast variability. Loading supply settings without validating if they are correct restricts the value demand planners add and that of the demand plans they generate.

Scenario Planning Requires Properly Managed Supply Assumptions

Properly managed supply assumptions create better scenario planning. Scenario planning is a useful part of the S&OP process that aims to maximize margins and profitability. Many of us already create scenarios based upon various demand expectations, but we should also create scenarios based upon potential supply changes. Understanding how adding an extra shift impacts inventory is just as important in reaching our goals as understanding what happens if customer X sells 40% more than planned.

Taking the time to understand the assumptions outside of demand allows us to create scenarios and understand potential financial risk to the business. Understanding variability in supply and how we are performing against expectations will certainly improve the quality of the scenarios we run in S&OP.

I believe demand planners need to teach supply planners how to recognize and manage assumptions.

Bottom Line: Supply Planners Can Learn Much From Demand Planning

I believe demand planners need to teach Supply Planners how to recognize and manage assumptions. Not only that, like Demand Planners, Supply Planners should also be held responsible for understanding and managing variability.

Metrics may be different between demand and supply, but they have the power to work together to reduce it. Supply planners must understand why there are differences between planned and actual results, find the root causes of the differences and understand when we might see changes in the future that don’t adhere to standards. When we fail to manage supply variability, we introduce additional variability not just into the supply plans but also into the demand plan, resulting in inventory imbalances and poor service levels.

If you haven’t defined which supply attributes are key in your supply chain, 2020 is the year to take a leaf out of demand planning’s book and start defining, reviewing, and measuring them and incorporating them into your process as core assumptions.

It’s no wonder that supply chain planning environments are often challenging and chaotic, with demands coming at us from all directions. While customers and suppliers are often the cause of our anxiety, some of the most threatening fire often comes from our own executive management. Dealing with internal leaders requires courage – indeed, the success of your organization depends on it.

Regardless of whether it’s a deliberate tactic or a reflexive response, when the c-suite instills and maintains a corporate culture that stifles open and honest communication, that leadership can sometimes be our greatest enemy. Over the years, I’ve witnessed situations in which truth and transparency are desperately lacking.  However, fearing the wrath of executive management can make an organization’s stakeholders very reluctant to  reveal bad news. To avoid a dressing-down in front of the troops, bad news is often sugar-coated, or even worse, not communicated at all. One hopes that bad news isn’t a day-to-day event, but when bad news is looming, it should be addressed head-on and in a timely manner.

The Reality Of Demand Forecasting

When it comes to forecasting demand, many factors can contribute to a rosy outlook. We develop and launch new products with the hope that they’ll do well – all the years of researching and developing products inclines us to be optimistic whether it’s warranted or not. Or Marketing is bullish about a new promotion because their budget depends on these projected revenues. But these are anticipated volumes and forecasts do have a remarkable propensity for being less than right, and you are the one who has to separate reality from fiction.

Have the courage to declare that the plan did not materialize – your business will benefit from the truth in the end

What should your organization do when projected volumes aren’t coming to fruition? The sooner you can notify the rest of the organization, the better your chances are of achieving a positive outcome or even mitigating risk.  Yes, there will be a net lower revenue, but additional resources won’t be wasted on building products to a finished goods level, only to sit in inventory. Have the courage to declare that the plan did not materialize – your business will benefit from the truth in the end – and then create and enable alternate strategies to overcome these areas of constrained demand.

New Product Introduction Gate Process

New product introductions can be several years in the making, and the life cycle of that product can be as short as one year. Depending on how much time and money has been invested in the new product, if the product launch fails, it could have an enormous impact on revenue and market share. Product engineering teams generally have a strict set of gates that a product must pass through as it moves its way closer to release.

Rather than ducking for cover, honesty now saves valuable time and money

These pre-defined checks and balances are in place to ensure that the product is ready to advance to the next step. When there are great expectations on launching a new product, no one wants to declare failure on the passage of a gate, particularly if there are many more gates ahead that will course-correct. So, what does a fearful organization do? Rather than face management, it gives the product a pass and lets it move forward. This only moves the problem up the line to the point that it can jeopardize the launch itself. Rather than ducking for cover, honesty now saves valuable time and money.

Truth In Available Line Capacity

Manufacturing lines have finite levels of capacity. We have yet to see a plant state capacity at its full theoretical level, and that makes perfect sense. But when you state capacity at a lower level – sometimes referred to as “sandbagging” – the reduced level of capacity is used by the plant for many reasons, such as variability on the line, or distrust of demand, or another creative explanation. The result is a self-inflicted, artificially constrained plan. We get it. Things happen outside of our control. However, it’s imperative to be honest with your capability up front, because it can only help the overall success of the plan, and it will actually reduce the time for error resolution.

The Supply Is On The Way…..Or Is It?

Suppliers can come in all forms and from all corners of the globe. They provide us with everything from piece parts to semi-finished to fully finished goods. Our ability to deliver a finished product to our customers is highly dependent upon the timely and reliable delivery from our suppliers. We place purchase orders on our suppliers, receive a delivery date, and expect an on-time delivery.

Honest and early communication helps to mitigate the negative impact of late supplier deliveries

But when all deliveries are not timely, what do we say when executives are breathing fire down our necks? When there’s a short window between how much advance notice you have before you need to report to management, what do you communicate before the “shoot the messenger” game starts? The answer is, don’t play the game at all. Honest and early communication helps to mitigate the negative impact of late supplier deliveries.

How Big Is Your Inventory Buffer?

Everybody says inventory is a necessary evil; necessary because we need inventory for order fulfillment, and evil because too much of it ties up cash. Typical marching orders from management include a mandate to reduce inventory levels. But as time passes and inventories rise, or inventory levels dip below minimums, what do you communicate to management? Management won’t like either scenario, but too much is probably the least favorable answer. Why? Because once product is in inventory, you can’t change it immediately. This is a case of bad news vs. worse news—while neither scenario is ideal, communicating accurate levels to the rest of the organization allows for the proper actions to be taken, albeit after the fact.  Inventory might be bad, but it is still that necessary evil which should be measured at actual levels and communicated to management.

Honesty Is Always The Best Policy

The old expression, “Don’t bring me bad news; bring me solutions,” is generally good advice. But what happens when there are no immediate solutions to address bad news? Bad news is bad for a reason – ducking for cover to avoid drawing fire only makes it worse. Honesty and transparency are always the best policy, and open and honest communication are the only ways to address, mitigate, or completely remove the negative impact of bad news. Changing an oppressive business culture into a proactive entity that fosters honest, transparent behavior, starting at the top, will serve any organization well.

Bill Mrzlak is CEO of ChainSequence.com.