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



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



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%

Lookingatinventorytechnology

enhancements

Lookingatinventoryprocessorpolicy

changes

PercentageofRespondents,n=137

61%

91%

0% 20% 40% 60% 80% 100%

Lookingatinventorytechnology

enhancements

Lookingatinventoryprocessorpolicy

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.



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

Marketpressuretoreduceordertodeliveryleadtimes

Pressuretoimproveservicelevels

Shortageofworkingcapitaltosupportoperations/expansions

Corporateneedtoimprovereturnoninvestedcapital


VeryInfluential Critical

26%

36%

30%

25%

38%

10%

7%

15%

20%

29%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Increasingleadtimes,variability,andcarryingcosts

Marketpressuretoreduceordertodeliveryleadtimes

Pressuretoimproveservicelevels

Shortageofworkingcapitaltosupportoperations/expansions

Corporateneedtoimprovereturnoninvestedcapital


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



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 customer service level: 96% Average cash conversion cycle : 15 days Average forecast accuracy at product family level: 87%

Industry Average: Middle 50% of aggregate

performance scorers

Average customer service level: 88% Average cash conversion cycle : 2 months Average forecast accuracy at product family level: 73%

Laggard: Bottom 30% of

aggregate performance scorers

Average customer service level: 79% Average cash conversion cycle : 4 months or more Average forecast accuracy at product family level: 51%


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.



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

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Improveforecastingaccuracy

Optimizeinventorylocationand

quantitiesacrossournetwork

Improvereplenishmentstrategies

Improveinventoryvisibility

Perce

ntag

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ents BestinClass Average Laggard

n=131

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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

Reduceleadtimessothatorderscanbedeliveredquickerandgetpaidfaster

AutomateARProcess

Stocktherightinventoryattherightplace

Adoptabuildtoordermodel

NegotiateDPOextensionwithsuppliers

ReceivablesFinancing

Changecustomercreditpolicies

Use3rdpartyInventoryfinancing

Use3rdpartyfinancingtopaysuppliersfasterwhileextendingtermsforthebuyer

CashtoCashCycles=DSO+DIODPO

Reduceleadtimessothatorderscanbedeliveredquickerandgetpaidfaster

AutomateARProcess

Stocktherightinventoryattherightplace

Adoptabuildtoordermodel

NegotiateDPOextensionwithsuppliers

ReceivablesFinancing

Changecustomercreditpolicies

Use3rdpartyInventoryfinancing

Use3rdpartyfinancingtopaysuppliersfasterwhileextendingtermsforthebuyer




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



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



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




Optimization




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.



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



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.



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



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:



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



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



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.



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



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.



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.



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.



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.




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 ( [email protected])

Since1988,Aberdeen'sresearchhasbeenhelpingcorporationsworldwidebecomeBestinClass.Havingbenchmarkedtheperformanceofmorethan644,000companies,Aberdeenisuniquelypositionedtoprovideorganizationswiththefactsthatmatter thefactsthatenablecompaniestogetaheadanddriveresults.That'swhyourresearchisreliedonbymorethan2.2 millionreadersinover40countries,90%oftheFortune1,000,and93%oftheTechnology500.

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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.

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www.demandsolutions.com

[email protected]



Supply Chain Consultants (SCC) designs and markets a family of software tools to help manufacturers manage their supply chain.

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Executive SummaryBest-in-Class PerformanceCompetitive Maturity AssessmentRequired Actions

Table of ContentsFigures Tables

Chapter One:Benchmarking the Best-in-ClassBusiness ContextThe Maturity Class FrameworkThe Best-in-Class PACE ModelStrategic Actions of the Best-in-Class

Chapter Two:Benchmarking Requirements for SuccessCompetitive AssessmentCapabilities and EnablersProcessOrganizationPerformance ManagementTechnologyDemand AnalysisInventory SegmentationInventory OptimizationInventory Replenishment

Chapter Three:Required ActionsLaggard Steps to SuccessIndustry Average Steps to SuccessBest-in-Class Steps to Success

Appendix A: Research MethodologyAppendix B: Related Aberdeen ResearchFeatured Underwriters

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