Inventory Management 3 Keys To Freeing...

Inventory Management
3 Keys to Freeing Working Capital

May 2009
Nari Viswanathan
~ Underwritten, in Part, by ~
Inventory Management: 3 Key Strategies to Freeing Working Capital
Page 2
2009 Aberdeen Group. Telephone: 617 854 5200
www.aberdeen.com Fax: 617 723 7897
Executive Summary
In these times of economic uncertainty and global credit crunch, companies
need to actively seek out best practices in how to move from working
capital optimization theory to practical initiatives that will improve
corporate financial performance while maintaining customer satisfaction.
Supply chain, procurement, and financial professionals have an opportunity
to use working capital innovations to create a market advantage for their
companies. Cash velocity can be a competitive differentiator and companies
need to assess a variety of breakthroughs in working capital management to
keep pace with their peers. Aberdeen surveyed over 170 companies to find
out their challenges and plans relating to inventory management to publish
this benchmark report.
Best-in-Class Performance
Aberdeen used three key performance criteria to distinguish the Best-in-
Class from Industry Average and Laggard organizations. These metrics are
determinants of Best-in-Class status with respect to achieving tradeoffs
between customer service levels and working capital:
Average customer service level: 96%
Average cash conversion cycle : 15 days
Average forecast accuracy at the product family level: 87%
Competitive Maturity Assessment
Examples of the Best-in-Class process differentiators are:
Best-in-Class companies are 1.5-times as likely to have the ability to
determine safety stock targets for inventory at critical nodes in the
supply chain, which is typically owned by the inventory analyst
within supply chain and is a monthly / weekly process
Best-in-Class companies are 40% more likely to have the ability to
replenish inventory into distribution buffers based on customer
demand, which is typically owned by the inventory analyst and is a
weekly / daily process
Required Actions
Some of the recommendations that are discussed in Chapter 3 are:
Segment finished goods inventory based on financial performance
Focus on moving away from rule of thumb inventory target settings
Create the ability to analyze demand patterns and create accurate
SKU-level forecasts
Tie inventory and financial metrics together
Research Benchmark
Aberdeens Research
Benchmarks provide an in-
depth and comprehensive look
into process, procedure,
methodologies, and
technologies with best practice
identification and actionable
recommendations.
This year, our major focus
within the supply chain
organization is on reducing
working capital, primarily
through optimizing our
inventory management. This
initiative has been under way
for several years, but is now
more highly prioritized because
of the economic situation. Our
companys goal is a 10%
reduction in on-hand inventory
by the end of this year. In
addition to this, in order to
remain competitive in this
tough business climate, we have
begun renegotiating contracts
with our 3PL providers globally.
With increased supply chain
budget constraints, we have
had to re-allocate resources
within the supply chain
organization to support these
two initiatives.
~ Manager of IT,
Large consumer goods
manufacturer
Page 3
Table of Contents
Executive Summary....................................................................................................... 2
Best-in-Class Performance..................................................................................... 2
Competitive Maturity Assessment....................................................................... 2
Required Actions...................................................................................................... 2
Chapter One: Benchmarking the Best-in-Class ..................................................... 4
Business Context ..................................................................................................... 4
The Maturity Class Framework............................................................................ 6
The Best-in-Class PACE Model ............................................................................ 6
Strategic Actions of the Best-in-Class................................................................. 7
Chapter Two: Benchmarking Requirements for Success .................................... 9
Competitive Assessment......................................................................................10
Capabilities and Enablers......................................................................................11
Chapter Three: Required Actions...........................................................................19
Laggard Steps to Success......................................................................................19
Industry Average Steps to Success ....................................................................19
Best-in-Class Steps to Success............................................................................20
Appendix A: Research Methodology.....................................................................22
Appendix B: Related Aberdeen Research............................................................24
Featured Underwriters..............................................................................................25
Figures
Figure 1: Companies Are Actively Re-evaluating Inventory Management....... 4
Figure 2: Key Pressures to Improve Inventory Management ............................. 5
Figure 3: Strategic Actions Taken by Best-in-Class Companies......................... 7
Figure 4: Approaches for Impacting Working Capital.......................................... 8
Figure 5: Process Playbook for Closed Loop Inventory Management.................14
Tables
Table 1: The Maturity Class Framework................................................................. 6
Table 2: The Best-in-Class PACE Framework ....................................................... 7
Table 3: Competitive Framework...........................................................................11
Table 4: Closed Loop Inventory Management Technology Enablers................14
Table 5: The PACE Framework Key ......................................................................23
Table 6: The Competitive Framework Key..........................................................23
Table 7: The Relationship Between PACE and the Competitive Framework....23
Page 4
Chapter One:
Benchmarking the Best-in-Class
Business Context
In these times of economic uncertainty and global credit crunch, companies
are actively seeking best practices for reducing inventory holdings
throughout their multi-tiered supply chain networks. In fact, as Aberdeens
recent survey of overall supply chain trends shows, reducing inventory is the
top action companies have taken to date in response to the recession
(reported by 54%). Companies are looking for practical initiatives that can
unlock working capital while maintaining customer satisfaction. With 62% of
companies reporting a drop in customer demand over the past year,
focusing on inventory is critical if a company wants to avoid a spike in write-
offs due to obsolescence, when the stock builds up but cannot be sold.
Aberdeen has surveyed 170 companies to uncover the most pressing
current challenges and best practices in inventory management, summarized
in this report.
This study confirms that inventory management processes and technologies
are being actively re-evaluated by companies today. As Figure 1 shows, 91%
of respondents say they have made or been asked to provide
recommendations to management in the past six months on how to
improve their companys inventory management processes. Fully 61% of
respondents say they have made, or have been asked to make, inventory-
related technology recommendations within the past six months.
Figure 1: Companies Are Actively Re-evaluating Inventory
Management
61%
91%
0% 20% 40% 60% 80% 100%
Lookingatinventory
technology
enhancements
Lookingatinventory
processorpolicy
changes
PercentageofRespondents,n=137
61%
91%
0% 20% 40% 60% 80% 100%
Lookingatinventory
technology
enhancements
Lookingatinventory
processorpolicy
changes
Source: Aberdeen Group, May 2009
Examining the key pressures that companies are facing with respect to
inventory management, we see that the corporate need to improve return
on invested capital (29%), shortage of working capital to support operations
/ expansions (20%), and the pressure to improve service levels (15%) are
acting simultaneously, which creates the need for balancing these mutually
exclusive business pressures. Given the recessionary conditions in the
financial market, it makes sense that the top two critical pressures are
working capital related.
Fast Facts
Ninety-one percent (91%) of
companies indicate that they
are involved in reviewing
opportunities for improving
inventory performance
through process changes.
Corporate need to improve
return on investment capital
and shortage of working
capital to support our
operations / expansions are
the top two pressures.
Page 5
Figure 2: Key Pressures to Improve Inventory Management
26%
36%
30%
25%
38%
10%
7%
15%
20%
29%
0% 10% 20% 30% 40% 50% 60% 70% 80%
Increasingleadtimes,variability,
andcarryingcosts
Marketpressuretoreduce
ordertodeliveryleadtimes
Pressuretoimproveservicelevels
Shortageofworkingcapitaltosupport
operations/expansions
Corporateneedtoimprove
returnoninvestedcapital
VeryInfluential Critical
26%
36%
30%
25%
38%
10%
7%
15%
20%
29%
0% 10% 20% 30% 40% 50% 60% 70% 80%
Increasingleadtimes,variability,
andcarryingcosts
Marketpressuretoreduce
ordertodeliveryleadtimes
Pressuretoimproveservicelevels
Shortageofworkingcapitaltosupport
operations/expansions
Corporateneedtoimprove
returnoninvestedcapital
VeryInfluential Critical
In order to further analyze inventory management processes, Aberdeen
identified Best-in-Class characteristics for people, process, technology and
metrics.
Challenges of Working Capital & Inventory Seen Through the
Eyes of a Biotechnology Manufacturer
Thomas Panzer, VP of Supply Chain, Bayer Healthcare, spoke at Aberdeens
2009 Supply Chain summit on the topic of Inventory Optimizationin the
Biotech Industry. The following are some of the salient points from that
session.
Pressures
The cost of maintaining working capital buffer has increased
significantly after the credit crisis.
There is a severe need to free cash to finance the growth. This is
forcing companies to optimize their working capital for flexible,
responsive, and cost effective supply chains.
Industry Challenges
Given the focus on life saving drugs, running out of stocks is not an
option and service levels have to be as close to 100% as possible.
Highly regulated environment and comprehensive requirements
from health authorities: These result in a situation where the stock
requirements are not governed by inventory theory but often by
legal and government in-country stock levels.
There are also shelf-life limitations; hence inventory needs to be
drained out by end of life.
continued
We sell into consumer
packaged manufacturers who
have seen an erosion of 20% of
their demand in the last six
months. As a result our
customers are forecasting
conservatively and trying to
drain out their existing
inventory stocks. This has
resulted in our organization
having to reduce the capacity
dramatically. We are now
concerned about the eventual
upswing where we will not be
in a good position to address
the increased demand.
~ Director of Supply Chain,
Mid-size Process Manufacturer
Page 6
Challenges of Working Capital & Inventory Seen Through the
Eyes of a Biotechnology Manufacturer
Need to manage Cold-chain products, which are essentially
temperature controlled supply chains. In other words, there is a set
temperature range that has to be maintained for the products
during the end-to-end manufacturing process.
Complex manufacturing process.
Regulatory constraints drive planning complexity. Changes to raw
materials, equipment, facilities, processes, formulations, and
packaging components can create unusable inventory a key
working capital challenge.
The above points illustrate the industry-specific challenges associated with
Biotechnology dealing with working capital management. Every industry has
different levels of similar challenges but the common denominator in the
current economy is the same: Cash is king.
The Maturity Class Framework
Aberdeen used three key performance criteria to distinguish the Best-in-
Class from Industry Average and Laggard organizations. These metrics
determine the Best-in-Class status with respect to achieving tradeoffs
between customer service levels and working capital.
Table 1: The Maturity Class Framework
Definition of
Maturity Class
Mean Class Performance
Best in Class:
Top 20%
of aggregate
performance scorers
Average cash conversion cycle : 15 days
Average forecast accuracy at product family level: 87%
Industry Average:
Middle 50%
of aggregate
performance scorers
Average cash conversion cycle : 2 months
Laggard:
Bottom 30% of
aggregate
performance scorers
Average cash conversion cycle : 4 months or more
The Best-in-Class PACE Model
Best-in-Class companies are able to continuously manage inventory
throughout their supply chain to improve customer service levels, forecast
accuracies, and perfect order metrics. These companies follow the
principles of closed loop inventory management.
Page 7
Table 2: The Best-in-Class PACE Framework
Pressures Actions Capabilities Enablers
Corporate
need to
improve
return on
invested
capital
Improve
forecasting
accuracy
Optimize how
much and where
to hold inventory
across the
network
Ability to analyze demand patterns and create
accurate SKU-level forecasts
Ability to determine safety stock targets for
inventory at critical nodes in the supply chain
Measurement of customer service levels during
the execution phase
Ability to replenish inventory into distribution
buffers based on customer demand
Demand analysis (SKU-
level forecasts)
Inventory
Replenishment
Inventory Optimization
Inventory Segmentation
Strategic Actions of the Best-in-Class
It is important to note the differences and similarities between the strategic
actions taken by the Best-in-Class and all others. Figure 3 shows that Best-
in-Class firms are slightly more likely than all others to be involved in
improving forecast accuracy. However, distribution-centric companies
(includes CPG, consumer durables, retail, apparel, food / beverage) form a
slightly higher percentage within Best-in-Class (45%) than in Average or
Laggards. This could potentially explain a higher focus on demand-driven
supply chain in the Best-in-Class group.
From the overall market standpoint, it is important to look at forecast
accuracy and inventory optimization as two sides of the same coin and not
prioritize one versus the other. Gaining high forecast accuracy is only the
means to an end namely gaining higher customer service level and reduced
inventory.
In chapter 2 we will explore the specific areas where Best-in-Class
companies are differentiated in the execution of various inventory
management actions.
Figure 3: Strategic Actions Taken by Best-in-Class Companies
78%
66%
50%
38%
73%
71%
41%
45%
55%
76%
50%
32%
25%
50%
75%
100%
Improveforecasting
accuracy
Optimizeinventory
locationand
quantitiesacross
ournetwork
Improve
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strategies
Improveinventory
visibility
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BestinClass Average Laggard

n=131
78%
66%
50%
38%
73%
71%
41%
45%
55%
76%
50%
32%
25%
50%
75%
100%
Improveforecasting
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Optimizeinventory
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73%
71%
41%
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55%
76%
50%
32%
25%
50%
75%
100%
Improveforecasting
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Optimizeinventory
locationand
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Page 8
Aberdeen Insights Strategy
For many companies, especially with global supply chains, inventory is the
biggest lever impacting their working capital position. Due to increased global
complexity companies are experiencing long lead times and high demand
volatility. This has resulted in an increased emphasis on managing inventory.
Organizations are looking for ways to leverage inventory management
processes and technologies to unlock working capital.
The measure of net working capital is the Cash-to-Cash cycle:
Cash Conversion Cycle (absolute measure) = (DSO + DIO DPO)*
*DSO=Days Sales Outstanding
DIO=Days Inventory Outstanding
DPO=Days Payable Outstanding
Working capital is a major driver of cash flow and ties up capital that could
instead be used to pay back debts, pay interests associated with short-term
loans and reduce cost of financing, and invest in future growth.
There are several approaches available to impact the cash-to-cash cycle, as
Figure 4 indicates, targeting the improvement in one or more of these
metrics:
Receivables Days Sales Outstanding (DSO)
Inventories Days Inventory Outstanding (DIO)
Payables Days Payable Outstanding (DPO)
Figure 4: Approaches for Impacting Working Capital
CashtoCashCycles=DSO+DIODPO
Reduceleadtimes
sothatorderscanbe
deliveredquickerand
getpaidfaster
Automate
ARProcess
Stocktherightinventory
attherightplace
Adopta
buildtoorder
model
NegotiateDPOextension
withsuppliers
Receivables
Financing
Changecustomer
creditpolicies
Use3
rd
party
Inventoryfinancing
Use3
rd
partyfinancing
topaysuppliersfaster
whileextendingterms
forthebuyer
CashtoCashCycles=DSO+DIODPO
Reduceleadtimes
sothatorderscanbe
deliveredquickerand
getpaidfaster
Automate
ARProcess
Stocktherightinventory
attherightplace
Adopta
buildtoorder
model
NegotiateDPOextension
withsuppliers
Receivables
Financing
Changecustomer
creditpolicies
Use3
rd
party
Inventoryfinancing
Use3
rd
partyfinancing
topaysuppliersfaster
whileextendingterms
forthebuyer
Page 9
Chapter Two:
Benchmarking Requirements for Success
The implementation of inventory management processes and the associated
organizational changes are critical in weathering the recessionary conditions
being faced by organizations today. Information technology also has a
supporting role to play in this endeavor.
Case Study Inventory Planning Helps Legend Valve Maintain
Customer Service & Reduce Inventory
Company Background: Legend Valve is a mid-size wholesale distributor of
valves (both commercial as well as residential) with over 5,500 Stock Keeping
Units (SKUs) in inventory. Legend Valve specializes in industrial plumbing
values and fitting as well as radiant in-floor heating. Its customers are
professional wholesalers who then sell to the local market installers or
contractors. They have approximately 5,000 customers in the continental USA.
In terms of the supply chain, there are two distribution centers that they own.
Legend Valve has adopted an outsourced manufacturing model with design
done in-house and manufacturing contracted to suppliers in Italy, Mexico, and
Asia. The average lead-times for their products are 90 to 120 days.
Their selling point to their customers is a commitment to meeting delivery
dates to their customers.
Challenges:
The unique market differentiator for Legend is its service guarantee to its
customers. Legend Valve discounts backordered items 5% along with a 5%
discount for orders that do not ship in 24 hours.
However, this focus on customer service comes with its own challenge. In
order to maintain the high level of fill rates / customer service, the company
had stored a high level of inventory for their SKUs, including the slow moving
ones. The company realized that its inventory turn levels were too low given
the challenging economy. The lead-times were also 90 days or more due to the
majority of their products. This resulted in variability in supply.
Solution / Actions Taken:
Inventory management was not new to Legend Valve. The company already
had an in-house system that was being used to come up with inventory
stocking levels. However this system was difficult to maintain and enhance due
to its custom nature.
In order to resolve the situation, the company embarked on an inventory
management project that had to balance the fill rates with the inventory turns
through the adoption of a packaged application. The company selected a best-
of-breed inventory planning solution as part of this initiative. The EVP of
Legend Valve says, The packaged software actually has 80% to 90% of the
capabilities that our existing custom solution had.
continued
Fast Facts
Seventy (70%) of Best-in-
Class companies adopt a
statistical method to
establish inventory targets
Seventy (70%) of
respondents indicate that
they revise their inventory
targets once a quarter or at
a lower frequency
Page 10
Case Study Inventory Planning Helps Legend Valve Maintain
Customer Service & Reduce Inventory
But the custom solution was implemented over the course of two to three
years. The packaged application was actually deployed within 45 days which
was a big achievement.
The EVP of the company also says, We were not willing to sacrifice fill rate
for increased inventory turns. After seeing a live demo with our data, we were
convinced that the product could improve even more on our performance.
Even with the difficult economy, perhaps because of it, we committed on the
spot. We were confident we would receive positive financial results through
inventory reductions that would pay dividends long before the end of the
current downturn.
Benefits Gained:
Improved visibility to the purchasing department regarding inventory
ability to manage by exceptions. The purchasing personnel are able to
leverage pre-built reports to identify cases where some items are
projected to be out of stock based on existing demand patterns or to
identify items that have excess inventory compared to projected sales.
Individual productivity of the people managing inventory has gone up
after the solution has been implemented due to automation of existing
tasks.
Automated forecasting and replenishment saves 20 man-hours per
week (approximately $35,000 per year).
Reduction of excess of inventory of $300,000 while maintaining 98% or
better fill rate.
Decrease in inventory value of more than 12% in 2.5 months.
Improvement of inventory turns by 30% expected within the first 12
months.
Return on Investment in less than three months.
Competitive Assessment
Aberdeen Group analyzed the aggregated metrics of surveyed companies to
determine whether their performance ranked as Best-in-Class, Industry
Average, or Laggard. In addition to having common performance levels, each
class also shared characteristics in five key categories: (1) process (the
approaches they take to execute their daily operations); (2) organization
(corporate focus and collaboration among stakeholders); (3) knowledge
management (contextualizing data and exposing it to key stakeholders);
(4) technology (the selection of appropriate tools and effective
deployment of those tools); and (5) performance management (the
ability of the organization to measure its results to improve its business).
These characteristics (identified in Table 3) serve as a guideline for best
practices, and correlate directly with Best-in-Class performance across the
key metrics.
Our company distributes floor
covering (hardwood, laminate
etc.), wood working products,
and natural stone slabs to
retailers. The housing market
collapse has created an
extremely challenging business
environment. There was a
sudden drop in demand
resulting in excess inventory.
Over the last six months we
have reduced over $4.5 million
in inventory through the
following process initiatives:
Reviewed entire order book
and sales history and came
up with ABC stocking
strategy
Exchanged dormant
inventory with current
inventory with primary
suppliers
Reduced discontinued
inventory through special
discounts
~ Director of Procurement,
$50 million to $100 million
distribution company
Page 11
Note that the percentages indicate the respondents have selected "strong
capabilities" or "very strong capabilities" out of five choices that include "no
capabilities, "poor capabilities, "acceptable capabilities, "strong
capabilities," and "very strong capabilities.
Table 3: Competitive Framework
Best-in-Class Average Laggards
Ability to determine safety stock targets for inventory at
critical nodes in the supply chain
47% 30% 29%
Ability to analyze demand patterns and create accurate
SKU-level forecasts
34% 28% 16%
Ability to utilize statistical methods to establish inventory
targets
Process
70% 59% 45%
Inventory Target setting is part of the S&OP process team
Organization
63% 60% 42%
Measure of customer service levels during the execution
phase
44% 32% 24%
Availability of end-to-end inventory data for performing
inventory management functions
Knowledge
25% 12% 10%
Technology enablers for closed loop inventory
management
Technology
38% Inventory
Replenishment
38% Demand
Analysis
34% Inventory
segmentation
28% Inventory
Optimization
29% Inventory
Replenishment
28% Demand
Analysis
26% Inventory
segmentation
12% Inventory
Optimization
21% Inventory
Replenishment
13% Demand
Analysis
11% Inventory
segmentation
0% Inventory
Optimization
Ability to create SKU level forecasts
Performance
66% 58% 43%
Capabilities and Enablers
Based on the findings of the Competitive Framework and interviews with
research participants, Aberdeens analysis of the Best-in-Class demonstrates
the following capabilities and enablers in process, organization, performance
management, and technology.
During these trying economic
times, supply chain flexibility
and responsiveness are critical.
Lexmarks key current Latin
American supply chain
initiatives include multi-level
inventory optimization and re-
engineering of the Sales and
Operations Planning Process
(S&OP). We are working hard
to be more proactive in the
supply chain organization by
aligning plans with the business
goals. We want to improve the
ease and efficiency of the S&OP
process. This requires
improved communication and
data sharing across various
internal teams and processes.
Although these initiatives were
under way prior to the
economic downturn, todays
tough economy puts increased
pressure on our supply chain
organization to facilitate their
successful implementation.
~ Elena Palacios, Director of
Supply Chain & Operation for
Latin American Region,
Lexmark International, Inc.
Page 12
Process
Best-in-Class companies are, compared to all others:
1.5-times as likely to have the ability to determine safety stock
targets for inventory at critical nodes in the supply chain, which is
typically owned by the inventory analyst within supply chain and is a
monthly / weekly process.
Simplistic general rule of thumb methods lead to flabby supply
chains. Companies facing high customer service level requirements,
short product life cycles, or multi-tier manufacturing or distribution
networks have the most to gain from moving toward item-location
level inventory policies.
40% more likely to have the ability to replenish inventory into
distribution buffers based on customer demand, which is typically
owned by the inventory analyst and is a weekly / daily process.
Twice as likely to have the ability to segment inventory based on
customer service requirements, which is typically owned by the
demand planning organization and is a quarterly / monthly process.
Different products have different costs and lead times. For example,
a customer who requires a custom part from a manufacturer (Build
to Order) will have different service requirements than a customer
who sells a commodity (Build to Stock) part. Thus segmentation of
the customers based on their inventory management requirements
is necessary.
1.5-times as likely to be leveraging a statistical method for
computing inventory targets.
Seasonal industries can see large swings in demand as well as lead
time variability across demand peaks and lows driven by seasonality.
Construction equipment companies are examples of companies that
have long-term seasonality and the apparel industry involves short-
term seasonality.
All of the Best-in-Class differentiators outlined are key influencers in
achieving closed loop inventory management and are impacting several
different organizations and have different frequencies / cadences. The
amount of effort required in gaining success in enabling each of these
process steps cannot be underestimated. For example, the usage of
statistical methods for computing inventory targets can result in unreliable
targets unless the correct process and technology enablers are adopted.
Organization
Best-in-Class companies are 30% more likely than all others to be
managing inventory at the network level.
Organizations that have either provided a single owner of inventory
or provide a cross-functional team for managing inventory are
better positioned to achieve closed loop inventory management
excellence. This is due to the fact that the associated processes are
Page 13
cross-functional in nature and the organizations structure impacts
how the process is executed.
Best-in-Class companies are twice as likely to have the finance
organization be the primary force for improving inventory
management.
Embedding cash conversion into the supply chain / procurement
performance metrics and having a finance executive on the supply
chain steering committee can also help move towards more
effective cross-functional management of the process.
Best-in-Class companies are 1.4-times as likely to have the inventory
target setting process as part of the S&OP meetings.
Optimizing inventory safety stock policies without due consideration of
capacity and material constraints is not enough. Inventory management
should be viewed within the context of a supply and demand balancing
process that is associated with S&OP. Rough cut capacity planning within
S&OP process should be augmented with inventory analysis. Even though
adding inventory analysis into the S&OP workflow is a process
enhancement, organizational issues are more important to manage in this
case. The owner of inventory in organizations is not the same person who
owns the S&OP process, resulting in organizational silos.
Performance Management
Best-in-Class companies are 1.5-times as likely to have the ability to
analyze demand patterns and create accurate SKU-level forecasts.
Best-in-Class companies are twice as likely to have the ability to
measure customer service levels during the execution phase.
As the VP of Supply Chain of a large high-tech manufacturer says, Our
biggest challenge has been that the metrics that we use for linking the
inventory levels to financial metrics are historically focused on lagging
indicators. We constantly identify problems after they have already
happened. We have not been able to operationalize [sic] the key metrics
such as cash-to-cash cycle and use it to drive responsive behavior in our
supply chain.
Technology
Aberdeen research from June 2008, Technology Strategies for Closed Loop
Inventory Management, found that Best-in-Class companies follow the
principles of closed loop inventory management. Figure 5 shows the
components of closed loop inventory management. The outermost circle
shows the events that occur and the inner circle shows the metrics that
should be tracked as these events occur.
Page 14
Figure 5: Process Playbook for Closed Loop Inventory Management
Source: Aberdeen Group, April 2008
Each component of closed loop inventory management directly addresses
the root causes of poor customer service levels, rising costs, poor RONA
and the need to improve working capital. The numbers in Table 4 show the
percentages of respondents that indicate "strong" or "very strong"
capabilities in a five-point measurement scale. The table demonstrates that
Best-in-Class companies are more likely to be using a technology enabler in
each the key inventory management events.
Table 4: Closed Loop Inventory Management Technology Enablers
Best-in-Class Average Laggards
Demand analysis 38% 27% 13%
Inventory segmentation 34% 26% 10%
Inventory optimization 28% 10% 0%
Inventory replenishment 38% 29% 21%
Extended inventory visibility 21% 15% 3%
Event management 19% 7% 5%
Responsive execution 25% 14% 5%
Demand Analysis
This process step involves utilizing a demand analysis module to uncover
intermittency or bias in the forecast. 47% of respondents indicate that they
Page 15
leverage spreadsheets for this part of the closed loop inventory
management process.
Long tails demand profile or intermittent demand is becoming a key issue
with companies due to proliferation of SKUs. This is a significant issue that
should be considered for resolution. This is a critical issue especially for the
OEM service parts, aftermarket and distribution industries.
As the Director of Supply Chain of a mid-size electronics distributor says:
Our average turns equal around 2 because certain parts of our portfolio
have extremely low turns due to the intermittent demand. Our ability to
forecast these products accurately is critical to our financial performance.
Our larger customers are squeezing us to purchase products at higher
volumes due to the downturn which is adding to the high levels of inventory
for the intermittent products.
Inventory Segmentation
Seventy (70%) of respondents indicate that they revise their inventory
targets once a quarter or at a lower frequency. Inventory policies should
not be updated very frequently due to the nervousness it creates in the plan
a monthly frequency is the ideal frequency, which 24% of respondents
selected.
Inventory segmentation, however, should be done based on business drivers
such as profit margin optimization. For example: A large consumer
electronics manufacturer saw a spike in demand for a specific type of video
recording device that it had not foreseen, resulting in lost revenue. For the
next cycle of planning, the company changed its process to segment the
inventory at a more granular level of attribute of the product than what
they had done previously. The key takeaway is that the process and the
technology that enables it should be flexible enough to support
segmentation in the middle of the planning cycle driven by impending
business challenges.
Inventory Optimization
This process step involves being able to consider the entire network
either the finished goods inventory in distribution-centric environments or
including Work-in-Process (WIP) inventory for manufacturing-centric
environments and right-size the inventory buffers.
Over 43% of respondents set their inventory policies based on general rules
of thumb. Forty-nine percent (49%) of respondents leverage spreadsheets
for doing inventory optimization and 27% leverage ERP systems. Twenty-
three (23%) leverage some form of home grown system. Only 16% leverage
a best of breed SCM solution.
Inventory optimization is an area where there are demonstrated tangible
financial benefits that can be obtained over a very short term (see
Aberdeens June 2008 benchmark, Technology Strategies for Closed Loop
Inventory Management). This is an area that should be looked at closely for
investment. Here is an example success story for inventory optimization:
Page 16
Case Study Large Semiconductor Manufacturer Prepared for the
Downturn through Inventory Optimization
Company Background: The company is a large North American high-
technology manufacturer of semiconductor based products with multiple
business units. The supply chain for the organization is complex, with
predominantly in-house manufacturing with a small portion of outsourced
manufacturing. The semiconductor products have to go through a long lead-time
process where the wafer start process step all the way to the final product
inspection takes several months. There is a single worldwide distribution center
from where the products are then transported to the customers of the
organization, which are the large contract manufacturing companies.
Challenges:
The following challenges were faced by the organization:
Long lead-time process with multiple process steps
Variability in customer demand resulting in demand volatility
Lots of parts face intermittency in terms of volumes
Lower on-time to estimated ship date metrics
Lower on-time to customer requested dates
The above were some of the challenges faced two years ago when it was decided
to implement an inventory optimization solution.
Solution:
A best of breed inventory optimization solution that was being used in one of
the analog divisions was selected for corporate-wide roll-out. This solution has
resolved several of the challenges outlined above. The following are the process
steps implemented using the solution:
Demand analysis An upstream demand management solution computes
the statistical forecasts at the SKU-location level and sends it to the IO
module. The IO solution comes up with an accurate demand profile for
computing the safety stock levels. This process step is executed once a
week.
Inventory segmentation The solution affords significant flexibility for
segmenting inventory based on business rules. Every business unit has a
different requirement in terms of segmentation volumes, revenues, etc.
For example, one of the business units is looking into lead-time based
inventory segmentation. If the back-end cycle time for a product is eight
weeks and if the lead-times that are acceptable to customers is greater
than eight weeks, the inventory level requirements are lower than if
customers demand lead-times lower than eight weeks.
continued
Page 17
Case Study Large Semiconductor Manufacturer Prepared for the
Downturn through Inventory Optimization
Inventory Optimization As mentioned previously, there are multiple
echelons within the supply chain and the biggest challenge for the IO
module is to decide where to position inventory whether at the
finished goods level or at the die bank level. The advantage of storing
inventory at the die bank level is the flexibility of being able to
manufacture multiple products as close to demand as possible
(postponement strategy). The solution supports this tradeoff and
ensures that the maximum inventory is kept at the die bank stage of the
process. The IO process runs weekly on Monday, and over the course of
the week the planners update the system and approve or disapprove the
suggested targets.
Benefits of the Solution:
The following were the benefits obtained due to the solution:
Postponement results in reduced finished goods inventory.
Ability to get faster visibility to changes in market demand and trends.
For example, due to the recession, there was a significant decrease in
demand. The solution allowed faster visibility to this trend.
Ability to segment inventory based on business drivers like lead-times
and revenues.
Ability to do tradeoff between customer service levels and inventory
levels store lower inventory but retail the customer service levels
committed.
With the organization selling a portfolio of many thousands of SKUs,
they had traditionally buffered their higher running products with
inventory, but that left out a portion of their portfolio both from a
revenue and SKU perspective. Now with the solution, the organization
has gained the ability to evaluate the full portfolio of their products for
the appropriate level of buffer needed.
Inventory Replenishment
Best-in-Class companies are 50% more likely to have implemented a strong
process for inventory replenishment. Why has the overall market not
concentrated on this area? Our research finds that 49% of survey
respondents utilize their ERP system to manage replenishment and 27% of
respondents utilize spreadsheets / legacy homegrown solutions for
inventory replenishment. The issue is not the technology but the lack of
realization that replenishment is in fact a critical step within closed-loop
inventory management.
Delivering the target service levels to the customer in this environment
poses heavy requirements on the process: highly precise time-phased
propagation of the statistical demand signal across the supply chain,
elimination of any bullwhip effect amplification, and detailed capacity and
Page 18
calendar constraint representations. In other words, to be sustainable with a
reasonable total cost of ownership, the process must be highly automated.
Traditional approaches ignore the importance of the replenishment step and
send the results of optimization directly to the ERP system, thus nullifying
the effort spent creating the statistical profile for service levels of each SKU.
Aberdeen Insights Turn and Earn Metrics
Supply chain organizations are often too focused on operational metrics
without due consideration of the financial metrics. There is a widely
adopted metric called Turn and Earn (measured as the product of gross
margin and inventory turns as an average for the products manufactured
by a company). Over 50% of the respondents did not know the value for
their company or did not measure this metric.
What is the value of the Turn and Earn Metric? Why is this important in
the context of this research?
Inventory turns are not the only measure of excellence of a company in
terms of operational performance. The financial impact that the product
makes on the top line margin is also critical. If the inventory turns are
very high but the profit margins are low or if the inventory turns are too
low in spite of profit margins being high both of these situations are
sub-optimal. This metric can also serve as a mechanism to segment the
inventory and rationalize the product portfolio.
As the Director of Supply Chain of a mid-size electronics distributor says,
Our average turns is around two and the average profit margin around
40%, resulting in a good overall turn and earn index. However certain
parts of our portfolio have extremely low turns due to the intermittent
demand. Our ability to forecast these products accurately is critical to
our financial performance.
Page 19
Chapter Three:
Required Actions
Whether a company is trying to move its performance in inventory
management from Laggard to Industry Average, or Industry Average to
Best-in-Class, the following actions will help spur the necessary performance
improvements:
Laggard Steps to Success
Segment finished goods inventory based on financial
performance. Twenty-nine percent (29%) of Laggards have
indicated strong process capabilities in optimizing inventory based
versus 47% of Best-in-Class companies.
The key attributes typically used for inventory segmentation are
volumes, picking volumes, complexity of customization, and lead-
times and profit margins. Given the current economic challenges,
companies need to segment the finished goods inventory based on
profit margins.
Move away from rule of thumb inventory target settings.
Thirty-five (35%) of Laggards have indicated strong process
capabilities in analyzing demand patterns and creating accurate SKU-
level forecasts, versus 63% of Best-in-Class companies. One of the
reasons why Best-in-Class companies have been able to achieve this
is that they are 1.5-times as likely as Laggards to employ statistical
forecasting approaches.
Integrate inventory target settings into S&OP meetings.
Forty-two (42%) of Laggards have indicated strong process
capabilities in setting safety stock targets for inventory during the
S&OP process, versus 63% of Best-in-Class companies.
S&OP processes are currently extremely demand focused versus
focusing on balancing supply demand and finance. One of the critical
aspects of finance is working capital, which is in turn dependent on
inventory. Hence it is necessary for companies to manage inventory
in a holistic fashion as part of the S&OP process workflow.
Industry Average Steps to Success
Extend inventory management beyond finished goods
inventory management. Thirty percent (30%) of Industry
Average companies have indicated strong process capabilities in the
ability to perform inventory optimization, versus 47% of Best-in-
Class companies.
The working capital and cash-to-cash cycle metrics depend on the
end-to-end inventory within the supply chain, including raw
materials, work in progress, and the finished goods inventory. Even
though the optimization of the finished goods inventory is critical in
Fast Facts
Thirty-five percent (35%) of
Laggards have indicated
strong process capabilities in
the ability to analyze demand
patterns and create accurate
SKU-level forecasts, versus
63% of Best-in-Class
companies.
Only 10% percent of Best-in-
Class companies indicate
that their financial
organization is driving
inventory management. Only
21% have revenue targets set
up by finance and then
allocated down into
inventory targets.
We have two channels for our
products retail and the
instructional dealers who in
turn supply the teachers and
students. We have also seen a
reduction in demand due to the
recession due to budget cuts
and our inventory levels have
shot up (though the impact is
likely to be lower than other
consumer products). We have
added a bolt-on best of breed
solution on top of our ERP
system to try to improve the
forecast accuracy and reduce
the inventory levels.
~ Director of Supply Chain,
Large Consumer Electronics
Manufacturer, Educational
products BU
Page 20
order to retain customer service levels, when the focus is towards
working capital management then it is important to look into the
inventory holistically, including non-finished goods inventory.
Create ability to analyze demand patterns and create
accurate SKU-level forecasts. Twenty-eight percent (28%) of
Industry Average companies have indicated strong process
capabilities as a part of their ability to analyze demand patterns and
create accurate SKU-level forecasts, versus 42% of Best-in-Class
companies.
Companies should identify inherent intermittencies introduced into
their demand profiles before coming up with the safety stock levels.
There is a phenomenon occurring in companies called "long tails"
where the typical normal distribution associated with product
forecasts are becoming more of an elongated tail profile where SKU
proliferation is making the forecasting process challenging. Find out
how your demand planning solution provider addresses the long tail
problem.
Extend inventory management capabilities into execution
processes (i.e. inventory replenishment). Twenty-six percent
(26%) of Industry Average companies have indicated strong process
capabilities in their ability to replenish inventory into distribution
buffers based on customer demand, versus 48% of Best-in-Class
companies.
Replenishment has been an afterthought in inventory management
implementations mainly due to this process being thought of as a
commodity process within an ERP / MRP / DRP II solution.
Delivering the target service levels to the customer in this
environment poses heavy requirements on the process: highly
precise time-phased propagation of the statistical demand signal
across the supply chain, elimination of any bullwhip effect
amplification, and detailed capacity and calendar constraint
representation. Ask your ERP or inventory optimization solution
provider about how they handle intelligent replenishment.
Best-in-Class Steps to Success
Create a closed loop inventory process. Thirty-nine percent
(39%) of Best-in-Class companies indicate having a strong ability to
respond quickly to market events while executing to inventory
requirements.
Event management is a critical layer of technology that can help
bridge the gap between the planning and logistics organizations. This
capability enables execution process to be monitored and ensures
that it is within the limits / constraints imposed by the upstream
planning process.
Page 21
Tie inventory and financial metrics together. Only 10%
percent of Best-in-Class companies indicate that their financial
organization is driving inventory management. Only 21% have
revenue targets set up by finance and then allocated down into
inventory targets.
In addition to strictly operational metrics, such as forecast accuracy
or inventory turns, it is critical for the supply chain organization to
tie the metrics into financial parameters, such as budget, profit
margin, and working capital.
Perform end-to-end inventory optimization. Only 19% of
Best-in-Class companies have the ability to perform multi-echelon
inventory optimization namely they leverage a system that
understands demand and lead-time variability across the supply
chain and assigns policy at each SKU location. This technology
globally optimizes inventory policies across supply chain tiers,
accounting for both demand and supply variability using a stochastic
(probabilistic) approach versus a rules-based or deterministic
approach that does not fully account for variability.
Aberdeen Insights How to Prepare for the Eventual Upswing?
Even though the discussion in this report has centered on strategies and
tactics to adopt for a recessionary economy, the situation can turn around
rapidly and we will eventually see an economic recovery. Let us take a five
tier supply chain as an example for our analysis.
Raw Materials Manufacturer CPG Manufacturer
Retailer Consumer
In this example, the consumer behavior has been pessimistic for the last
six months, resulting in urgency from the retailers and CPG manufacturers
to drain out the inventory in their network and try to meet the new
reality of lowered forecasts. This has resulted in a bull whip effect of even
more reduced demand on the part of the raw materials manufacturer.
The raw materials manufacturers are doing one of the following things:
a) Reducing capacity
b) Selling to alternate markets or customers
c) Going out of business
What happens now if the consumer behavior suddenly becomes more
optimistic? There is going to be a rapid increase in demand from the
retailers and manufacturers but without the corresponding flexibility from
the raw materials manufacturers to ramp up.
Page 22
Appendix A:
Research Methodology
Between April and May 2009, Aberdeen examined the use, the experiences,
and the intentions of more than 170 enterprises involved in using inventory
management solutions in a diverse set of enterprises with a specific focus on
improving working capital. Aberdeen supplemented this online survey effort
with interviews with select survey respondents, gathering additional
information on inventory management strategies, experiences, and results.
Responding enterprises included the following:
Job title: The research sample included respondents with the
following job titles: C-Level executive (CEO, CFO, CTO, CIO)
(6%); VP / General Manager (14%); Director (33%); Manager (31%);
other titles (16%).
Functional Responsibility: The research sample included respondents
with the following functional areas of responsibility: Logistics /
supply chain (62%); operations / procurement (21%); Finance (4%);
IT / BPM (6%); other areas (7%).
Industry: The research sample included respondents from the four
major industry segments Process, Consumer, Discrete and High-
tech / electronics. Key demographics are:
o Discrete (19%): Automotive (10%), Industrial Product
Manufacturing (5%), Industrial Equipment Manufacturing (4%)
o Consumer (32%): Consumer Durable Goods (5%), Consumer
Packaged Goods (4%), Consumer Electronics (4%), Distribution
(7%), Food / Beverage (6%), Retail (3%), Wholesale (3%)
o Process (18%): Chemicals (5%), Metals and metal products /
Mining / oil / gas (5%), Paper / lumber / timber (2%),
Pharmaceutical manufacturing (6%)
o High-tech / electronics (17%): Computer equipment and
peripherals (3%), Health / medical / dental devices or services
(7%); High-technology (3%); Telecommunication equipment /
services (4%)
Geography: The majority of respondents (69%) were from North
America. Remaining respondents were from the Asia-Pacific region
(9%), Europe (19%), and rest of world (South / Central America,
Caribbean, Middle East, Africa) (3%).
Company size: Thirty-nine percent (39%) of respondents were from
large enterprises (annual revenues above US $1 billion); 42% were
from midsize enterprises (annual revenues between $50 million and
$1 billion); and 19% of respondents were from small businesses
(annual revenues of $50 million or less).
Headcount: Sixteen percent (16%) of respondents were from small
enterprises (headcount between 1 and 99 employees); 32% were
from midsize enterprises (headcount between 100 and 999
Study Focus
Responding supply chain
executives completed an online
survey that included questions
designed to determine the
following:
Current level of focus
towards inventory
management and working
capital management
Key pressures being faced by
companies with respect to
inventory management
Current and planned use of
inventory management to
improve customer service
levels, reduce costs and
improve corporate return
on invested capital
Best-in-Class behavior
patterns and suggestions for
Average and Laggards to
reach advanced status
The study aimed to identify
emerging best practices for
inventory management usage in
supply chain, and to provide a
framework by which readers
could assess their own
management capabilities.
Page 23
employees); and 52% of respondents were from large businesses
(headcount greater than 1,000 employees).
Table 5: The PACE Framework Key
Overview
Aberdeen applies a methodology to benchmark research that evaluates the business pressures, actions, capabilities,
and enablers (PACE) that indicate corporate behavior in specific business processes. These terms are defined as
follows:
Pressures external forces that impact an organizations market position, competitiveness, or business
operations (e.g., economic, political and regulatory, technology, changing customer preferences, competitive)
Actions the strategic approaches that an organization takes in response to industry pressures (e.g., align the
corporate business model to leverage industry opportunities, such as product / service strategy, target markets,
financial strategy, go-to-market, and sales strategy)
Capabilities the business process competencies required to execute corporate strategy (e.g., skilled people,
brand, market positioning, viable products / services, ecosystem partners, financing)
Enablers the key functionality of technology solutions required to support the organizations enabling business
practices (e.g., development platform, applications, network connectivity, user interface, training and support,
partner interfaces, data cleansing, and management)
Table 6: The Competitive Framework Key
Overview
The Aberdeen Competitive Framework defines enterprises
as falling into one of the following three levels of practices
and performance:
Best-in-Class (20%) Practices that are the best
currently being employed and are significantly superior to
the Industry Average, and result in the top industry
performance.
Industry Average (50%) Practices that represent the
average or norm, and result in average industry
performance.
Laggards (30%) Practices that are significantly behind
the average of the industry, and result in below average
performance.
In the following categories:
Process What is the scope of process
standardization? What is the efficiency and
effectiveness of this process?
Organization How is your company currently
organized to manage and optimize this particular
process?
Knowledge What visibility do you have into key
data and intelligence required to manage this process?
Technology What level of automation have you
used to support this process? How is this automation
integrated and aligned?
Performance What do you measure? How
frequently? Whats your actual performance?
Table 7: The Relationship Between PACE and the Competitive Framework
PACE and the Competitive Framework How They Interact
Aberdeen research indicates that companies that identify the most influential pressures and take the most
transformational and effective actions are most likely to achieve superior performance. The level of competitive
performance that a company achieves is strongly determined by the PACE choices that they make and how well they
execute those decisions.
Page 24
Appendix B:
Related Aberdeen Research
Related Aberdeen research that forms a companion or reference to this
report includes:
Working Capital Optimization: Improving Performance with Innovations
and New Technologies in Inventory Management and Supply Chain
Finance; June 2007
Supply Chain Executive's Strategic Agenda 2008: Managing Global Supply
Chain Transformation; January 2008
Technology Strategies for Closed Loop Inventory Management; April
2008
Sales and Operations Planning: Aligning Business Goals with Supply Chain
Tactics; June 2008
Demand Management in Process Industries: Strategies for Being Demand
Driven in a Globalized Economy; September 2008
Beyond Visibility: Driving Supply Chain Responsiveness; September 2008
Working Capital Optimization: Finance and Supply Chain Strategies for
Todays Business Environment; October 2008
The Secret SaaS: On-Demand Supply Chain Management; December
2008
Information on these and any other Aberdeen publications can be found at
www.aberdeen.com.
Author: Nari Viswanathan, VP / Principal Analyst, Supply Chain Management (
nari.viswanathan@aberdeen.com)
Since1988,Aberdeen'sresearchhasbeenhelpingcorporationsworldwidebecomeBestinClass.Having
benchmarkedtheperformanceofmorethan644,000companies,Aberdeenisuniquelypositionedtoprovide
organizationswiththefactsthatmatter thefactsthatenablecompaniestogetaheadanddriveresults.That'swhy
ourresearchisreliedonbymorethan2.2 millionreadersinover40countries,90%oftheFortune1,000,and93%of
theTechnology500.
AsaHarteHanksCompany,Aberdeenplaysakeyroleofputtingcontentincontextfortheglobaldirectandtargeted
marketingcompany.Aberdeen'sanalyticalandindependentviewofthe"customeroptimization"processofHarte
Hanks(Information Opportunity Insight Engagement Interaction)extendstheclientvalueandaccentuatesthe
strategicroleHarteHanksbringstothemarket.Foradditionalinformation,visitAberdeen www.aberdeen.com orcall
(617)7237890,ortolearnmoreaboutHarteHanks,call(800)4569748orgoto www.hartehanks.com.
ThisdocumentistheresultofprimaryresearchperformedbyAberdeenGroup.AberdeenGroup'smethodologies
provideforobjectivefactbasedresearchandrepresentthebestanalysisavailableatthetimeofpublication.Unless
otherwisenoted,theentirecontentsofthispublicationarecopyrightedbyAberdeenGroup,Inc.andmaynotbe
reproduced,distributed,archived,ortransmittedinanyformorbyanymeanswithoutpriorwrittenconsentby
AberdeenGroup,Inc.
Page 25
Featured Underwriters
This research report was made possible, in part, with the financial support
of our underwriters. These individuals and organizations share Aberdeens
vision of bringing fact based research to corporations worldwide at little or
no cost. Underwriters have no editorial or research rights and the facts and
analysis of this report remain an exclusive production and product of
Aberdeen Group.
Since 1985, St. Louis-based Demand Solutions has provided software for the
full spectrum of supply chain management inventory planning, sales &
operations planning (S&OP), demand forecasting, collaboration, inventory
optimization and replenishment, advanced planning & scheduling and retail
planning. Its products are affordable, easy to implement, easy to use and
deliver fast ROI. More than 10,000 customers in over 70 countries rely on
Demand Solutions.
For additional information on Demand Solutions:
Demand Solutions
165 N. Meramec Ave., Suite 300
St. Louis, MO 63105
314-727-4448
800-886-3737
www.demandsolutions.com
info@demandsolutions.com
Page 26
Supply Chain Consultants (SCC) designs and markets a family of software
tools to help manufacturers manage their supply chain.
SCC offers Zemeter Inventory Analyzer, which provides multiple types of
user-defined inventory calculations to help free working capital while
maintaining excellent levels of customer service.
Benefits of the Inventory Analysis software include:
Reducing inventories without harming customer service;
Quantifying dollars reducible (over target) at flexible levels of
aggregation (by any slice/dice combination);
Providing executives with a clear, simple birds eye view of total
cash reductions achievable across materials and plants;
Tracking progress continuously versus reduction targets.
For additional information on Supply Chain Consultants:
Supply Chain Consultants
5460 Fairmont Drive
Wilmington, DE 19808
302-738-9215 x245
www.supplychain.com
Dwonderling@supplychain.com

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