Practice Area Overview

Inventory Optimization & Management

Case Study
At one consumer goods manufacturer
we worked with, safety stock targets
were a mlange of system defaults,
values inherited from long ago,
and values set by the software
installation team with little regard for
the business problem. The planners
whip-sawed targets up and down
on a weekly basis in reaction to one
crisis after another. The result was
the classic problem of aggregate
inventory exceeding financial targets
and flagging customer service.
Our team looked at the key drivers
for setting a data-driven safety stock,
namely lead-time for replenishment
orders and demand variability. The
analysis showed that by simply
changing the safety stock levels on
parts, we could both reduce overall
inventory and greatly improve
customer service levels.
Figure 1 shows scatter plots of the
before and after safety stock settings
for several hundred parts in the
portfolio. Inventory science says that
inventory should go up as re-supply
lead-time increases. Likewise, as
demand volatility increases, so too
should safety stock. These trends are
obvious in our after results. Before
the application of rigorous analytics,
the safety stock values were all over
the map.

Introduction
We all buy insurance. We insure our health, our
home, our car. And properly managed, everyone
wins. As individuals we enjoy peace of mind,
sleeping easy at night knowing were protected in
the face of disaster. And the insurers earn a living in
exchange for absorbing our risk.
Rates, of course, vary depending on the level of
that risk. Smokers pay more. Homeowners on a
flood plain pay more. And young drivers pay more.
The actuaries use mountains of historical data to
determine who should pay what.
Inventory is one of our supply chains insurance
policies. We pay extra for safety stock to keep
the supply chain running in the face of disruptive
events. Adopting good supply chain behaviors
minimizes our risk and reduces our annual inventory
insurance premiums. The firms best skilled at this
supply chain equivalent to actuarial science achieve
the highest level of customer service for each
inventory dollar they invest.
We consider eight key elements when working to
improve supply chain inventory management.

1. Network Inventory
In a multi-echelon system one in which we take a
network-wide view of the many nodes in the supply
chain the optimal levels of inventory depend
on whats going on elsewhere in the network. A
common pitfall of inventory management is failure
to think globally, act locally. Decisions made at a
local level (e.g., minimizing factory inventory) often
come at the expense of the globally optimal solution
(service out of a downstream distribution center).

For example, we see many firms fail to properly

locate the push-pull boundary. Thats the point
in the supply chain at which you transition from
pushing (operating to a forecast) to pulling, or
responding directly to customer demand.
Locating the push-pull boundary correctly may
enable the pooling of demand uncertainty across
multiple markets, reducing overall inventory needs.
Its the same logic that explains why group insurance
rates are generally lower. (For more information,
see our overview on supply chain network design.)

2. Part-Level Inventory
When designing a supply chain network we model
inventory in bold strokes to support strategic
decisions. But supply chains succeed (or fail) on the
back of day-to-day operations. We need detailed
inventory decisions for each part at each location.
We use different techniques for scientifically
managing the inventory of parts that go into
manufactured products, where demand for the
lower-level components depends on the plan for
the top-level items. In the post-sales service world,
parts play a different role and they are planned in a
somewhat different manner. Nonetheless, the same
fundamental science of inventory management
applies.

3. Inventory-Driven Costs

We find it important to highlight the expense of

inventory (income statement) as well as the balance
sheet impact.
Most firms account for the trade-off between free
cash and cash tied up as an inventory asset. But

Why End-to-End Analytics?

Successful inventory management
requires discipline and attention
to detail built on a foundation of
rigorous analytical processes. The
End-to-End team has extensive
experience helping businesses
tune their inventory management
practices in industries ranging from
cosmetics to baked goods to medical
instruments to high tech. Equally
important, as practitioners in industry
we have held responsibility for
managing inventory. We know how
to meet both financial and customer
service targets.
This experience allows us to put
together the right project team,
understand the key dynamics of
the problem, interpret the source
data, and use the right mix of
tools and models (ranging from
simulation to network optimization to
spreadsheets) to help make the right
part-by-part recommendations.

firms tend to underestimate the full cost of holding

inventory by as much as 100%. They fail to account
for costs of warehousing, shrinkage, returns, and the
potential for obsolescence.

4. Lot Sizing

The concept of an economic order quantity (EOQ)

dates back a century, but it should still be part of
every inventory management toolkit.
We routinely encounter businesses that
inappropriately size replenishment orders, either
overinvesting in inventory or enduring excessive
transaction costs to manage their parts. We taught
one firm how to save 40% ($2M/year) just by right
sizing their replenishment orders.

5. Service Levels
The flip side of an inventory problem is a customer
service problem lost sales, penalties, backorders to
manage, and a bruised reputation. Proper inventory
management finds the right level of investment to
stave off the costs of poor service.
Understanding the ramifications of running out
of material enables a rational decision about how
much inventory to hold. Have you sold a lucrative
fast-response service contract? The cost of poor
service will be high. Alternatively, if the end
customer is buffered by downstream finished goods,
the relative cost of a stockout is lower.

6. Safety Stock

Analytical techniques allow you to set an inventory

level based on real data from your business, not just
gut feel. First we assess the risk the chance that
you will run out of inventory before a replenishment
order arrives. Our inability to confidently forecast
variable demand typically drives this calculation.
We also look at the lead-time and reliability of the
replenishment process, since late suppliers cause
stock-outs as well.
Finally, we weigh these risks against the cost of
stocking out, often translating this into a target
service level (e.g., 92% off-the-shelf availability).

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7. Transaction Systems

Transaction systems play an important role in

managing inventory. As the name implies, they
manage all the transactions material moving in,
material moving out, and the balance on hand. This
information is a critical starting point for inventory
management. However, the ability of various
transaction systems to provide decision support
capability how much inventory should I hold?
varies widely.
In our experience across many corporate
landscapes, the norm is a system falling short of the
mark. This is generally not the fault of the software,
as most commercial systems have adequate builtin technical capabilities. Rather, we often find
the problem to be systems poorly tailored for the
specific business need.

8. Processes & Metrics

Success in practice depends on more than just

better science. It takes discipline to maintain
material master data, supplier data, and planning
parameters over the product life cycle. One
company entered some part values incorrectly
inflated by a factor of 1000 and as a result held
inappropriately low levels of inventory for cheap C
parts. This resulted in inexcusably missed orders.
And, as we so often find, individual and
organizational performance metrics need to be
aligned. A blanket cry to Cut inventory! often
leads to suboptimal results, with service being
sacrificed for inventory. See Figure 2 for the results
of one organizations tenacious effort to improve
overall performance.

Getting Started
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www.e2eAnalytics.com, or contact us by email
at info@e2eAnalytics.com.