JUMPSTART INVENTORY PRODUCTIVITY: Using Speed and Information to Improve Inventory Utilization (PDF Version)

Introduction

Vast amounts of inventory are pointlessly trapped in companies and their supply chains, costing businesses enormous amounts of money annually. Trapped, unproductive inventory is common to almost every industry vertical. For example, contract manufacturer Solectron has 88 days of inventory on hand, while competitor Sanmina only has 51 days. Coca Cola has 68 days inventory on hand versus Pepsi's 23. These differences amount to hundreds of millions of trapped capital. Differences of this magnitude are pervasive, as shown in Figure 1.

Figure 1: Pervasive Differences in Inventory Productivity

These inventory productivity differences are also a major reason for differences in companies' stock market valuations. Figure 2 illustrates the relationship between inventory productivity and stock market value for the contract manufacturing sector. This relationship shows that in inventory intensive industries, the market value of the company is strongly related to inventory productivity. If Solectron, in Figure 2, were able to reduce its inventory on hand to reach a productivity level comparable to Sanmina's, then it would increase its market value by $3.8 billion.

Figure 2: Market Value Driven By Inventory Productivity

Source: Multex Investor October 15, 2001; Coplenish Analaysis

So how do we move the needle on inventory productivity if it is so important to business valuation? The answer lies in beating the enemies of inventory productivity - time and uncertainty - by moving to a high speed, high frequency supply chain.

The Battle: Fast and Frequent versus Time and Uncertainty

Time and uncertainty are the enemies in the battle for high inventory productivity. The more time and uncertainty that exist in the supply chain, the more inventory will be required to compensate. To understand this relationship better, lets start by asking the question - Why do we carry any inventory in the first place?

If we could get any quantity of inventory at any time we wanted without waiting, we wouldn't need to carry inventory at all. Unfortunately, we have to wait to have inventory delivered to us - sometimes it's fast and sometimes it's slow. We're also never really sure how much demand there will be for a product, so we never know precisely how much inventory to have. To compensate for these time delays and uncertainties we carry inventory so that we can provide our customers with high service levels.

How much inventory we carry depends on how frequently we place orders, how long it takes to get the order filled and how much uncertainty we have to deal with. These variables are also tied together, so that increases in one tend to lead to increases in the others. For example, if we place orders infrequently then our suppliers face more uncertainty in demand and have a more difficult time filling our orders, causing delays in getting the inventory delivered. On the positive side, if orders are placed more frequently, then we experience less uncertainty in demand; if orders are filled more quickly, then we need less inventory to cover the waiting period.

The power of 'fast and frequent' to lower inventory levels was examined in a research study of the impact of vendor-managed inventory in the retail supply chain. The study reveals the impact on inventory levels from increasing the frequency of order placement. These dramatic results are shown in Figure 3.

Figure 3: Relationship of Inventory to Order Frequency

Source: M. Waller, M. Johnson and T. Davis, Vendor Managed Inventory in the Retail Supply Chain, Journal of Business Logistics, Vol. 20, No. 1, 1999

In addition to improved inventory productivity, 'fast and frequent' creates the opportunity for higher margins. The increased responsiveness creates value for customers - lower inventory, less excess and obsolete inventory, fewer markdowns, and smaller space requirements. These profitability improvements can be calculated and used to show customers why the return on investment they get from your supply chain justifies a price premium versus the competition.

Winning the war - Two examples of Fast and Frequent

As reported in a recent book entitled Velocity Management (See Note 1), the U.S. Army adopted a program called Velocity Management aimed at increasing the clockspeed of its supply chain. One of the early targets for this initiative was the order fulfillment process for spare parts. As the Army looked at its order fulfillment process, its first action was to review the metrics used to manage the system. The metrics tended to be localized and not customer oriented. They developed a metric called Customer Wait Time (CWT) to capture the complete cycle time from order placement to receipt by the customer. This gave the organization a better view into what the customer experience really was. The average CWT was quite long, averaging 17 days for repair parts. Perhaps more importantly, the Army decided to look at the variability in CWT and found that there was a huge variation. As a result, the Army put in place metrics that measured not just the average time, but also measured the time it took to get 50% of orders delivered, 75% of orders delivered, and 95% delivered.

By analyzing where time was lost in the system, the Army identified opportunities to substantially compress the time in the process. The concept of 'fast and frequent' has been at the heart of their efforts to improve the performance of the supply chain. Putting 'fast and frequent' in place, the Army streamlined administrative flows to speed up the order process, delivered more frequently by moving from a heavy emphasis on freight consolidation to a regularly scheduled, route-based delivery approach, and compressed replenishment lead times to dramatically improve fill rates without any additional inventory. The results have been very positive as shown in figure 4.

Figure 4: Improvement in Customer Wait Time For Repairs

Source: Velocity Management

An example of applying the concept of 'fast and frequent' from the commercial sector is MicronPC, which increased its inventory turns from 10 to 55, reducing inventory on hand by 87%. The change in the business model also reduced lead times to their customers by 60%, which in turn enabled them to improve sales forecast accuracy from 38% to 70-80% and reduced excess and obsolete charges by 70% (See Note 2). As with the Army, MicronPC began by putting the numbers together to focus on time and frequency as key measures of performance. Lead times, order cycle times and inventory turns became the focus. They consolidated suppliers based on responsiveness and reliability. They turned up the velocity of information flow and shortened process times. Consequently, the frequency of information flow has increased to a point where inventory availability information is updated hourly from suppliers and production requirements are communicated every hour.

The results from focusing on 'fast and frequent' are truly impressive. In the Army's case, they have extended the concepts of 'fast and frequent' broadly across their organization and sustained it in both times of peace and war. In the case of MicronPC, they have raised their performance to a level comparable with Dell Computer's in two and a half years. It may not be easy, but the results are worth the effort.

The Barriers to Fast and Frequent

So what are the barriers that the Army and MicronPC had to overcome that any company will need to address in order to replicate the results of a 'fast and frequent' supply chain?

• Lack of real time visibility. Not knowing your inventory position continuously introduces time lags and excess inventory. Major corporations often run multiple ERP systems and are increasingly outsourcing distribution and manufacturing, making continuous review processes difficult and costly to implement. As a result, companies review their inventory positions less frequently, and consequently order less frequently. In addition, this inability to see the full inventory position means that duplicate inventory gets trapped in the system.
• Incentives to order in bigger batches. Lack of flexibility and high transaction costs motivate companies to offer customers quantity discounts that drive up the average order size. A higher average order size means that customers place fewer, larger orders, reducing order frequency and increasing uncertainty in the supply chain.
• Truckload economics. Transportation economics encourage companies to ship in full truck or container loads. To accomplish this transportation aggregation, companies focus once again on increasing average order sizes or on holding orders until full truck or container loads can be accomplished. Order frequency is reduced and inventory holding costs are driven up.
• Poor trading partner performance. Customer and supplier behaviors can be a major barrier to improved performance. Customers who share little information and have long order cycles add to your demand uncertainty, increasing the amount of inventory you need to carry to support them. Suppliers who are slow and unreliable add more cost into your business because you are forced to carry more inventory to compensate for their weaknesses.
• Inadequate metrics. Traditional supply chain measurement systems do not capture nor report the metrics required to manage the processes for speed and frequency. Metrics like fill rate and inventory turns don't focus an organization on increasing the speed and frequency of fulfillment and replenishment processes. Metrics that do focus on speed, like average lead-time, tend to measure internal processes - the time from order receipt to order shipment. Measures like this do not orient an organization to manage the time that matters to the customer, such as the time from hitting a reorder point to a replenished status. Order frequency, both received and placed, is almost never measured, making it highly variable.
• Insufficient process management. This one's simple; what's not measured doesn't get managed.

Seven Action Items for a Fast and Frequent Supply Chain

Overcoming these barriers requires concrete action to make a high speed, high frequency supply chain a reality. Here are seven action steps that will put you on the path to 'fast and frequent'.

1. Get real time access to the information you need. One challenge every company should be working to overcome is the issue of inventory and order visibility across the extended enterprise. Many large companies have multiple ERP and warehouse management systems that each have segments of the company's inventory under management. Others use third party logistics companies that have inventory in other disconnected systems. Additional inventory is located in places where no systems exist, such as inventory located on mobile fleets and in tool cribs. There are lots of places where inventory can be located and many systems that control this inventory.

Getting information about all the inventory in the extended enterprise is critical to any successful implementation of 'fast and frequent' principles. If you don't know what you have down to the individual item and location level, it is very difficult to put in place solutions that drive up inventory productivity. This visibility is essential to getting all the inventory under continuous review so that time lags can be taken out of the supply chain.

Fortunately, much effort has been put into the development of web-based applications over the past two years that address the issue of connecting disparate information sources into a global database of inventory position and order status. Tools from companies like Optum, Vizional and World Chain can be used to integrate the extended enterprise and even integrate views of customer and supplier inventory positions.

2. Move from purchase orders to continuous replenishment. Discrete purchase orders for specific quantities of stock get in the way of implementing the concepts of 'fast and frequent'. The concept of the discrete purchase order leads to batching up orders and working to get the best price. This approach entails significant overhead, works against high frequency replenishment and misses the value of fast, high frequency replenishment.

Instead, blanket purchase orders committing to rates of purchase within various categories of products with flexibility to move the volume commitment from one product to another are much more supportive of running a lean inventory model. Many of the principles found in programs like continuous replenishment can make a material reduction in your inventory levels and in your customer and supplier inventory levels. The focus needs to be on compressing lead times and increasing the frequency of order placement. If you're on a monthly cycle, figure out how to get to bi-weekly or weekly order placement. Constantly push to get the frequency up, both in the orders you place and in the orders you receive. The ultimate endpoint is to move to a sell one, order one system where time delays are removed from the supply chain.

This type of approach has benefits when applied to both customers and suppliers. The focus should be on how to make inventory flow like a continuous stream, as opposed to big batches being moved in waves.

The same technologies that enable you to gain visibility into the status of inventory position across the enterprise can also be used to share information with suppliers and customers so that they can see reorder points being reached and anticipate orders. This creates a time benefit that can be used to lower inventory and expedited freight costs.

3. Replace truckload economics with route economics. Mastering the transportation economics of 'fast and frequent' is essential. The model for managing both inbound and outbound transportation needs to move from aggregating orders into full truckloads with single destinations to an approach that builds routes and aggregates orders into the routes. This route-based approach can dramatically mitigate the incremental costs of transportation.

Again, this is an area where substantial investments have been made by companies like Descartes Systems Group and UPS/Roadnet to build applications that enable route based transportation management. Developing this capability within your supply chain is key to implementing 'fast and frequent' at a low cost.

4. Manage and motivate trading partners for performance. Start by measuring, reporting and communicating to your customers and suppliers. Educate them about how their behaviors impact the supply chain. Teach your customers the impact of low order frequency and provide incentives for them to order in more frequent, smaller batches. Motivate your suppliers to deliver faster, more reliably. If they can't get the job done, get rid of them.

5. Develop and deploy the metrics of Fast and Frequent. While it is difficult to generalize measures that work for all industries, metrics that measure inventory productivity, speed and frequency are needed. Add these metrics to the traditional measures of fill rates and inventory turns.

One of the most powerful measures is gross margin return on inventory investment (GMROI). Both gross profit and inventory value are collected at various levels of aggregation from a company wide view down to the individual product level. If you can measure it down to the product or category level, it can be used to focus on the areas that can drive the highest return on investment from adopting fast and frequent. Segment your products by sales volume and GMROI; those with high sales and low GMROI are your immediate priorities for improving inventory productivity.

Next up should be measures that monitor inbound and outbound speed from initiating event to closing event. On the inbound side, you should measure replenishment wait time (ideally down to the SKU-location level) - the time from hitting the reorder point to a replenished status. This goes beyond just measuring lead-time to the full measure of elapsed time between the two critical events of hitting the reorder point and receipt into inventory. On the outbound side, a similar measure of customer wait time should be implemented that captures at least the time from order placement to delivered and received by the customer. (Even better would be the exact same measurement events used in the replenishment wait time.) To supplement these measures, extend them to capturing not just averages, but also capturing median, 75th percentile and 95th percentile performance.

The third set of measures that should be implemented are those that deal with frequency. How often do you place orders and how often do you receive orders? To the extent that these frequency measures can be driven down to individual SKUs, they can be even more useful management tools. Map this frequency against volumes. The high volume, low frequency SKUs are prime targets for increasing inventory productivity quickly.

Beyond these three high level sets of measures there will be many more that make sense for each individual company. As you dive into root causes of why you have low GMROI inventory, slow cycle times and low frequency order placement you will discover new measures to deploy that make sense for your business.

6. Hire an expert to guide the change process. These changes involve a whole new way of thinking for your organization and supply chain partners. Having a successful, veteran implementer on your side can make a world of difference in making the changes a reality. Any organization that moves from a batch oriented environment to a 'fast and frequent' environment needs to learn to think differently about how to get things done. Someone who has been through the process before can greatly speed up the process and help ensure success.

7. Institutionalize Fast and Frequent Management. There are many ways to institutionalize continuous improvement programs. Most involve the basic concepts of defining the what's important to manage, measuring performance, developing and implementing solutions, and repeating the process over and over again.

By putting in place the metrics outlined above you will naturally define what's important to manage in your business. As the data is collected to measure performance, questions will naturally appear. Answering these questions will set you off on a never-ending journey of continuously improving your inventory productivity.

Notes:

1. Velocity Management - The Business Paradigm that has Transformed U.S. Army Logisitcs, RAND , 2001

2. Breaking the Mold of the Traditional Supplier/Manufacturer Relationship, Presentation at Council of Logistics Management Conference, 2001, J. Janson- Micron PC, T. Marrott - Modus Media International