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The Systemic Inventory Review:

A holistic approach to identifying Inventory Issues & Opportunities

Quentin Samelson March 2013

Introduction: This short white paper is intended to offer a simple but comprehensive approach to understanding the inventory situation at a company (or division of a company). Although the same tools and techniques will work in nearly every organization, deciding which should get the highest priority depends on the specific situation and environment encountered. Sometimes there will be glaring issues a forecast with grossly overstated demand or a completely dysfunctional receiving process, for instance. While those should certainly be addressed with urgency, its also important to take a holistic view of the inventory situation. Attacking the visible issues doesnt always address all of the critical issues. The Inventory System title is meant to indicate the entire system policies, physical processes and methods, computer processes & systems that works together (or doesnt work, in many cases) to put the right inventory in the right place at the right time. Review is intentionally a flexible concept it may include everything from informal brainstorming sessions to a formal audit process, as may be appropriate in analyzing & understanding the system in place within a particular organization.

Seven Elements of the Systemic Inventory Review Process The seven elements listed below fall into roughly a four-step process. The first four elements are all associated with different ways of thoroughly assessing process and performance, and identifying issues. The second step is intended to quickly identify major pain points & find opportunities for quick improvements. The third step employs a set of simple techniques to begin putting discipline into inventory operations; and the fourth builds a supply-chain model to permit adjustments and begin the process of optimization. Although the four steps are intended to executed in sequence, some overlap is acceptable. Step 1. Assess Element A. Site Process & Performance Review B. Inventory Accuracy Audit (Stock-Take) C. Inventory Anomaly Investigation Description Review of processes, policies & methods used to manage inventory in each manufacturing or distribution site. Analysis of inventory accuracy performance, as well as processes & physical environment creating inaccuracies. Review of specific areas where inventory either shouldnt be or shouldnt stay to find and correct errors. (These areas typically represent transition points between operations or facilities.) Review of global or shared processes, such as planning/ forecasting, supply management, etc. that affect inventory globally & at individual sites. Identify opportunities for quick improvements, as well as issues that need further study and issues that will require an investment (time, resources, money). Execute quick improvements. ABC/ Pareto Analysis and management; variability / XYZ analysis and mgt; dual/ multiple sourcing; etc. Build simple model & identify opportunities to improve speed and agility.

D. Global Process Review

2. Improve

E. Identify & Mitigate Pain Points

3. Execute 4. Adjust & Optimize

F. Implement Simple Inventory Mgt Techniques G. Build Supply Chain Model & optimize

An overview follows of each element, and how the different elements support the goal of a comprehensive understanding of the inventory issues and opportunities within an organization. A. Site Process & Performance Review: this is often one of the most effective mechanisms for discovering not only what inventory issues are confronting an organization, but also a rich source for solutions to those issues. Frequently one site will have solved, or at least mitigated, some of the problems that exist at other sites. The site reviews are intended to assess & understand the individual drivers of inventory at each site, and are usually organized functionally. The structure below is typical: a. People policies, training, etc. b. Procurement/ Suppliers c. Planning/ Scheduling d. NPI / Product Design e. Materials Handling f. Manufacturing g. Information Systems Note that some of the topics above (b, c, d, & g) may be fully or partly managed on a corporate or global level. Even in these cases, it is useful to review them at a site level to understand the overlaps and hand-offs between the global & local functions and to expose issues. (Example: the casting supplier that a corporate commodity manager has negotiated may provide low cost products, but may cause high freight costs and/or shortages due to its remote location.) Site Process & Performance Reviews are typically highly structured, documented and scored so that different sites can be compared and progress can be assessed over time. B. Inventory Accuracy Audit: for internal control purposes, most companies have some kind of annual or quarterly physical inventory process. The intent here is not to simply do another stocktake but to understand the size, location & cause of errors. Inventory errors can be caused by systems issues, physical/mechanical problems, product data (BOM) errors, and control or security issues. The key question is whether inventory accuracy issues are severe enough to cause disruptions to supply. If the answer is yes, they need to be understood & resolved. C. Inventory Anomaly Investigation: Similar to the accuracy audit, this is an area where the question is simply whether issues are severe enough to cause disruptions. Most anomalies occur in transitions or pass-offs between organizations or locations. They typically manifest as items in Goods-in-Transit, Work in Progress, or other temporary locations that age past a reasonable level. Situations like this need to be analyzed and resolved; if there are more than just a few, the root cause(s) should be investigated & permanent corrective action should be put in place.

D. Global Process Review: this is the counterpart to the Site Process & Performance Review. Most large organizations have either completely or partially centralized certain functions. The processes that are managed at a corporate or global level need to be understood in and of themselves, but also in terms of pass-offs to the sites. Topics would generally include: a. People policies, training, etc. b. Procurement/ Suppliers especially supplier agreements/ contracts and supplier order/scheduling practices c. Planning/ Scheduling especially forecasting processes & the S&OP process, including those actions taken to provide flexibility & agility. d. Customer Agreements & order/scheduling practices e. NPI / Product Design f. Information Systems at a global level, the entire systems landscape needs to be understood. Companies usually have a patchwork of formal & informal systems and databases. From an inventory standpoint, the key areas to understand include hand-offs / integration between systems; data access (ability to generate reports); and MRP settings and processes. Where are the current system limitations, what is the plan to resolve those limitations, and what is the best current work-around? g. Risk Management. Is this done formally or informally? What risks are considered? What risks have been encountered in the past? E. Identify & Mitigate Pain Points: The first four elements will undoubtedly identify a number of issues. However, the relative priority of those issues may not immediately be apparent; and often there is sufficient urgency that the organization simply cant wait for a painstaking analysis to be completed before action is taken. There is a need for quick, positive action to make things better. So this step often may be the first step taken, and it often will be iterative in nature. The process may start with a brainstorming exercise, or simply a series of high-level interviews, to identify the highest-priority issues. A sort of triage needs to be performed on those issues: (i) quickly identify where there are opportunities to make rapid, short-term improvements without the need for large investments of time, personnel or cash; (ii) identify those areas that require further study to determine how and where to make improvements, and (iii) identify the issues that will require a substantial investment (again, of time, personnel, and/or money) to resolve. F. Implement Simple Inventory Management Techniques: Effective inventory management does not usually need very sophisticated tools and techniques. To a great extent, deploying Pareto analysis via several variations of the ABC classification concept, combined with application of the Pareto principle (focusing attention on the critical few rather than the trivial many), will provide enormous benefits. Those benefits will be both tactical (quickly gaining control over critical inventory levels) and strategic (identifying core problems that, if resolved, will make it easier to keep inventories under control). Although its not the only simple inventory management technique, the power of ABC analysis can easily demonstrate the value possible from effective application of such tools. ABC analysis will generally identify the 1% to 5% of the total part numbers or item codes that represent roughly 80% of the inventory value. Using an 80%/ 15%/ 4%/ 1% split for ABCD classifications will quickly identify the small number of items that must be aggressively managed, as well as the

large number of items that should be managed with high enough inventory levels that they do not require much management effort. But even more power can be obtained by building small matrices, such as: Last months code A B C Current Month: A No change Avoid XS/OBS Take action to avoid Excess/ Obs Current Month: B Take action to No change avoid shortages Avoid Shortages No change Current Month: C When items move from one classification to another, demand is generally growing or decreasing to the point that either shortages or excess are likely to result. If action is taken immediately, the impact of those changes can be largely (often completely) avoided. A similar matrix can be built to compare ABC classifications to XYZ classifications, where XYZ is a statistical calculation of the variability of demand: X parts have very stable demand, Z parts have highly volatile demand, and Y parts are in between. X Y Z A Manage for lowest Manage for low Allow some safety buffer/ possible inventories; use inventory; combine Manage for high flexibility. low-cost freight; use JIT/ pull concept with Optimize combination of JIT/ pull concepts. combination of surface inventory, expedited freight & & expedited freight. other techniques. B Run at low end of B Run in middle of B Run at high end of B inventory range; use range; combine JIT/ inventory range but manage low-cost freight & pull concept with for flexibility. Same set of JIT/pull concepts. combination of surface tools as for A-Z combination. & expedited freight. C Run at low end of C Run in middle of C Run at high end of C inventory range inventory range inventory range G. Build Supply Chain Model & (begin to) optimize. Optimizing a supply chain is a neverending process of matching a supply chains capabilities to market conditions and the goals and strategy of the organization. Unless the organization has a very simple supply chain, building a model is an essential first step. Even a simple model will create a foundation for understanding the supply chain holistically. As the actual conditions of the marketplace are better understood, and new capabilities are added to the supply chain, additional sophistication can be added to the model. At the very beginning, however, simply understanding (1) the nature of customer demand especially how variable or predictable it is, (2) the sources of supply i.e. manufacturing facilities & third-party suppliers of saleable goods, and (3) the means of distribution between supply & demand, including any distribution centers, can expose key opportunities for improvement. An example: the company has a low-cost manufacturing facility in Asia for its product. The transportation time to the USA is 4 to 6 weeks and air freight is expensive because the product itself is heavy & bulky. It maintains 2 weeks average demand on hand in its (single, centrally located) distribution center, and it maintains a steady flow of a weeks average demand from its Asia manufacturing facility to the US distribution center. Yet the distribution center stocks out from time to time, because customer demand is so volatile that occasionally it will exceed 2 weeks worth of product in a single week and that high demand level can last for up to a month.

If supply isnt available, customers will switch to another source so every missed sale is gone forever. Looking at this scenario, the company can model a number of different solutions: a. Maintaining higher inventory in the DC. b. Using premium freight to move stock from Asia to the USA. c. Developing a premium surface logistics process that will shorten the transit time from 4-6 weeks down to 2-3 weeks, with better predictability. d. Using a slightly higher-cost internal or external manufacturing facility located in North America to provide a second source of supply. e. Improving predictability of demand. For instance, analysis of past demand may reveal that high customer demand is seasonal, or related to specific weather events. This may allow the company to stock up at the DC in advance of expected high-demand periods. The optimal solution will often be a combination of different solutions, and will continually develop as processes are enhanced and understanding of the marketplace improves.

Conclusion: Every company with inventory issues has its own mixture of urgent problems, ongoing constraints, and capabilities so a perfect solution for one company may be less than ideal, or even counterproductive, at another. Sometimes one or another particular problem is so urgent that it must be solved or at least mitigated before a more comprehensive approach can be taken. Ultimately, however, the holistic approach outlined above will pay off by ensuring that the company looks at inventory management as a system rather than one or two stand-alone processes.