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% of all respondents
Source: Aberdeen Group, June 2007
Companies are facing more challenges in managing working capital due to growth pressures, such as entry into new market segments, geographic expansions, acquisitions or product R&D funding requirements in addition to challenges in acquiring credit to enable the above tasks. Shareholder oversight of corporate performance metrics (both short-term and longterm) is causing organizations to create mandates for change in AR/AP functions, as well as in procurement and supply chain operations, to reduce working capital requirements and increase inventory turns. Figure 2: Current and Future Improvement Focus
Reduce inventory Shorten Days Sales Outstanding (DSO) Increase Days Payable Outstanding (DPOs) More effectively use short-term financing Move inventory off books More effectively invest cash short-term Other
84% 63% 45% 36% 35% 32% 24% 13% 20% 26% 28% 23% 29% 8%
% of all respondents
Source: Aberdeen Group, June 2007
Figure 2 shows that the vast majority of companies today are concentrating on reducing inventory and shortening Days Sales Outstanding (DSOs); innovators are also focusing on many other areas to drive working capital improvements. Given that reducing inventory is the biggest action that companies want to take to improve working capital, it is critical to understand the right approach to doing so rather than haphazardly cutting inventory.
Our company has been expanding rapidly into new markets by acquisitions. Our investors were unhappy with our financial performance in 2005. Since then, we have embarked on an inventory optimization initiative to drive down inventory levels. - VP of Supply Chain, Medical Devices Company
Inventory Misconceptions
Simplistic inventory policies work well. Companies that use ABCD inventory policies or simple weeks-of-supply rules frequently have 15% to 30% more inventory than they need, as well as lower customer service levels. They hold too little inventory for items with lumpy demand and too much for items with steady demand. Holding all items at all levels in our finished goods network will give us the highest service levels. Companies with multiple tiers of finished goods distribution frequently hold the wrong amount of inventory in the wrong locations and suffer out of stocks despite high inventory investments. Many of these companies should be holding some items just at their hub locations. It is fine for each location or tier in the supply chain to set its own service level targets and replenishment planning frequencies. The lack of synchronized inventory policies across manufacturing stages and distribution tiers builds up unneeded inventory across the supply chain. In addition, firms with highvolume, high-variability environments often have replenishment planning frequencies that are too slow, creating unnecessary stockouts and greater inventory costs. Inventory minimization should be the goal. Companies with strong Lean philosophies often suffer from longer-than-necessary order lead times, high total delivered costs, and service level issues because they hold too little raw material and in-process buffer stock.
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Using purchase orders or release notices for replenishment is efficient. A growing number of companies that used to cut purchase orders or release notices for their suppliers are discovering it is more effective to ask suppliers to take responsibility for maintaining inventory between min / max levels.
These misconceptions around inventory impact both top line revenue and bottom line results. Top line revenue: 1) revenue loss from stock-outs and late or incomplete orders that are cancelled; 2) customer retention issues because of service failures, long lead times, and flexibility challenges Bottom line results: 1) too much working capital tied up in inventory (also impacts the balance sheet); 2) lost manufacturing productivity and higher warehouse, labor, and transportation costs (e.g., expediting costs) caused by inventory delays or shortages; 3) profit erosion and write-offs from obsolete or declining price inventory
Aberdeen research has identified that Best-in-Class companies do not fall into the traps mentioned above. The key Best-in-Class characteristics are mentioned below.
Best-in-Class companies are able to analyze their inventory network and policies to add inventory where there are opportunities for winning additional market share and reduce inventory where it is not needed. They do not trim inventories across the board to reduce cost. Through this approach, they are able to increase their overall customer service levels while simultaneously reducing their total inventory carrying costs. Thus these companies are able to improve other key metrics like customer retention, gross margin and inventory turns. Figure 3: Best-in-Class Performance With Respect to Inventory Management
Increased finished goods inventory turns
73% 46% 73% 42% 64% 41% 45% 28% 0% 10% 20% 30% 40% 50% 60% 70% 80%
Reduced lead-time to customers Increased perfect order %(on-time and complete) to customers Increased customer retention
BIC Overall
It is clear from the above that technology plays an important role in inventory management success. Process changes are important, but in order to achieve sustainable benefits, Best-in-Class companies are more likely to supplement process changes with improved technology.
Case in Point: Inventory Management Strategy for Wholesale Distribution and Slow Moving Parts
NTU (Technische Unie) is a wholesaler, distributing goods for electrical equipment, heating and climate technology, plumbing, sanitary and consumer goods including audio, video, and household-appliances. The catalog for NTU has over 350,000 line items of which there are 82,000 active SKUs. Of these, 10,000 are fast moving products and 72,000 are slow moving products. NTU operates on very short lead-times with customer expectations of delivery within 24 hours of the order. NTU owns two warehouses which are sourced by over 600 suppliers, of which per-day delivery is from more than 200 suppliers. NTUs replenishment process operates on a daily basis with over 4,000 orders generated. Replenishment cycles are daily based on forecast data, initial inventory, lead-times, and lot sizes. Supply lead-times are an average of 25 days with all suppliers present in the "Euro region." Italy, Germany, and Britain are the primary sourcing countries. The challenge faced by NTU was poor forecast accuracy - especially that of the 72,000 slow-moving SKUs. In addition, the prior system was obsolete and no longer receiving support from a maintenance perspective. NTU implemented a demand, inventory, and replenishment planning solution that is able to support forecasting for intermittent demand and plan inventory based on service level agreements. During implementation, it was identified that overall inventory actually went up before coming down which was predicted by the software implementers and anticipated by the NTU project team. The underlying cause was that the system optimized the mix of products in such a way that some products had forecast and inventory requirements which were lower than the finished goods inventory needed to achieve NTUs desired service levels, whereas other products had inventory requirements higher than that and also needed to achieve their service targets. In other words, there was a period of re-balancing of inventory where the products with lower forecasts, based on customer demand, had to be sold out and the inventory flushed through the system, while other products had to be expedited in with immediate effect to achieve the target service levels. The effect of this was used positively by the project team at NTU to phase the roll-out of their implementation across their entire supplier base in a way that minimized the impact on cash flow a lesson which should be shared with other companies looking to implement an inventory optimization solution. Benefits include: Improvement in inventory turns Improvement in customer order fill rate Improvement in forecast accuracy at the product SKU level (even for slow moving parts)
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Case in Point: Micron Optimizes Inventory Using Postponement and Multi-echelon Strategies
Micron is one of the worlds leading providers of advanced semiconductor solutions. Microns DRAM and Flash components are used in todays most advanced computing, networking, and communications products, including computers, workstations, servers, cell phones, wireless devices, digital cameras, and gaming systems. Micron has a complex multi-echelon network of internal manufacturing, geographically dispersed subcontract manufacturers and inventory staging locations. There are primary echelons within their supply chain including wafers, die, components, and memory modules positioned at over 100 locations around the world. Micron's supply chain challenge is to improve service levels and reduce order-to-delivery lead times while decreasing the costs associated with running a complex supply chain, especially working capital attributed to inventory. In order to resolve these challenges Micron is aggressively working to improve visibility into inventory, deploy multi-echelon inventory optimization strategies / tools, and increase the use of postponement in order to service their customers faster and more reliably. Micron has implemented a best-of-breed SCM suite for demand planning and supply planning and an inventory optimization tool that supports multi-echelon planning. The demand planning tool takes multiple forecast inputs from customers, sales, and marketing and is rationalized against a statistical forecast to remove the inherent bias within manually developed forecasts. The resulting demand plan is then fed into the multi-echelon tool which derives the safety stock and pipeline stock required to hit the customers desired service level by location. The targets are more robust as they are based upon forecast accuracy, production lead times, transportation times, and supply variability. The following benefits have been gained in the last two years: Perfect order percentage (on time and complete) to customers increased by 11% For key products, order fulfillment lead time has been reduced from 14 days to three days Customer rating of their performance has improved dramatically
"One of our biggest challenges for our supply chain group is to improve customer service levels - reducing lead-times, increasing postponement, and optimizing inventory are three different business strategies that we are implementing to achieve our goals." ~ Simon Tunmore, Director of Supply Chain, Micron Technologies
Recommended Actions
Aberdeen research finds that the motivations and approaches for improving inventory are very similar across large scale as well as mid-size organizations. However the requirements for software technology that supports these processes is quite different - for mid-size organizations ease of use, packaged nature of apps and price are critical factors as compared to large organizations which may require customization and scalability. Organizations should look into SCM software suites that enable the following capabilities as a strategic investment.
2008 Aberdeen Group. www.aberdeen.com Telephone: 617 854 5200 Fax: 617 723 7897
By adopting the following practical approaches, companies can embark on their journey to reduce inventory the right way and unlock working capital: Identify the attributes of segmentation. Only 9% of Laggards have indicated strong process capabilities in segmenting inventory based on customer service requirements, versus 36% of Best-inClass companies. Companies should implement customer level forecasting and inventory / service segmentation processes. The key attributes based on when segmentation has to be done must be identified as well; for example, volumes, picking volumes, complexity of customization, and lead-times. Analyze forecasts and remove bias. Only 12% of Laggards have indicated strong process capabilities in the ability to analyze demand patterns and create accurate SKU-level forecasts, versus 34% of Best-in-Class companies. Companies should analyze the forecasts from their customers and ensure that forecast bias is removed and the forecast is allocated down to the SKU level based on the individual demand profiles associated with the SKUs. This may require the implementation of demand analysis solutions.
Identify demand echelon. Only 16% of Laggards have indicated strong process capabilities in the ability to determine safety stock targets for inventory at critical nodes in the supply chain, versus 48% of Best-in-Class companies. Companies should look into their distribution and manufacturing processes and identify the echelons where the demand is being placed. If the demand is being placed only at the finished goods distribution level, then safety stocks should be calculated at that echelon. In environments where components, finished goods, and even raw materials are being sold to customers, a multi-echelon optimization may be required. For more information on this or other research topics, please visit www.aberdeen.com. Related Research
Technology Strategies for Closed Loop Working Capital Optimization: Improving Inventory Management; April 2008 Performance with Innovations and New Technologies in Inventory Management Technology Strategies for Inventory and Supply Chain Finance; June 2007 Management September 2006 Author: Nari Viswanathan, Vice President and Principal Analyst, Supply Chain Management and Logistics (Nari.Viswanathan@aberdeen.com)
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