Maximizing Working Capital without Crippling your Supply Chain
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Transcript of Maximizing Working Capital without Crippling your Supply Chain
An Optiant White Paper
The Executive Guide to
Maximizing Working Capital without Crippling Your Supply Chain
How to stop brute-force inventory reductions and position your company for the coming economic recovery
2 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
Slashing Inventory Now May Cripple Your Supply Chain—and Your Business.
The Importance of optimization, rather than brute-force cutting, to free up working capital now while enhancing responsiveness during the recovery
The severity and rapidity of the economic downturn caught just about every
business by surprise. Although it’s normal for demand changes to cause inventory
to “overshoot” the demand curve, this sharp and deep cycle has pummeled those
who did not have the necessary disciplines and competencies in place to
proactively managing their process,.
Not surprisingly, the crisis-management reaction has included brute force
reductions in inventory, headcount, sourcing and production capacities.
Unfortunately, the continued need for working capital during the downturn creates
perfect conditions for potentially disastrous decision-making. Mandates such as
“cut inventory by 20%” can indeed produce liquidity—while leaving the supply
chain less able to function efficiently and unable to meet higher customer demand
during the recovery. Bad inventory management today makes the company less
competitive during the upswing and amplifies the damage caused by the economic
crisis. By contrast, market leaders work these cycles to gain share and strengthen
their people, process, and technologies.
Competency. Corporate performance during today’s volatile economy, credit
crunch, and financial crisis is intrinsically connected to supply chain competency.
Successful companies will analyze all the factors that led them to hold inventory in
the first place, such as supplier lead times, demand fluctuations and uncertainty,
production capacity, sales forecast errors, etc. The smart move is to enhance
supply chain infrastructure through intelligent decisions about where to cut
inventory and by how much, right down to the SKU-by-location level. To do this,
the organization needs to enable its people, process, and technology around
inventory management.
Consider the impact of inventory management on availability of working capital. In
a business that can’t control inventory, any time demand falls the supply chain will
keep building when it shouldn’t. The result is excess inventory that sits until
discounting or obsolescence finally moves it off the shelf, which causes a drop in
the balance sheet and a loss on the P & L. For a company in need of working
capital, this is not a preferred strategy for “converting” inventory to cash.
In today’s uncertain economy demand is harder to forecast than ever, yet
somehow the supply chain must deliver the working capital that is key to the
company’s short-term health and long-term strategic vision. As modern business
cycles become faster and more severe, winning companies depend on inventory
efficiency to provide investment dollars during the down cycle.
“Inventory optimization is now among the top three priorities for many supply chain organizations as they seek to create increased efficiencies during the continued global recession..”
Manufacturing Insights, June 2009
3 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
The Recessionary Economy’s Double-edged Sword
While too much inventory traps and diminishes working capital, too little results in
missed sales, lost revenue, and lost customers. Both scenarios can occur during
the business cycle.
A plunging-and-recovering economic cycle poses double danger to complex,
vertically integrated businesses. First is the cost of sluggish reaction to dropping
demand. Many manufacturing
teams are measured on building
products and using resources as
efficiently as possible. This can
lead to a supply chain strategy
that is “determined” to keep
building to the plan long past the
logical stopping point. Excess
inventory builds up during the
lag period and saps working
capital at the time it is most
scarce. The potential arises for massive channel-stuffing and obsolescence as
overstock sits for months. When the inventory cuts do come, they take the form of
brute-force mandates rather than intelligent decisions.
Unprepared. After the effects of across-the-board cuts set in, we come to the
second danger. Eventually demand recovers, leaving organizations that manage
inventory by “rule-of-thumb” completely unprepared to take advantage and
rebound quickly. Forecasts change rapidly and unpredictably. “Gun-shy”
managers are slow to ramp up. Suppliers who not long ago were shut off are now
unable to quickly revive themselves. Some suppliers and contract manufacturers
will go bankrupt. When demand
recovers, having fewer suppliers
can create a bottleneck in
capacity, especially in cases of
long international lead times.
What is a 90-to-120-day lag in
response costing your business?
Way too much. The cost comes
in many forms: lost revenue,
poor return on assets, bad cash
position during a crucial time,
inability to take market share away from slower competitors.
Although you can’t manage the economy to create more demand, you can chart a
“course of lowest cost” by successfully managing inventory. To navigate this
difficult passage, the supply chain must minimize its costly tendency to overshoot
changes in the demand curve. Someone has to balance out the uncertain demand
“Most companies have mastered the basics of Supply Chain execution. Where they struggle is designing supply chains that are as flexible as their market requires.”
Senior Manager, Accenture
“Increasing the productivity of assets has taken on more importance because of its direct relationship toward maximizing working capital and improving the bottom line.”
Simon Ellis Supply Chain Practice Dir. IDC Manufacturing Insights
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ExcessInventory
Original Build Plan
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Rule‐of‐thumbinventory adjustments
Lost Revenue
Manual Response
Excess Inventory
4 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
and inaccurate sales forecasts. But how can they know what to cut, what to keep,
what to order, what to postpone? Where is it smart to reduce and where is it
suicidal? Where does the confidence come from to ramp up manufacturing, take
maximum advantage of increasing demand, and grab more market share? The
key lies in reacting to demand signals early enough and positioning sufficient
buffer inventory in the right locations.
Bouncing back. Rules of thumb and spreadsheet calculations are not up to the
job, but there is a higher level of analytical power available that has proven over
and over that it can minimize the “overshoot” effect both during the plunge and the
ramp-up. Optiant’s inventory optimization technology applies proven mathematical
algorithms to model the overall supply chain and map the interdependencies of its
components. The analysis predicts exactly how different supply chain
configurations will behave in
response to possible changes in
the demand curve. Greater
inventory competency lets the
organization respond with
confidence—quickly adjusting
inventory targets and policies to
minimize costs, maximize profit,
and maintain required service
levels.
This means the avoidance of
excess inventory and obsolescence during a demand drop and very little missed
sales revenue during an upswing. Faster response improves competitive
advantage during the recovery and a growth in market share. In an exaggerated
plunge-and-recover cycle, good inventory management means the difference
between bouncing back from the downturn and being run over by it.
Becoming Recovery-Ready and Uncertainty-Proof
Great demand uncertainty breeds little confidence in how to get back on top of the
demand curve. Normally, when demand exceeds the safety stock, managers
resort to tactics such as expediting, subcontracting, premium freight transportation,
or overtime to accommodate the
demand windfall. But in a plunge-
and-recover scenario, if vital
inventory is not on hand at
multiple stages of the supply
chain, sales will be lost at the
precise time they are most
crucial.
Even as demand changes over
time, the degree of uncertainty is
“A multi-echelon inventory optimization application can be a powerful lever in optimizing overall supply chain performance.”
AMR Research
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Rule‐of‐thumb
AvoidableLost
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Optimized Response
Optimized
Avoidable Excess Inventory
5 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
predictable and can be managed. Using existing demand data, a smooth demand
curve can be generated, with variability shown as high and low bounds: in effect,
uncertainty forms an envelope around the demand signal. Inventory planners can
choose how wide an envelope to plan for, given their service level requirements
and business goals. Managers can confidently hold more raw materials and sub-
assemblies at lower-cost stages, ready to produce high-cost finished goods in
multiple variants quickly when needed. Selected long-lead-time items can be
stocked at higher levels than other SKUs so as not to impair response to a sudden
increase in demand. The SKUs associated with high-profit goods can be given
preferential treatment while low-value stock gets lesser priority.
Optiant inventory technology is uniquely focused on handling uncertainty. It is the
leading—and only—decision support solution that creates confidence and
predictability in the face of both demand and supply volatility and uncertainty.
The Difference Between Operations and Optimizations
It’s a common misperception that operational supply chain tools such as ERP and
Advanced Planning Systems somehow improve the strategy and tactics of
inventory management. This is not the case. Operational tools in a deterministic
planning system actually amplify inventory overshoot because operational and
transactional systems do not address the issues of how much inventory is optimal
or where it should be held within the overall supply chain.
For instance, inventory is often located using the same structure defined in the
ERP/APS system, even when these stock-holding locations are physically close to
one another. Pooling inventory could reduce runs between the stock-holding
positions and improve fill rates. Optimized stock pools are an excellent technique
to maintain consistently high service levels while saving between 30%-50% of
safety stock cost—but stock pooling is beyond the scope of ERP and APS
systems.
In another example, simple "days-of-supply" inventory targets often cause stock to
build up earlier in the supply chain than needed, causing a tendency to miss high-
demand peaks where maintaining fill rates is a crucial task. Inventory optimization
maintains fill rates by intelligently allocating the right amount of stock to each
location, week by week and month by month (whether the inventories are pooled
or not).
ERP and APS systems do not address uncertainty. Instead, ERP systems
should be used as a source of supply, demand, forecast and production data for
an inventory optimization solution such as Optiant’s PowerChain suite, which
models, analyzes, and recommends smart inventory targets and policies.
Optiant technology models the complex supply chain as a multi-stage network,
incorporating production lead-time at each stage and “dollarizing” the impact of
different supply chain decisions (such as how much buffer stock should be held
and where it should be located). The analysis takes into account transaction data
Optiant’s advanced
mathematical optimization
technology—nonlinear, integer
programming originated at the
MIT Sloan School of
Management—provides
strategic and tactical decision
support, versus the operational
support provided by ERP
systems.
6 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
as well as uncertainty in demand, volatile supply costs and delivery timetables,
inaccurate or inconsistent forecasts, and more.
Trying out alternative what-if scenarios helps planners see clearly which decisions
will produce a successful outcome (service levels met or improved) while
minimizing costs across the entire supply chain. Optiant’s technology is flexible
and easy-to-use, focusing planners’ attention on “exceptions” from the norm that
should be corrected. It can feed updates to the ERP system on a regular basis so
that inventory is optimized routinely.
Alignment Must Begin at the Top
Supply chain mandates come from the senior staff, and supply chain leadership
needs to come from the same place. The questions senior executives should be
asking of their supply chain teams include:
What’s the most profitable way to bring inventory back into alignment with
the demand curve?
How should we position inventory and capacity throughout the chain to be
ready for a recovery while handling demand uncertainty?
How can we position our people and competencies to take full advantage
of increased demand while minimizing losses during future downturns?
Supply chain managers should be able answer to these questions based on hard
data and facts. If they can’t, it’s because wise inventory decisions (that minimize
costs while maximizing customer service levels in spite of uncertain demand)
require a specialized decision support system that provides one accurate picture of
the entire supply chain and pulls managers together in understanding its efficient
operation.
While manufacturers should ideally design, model, and optimize their supply
chains in a collaborative environment, many decisions are in fact made in silos of
Sourcing, Manufacturing, Distribution, and Customers.
In many companies, these teams have directly conflicting systems of goals and
rewards. Taken individually their decisions may be justified, but the totality creates
massive overstocks and lag times (as well as other inefficiencies), and these
contribute directly to the company’s inability to dig its way out of a deep demand
trough as quickly as it must.
An end-to-end optimization solution (such as Optiant’s PowerChain suite) allows
companies to take a “cross-silo,” holistic approach to designing and optimizing
their supply chains, rather than viewing them as a series of local decision points.
Led by a broad initiative from senior management, collaborative decisions can be
made from the perspective of what’s best for the overall supply chain, rather than
individual sites striving to “have enough on-hand so we won’t have to expedite.”
For instance, Optiant may recommend replacing safety stock held at each and
every stage in the supply chain with a decoupled approach to lower total safety
“People in the functions are usually busy with their own business and don’t take time to understand and focus on how they impact inventory in the overall supply chain. There is nothing like simple, visible data to bring people together in problem solving, agreement and decisions.”
Senior supply chain exec
One Optiant client was able to
reduce finished goods
Inventory by 36%, raw
materials & WIP by 47%, and
improve delivery performance
by 17%.
7 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
stock while maintaining service levels. Armed with one, fact-based representation
of how the supply chain works, the executive staff can provide confident leadership
that cuts across the silos.
Cross-functional cooperation and vision regarding the end-to-end supply chain
should be a game-changing initiative driven by senior management.
Preparing for Change—and Greater Profitability—in Just 90 Days
A time of uniquely low demand is like an auto race running under the yellow flag: it
is an opportunity to prepare both the supply chain and all of its stakeholders to
prosper when full-speed competition resumes.
The perfect time to implement a more efficient decision-support solution is
as early as possible in the plunge-and-recover cycle. Optimization tools set in
place now will create a lean inventory environment that responds to demand—
especially volatile demand—with speed and confidence. Inventory optimization
solutions are much easier to implement than, say, an ERP system, and can quickly
create savings in the millions. Optiant routinely implements in just 90 days, with no
disruption to existing ERP and APS systems (the independent Optiant solution
feeds optimal recommendations to supply chain managers and the enterprise
systems).
The goal of any inventory management system is to provide the best possible
customer service within the constraint of the lowest practical inventory cost. This
improves company performance during any business cycle, but sharp downturns
provide a special opportunity for excellent companies to free up working capital,
become stronger, and gain market share during the recovery.
Here are the key guidelines:
Reform your inventory rather than slashing it through brute-force
reductions.
Free up working capital by intelligently reducing excess inventory—but
avoid cuts that hurt your ability to gain market share during the recovery.
Correct the tendency for inventory to badly “overshoot” the demand curve.
Become able to react to demand changes faster than your competitors
can.
Provide supply chain stakeholders with one accurate overview that helps
them understand the big picture.
Empower managers to follow recommendations that strengthen the entire
supply chain and improve the company’s ability to compete and win.
Exercise senior leadership to drive inventory improvement during “yellow
flag” period.
“The ability to optimize inventory across multiple echelons, with global visibility of customer service commitments, costs, and demand and supply variability, is an inherent need in every complex supply chain.”
AMR Research
“With quite reasonable acquisition cost and attractive ROI, inventory optimization applications are quite compelling…the level of benefit may surprise you!"
IDC Manufacturing Insights
8 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT
Optiant’s PowerPoint Suite of Inventory Optimization Solutions
Optiant provides an innovative solution for determining optimal safety stock
locations and levels in a complex supply chain. Using the PowerChain platform, a
user can design and model a supply chain as a network, where the nodes of the
network are the stages of a supply chain. Each stage uses a base-stock policy to
control its inventory levels and quotes a service time to its customers, both internal
and external. The PowerChain optimization engine then determines optimal safety
stock locations and levels for minimal cost of the safety stock of the supply chain.
The benefits include lower investment in safety stocks, higher return on assets,
lower on-going inventory holding cost, higher customer service levels and
increased revenue. In addition, the PowerChain suite serves as an effective
communication tool across the many functional and geographical divisions within a
typical supply chain, enabling collaborative decision-making.
For more information on how inventory strategy and tactics can be improved within
your organization, email [email protected] or visit www.optiant.com
Optimizing Supply Chains. Maximizing Results.