Get Down to Detail on Inventory

Sept. 17, 2007
Overall positions on business inventories are important to economists, but individual companies are struggling with the details. Aggregating detail on

Overall positions on business inventories are important to economists, but individual companies are struggling with the details. Aggregating detail on field inventory is a big challenge. Figuring out how to optimize use of those inventories is the next critical step in getting maximum return on the capital invested in those forward stocking locations.

Scenarios differ somewhat by industry. Retailers face costly lost sales if they don’t have the right inventory in the right place. On the other hand, overstocks generally necessitate deep discounts to clear shelves for the next item. In the automotive parts segment, dealers face competition from non-OEM retailers, so manufacturers want to support bringing customers back to the dealer. And, in high-tech, product life cycle comes heavily into play.

A common theme for inventory optimization revolves around customer service. For KLA-Tencor, customer service isn’t just a catch phrase. A supplier to semiconductor manufacturers, its objective is to maintain high levels of availability for 60,000 spare parts on 20,000 systems in more than 300 wafer fabrication plants around the world. When he joined KLATencor, Joseph Chamberlain says, they were using distribution requirements planning (DRP) to forecast individual part requirements at the lowest level in the network using moving averages. The company brought in a number of systems suppliers to propose solutions. Chamberlain, who is now an independent consultant, went through a selection process and identified a short list of potential solutions and then held what he terms a “bake off” for the contenders.

He gave each supplier a portion of the installed base and a portion of parts demand and had each provide their solution. He then looked back over the solutions the companies provided to determine what would have been the most optimized solution and what the service levels would have been over the last three months using that solution. The choice came down to MCA Solutions’ Service Planning and Optimization Strategy (www.mcasolutions. com) product.

Commenting on these and other experiences, Chamberlain, principal of Service Supply Chain Management Consulting (, says he knew that if he could solve the planning issue, he could begin to focus on other strategic opportunities. In fact, says Chamberlain, he had eight people doing nothing but emergencies. In the end, he cut that to three people handling emergencies and freed the others to focus on more strategic functions like buying and planning, evaluating regional supplier alternatives on the buy side, considering a move to a lead logistics provider, and implementation of a single enterprise resource planning (ERP) system.

While any organization is likely to be pleased with reduced inventories and better inventory efficiency (KLA-Tencor reduced inventory levels by over 10% and improved service levels), reallocating vital resources amplified those results through improvements in other areas of the business. “We were making several changes concurrently and because we no longer spent every day on a fire drill, we got to focus on some strategic capabilities,” Chamberlain points out.

Inventory optimization can lead to network reconfiguration. Chamberlain comments, “When you begin to plan by hours and play for responsiveness, you do open the door to changing your network.” He offers the example of putting a single distribution center in Waco, TX vs. operating one in Austin and one in Dallas to ensure you can keep time commitments on customer deliveries. But any time you consider a change like that, you face internal issues. Internal customers like being able to see and touch inventory. Another factor is that even though the service guarantee might be four hours, the fact that a large part of the time you deliver in one hour, it sets a new customer expectation. Simply meeting the promise might be perceived as reducing performance.

The visibility gained throughout the network can provide some powerful tools, says Chamberlain. The obvious benefit of reducing premium transportation costs by shipping more scheduled orders and having fewer emergencies can multiply with better visibility, allowing inventory to be shifted between field stocking locations. Chamberlain was able to develop a measure for transportation costs relative to fill rates. He says that every 1% drop in regional fill rate drove a 5% increase in freight expense. The inverse was true, he suggests, and a 1% improvement in fill rate could drive a 5% reduction in freight costs. While the numbers may vary by industry or by company, the relationship between inventory accuracy and transportation costs should still exist.

With 28 years in retail supply chain and logistics, Jim Bengier agrees that the “supply chain window is becoming more extensive” with increased globalization. Though safety stocks are important to retailers, inventory is more likely being pushed upstream rather than downstream, comments the director of global industry marketing for Sterling Commerce. Bengier adds the amount of safety stock retailers carry fluctuates based on their experience with disruptions.

There is a degree of safety stock built into the pipeline, says Bengier, and it tends to be more with the purchase orders and in the manufacturing rather than in the warehouse, which breaks somewhat with what has been his past experience as a retail supply chain manager. Retailers are negotiating hard on that front and postponing taking ownership of inbound inventory as long as possible. “They don’t want to take ownership of the product until it’s left the port,” says Bengier, referring to the US port where the goods land. So, safety stock, for retailers, is in the form of an order, which gives them some flexibility and, within certain time constraints, allows them to cancel the order. With the cost of capital going up, many companies are using these less traditional inventory methods to reduce their exposure on capital.

Order visibility becomes a more critical component of inventory optimization when the buyer wants to keep the goods off its books but count those goods as inventory with an availability date, as retailers appear to be doing. Retailers are looking at where their demand is developing and attempting to be proactive and shift orders to synchronize with that demand.

One option, says Bengier, is that if a retailer has integrated orders and demand and has a good transportation management system (TMS) and close coordination with carriers, it can route orders to distribution centers (DCs) as they land at a US port.

What most retailers try to do, continues Bengier, is to catch the order before it is loaded on the ship at the origin port and route the goods based on where demand is developing. When he managed a retail supply chain, Bengier says, he would have some shipments follow the conventional route to the US West Coast, but other orders might be routed from Asia via the Suez Canal to the US East Coast and then directly to DCs in the East and Midwest. In doing this, Bengier says he would look at how fast he needed the product, the anticipated port throughput situation, carrier cost and performance before committing the load.

Channels behave differently. It’s well documented, says Bengier, that customers will order online and wait for the product. “As long as you communicate very clearly to them when they’re going to receive the product, consumers will go ahead and wait online for it.” This allows retailers some leeway to pre-sell items and gauge demand. Retailers are clearly moving to multi-channel models and even some cross-channel selling, but are they keeping up with inventory strategies that can aggregate inventory across those different channels and allocate where the need is developing?

Some consumer electronics retailers are offering on-line customers an option to pick up certain orders at a local store. With good visibility out into the field inventory, the retailer can make good on its promise to have the goods waiting when the customer arrives, but there appears to be a gap when it comes to fulfilling an on-line order from a nearby retail site that may have plenty of stock in a particular item. The constraint is that retail stores tend to be designed to receive goods through the back door and see them walk out the front door. They don’t have facilities to pack and ship individual orders. The trend of the last few years has been to minimize the back-room operations and maximize retail display real estate so more goods are in front of buyers and less space is taken up by the store room. It doesn’t appear likely retailers will reverse this approach to add a parcel shipping operation to retail outlets.

A variation of cross-channel stocking comes into play with some retailers who have physical outlets or have struck deals with retailers handling their goods to allow consumers to return items to a local retail store where the goods can be entered into stock or processed with other returns.

True cross-channel inventory optimization will have to break down a few barriers in some markets. Until then, stocks allocated to the catalog/on-line channel will remain separate from those allocated to retail sales. One reason may be the lack of visibility, but those tools seem easier to obtain. Another factor is the different type of shipment—pallets vs. parcels. And a third contributing factor could be who handles the channel. Many retailers may have third party logistics providers managing their newer channels because of the efficiencies they can bring to an operation that doesn’t overlay with existing systems and methods.

There are always exceptions, and OE Connection ( is managing some cross-channel optimization in automotive parts. Original equipment manufacturers supply dealers with parts and it is the dealers who are providing parts to local installers, collision ships, fleets, and consumers.

Dealers’ attitudes towards maintenance and service have been changing in recent years. The repair shop has shifted from an after-sale service to a pre-sale opportunity, so getting customers to come back for maintenance is important. Where local providers are performing work the dealer can’t do or where the consumer preference is for his or her local mechanic, parts sales account for a major profit opportunity for dealers.

Dealers are encouraged to hold parts inventories through incentives that can include higher discounts for higher recommended stocking positions. Charles Rotuno, president and CEO of OE Connection, recalls one estimate that parts may account for 14% of revenue for a dealer, but they are as much as 80% of profit. Clearly, the parts business has become come very important to dealers, not only as a matter of customer service.

What OE Connection has done for this industry segment is to aggregate inventories across channels to create a virtual inventory. Dealers will order from parts distribution centers, but when the parts DC (PDC) doesn’t have the parts or they are on backorder, the dealer has an option to buy from other dealers in its area. OE Connection handles about 200,000 dealer- to-dealer transactions a day through an Internet-based inventory.

OE Connection draws inventory information out of dealers’ inventory systems electronically, so the purchasing dealer has access to a wide range of stocking locations. Regular delivery runs from the PDC can deliver parts and pick up dealer-to-dealer transfers, so if dealer A has a part dealer C needs, they handle the transaction and the part is loaded onto the delivery truck when it stops to deliver at dealer A’s facility and then delivered to dealer C with is shipments from the PDC. If dealer C is not on the same delivery circuit as dealer A, other expedited transportation can be arranged.

Some dealers specialize in their parts inventories based on the strength of their service operations, so they may go deeper in some parts categories than others. According to Ted Fellowes, vice president of supply chain solutions, there are even special stocking locations handling vintage parts, and any dealer on the network has visibility into that inventory.

An interesting aspect to the OE Connection inventory optimization model is that it connects competitors. An east-side Toyota dealer may acquire parts from a west-side dealer with whom it competes on new car sales. In that respect, it’s unlikely a Best Buy store will fill a customer order for a Toshiba flat panel television from stock at a cross-town Circuit City, but there are some interim steps to break down some channel silos within a corporate family that will help optimize inventories and cut overhead while maintaining or improving customer service.

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