Is Inventory the "necessary evil"?
1. The drive towards Globalization has resulted in the focus to not only look at the developing markets for cheap supply, but also to tap these developing markets to drive future growth. These newer markets do add to the overall growth of the organization, but also pose newer challenges in meeting the customer demand satisfactorily
2. Increasingly demanding customers with information at finger tips and lower brand loyalty
3. Increased channels to service the customers with varying degrees of Customer Service expectations
4. Intense competitive activity driving lower prices and reduced scope for differentiation
5. Increased pace of product innovation - rapid new product introductions combined with rapidly reducing product life cycles.
All these factors contribute to the overall Demand Volatility in the Supply Chains while confronting with the reality on the Upstream:
1. Increasing lead times with most of the manufacturing bases of suppliers outsourced or offshore
2. The Escalating costs of fuel drive these supply chains to employ slower and economical modes of transport like by water rather than by air. This not only adds to the overall lead times but also the overall lead time variability of the Upstream partners
We see the following competing forces in action that need to be addressed well:
We have traditionally employed Inventory as a buffer against these competing forces. The Inventory, while helping in decoupling the subsequent stage from the activities in the preceding stage, also does result in various types of costs and thus are generally the sour point for most of the Finance executives.
There are many articles and blogs that weigh the benefits against the costs associated with carrying Inventory. The focus of my blog is however with one peculiar aspect of the challenge mentioned above - the increased number of stages or echelons in an end-to-end Supply Chain exacerbating the potential downside impacts of carrying Inventory. We further narrow down our focus on the Safety Stocks that are required to cover the variability / uncertainty related to the Customer Demand and the Supplier Lead Times. The more the number of echelons and the more the number of stocking points, the larger would the total Safety Stock in the Supply Chain. This is a key point to keep in mind that we can no longer plan for inventory to be available in every node in the Supply chain.
We do see the use of Weeks of Supply as a way to setup Safety Stock at every node in the Supply Chain, though this approach is a sure-fire way for disaster as the inventory lying in the network faces two significant costs - the Opportunity Cost and the Obsolescence Cost. If we were to employ the concept of Risk Pooling and have the Safety Stock maintained in one single location, the total Supply Chain Safety Stock would be reduced by a factor of the Square Root of the number of nodes. From a Safety Stock perspective, again the idea is that this Stock must be determined to cover the Lead-time variability from all the upstream stages and the Demand variability from all the downstream stages. This approach when used to meet a specified target service level is an improvement over the static weeks of supply-based target for the Safety Stock. This capability is available as part of most Advanced Planning Solutions available in the market, one of them being SAP SCM.
The above-mentioned approach has ample room for improvement by deploying the Inventory Optimization models to determine the Inventory levels across multiple echelons of the Supply Chains. The Inventory Optimization functionality is generally available as an add-on tool that complements very well and feeds into the Replenishment planning modules within the Advanced Planning Systems [for e.g. SmartOps which provides multi-echelon Inventory Optimization has very tight integration with SAP APO].
I would like to not conclude whether Inventory is indeed a necessary evil yet, but would like to end this blog with the following interesting analogy made by Mr. Larry Lapide about Inventory in his article in SCMR:
"I wrote an article where I used the analogy that inventory is like cholesterol. Both have two components to them: good and bad. So like cholesterol, you want to keep your total inventories as low as possible, but you don't want the good component to get too low."