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Four Ways Inventory Optimization Can Address Tighter Supply Constraints

By Jeff Bodenstab8 May 2018

As the (U.S.) economic expansion enters its ninth year, supply constraints are showing up in supply chains.

The Wall Street Journal recently advised “In the battle for economic supremacy, investors should quickly be realizing it’s increasingly about supply, not demand.” (The Next Challenge for Global Growth: Keeping Up With Demand, April 24, 2018). Along with multiple examples they cite the Institute for Supply Management’s (ISM) order backlog index, which has reached its highest level in 14 years. Due to robust demand, the ISM says supply chains are “struggling to keep up.”

When supplies get tight, inventory optimization can help focus production around the most critical products while reducing requirements for other items. Multi-Echelon Inventory Optimization (MEIO) looks at the end-to-end supply chain to enable users to make more informed decisions about the location, amount and type of inventory.  Full blown inventory optimization projects can take up to a year, but on-demand inventory target setting can be implemented and addressing constraints in just a few weeks.

Gartner says that clients typically see 10% to 30% inventory reductions upon the successful implementation of MEIO above and beyond those gained through System of Record (SOR) planning systems (Key Principles for Implementing MEIO to Cope with Supply Chain Variability, Tim Payne, September 2016).  Inventory (both finished goods and materials) can then be allocated to more critical demand.

Inventory Optimization addresses multiple issues

MEIO allows a company to position the inventory to meet financial and marketing objectives in a much more efficient manner than “one size fits all” inventory. Here are four ways inventory optimization can help alleviate constrained supply.

  1. Postponement for Inventory Configuration – optimizes the trade-off between upstream and downstream inventory to identify the most globally efficient balance. Allocating inventory upstream where it has the broadest range of possible uses (i.e., “risk pooling”) is traded off against positioning it downstream near the demand.  It addresses the issue of “in what form should I hold my inventory; as raw material, finished goods, or something in between?”   It can automatically suggest the right “decoupling points” and the adequate levels of materials, components, subassemblies and finished goods in any location of the entire supply chain.
  2. Stage optimization applies the same postponement principles, but to the distribution part of the network, where the form of the inventory usually does not change, only its place in the network. For instance, it addresses decisions about whether to stock inventory at the factory, in a centralized distribution center, at regional network, or some combination of the above.
  3. Prebuild Analysis aligns inventory requirements with build ahead capabilities. In a finite capacity environment with reduced supply, prebuilt inventory can be carefully planned to cover the demand in the period of inadequate supply. An inventory optimization system can dynamically define the prebuilt inventory requirements on the basis of time-phased forecasts.
  1. Lot Size Optimization is the simultaneous optimization of safety stock and cycle stock values. Inventory analysis identifies the optimal trade-off between either the set-up cost (for manufacturing) or the handling cost (for replenishment) versus the inventory holding cost.

Any of the above can allow a company’s supply chain to reduce unneeded inventory consumption and therefore be more responsive to supply constraints. In one example, P Castrol initiated an inventory optimization program as part of a larger Sales and Operations Planning (S&OP) process. Project manager Alessandro Tenaglia reported afterwards, “We had huge reductions in stock levels of 20% in the first year, followed by additional 20% the following year. We were surprised that the benefits came not just in finished products but in also raw material and components. We realized was that more reliable production plans led to the reduction of components and raw materials even more than the reduction of finished goods.”


Click below for a guide to selecting an appropriate Inventory Optimization tool.


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