Transform your organization with digital inventory optimization
Transform your organization with digital inventory optimization
Insight

Transform your organization with digital inventory optimization

Inventory reduction is a key target of companies to reduce working capital and its associated costs, leading to improved cash flow.

Inventory reduction remains one of the key targets of companies wanting to reduce working capital and its associated costs, leading to improved cash flow. Simultaneously, customers are demanding higher service levels and increased convenience. Meeting these seemingly conflicting objectives is a major challenge for many organizations on their digital journey, but let’s discuss how inventory optimization (IO) can help you address these challenges.

For this blog, we will provide an overview of IO basics and provide a short explanation of the advantages of multiple-echelon inventory optimization (MEIO) compared to single-echelon optimization. For those seeking more in-depth information, we’ll point you in the direction of a book chapter that contains the mathematical concepts that can help you understand important details for your digital transformation journey on different levels of maturity.

Types and purposes of inventory

The lean principle taught us that unnecessary inventory is one of the seven types of waste. That raises the question of what constitutes unnecessary inventory and what does not? In other words: What is the purpose of inventory?

To answer this question, here are definitions of the main types of inventory or stock:

  • Cycle stock represents the amount of inventory that is kept to fulfill the demand of the downstream stage until the product is replenished. Ideally, the cycle stock amount matches the replenished stock. This requires the future demand forecast to be 100% accurate to avoid stock-outs. Since this is not achievable in reality, you have to keep safety stock. The longer it takes to replenish the inventory, the more amount of cycle stock is necessary to be kept.
  • Safety stock is used as a buffer against uncertainty. Without it, a decrease in the anticipated supply or an increase in anticipated demand of the product would lead to a guaranteed stock-out and decreased customer service level. Demand-side uncertainties, such as inaccurate forecasts or changing customer orders, typically account for the largest portion of the total safety stock. On the supply side, there is a lower-than-expected yield of a production run or variability in the lead time of incoming products needed to manufacture the outgoing products. However, if there was no uncertainty on both the supply and demand sides, you wouldn’t need safety stock.
  • Tactical and strategic stock is inventory build on top of cycle and safety stock and can serve a variety of purposes. Tactical inventory is built up in the short to mid-term for a specific purpose—for example, when a supply planner decides to build up enough inventory to conduct a full machine shutdown and maintenance without impacting customer service levels. Similarly, strategic inventory can fulfill business purposes that are relevant in the mid- to long term, such as hedging raw material to counteract an anticipated price increase.

In summary, inventory is kept for a variety of legitimate reasons that are legitimate. Any inventory on top of the described purposes is excess inventory that serves no purpose and reduces the organization’s working capital.

Single vs. multi-echelon optimization

Optimizing the safety stock inventory levels in a multi-echelon supply chain locally might result in sub-optimization.

Each echelon is focused on maintaining a customer service level that their immediate downstream customer demands, but for an optimized solution the focus should be on the end customer and inventory decisions should be made based on the end customer service requirements. For that reason, MEIO can achieve significant cost savings, especially in complex supply chains, even if a sophisticated single echelon optimization is already in place. 

In the book chapter this concept will be further illuminated by developing multiple guaranteed service models (GSM) and walking through different scenarios. The reader will be guided through the mathematical foundation of the model and led to the conclusion that only a holistic view of the supply chain finds the optimal solution and can save costs without sacrificing end customer service levels.

Generally, MEIO is not implemented in the form of spreadsheets, but instead with the help of specialized software since the model and calculations can be too complex and the data volume too big for spreadsheet software to handle. That means to achieve the next level of inventory optimization maturity an investment must be made by the company including an underlying business case. Businesses might have a different set of requirements and being able to understand and challenge the software vendor’s proposed solution can be advantageous to the success of the project. For this reason the practitioner should understand the concepts of IO in detail. It also becomes important during the vendor selection process to inquire about specific capabilities on the software.

Conclusion

There is an opportunity for inventory optimization in many organizations that handle physical goods. With the right understanding, formulas and tools, your company can reduce total inventory, increase service levels and thus achieve cost savings.

The basics covered in this blog can help set the stage for your organization to take a deeper dive into the inventory optimization tools discussed in a book containing content from some of KPMG’s supply chain consultants, Technology optimization and change management for successful digital supply chains. The specific part about inventory optimization can be found in chapter 10. Further let us know if KPMG can assist you on your inventory optimization journey.