What Drives Inventory Effectiveness in a Market-Driven World? Insights on the Use of Multi-Tier Inventory Optimization and Inventory Effectiveness

10/27/2015

By Lora Cecere

Founder and CEO Supply Chain Insights LLC

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Contents

Research Methodology

Disclosure

Executive Overview

What Is a Market-Driven Value Network?

The Role of Inventory in Building a Market-Driven Strategy

Why Is It Important to Align Inventory Strategies?

Inventory Technologies: Current State

Characteristics of Companies Using Advanced Software

The Role of Technology in Driving Improvement

What Does It Mean to Be Market-Driven?

What Is the Role of Inventory in a Market-Driven Value Network?

Misconceptions

Recommendations

Conclusion

Appendix

Other Reports in This Series

Terms to Know

About Supply Chain Insights LLC

About Lora Cecere

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Research Methodology This report answers the question “What is the value proposition of inventory optimization software?” It

is based on the results of a quantitative survey about inventory management technologies. To gain

additional insights, and to make this a better report, the findings were vetted with small roundtables of

supply chain professionals.

In Figure 1, we share the objectives, methodology, and demographics of the inventory management

study completed in 2015.

Figure 1. Research Overview

The market for inventory optimization is “muddy” with many solutions that overlap. To try to derive

insights, the respondents’ use of inventory optimization solutions were classified using the

nomenclature in Table 1. In this study we analyze the impact of 32 companies with advanced

inventory capabilities against 32 with basic inventory optimization software. For the purposes of the

study, advanced inventory capabilities are defined as the use of deeper optimization than linear

algorithms in Enterprise Resource Planning (ERP) or Advanced Planning Systems (APS). As will be

seen in the report, more companies are using deep optimization within the enterprise than in the

value chain (multi-tier capabilities).

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Table 1. Software Classifications for Analysis

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be the place where visionaries turn to gain an understanding of the future of supply chain

management. This report is written with this goal in mind.

Disclosure Your trust is important to us. In our business we are open and transparent about our financial

relationships and our research operations. In this process we never share the names of respondents

and or give attribution to the open-ended comments collected in the research. This research was

funded 100% by the Supply Chain Insights team.

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the Citation page of our Supply Chain Insights Website.

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Executive Overview Growth is slowing. Rising complexity in today’s supply chain is unprecedented. As a result, inventory

management is a hot issue. The average company has invested in many inventory optimization

solutions, but few companies feel they have driven results.

There are many drivers of inventory, and the management of inventory levels requires both discipline

and a cross-functional focus. This is especially true for the global multinational. The definition of the

global supply chain greatly impacted inventory requirements.

Supply chain processes are now over 30-years old. While there is a generalized belief that the

maturity of supply chain processes has improved inventory turns, as can be seen in Table 2, the

improvements in cash-to-cash have primarily been driven by lengthening payables, not inventory

improvements. In industries like beverage, pharmaceuticals, consumer packaged goods and medical

devices, the industry averages have gone backwards (inventory turns have decreased not increased).

Table 2. Progress by Industry for the Period of 2006-2013

In an ideal world, the supply chain drives growth, improves operating margins, reduces inventories,

and accelerates inventory turns. It is a continual balancing act between metrics which have nonlinear

relationships.

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Each industry has a different potential with unique rhythms and cycles; and as a result, the inventory

targets from one industry cannot be ascribed to another. Improvement in inventory is accomplished

through the use of technologies and focused process discipline. The available technologies come in

many forms and variations. As a result, the market is very confusing. One of our goals in this report is

to simplify the buying process by defining the value proposition for advanced inventory optimization

technologies.

In this report we start by defining a market-driven value network. We then define the role of inventory

within a market-driven value network, and evaluate the impact of technologies to improve

competitiveness.

What Is a Market-Driven Value Network? The concept of a market-driven value network is the maturation of demand-driven concepts and is

defined as a network that focuses on improving supply chain excellence across multiple tiers of the

supply chain using outside-in processes. This evolution is outlined in Figure 2.

Figure 2. Evolution of Demand-Driven Concepts

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The Role of Inventory in Building a Market-Driven Strategy The supply chain is volatile in both demand and supply. As shown in Figure 3, demand and supply

volatility, along with cross-functional horizontal alignment, are major areas of business pain. When

organizations are aligned horizontally there is greater improvement in inventory. Executive team

understanding of inventory principles, clarity of supply chain strategy, and the impact of product

quality are less of an issue.

Figure 3. Elements of Business Pain in Past vs. Future

Why Is It Important to Align Inventory Strategies? To dampen demand-supply volatility there are two primary buffers: inventory and manufacturing

capacity. With the outsourcing of manufacturing, inventory has grown in importance and is now the

primary buffer for supply chain volatility in the extending economy.

While traditional supply chain technologies and processes focus on inventory levels with a laser-focus

on minimizing safety stock levels, as companies become more market-driven, there is a need to

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right-size buffers and focus on both form and function of inventory. The focus is more holistic. It

becomes more outside-in with a focus on multi-tier value networks and the determination of inventory

strategies at multiple tiers, or nodes, within the supply chain.

The concepts fundamental to defining form and function of inventory are explained in Table 3.

Table 3. Definition of Form and Function of Inventory

The first step is getting clear on the role of lead times, inventory, and operations complexity. A high-

capacity manufacturing plant can have a high throughput, but a long cycle time. The longer the

response time, and the greater the variability, the greater the need for inventory buffers. Capacity,

lead-times, cycles, and throughputs are intrinsically linked in the determination of inventory strategies.

As supply chains become more global, it becomes more complex, requiring technologies and the

design of the supply chain to ensure that inventory is the appropriate buffer.

Within the organization there are many supply chains. As companies become more customer centric,

there is a focus on customer segmentation and the translation of business policies into inventory

strategies. For the greatest success the definition of inventory strategies needs to be closely

interwoven into this work. Companies with the best results use both network design and inventory

management technologies to design and define inventory buffer strategies based on the operating

strategy.

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Inventory Technologies: Current State Today we find that most companies have implemented ERP or APS, but the implementation of multi-

tier inventory optimization with deeper optimization logic is a smaller subset of companies. So much

so that it was hard to get a comparison group for this report. (We used our informal networks and

inside information to drive a response rate on more advanced software to compare the types of

inventory technology and make a comparison.)

Older technologies, i.e. ERP and APS, optimize supply chains node-by-node. Few technologies

optimize concurrently across make, source, and deliver. The movement to a multi-tier strategy

requires the use of deeper analytics to design the form and function of inventory while optimizing

inventory levels across the network. For many supply chain leaders, the design of inventory strategies

to manage form and function of inventory within value networks is understood conceptually, but is

slowly being adopted. For laggards, it is a set of new concepts.

When supply chains were simpler it was sufficient to calculate inventory levels: the right amount of

safety stock to hold at each node in the supply chain. This is no longer the case. In market-driven

value networks it is important to shift the focus to be more inclusive and to focus not only on inventory

levels, but also on the form and function of inventory as defined in Table 1.

Characteristics of Companies Using Advanced Software Companies that use advanced software are more likely to be satisfied with the use of the software

and drive a return on investment (see Table 4). The adoption of more advanced capabilities takes

time (16 months on average versus nine months). As a result, companies using advanced software

have managers that better understand the use of these deeper solutions.

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Table 4. Profile and Comparison for Advanced Software Users of Inventory Optimization versus Basic Inventory

Software Users

Companies want to grow and inventory management is a fundamental capability. This includes the

management of new product launch, trade promotions, and price changes. It is not easy. New

product launch error averages 80%; and as a result, the introduction of new product launch is fraught

with issues of out-of-stocks and inventory write-offs.

Growth also adds complexity. With the resultant increase in item complexity—proliferation of items on

the item master and the increased complexity of managing a global matrixed organization—inventory

strategies and the use of inventory technologies grow in importance. As a result, the design of

inventory as a buffer becomes more critical. As shown in Figure 4, users of more advanced software

rate themselves as more successful in the management of inventory decisions. This is significant at a

90% confidence level.

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Figure 4. Comparison of Company Effectiveness with the Performance of Inventory Optimization Software

The Role of Technology in Driving Improvement In driving inventory improvements, the technology choice is one part of the equation. The two most

important factors that are not performing well are S&OP maturity and the adherence to S&OP targets

(see Figure 5). While organizations are not performing well on forecast accuracy, the proper design of

flows and buffer strategies through the use of more advanced inventory software can overcome the

issues with high demand error. Increasingly, in the research we see the adherence to inventory

targets recommended by the software to be a distinguishing factor for success. While this sounds

easy, it is not. Organizations have difficulty accepting answers from a ‘black box’ optimizer and many

finance groups mistakenly play with inventory levels to meet quarterly and yearly Wall Street

commitments. In our research on the Supply Chains to Admire analysis, we see that the use of more

advanced technologies, the adherence to inventory targets from the technologies, and the maturation

of Sales and Operations Planning are the keys to success in driving continued improvement of

inventory levels while improving margins and driving growth.

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Figure 5. The Role of Inventory Technology Versus Other Factors in Achieving Inventory Goals

To effectively use the technologies, process excellence requires close coordination and alignment

with corporate finance. It should come as no surprise that companies who are more advanced in their

usage of inventory management software have closer alignment with finance and the operations

group, and between the sales and finance groups. The difference in alignment is significant at a 90%

confidence level.

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Table 5. Organizational Horizontal Alignment by Type of Software Used to Guide Inventory Decision Making

In the study we ask respondents to answer “open-ended questions” on inventory effectiveness and

the use of the technologies. Some of the notable trends are captured in the quotes in Figure 6.

Figure 6. Open-Ended Survey Responses

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What Does It Mean to Be Market-Driven? A market-driven value network senses and responds market-to-market (from channel to supplier).

When successful, a market-driven process is both horizontal and bidirectional to enable the

organization to continually test and learn and orchestrate processes cross-functionally. In the five-

stage maturity model shown in Figure 7, it is a continuation of the demand-driven value network

journey.

The focus of a market-driven value network is holistic. The design is to maximize opportunity and

mitigate risk in the end-to-end supply chain. When successful, these processes become outside-in,

focused on sensing and responding based on channel demand versus the more conventional

processes that are inside-out, driving deterministic optimization based on shipment and order

patterns. In the development of outside-in processes, companies orchestrate cross-functional trade-

offs through processes like network design and Sales and Operations Planning.

Figure 7. Five-Stage Maturity Model to Becoming Market-Driven

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As the supply chain becomes more market-driven, the role of inventory becomes more important. It

requires the management of flows, buffers and constraints in concurrent optimization. A traditional

focus on forecast accuracy is not sufficient. Instead, it requires holistic thinking. Some of the greatest

misconceptions in the development of market-driven strategies are listed in Figure 8.

Figure 8. Common Misconceptions of Market-Driven Strategies

Companies executing a market-driven strategy need to design inventory buffers along with push/pull

decoupling points, analyze inventory levels and set-points at multiple nodes simultaneously in the

value network, and design the supply chain with a keen focus on the form and function of inventory.

The old techniques of deterministic optimization node-by-node are not adequate.

What Is the Role of Inventory in a Market-Driven Value Network? As companies increase the number of items on the item master, and deploy demand-shaping

strategies, demand latency increases. Demand latency is the time for the purchase of an item by an

end-consumer to be translated across multiple tiers of the supply chain into an order to drive

replenishment. The longer the tail of the supply chain, the greater the demand latency. For example,

in consumer packaged goods products, an over-the-counter drug can have a demand latency of 45-

60 days, while a fast moving consumer good like carbonated beverages has a demand latency of 1-2

days. The greater the demand latency, and the longer the tail within the supply chain, the more

important the design of inventory strategies.

A summary of organizational tensions is shown in Figure 9.

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Figure 9. Organizational Tensions to Reduce Inventory Levels

To understand the long tail of the supply chain, reference Figure 10. To understand this within your

own organization, and calculate the tail of different divisions, plot items based on volume and order

frequency.

Figure 10. The Long Tail of the Supply Chain

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In plotting the unique rhythms and cycles of the supply chain, the items on the tail which have low

volume and lumpier order patterns require the use of new inventory techniques. This includes the

design of inventory buffers, the definition of push/pull decoupling points with a focus on

postponement, a focus on form and function of inventory, and the use of multi-tier inventory

management.

The logic is in the math. Products on the long tail of the supply chain have a higher coefficient of

variance (COV). With a higher COV and a lumpier order pattern, these items require significantly

higher levels of safety stock. Late-stage postponement and risk pooling are frequently-used

techniques to reduce inventory risk and safety stock levels.

The longer the supply chain is, the greater the distortion of independent demand. This is termed the

“Bullwhip Effect.” In building the global multinational supply chain, the Bullwhip Effect increased in

most companies. This phenomenon is defined in Figure 11. With this increase in the bullwhip effect,

multi-tier inventory management matters more than ever.

Figure 11. The Bullwhip Effect

Over the last decade a lot of change has impacted the supply chain all at once. For most supply

chains it is not one factor that has increased inventory levels; instead, it is many. In Figure 12, to help

the team understand the total impact, we list a number of shifts that have impacted inventory levels.

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Figure 12. Business Factors Impacting Inventory Levels

Misconceptions When it comes to inventory management there are also many misconceptions. These include:

Inventory Management Is the Same as Replenishment. Inventory management and replenishment

are separate, but interrelated, processes. Inventory management includes the design of inventory

strategies to set inventory targets, including the execution of supply chain processes to design and

manage the form and function of inventory. In contrast, replenishment is about flow. It is usually push-

based logic, based on a series of rules, using dependent demand. Traditional replenishment logic adds

to amplification and distortion of the demand signal. The greater the demand error, and the greater the

supplier volatility, the greater the need for multi-tier inventory management.

The Market Leaders in Inventory Management Technology Have the Best Solution. While many

companies believe that the company which sells the most technology, and is the market-share leader,

is the best at managing inventory, this is not the case in multi-tier inventory planning. The companies

with the greatest market share—Oracle and SAP—have the weakest references. While both Oracle

and SAP will hotly debate this fact, we find a strong gap between the vendors’ perception of the market

and those of their clients.

Inventory Is a Cost to Be Managed. A frequent mistake made in the management of inventory in the

extended supply chain is a blanket reduction—a corporate mandate to reduce inventory— without

rationalizing the requirements for inventory in the value chain. Inventory should never be managed to a

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financial target. Instead, it needs to be based on the requirements of customer policy and the supply

chain strategy. For many, this understanding is one of the first to tackle.

All of the Solutions Have the Same Functionality. As can be seen in the Appendix, there are major

differences in the technologies to manage inventories in the extended supply chain. As a result,

companies should buy inventory management technologies based on process requirements, IT

standardization and cultural fit. While many think that solutions with a common name—technologies

purchased from a common vendor—are integrated, often the situation in the market is vastly different.

Most of the inventory technologies have been sold and resold multiple times in the market, with many

existing in an unintegrated state within a parent company.

Larger Vendors May Not Have the Functionality Now, But It Will Come. The market for multi-tier

inventory management was overhyped and largely underdelivered in the period of 2005-2007. Due to

market size, and the highly competitive and fragmented market, the levels of R&D investment have

slowed. As a result, buyers should buy based on today’s functionality, while not betting on future

promises by technology providers.

The Management of Inventory Does Not Need Technology. To get good at the management of

inventory, companies need technologies. The supply chain is a complex system that cannot be

adequately managed through calculations on a spreadsheet. Blow up your spreadsheet ghettos within

your organization and challenge your company to think more holistically about the role of inventory in

the market-driven value network.

I Can Use New Technologies without Changing My Planning Organization. The use of new

technologies requires time for planners to use them, and when implemented correctly leads to a new

set of business processes. Do not make the mistake of buying and installing the technologies, but not

getting the benefit because either the planners did not have adequate time to plan, or you did not take

the time to rethink the processes to use the new technologies.

Recommendations Based on our work with clients, the results from this study, and our analysis of technology options,

here we share six recommendations.

Focus on Cycle Stock. In most companies there has been a singular focus on improving cycle

stock. We find that the most common opportunity is in the management of cycle stock. This

improvement happens through the design of the network to build the right inventory strategies and

then the use of these inventory strategies in production planning. The connection of production

planning and inventory strategies is often a major opportunity.

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Include Determination of Form and Function of Inventory in the Development of Network

Design Strategies. The companies making the most progress on inventory are using more

advanced technologies along with inventory design tools to manage the form and function of

inventory.

Bring the Cost of Inventory as a Driver in Sales and Operations Planning Decisions. When

the design of the network and the management of inventory buffers are connected to the “what-if”

analysis of supply in S&OP, companies experience a great improvement in the building of a

feasible inventory strategy which minimizes inventory while mitigating costs. Work on building

maturity on inventory management in conjunction with S&OP. Make the cost of inventory real in

the minds of stakeholders.

Educate the Finance Team. The strongest performance happens when the finance team

understands the principles of inventory management and no longer sees inventory as a cost to

cut. This is achieved through simulation and “what-if” optimization to demonstrate the importance

of inventory buffers with increased demand variability.

Take It Slow. Do It Right. Note that the implementation of multi-tier inventory optimization is not

fast. The average time is 18 months. This is double the time of a normal Advanced Planning

project. Don’t rush the team. Let them take their time and do it right. Usually, the adoption of

deeper optimization for inventory optimization requires the redefinition of many internal processes.

Managing root cause issues will pay dividends in the long run.

Implement with Knowledgeable Resources. At first when you read this recommendation you

might say, “DUH!?” Let’s face facts. There are too few people in the world who are really

knowledgeable about these software tools. While many consultants will talk about inventory, we

find few to be knowledgeable in the technologies. Instead, we find the technology’s provider to be

the most knowledgeable on its use; and as a result, there are few cases where these technologies

should be deployed by a large system integrator. There are a few boutique consultancies around

the world who have built strong teams around inventory optimization. These are usually small and

focused consultancies with a strong heritage in inventory optimization.

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Conclusion The rate of change in the last decade in supply chain management practices is driving the need for

deeper and more sophisticated inventory management strategies. Today’s inventory buffers cannot

be managed effectively without the use of more advanced technologies; but, they also cannot be

adequately addressed without reorganizing the planning function to enable planners to design and

execute inventory strategies to manage the form and function of inventory. As shown by the balance

sheet results in this report, it matters more than ever.

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Appendix In this section we share the demographic information of survey respondents, along with research

findings, to support the key insights listed in this report. The study was limited to retailers,

manufacturers, and distributors. Companies responding to this survey received final results and had

the option to participate in global roundtables to discuss the results and network with other supply

chain leaders. At all times, the names, both of individual respondents and companies participating,

are held in confidence.

In this section the demographics are shared to help the readers of this report gain a better

perspective on the results. The demographics and additional charts to support the findings are found

in Figures A–G. To help the reader, at the bottom of each image we list the specific questions asked

in the quantitative survey along with the survey demographics. As shown in Figure A, the majority of

respondents are from process based (chemical, consumer packaged goods, food/beverage)

companies.

Figure A. Industry Overview of Respondents

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Figure B. Specific Industries Surveyed in the Study

Figure C. Company Revenues and Item Complexity

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Figure D. Respondent Role, Title and Region

Figure E. Software Used by Respondent Companies

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Figure F. Software Usage Among Respondent Companies

Figure G. Company Characteristics

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Other Reports in This Series This is the second report on multi-tier inventory optimization. However, inventory progress is not

made in isolation. Readers may gain added value by accessing complimentary reports on Sales and

Operations Planning and use of supply chain applications on our Supply Chain Insights website and

in our Beet Fusion community.

Putting Together the Pieces: Selecting S&OP Technologies 2015

Why Is S&OP So Hard?

Sales and Operations Planning: Current State of the Union

Inventory Optimization in a Market-Driven World

Maximizing the ROI in Supply Chain Planning

Research in Review 2014

Terms to Know Getting clear on terms is often the first step to driving a supply chain transformation in inventory

management. To help teams, here we provide the definitions of the terms used in this report:

Concurrent Optimization. The use of technologies to solve optimization problems across source,

make and deliver in-memory together to rationalize cross-functional trade-offs.

Demand Latency. The time it takes for order take-away at the point of consumption to translate into an

order for a manufacturer. The slower the velocity at the point of consumption, the longer the demand

latency.

Inventory Configuration. A focus on form and function of inventory, along with techniques like

postponement and risk pooling, to improve inventory buffers.

Multi-Tier Inventory Optimization. The use of inventory optimization to determine optimization levels

at multiple nodes in the supply chain simultaneously.

Postponement. An inventory strategy to delay steps of the conversion process until the demand for the

final product is known.

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About Supply Chain Insights LLC Founded in February, 2012 by Lora Cecere, Supply Chain Insights LLC is now in its fourth year of

writing research focused on delivering independent, actionable, and objective advice for supply

chain leaders. If you need to know which practices and technologies make the biggest difference to

corporate performance, we want you to turn to us. We are a company dedicated to this research. Our

goal is to help leaders understand supply chain trends, evolving technologies and which metrics

matter.

About Lora Cecere Lora Cecere (twitter ID @lcecere) is the Founder of Supply Chain Insights LLC and

the author of popular enterprise software blog Supply Chain Shaman currently read

by 5,000 supply chain professionals. She also writes as a Linkedin Influencer and

is a a contributor for Forbes. She has written four books. The first book, Bricks

Matter, (co-authored with Charlie Chase) published in 2012. The second book, The

Shaman’s Journal 2014, published in September 2014; the third book, Supply

Chain Metrics That Matter, published in December 2014; and the fourth book, The

Shaman’s Journal 2015, published in September 2015.

With over twelve years as a research analyst with AMR Research, Altimeter Group, and Gartner

Group, and now as the Founder of Supply Chain Insights, Lora understands supply chain. She has

worked with over 600 companies on their supply chain strategy and speaks at over 50 conferences a

year on the evolution of supply chain processes and technologies. Her research is designed for the

early adopter seeking first mover advantage.