eBooks & Briefs

How to Calculate Inventory and Service Level Improvements from Supply Chain Planning Software

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Start Here to Build a Strong Business Case for Planning Software

The disruption we’ve seen in supply chain planning as a result of the pandemic is unprecedented. Perhaps you are among the many companies that have learned the hard way that traditional planning methods fall short as market and demand volatility increase. Having the right supply chain planning technology is one way businesses can create efficiencies that free up cash in the near term as well as help build greater supply chain resilience for future disruptions.

An evidence-based business case for executives is critical to win approval for planning software investments. Not sure where to start? In this brief we lay out a simple plan for how to estimate potential supply chain KPI improvements including both hard numbers and “soft” benefits.

Supply chain planning (SCP) software is critical to driving profitable growth and providing agility in an ever-more-competitive and fast-paced environment.

How to Build a Strong Business Case for Your Supply Chain Planning Technology Investment. Alex Pradhan, published 7 June 2019.

Shalom Asayag, Service and Aftermarket Director, Lubinski

Step 1

Identify Goals and Metrics Critical to Your Business

A good first step on this journey is to evaluate the goals and metrics that guide your operations and underscore your competitive advantage.
Find the answers to questions like:

A strong SCP business case must explain how planning capabilities will directly impact executive-level objectives. (1).

(1) How to Build a Strong Business Case for Your Supply Chain Planning Technology Investment. Alex Pradhan, published 7 June 2019.

Step 2

Decide Where You Want to Improve and Estimate Impact

Once you have the answers to these questions, shift your focus to areas of opportunity within your organization and build a plan to improve your supply chain performance and align teams. We’ve identified three areas where a supply chain planning solution can have a huge impact on metrics your executive team cares about:

Service Level

How to Calculate Annual Benefit

We define annual sales as the annual sales of the inventory we are optimizing, whether it be a division, region, product line, etc.

Service level improvement typically ranges from three to five percentage points, but can be higher if the company currently is achieving less than a 90 percent service level. One rule of thumb is that you should be able to reduce stockouts by half and still achieve some inventory reduction. To break this down, a company that is achieving a 90 percent fill rate, we should be able to improve to 95 percent, a five percentage point improvement. A company that is achieving a 96 percent fill rate, we should be able to improve to 98 percent, a two percentage point improvement.
Gross margin should ideally be specific to that part of the company we are working with, but the corporate gross margin may be used as a substitute. This additional revenue carries only direct costs, therefore the entire gross margin is added to the bottom line.
Lost sales ratio is that portion of sales that are lost when the product is out of stock and not available. Typically, branded products have a 40 percent lost sales ratio, meaning that 40 percent of the time that the company is out of stock, customers will choose a product from another company, rather than wait or buy a different product that the company offers. Among consumer products companies a lost sales ratio of 28 percent is considered close to best-in-class. Commodity products usually have much higher lost sales ratios.

An example benefit calculation for improved service level would look like this:

Annual Sales

Service level

Gross margin

Lost sales ratio

Annual Benefit

$300m

annual sales

2%

service level improvement

50%

Total inventory carrying cost

40%

gross margin

$1.2m

annual net profit improvement

Inventory Savings

How to Calculate Annual Benefit

We define inventory as the total monetary value of the inventory being optimized.

The inventory reduction percent can vary widely depending on the application and on how much improvement in service level is targeted. Customers’ past results have ranged from 10 to 50 percent. Inventory improvement will relate inversely to service level improvement. Applications with little to no service level improvement will have larger inventory improvements. Applications with large service level improvements will have small inventory reductions.

Inventory carrying cost percent should be the sum of both cost of capital and the operational costs associated with carrying the inventory.

Operational costs vary greatly depending on the product. Products with high obsolescence (e.g., fresh food, electronics) should have high inventory carrying costs. Products which require expensive warehousing (refrigerated foods, dangerous goods) will also. A low operational cost may be five percent, but can be much higher. Operational costs may also be expressed not as a percentage, but as a function of volume, cases reduced or any other measure.

Total inventory carrying cost percent (cost of capital plus operational costs) is rarely below 15 percent, and can be much higher. An example inventory savings calculation would look like this:

Inventory

Inventory Reduction

Inventory Carrying Cost

Annual Benefit

$200m

Finished goods inventory

10%

Expected inventory reduction

15%

Total inventory carrying cost

$3m

annual inventory carrying cost savings benefit

Fewer Supply Chain Disruptions and Improved Productivity

It’s tempting to focus solely on tangible metrics such as inventory, lost sales and profit margin. However, supply chain planning investments can have additional benefits that impact the bottom line, yet are harder to quantify. They can be unpredictable and incremental, and will vary greatly from company to company, but can be significant nonetheless.

These include:

Investigate Other Companies’ Experiences

Raw metrics go a long way in justifying investments. However, numbers often have a deeper impact when they are part of a story incorporating examples of other companies that impacted key KPIs with supply chain planning software initiatives. Here are just a few to share.

Polaris customers want their products now—whether it’s parts for agricultural equipment or an impulse purchase of a personal watercraft. With volatile demand and high service expectations often comes excessive inventory levels. With probabilistic forecasting and stock mix optimization, Polaris has seen significant improvement in critical performance indicators that have turned the company around. In just two years it has reduced inventory by 15 percentage points and improved service levels by 10 percentage points, with significant improvement in planner productivity.

McDonald’s Mesoamérica needed to meet exceptionally high service levels while managing perishable products and dynamic promotions. A move to service-driven planning enabled the fast food giant to reduce inventory by seven percent, push service levels above 90 percent, reduce expedited shipments between stores by a whopping 83 percent, and significantly improve planner productivity and time management.

ToolsGroup as software and an asset, it has been a great tool. It gives you great visibility of the whole inventory. It’s predicting the forecast as has never been done before, and it has fantastic visual tools that the team is using to make some decisions.

Rafael Labbé, Supply Chain Director at Suministros y Alimentos, a distributor to McDonald’s Mesoamérica

A multi-national coffee bar company used POS data, telemetry and rapid re-planning to enable an entirely new approach to logistics and replenishment, redefining the ability to deliver barista-quality coffee in thousands of venues that were previously impractical. Further, one planner handles the planning for 5,600 points of sale. These unmanned coffee stations transmit POS data every 15 minutes to help a highly autonomous planning system forecast demand, optimize inventory and generate replenishment proposals for distribution and procurement. This innovative model is generating new revenue streams at minimal costs for the retailer.

Pharmaceutical firm Cipla Medpro developed the intelligence to identify potential stock-outs up to four months in advance. This gave them enough time to respond proactively to critically important customer demands. The automated statistical forecasting system is now consistently up to 20 percent more accurate than Cipla’s own market intelligence.

Look Beyond Quick Wins for Lifetime Value

Regardless of company size, industry or customer segment, supply chain planning improvement initiatives are crucial to a larger strategy of competitive market advantage, enabling you to work faster, smarter and more accurately to improve the bottom line. Implementing a supply chain planning solution can support these goals to yield a transformational impact.
When you become a ToolsGroup customer, we bring all our teams’ expertise together to develop and implement solutions aligned with your business objectives. With our support you can identify and execute methods that deliver sustained business value.