Why_? Why invest in Inventory Optimization?

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1 Why_? Westernacher Knowledge Series Whitepaper Why invest in Inventory Optimization? For a profi table supply chain, effective inventory managment is a key factor which is often challenged by confl icting requirements of the different players involved in the business planning process (Sales & Operations Planning)

2 Why invest in inventory optimization? Different players different targets. For a profi table supply chain, effective inventory management is a key factor often challenged by conflicting requirements of the different players involved in the business planning process (Sales & Operations Planning). The Sales department requires a high level of finished goods inventory in order to provide good customer service and satisfaction. Supply Chain Operations are interested in having high levels of raw material inventory allowing them to better react to uncertainties in supply. However, increased finished goods and raw material inventories will lead to higher inventory carrying costs, which will have a negative impact on financial performance. In contrast to the sales and operations functions, the finance department will demand lower inventories to reduce the company s capital investment and improve cash flow. If the competing objectives of high service levels and low inventory are not properly balanced, this will have a negative effect on customer service and financial performance with a corresponding loss of sales, reduced business confidence and profit. BUSINESS IMPROVEMENT THROUGH INVENTORY OPTIMIZATION + TRADITIONAL INVENTORY MANAGEMENT ME APPROACH STATE-OF-THE-ART INVENTORY MANAGEMENTM INVENTORY LEVEL Higher service level with the same inventoryn Same service e level with lower inventory SERVICE E LEVEL +

3 Balance is everything. Inventory Optimization (IO) is the systematic approach of achieving the balance between service level goals and cost. There is no need to blindly increase levels of stock in order to achieve better service. Advanced inventory optimization tools take into account demand and supply uncertainties and enable companies to achieve better fill rates with lower inventories. The basic drivers of inventory, such as forecast error or lead time variability are common to most supply chains, making inventory optimization relevant for every industry. There is a wide range of inventory management software available which uses sophisticated optimization algorithms to help achieve your inventory reduction targets without impacting - rather improving - your service level. Organizations that have implemented similar inventory optimization systems have reduced inventory levels by up to 25 percent within one year 1. Organizations that have implemented similar inventory optimization systems have reduced inventory levels by up to 25 percent within one year 1. up to 25 reduced inventory levels PERCENT within Balance is everything. 1 YEAR THE KEY BENEFITS OF THIS TYPE OF INVENTORY MANAGEMENT SOFTWARE INVENTORY REDUCTION VISIBILITY & TRANSPARENCY WHAT-IF ANALYSIS BEST PRACTICE PROCESS COMPETITIVE ADVANTAGE Inventory reduction while achieving target customer service levels leading to reduced operational cost and enhanced profi tability Improved visibility of inventory deployment with exception management 2 Various What-If scenarios can easily be performed A best-practice process for the management of inventory 2 can be established Increased competitive advantage

4 If you plan to embark on an inventory optimization initiative, you should not only consider the technical aspects of the project. Perhaps a more crucial aspect to consider is the operational model (e.g. processes, KPIs) and the organizational model (e.g. process roles and responsibilities and collaboration between roles). Inventory optimization is not a stand-alone process but has many interactions with other business processes and participants. A clear definition of the interfaces and full integration of all people and departments involved is key to achieving acceptance of these new cross-functional processes. THE INVENTORY OPTIMIZATION PROCESS IS EMBEDDED INTO A PROCESS CHAIN OF SUPPLY CHAIN PROCESSES STRATEGIC PLANNING DEMAND PLANNING INVENTORY OPTIMIZATION PROCESS SUPPLY & DISTRIBUTION PLANNING INVENTORY PERFORMANCE REVIEW LOGISTICS FINANCIAL REVIEW THE INVENTORY OPTIMIZATION PROCESS A best practice inventory optimization process will include six steps and can be modelled as shown below. 1. VALIDATE DATA INPUTS Check data completeness and plausibility 2. REVIEW INVENTORY PLAN AFTER OPTIMIZATION RUN Identify changes to the last planning cycle Review short and mid-term inventory projections in quantity and value 3. ASSESS DRIVERS OF INVENTORY Explore key input variables driving the optimization results Analyse root cause for major change Use inventory driver as a starting point to optimize adjacent business processes (e.g. forecasting process) 4. PERFORM WHAT-IF ANALYSIS Analyze the impact of adjusted input parameters on the fi nancial and logistics performance of the supply chain (e.g. investigate impact of slower but cheaper means of transport on the inventory value balance transportation versus inventory holding costs) Analyze which target service levels can be achieved with a reduced inventory budget (budget constrained inventory optimization) 5. UPDATE INVENTORY PLAN Update the inventory plan based on fi ndings or adjustments from preceding steps Adjust the plan on the basis of information that is not refl ected in the input parameters 6. EXECUTIVE REVIEW & APPROVAL Final plan is reviewed and approved by the main stakeholders Key outputs of the inventory optimization process are Safety Stock recommendations and conclusions about the total inventory level for all product types.

5 To fully comprehend how to manage inventory we must understand what the different types of stock are and what they are used for. KEY COMPONENTS OF INVENTORY Safety stock is a buffer stock used to mitigate the risk of stock outs due to uncertainties in supply and demand. SAFETY STOCK Cycle stock is the inventory that is planned to be sold based on the demand forecast during the exposure period of forecasted demand. Pipeline stock refers to goods that have left a compa- ny s warehouse but have not been bought by the ultimate consumers, customers or users and are therefore still within the company s distribution chain. Pre-Build Stock is required to anticipate demand peaks greater than capacity (e.g. seasonal fl uctuations, shortfall due to erratic production). Minimum Required Stock is needed to satisfy strategic marketing or merchandising requirements. CYCLE STOCK PIPELINE STOCK PRE-BUILD STOCK MIN. REQ. STOCK TOTAL INVENTORY Total inventory is formed by the sum of all these stocks, thus inventory optimization must track all of them and should not only focus on stand-alone safety stock minimization. There are interdependencies between the stocks and some of them might not be reduced due to valid business reasons (e. g. increase of cycle stock leads to a decrease in safety stock). DRIVERS THAT INFLUENCE INVENTORY Safety stock recommendations are typically the main output parameters of an inventory management software solution that are transferred to other planning processes (e.g. Distribution Requirement Planning (DRP), Supply Planning). However, within the scope of an inventory optimization initiative, the potential contribution of the other stock types to reduce inventory should also be investigated. SAFETY STOCK RECOMMENDATIONS CAN DERIVE FROM SEVERAL DIFFERENT FACTORS DEMAND VARIABILITY LEAD TIME AND LEAD TIME VARIABILITY SERVICE LEVEL LOT SIZE REVIEW FREQUENCY REPLENISHMENT FREQUENCY

6 Some IO tools (as SAP IBP IO) can calculate the variance of the demand in order to better determine the inventory recommendations. Having the possibility to calculate your forecast and safety stock recommendations in the same tool, simplifies the integration between these two processes. Cycle stock is based on the forecast until the next incoming delivery. Pipeline stock is based on the forecasts of all periods during the order processing and delivery lead time. Key drivers of both stock types are: KEY DRIVERS CYCLE STOCK Demand forecast Replenishment and review frequency Lot sizes Production rules PIPELINE STOCK Transportation and production lead time Order processing time Goods receipt time Demand forecast MAJOR CHALLENGES DURING AN INVENTORY OPTIMIZATION INITIATIVE You cannot improve what you cannot measure. KPIs and metrics must be established for each step of the inventory optimization process to help to proactively control the optimization process and take corrective actions. For example, to measure and visualize the course of the safety stock by location or the inventory value over a period of time is not a big deal but makes for better transparency of process performance. As previously discussed, inventory optimization must be considered as a cross-functional business process with many interactions between different departments. Providing a collaboration platform (such as JAM by SAP IBP) to share information, decide on tasks and actions and monitor the work progress is therefore a key prerequisite to the effective implementation of an inventory optimization process. The Inventory Optimization process is based on static (e.g. standard lead time) and fluctuating parameters (e.g. lead time variation). Static parameters are usually part of a company s master data and can easily be extracted from the operating system (knowing the correct data fields). The determination of fluctuating parameters usually requires more effort as their inputs must be gathered across an adequate period of time before they can be transferred into a measure for variation. Therefore data management is an integral and challenging part of the optimization process and plays an important role in the quality of the process inputs. Finally, it is also important that people who directly work in the optimization process have a good understanding of the science behind the process. This is essential to achieve trust, support and approval of the results. You cannot improve what you cannot measure

7 SAP IBP FOR INVENTORY A STATE-OF-THE-ART INVENTORY OPTIMIZATION TOOL SAP IBP for Inventory embeds the SmartOps algorithms in order to master uncertainty and drive inventory decisions for planners. It uses multi-stage optimization to most efficiently meet or exceed customer service levels, fully considering demand and supply uncertainties such as forecast error or lead time variability. The focus of IBP for inventory s optimization algorithm is on ensuring that the agreed service levels towards your customers is met, driven by your forecast within the constraints of cost, lead time, review frequency, lot size and the uncertainty of supply and demand. SAP is continuously gathering requirements from several different industries and including them in the road map for the IBP for Inventory software solution. THE KEY BENEFITS OF SAP IBP FOR INVENTORY COST REDUCTION IMPROVED PLANNING PRODUCTIVITY USER COLLABORATION SYSTEM INTEGRATION Inventory reduction up to 25% while maintaining the target service levels Multi-stage inventory optimization with one of the best in class IO algorithms to calculate time-phased safety stock recommendations Easy creation and real-time actioning of what-if scenarios and analysis to drive the inventory and supply chain optimization processes User-friendly interface based on MS Excel allows planner to create and adjust planning views themselves User-friendly KPI dashboards support the inventory optimization process and can be adapted by end users without the involvement of IT staff Use SAP Jam as a social collaboration platform to facilitate collaboration among end-users and planners Increased collaboration efficiency allows planners to spend more time on the inventory optimization process and improve inventory optimization Easy integration to any system using SAP HANA Cloud Integration (HCI)

8 WESTERNACHER SUPPORTS YOUR INVENTORY OPTIMIZATION INITIATIVE Westernacher has been one of the early adopters of SAP IBP. Our consultants have worked with several releases of the system and have seen how the product has developed over time. the solution in different industries, leveraging our agile methodology and our experience of the organizational change management aspects of an implementation project. We can provide the required process knowledge expertise, together with our experience of implementing CONTACT US Westernacher Business Management Consulting AG Im Schuhmachergewann Heidelberg, Germany Phone Fax planning@westernacher.com Authors Ute Messmer Sachin Vijayan linkedin.com/in/vijayansachin Dr. Steffen Blunck linkedin.com/in/blunck References Follow us on: Copyright 2017 Westernacher Busines Management Consulting AG. All rights reserved.