Taking Stock How Can Inventory Optimization Improve Financial Performance(1)

8/12/2019 Taking Stock How Can Inventory Optimization Improve Financial Performance(1)

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The need to achieve growth targets in volatile times using shrinking investment pools

has transformed the manufacturing CFO into a custodian of company value. Due to

high working-capital requirements and volatile operating costs, the CFO is increasingly

required to play an active role in supply-chain and inventory decisions. Suboptimal

inventory management directly impacts company value through working-capital

pressure and unrealized revenue as well as through budgeting, planning, and risk-

management issues. Demand- and supply-side volatility further aggravate these issues,

ensuring direct negative impact on key financial metrics.

Progressive manufacturing CFOs now realize that inventory

optimization is one of the key levers to optimize working capital

and cash flows and to improve sales and customer service.

Genpacts research shows that inefficient inventory management

can consume as much as 10 percent more working capital than

necessary and reduce cash flows by 4-5 percent.

Suboptimal inventories can lead to stock-outs that reduce sales

by 2-3 percent. Inefficient inventory practices can also result in

slower order fulfillment, which extends the cash-to-cash cycle and

raises the risk of penalty payments if customer service falls short ofcontractual requirements.

The financial impact of poor inventory management doesnt

end there. It can also saddle companies with direct costs (such

as higher interest expenses on inflated working capital) and

many indirect costs. For instance, any cash tied up in inefficient

inventory represents funds that the CFO could otherwise allocate

to other sales or marketing initiatives.

While poor inventory practices affect current sales and profitability,

they can also silently and invisibly steal from the companys future.

Many CFOs now realize that poor inventory management can

affect budgeting, forecasting, resource allocation, and strategy.For instance, companies that are often out of stock or incur costly

write-offs from obsolete inventories find themselves wrestling with

high variances between actual and planned.

Inventory optimizer

POINT OF VIEW

Taking Stock: How Can InventoryOptimization Improve FinancialPerformance?

Genpact


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Whats more, companies can incur significant legal liability from

slow or failed fulfillment in industries, such as automotive and

pharmaceuticals. They also face regulatory and environmental

risks in certain industries (e.g. chemicals), if they are stuck with

obsolete inventory that creates disposal issues.

Add it all up, and the ultimate risk for organizations that struggle

with inventory management is a lower financial valuation

(see Fig. 1). The cumulative impact of missed sales, lower profits,

increased borrowing costs, and higher legal and regulatory risks

can be a reduced market capitalization that investors assign to a

company that has not optimized its inventory practices.

The ultimate risk: A lower valuation

Increased supply-chain complexity, poor inventory visibility, and

high demand-supply volatility, significantly impair the CFOs

ability to calculate the many hidden costs and risks associated

with inventories. That, in turn, reduces the companys ability

to determine the internal rate of return needed to justify new

product launches.

Finally, poor inventory systems can also impair the organizations

ability to manage risk. If inventory is obsolete, it immobilizes

cash and creates costly write-offs that directly erode profits.

CFOs in charge

This revelation means that companies are making big changes in

how they manage inventories. Historically, many organizations

have allowed supply-chain managers in each business unit, factory,

or distribution center to set their own inventory levels with little

coordination. Unfortunately, too few of these organizations

created standard inventory policies. Furthermore, they didnt even

provide those units with the tools needed to determine optimal

inventory levels.

As global competition has intensified, though, companies realize

that their successif not their survivaldepends on the ability to

wring every inefficiency out of their systems. With a better

sense of the financial impact of poor distribution practices, these

organizations have put CFOs in charge of the supply chain.

And with the CFO in charge, many of these organizations have

embraced inventory-optimization solutions to improve financial

performance.

To start, these new optimization tools help CFOs and their staff

increase the accuracy of demand forecasts, improve alignment

between production and distribution, and reduce inventory levels

with minimal effect on sales or profits. Genpacts work with clients

has revealed that the best inventory-optimization solutions can

help companies reduce inventories by as much as 25 percent --

while providing forecasts that are 20-35 percent more accurate.

Ultimately, suboptimal inventory levels hit company value

Lost revenue due to sub optimal availability, slow cash flow due to

poor order fulfillment, liquidation of inventory at low prices

Volatility buffer inventories create higher carrying costs, cost of

ordering, etc.

Cost of supply-chain crises can severely erode customer value

Significant disposal costs for obsolete inventory in chemicals, etc.

Opportunity cost: Unlocked working capital, cash flows could

provide capital to fuel growth

Volatile inventory levels lead to high working-capital levels

resulting in higher cost of short-term financing

Limited inventory visibility and inaccurate demand forecasting

makes budgeting difficult

Product and inventory obsolescence results in write-offs

Cash-flow risk due to slow-moving products, poor visibility

Customer claims risk due to poor fulfillment in industries such as

automotive, pharma, etc.

Figure 1. Poor inventory practices can affect a companys cash flow, revenues, cost structureand, in turn, its overall valuation.

Company

value

FCF

Risk

Capital

Return

Revenue

Cost

CAPEX

Working

capital

Company

risk


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How does volatility impact inventory?

There are many sources of volatility in an increasingly fragmented, just-in-time, global supply-chain-inventory strategy that many

companies struggle to cope with. For example, commodity-cost volatility has made the supply chain a more complex, crucial, and

risky battleground. In a 2011 survey by Supply Chain Insights, 58 percent of Fortune 100 companies cited commodity pressures as

a risk to profits. Yet fewer than 2 percent of these same companies were able to translate this market volatility into a feasible sales

and operations plan.

Volatility affects prices, production, and inventories in two ways:

It directly affects the marginal value of storage (i.e., the flow of benefits from an extra unit of inventory). Hence, an increase in

volatility can lead to inventory build-ups and raise prices in the short run.

For a nonrenewable resource like oil, volatility affects the total marginal cost of production. An increase in price volatility can

result in a decrease in production.

In addition, fears of further spikes in commodity prices can lead to panic buying by many companies. Conversely, in markets

where commodity prices have plunged, suppliers have been left holding excess inventories that they must either sell at a loss or

write off.

The good news is that recent breakthroughs in stochastic-based inventory-optimization tools now enable companies to manage

inventories the same way they manage their cash. Using range forecasting, planning, price optimization, and POS-driven

replenishment tools, companies can now protect margins from swings in commodity prices or other events that unexpectedly

affect supply or demand.

Figure 2. Using Genpacts inventory optimization solutions, a typical US$1 billion company can reduce its working capital by as

much as $15 million and increase revenue by as much as $10 million.

Working Capital

Average inventory investments for ~ 6 to 8inventory turns

Up to 5-10% less WC

US$ 125-168 million

~US$ 5-15 million

High Inventory

20-30%

Typical industrynumbers

Typical in-efficiencies and

errors

What can besaved?

High Carrying Costs

2-5%

Obsolescence

5-15%

Slow Fulfillment

1-2%

Lost Sales

2-3%

US$ 20-50 million

~US$ 4-10 million

Average unrealized revenue~2-5%

Up to 20% more revenue

Revenue Realization

Through inventory optimization solutions, organizations can

reduce working capital, minimize write-offs of obsolete stocks, and

recapture sales that are lost when the right inventory existsbut

is on the other side of the world. A study by IDC Manufacturing

Insights found that organizations that use software, analytics, and

other solutions to optimize their inventories cut their stocks by as

much as 25 percent in one year and boost discounted cash flow by

more than 50 percent within two years.

Genpacts experience has shown that an average US$1 billion

organization can increase revenues by up to US$10 million through

inventory optimization, while reducing its working capital needs by

up to US$15 million (see Fig. 2).


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Inventory optimization can help CFOs im-prove financial metrics, enhance customerservice levels

By combining its experience in business-process and supply-chain

management with its proprietary tools and analytics, Genpact has

developed a range of inventory-optimization solutions that enable

clients to improve their financial performance. Compared to the

other alternatives, Genpacts solutions are easier to customize

and faster to implement. While other vendors provide software-based products that are time-consuming and disruptive, Genpact

solutions can be installed on-premise, in the cloud, or managed

largely via mobile applications. This enables an organization to

achieve a return on investment in as few as four monthsand

with a smaller upfront investment.

Regardless of delivery method, Genpact offers five solution

modules that map to the most critical issues of inventory

management: visibility, segmentation, planning and optimization,

demand forecasting, and product obsolescence. These modules

can be deployed individually or sequentially because they use the

same IT platform and tools.

Visibility management:Today, even mid-sized companies manage

supply chains that stretch across the world. Given the dispersed

nature of the modern supply chain, you need real-time visibility

into the flow of goods from suppliers, their subcontractors, and the

transportation firms that shuttle all of these goods around the world.

Genpact provides dashboards and centralized systems that give

you a comprehensive view of key forecast and inventory metrics.

This enhanced information then enables you to better segment

inventory, prioritize remedial actions. and set realistic targets for

improvement. Together, these moves can generate a 10- percent

reduction in working capital (see Fig. 3) and help recover up to 20

percent of unrealized revenue (see Fig. 4).

Genpacts solutions are built on Qlik View, a flexible, cost-

effective, and proprietary IT platform that enables us to custom-

fit technology around the organizations reporting process. And

where other vendors fall short, Genpact provides ongoing services,

such as internal and external benchmarking on key metrics.

Segmentation: Given the competitive pressure for suppliers to

offer a wider range of products and services, it is common to see

companies juggle hundreds of thousands of SKUs. The challenge

is to locate and cost-efficiently redistribute each of these products.

Genpact enables an organization to segment inventory by

customer type, product type, location, and many other categories.

This enables the organization to reduce excess inventories, focus

investments in the highest-performing segments, and, strengthen

financial performance. Genpact offers:

A cloud-based, in-house solution that integrates with existing

ERP systems. That means you pay only for the solution not

expensive infrastructure.

A multifaceted approach to inventory classification with metrics

for financial (e.g., gross margins), operational (e.g., velocity

of movement), and customer-oriented (e.g., high-volume

products) criteria.

Why isnt traditional inventory planning suited to high-volatility environments?

Typical inventory processes Implications in the new normal

Demand plans are based on time-series projections of

previous three to four years.With changing buying patterns, history is no longer valid.

Demand-and-supply plans treat residual inventory at

buying cost.

Inventory is no longer just the buffer stock. Its also a

commercial hedge against commodity volatility.

Annual long-range forecasts are fed to sourcing to secure

contracts for raw materials and semi-finished goods.

Statistical long-range forecasts are no longer sufficient without

considering macroeconomic inflationary factors.

Long-term contracts provide stable input costs.

A short-term price drop can become a missed opportunity.

Hedging strategies must be developed and regularly reviewed

for each input.

S&OP is focused on short-term revenue plans.Ignoring implications of long-term price trends can drastically

reduce profitability.


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Planning and optimization:Genpacts replenishment and distribution processes help the organization analyze supply and demand to

predict order and fill rates. Our planning processes help optimize lead times by making continuous adjustments based on supplier inputs.

This helps minimize carrying costs, stock-outs, and ordering costs while maintaining adequate service levels. Genpact provides its planning

analytics over a flexible and cost-effective IT platform to custom-fit technology and process to the organizations environment.

Figure 4. Genpacts inventory optimization solutions can help organizations capture as much as 20 percent of unrealized revenues

Visibility

management 4%

Total improvement up to 20 percent of unrealized revenue

2%

7%

3%

4%

Multi-criteria

inventory classification

Demand

forecasting

Planning and

optimization

Obsolescence

management

Near-time KPI visibility aids quick decisions

Structured techniques for optimal segmentation and

prioritized inventory investments

Advanced models coupled with market intelligence to

improve forecast accuracy

Proprietary techniques for optimal replenishment and service

strategies

Proactive forecasting, tracking, and management of inventory

risks throughout the lifecycle

Figure 3. Genpacts inventory optimization solutions can help reduce working capital as much as 10 percent

Visibility

management 1.5%

Total improvement up to 10 percent of working capital

2.5%

3.0%

2.0%

1.0%

10%

20%

Multi-criteria

inventory classification

Improvement potential

Improvement potential

Demand

forecasting

Planning and

optimization

Obsolescence

management

Near-time KPI visibility aids quick decisions

Structured techniques for optimal segmentation and

prioritized inventory investments

Advanced models coupled with market intelligence to

improve forecast accuracy

Proprietary techniques for optimal replenishment and service

strategies

Proactive forecasting, tracking, and management of

inventory risks throughout the lifecycle

Demand forecasting:Predicting future demand can be difficult,

given the seasonal nature of many markets and changes in

competitor offerings. Genpact offers advanced forecasting models

that account for ongoing demand volatility. Genpact helps create

standard processes that improve forecast accuracy and adapt to

dynamic market conditions. Genpacts demand forecasting models

incorporate:

Advanced algorithms (e.g., Croston, Fourier) to handle dynamic

and intermittent demand while reducing forecasting errors

Exception management and scenario development to help you

better respond to dynamic market conditions

Real-time market intelligence to help you forecast more accurately


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Obsolescence management:In many industries, product cycles

have become so short that some goods can become obsolete

within months of launch. Genpacts obsolescence- management

solutions help identifyand then adapt toany risks that could

render products obsolete earlier than expected. We enable

companies to:

Minimize working capital and boost profits by releasing cash

from excess inventory

Redeploy inventories more effectively

Identify existing and potential obsolescence

Estimate the risk of obsolescence

Why Genpact?

Genpacts inventory-optimization solutions leverage the extensive

skills and resources developed during our years as a subsidiary of

GE Capital. Genpact combines custom analytics and a proprietary

inventory-optimizer tool, as well as experience in business process

management, supply chain management, Six Sigma, and Lean Six

Sigma disciplines to develop actionable solutions for clients.

As a leader in inventory optimization, Genpact has helped clients

that manage more than US$5 billion in inventories and 500,000

different SKUs, generating a combined US$250 million in savings.

Our solutions help clients segment inventories by customer, cost,

product line, and other categories. This enables them to plan and

optimize inventories across multiple sites, build demand forecasts

and simulations to predict future inventory needs, and develop

strategies for reducing the risk of inventory obsolescence.

Genpact employs more than 250 experts in supply-chain analytics

and more than 150 inventory specialists across three global

locations. Our global delivery model provides cost efficiencies and

enables Genpact to leverage local market insights. Most of these

specialists have earned advanced degrees, possess experience in

multiple industries, and have experience in leading third-party

applications including FGS, Servigistics, and I2.

Genpact also brings to each assignment proprietary tools that are

modular, configurable, and technologically unobtrusive, and that

supplement current ERP and IT infrastructures. These include our

integrated forecasting application, PRODE, and our proprietary

inventory-optimizer tool.

Genpact provides its inventory optimization services as one-time

engagements or as part of long-term engagements. Using a

modular approach and flexible cloud delivery, Genpact can deploy

solution modules in as little as two months. That, in turn, can

enable clients to generate early results in as little as four months

with little or no upfront investment.

About Genpact

Genpact Limited (NYSE: G), a global leader in business process management and technology services,leverages the power of smarter processes, smarter analytics, and smarter technology to help clientsdrive intelligence across the enterprise. Genpacts Smart Enterprise Processes (SEPSM) frameworkand its unique science of process, combined with deep domain expertise in multiple industryverticals, leads to superior business outcomes. Genpacts Smart Decision Services deliver valuablebusiness insights to clients through targeted analytics, reengineering expertise, and advanced riskmanagement. Making technology more intelligent by embedding it with process and data insights,Genpact also offers a wide variety of technology solutions for better business outcomes.

For more information, visit www.genpact.com. Follow Genpact on Twitter,Facebookand LinkedIn.

Copyright Genpact 2013. All rights reserved.

For more information, contact:

[email protected]

Please visit our website at:

http://www.genpact.com/inventory-optimizer
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Taking Stock How Can Inventory Optimization Improve Financial Performance(1)

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