This is a common dilemma that constantly plagues supply chain professionals. The traditional supply chain paradigm supports the belief that reduction of inventory will lead to increase in part shortages and subsequently lower service levels. This paradigm is constantly being reinforced by credible sources such as the Wall Street Journal as evidenced in this WSJ article by Mark Gongloff where he seems to suggest that more inventory = more growth. However, this is just not true….under the new supply chain paradigm!
At the root of the problem is most inventory management is still driven by the planning process and forecast. The planning horizon is often 90 days. For some industries it could be as high as 6-12 months! Obviously when you are planning inventory the data is driven by the sales forecasts for the stated period. These forecasts are converted in to production schedules which are then translated to raw material requirements and component plans based on the bill of materials.
As we look at the total inventory in the supply chain, it can be broadly divided in to the following three areas:
- Inventory On Hand (including materials in Inspection)
- Orders Outstanding (Money committed for purchase of inventory)
- Goods In Transit
The topic of inventory reduction is usually internally focused at Inventory On Hand. Companies often begin with stated goals of reducing days on hand from something like 15 days down to 10 days. These goals are driven by an S&OP process or other management initiatives. The problem is how do you determine the optimal inventory mix when you reduce from 15 to 10 days? The inventory on hand normally comprises of the usage for the day and the amounts of safety stock required to cover variation in demand, lead times, service levels etc. Because this approach at inventory reduction isn’t impacted by process change, safety stock is the only component that can be reduced. Therefore, is a limit on how much reduction can be accomplished through reducing safety stock without increasing risk of stock out.
Alternatively, if you take a more holistic approach to inventory reduction by looking at all the three components described above then you can begin to identify and drive out variation in your supply chain. To do so, we should separate the planning and execution processes. Planning can continue to be based on forecasts and/or planned demand, while execution will be driven by a consumption driven replenishment model. The consumption driven model allows us to view what percentage of inventory tied to the supplier’s lead time and transit time, in addition to safety stock. This model provides suppliers with immediate visibility of what is being consumed and triggers the release of orders on a more consistent frequency an in a standard lot size. The goal is to eliminate the uncertainty (or whiplashing) aspect of the lead time! This will not only reduce inventory but also reduce the amount of safety stock required.
In order to begin this exercise, it is important to validate the supplier’s current lead time by measuring actual ship time with the stated order lead time. A collaborative process can help you determine this over a 90 days period. From our experience, we have seen an average of 15% to 20% reduction in lead time opportunity across most of the suppliers. It has also been proven that through this collaborative process of consumption driven replenishment, the lead time reduction can not only be sustained but even reduced further. This process will automatically have considerable effect in reducing part shortages as well.
Are ready to become a part of the new supply chain paradigm by – “reducing inventory while eliminating stock outs”?
If so, you can request a free inventory optimization assessment today to see how much inventory you might be able to reduce without stocking out. If not, please leave a comment below on your experience with this common supply chain issue.