So, how are companies like P&G now finding gold in supply chains that many thought had been stripped of surplus inventory? Years of experience with just-in-time deliveries, vendor-managed inventory activity, increasingly accurate forecasting, and responsive, collaborative disciplines such as sales and operations planning have indeed whittled work-in-process inventory and previously warehoused supplies and materials to levels that have sometimes turned out to be dangerously low.

But traditional inventory management practices are being made obsolete—the result of increasingly global supply chains and the move to more contract manufacturing, more dynamic product life cycles, and multi-channel distribution. Many companies are now actively reevaluating their inventory management processes and technologies, says research firm AberdeenGroup. Nearly two-thirds of the respondents to an Aberdeen study say they have recently made or been asked to provide recommendations to management on how to improve their inventory management technology.

The new focal point is inventory optimization, based on new insights from mathematical models that allow managers to envision and plan around much more complex scenarios. Specifically, new software gives planners simultaneous views of inventory across several supply chain stages, or echelons. “It's not always about sheer reduction of inventory—it's about optimizing the mix,” explains Will McNeill, an analyst with AMR Research. “You may end up still having $100 million in inventory but you may have a different mix that allows you to meet different service levels.”

“Inventory optimization is more than hype,” adds Lora Cecere, AMR's research director for consumer products. “The use of probabilistic optimization techniques to identify demand and supply variability, and the use of this analysis to make better decisions on inventory policy and strategy, can really improve the top line and service performance.” Cecere says that companies that have deployed inventory optimization technologies report that the tools can trim overall supply chain inventory by 12 percent and more, with improvements of 0.5 percent to 2 percent in order fulfillment rates.

Bill Tarlton is justifiably proud of P&G's prowess in managing its supply chains. “Our customer service levels have been kept extremely high—above 99 percent order fill rates,” he says. In recent years, operations have made huge gains in the measures that matter most to P&G: cost, cash, and time.

P&G has integrated with suppliers to cut materials inventories, collaborated with customers to reduce inventory at retail, built better information systems that enable improved materials and production planning, and helped improve the responsiveness of the company's manufacturing and distribution systems.

The payoff is evident in the company's financials: In fiscal 06/07, P&G's Beauty segment saw net earnings climb 13 percent, with sales gains of 7 percent. The year earlier, operating cash flow—a crucial measure at P&G—got a major boost from working capital improvements resulting from companywide emphasis on inventory management. Inventory days on hand in fiscal 06/07 were down by about eight days compared to the previous year.

But Tarlton is under no illusions about the current challenges. There is no let-up in the pressure for asset efficiency—a key contributor to cash flow growth and thus to total shareholder return. The Beauty segment, already a $23 billion business worldwide, is seen as a major growth plank for P&G, particularly in the developing regions.

Yet it's much less predictable than P&G's other business segments. “We face high demand variability with highly differentiated products like eye shadows and lipsticks, where there can be lots of expediting,” says Tarlton. “In such short life-cycle businesses, we have higher risks of inventory obsolescence as well as higher risks of customer outages.”

About four years ago, Tarlton and his colleagues began looking at the new multi-echelon software tools as a defense against escalating supply chain risks. P&G had always prided itself on developing its own analytical tools, but this called for a different approach. “We were dabbling in multi-echelon,” says Tarlton. “But in terms of the growth in volume and breadth of the product lines—with growing complexity and facing more and more product innovation—we just felt that our internally developed toolsets fell short. We believed we could get the fastest gains with third-party tools married to our supply chain expertise.”

The search began for a tool that would help the Beauty unit squeeze more inventory out of its holistic supply chains. “We wanted the cash position improvement—it was really about cash and cost,” says Tarlton.

Aside from reducing expediting costs, he expected to be able to improve forecasting and to find tools that could help his colleagues decide whether to carry safety stock or not. So, the software had to provide rich “what if” modeling capabilities. And it had to meet broad acceptance by the unit's business users—in other words, it couldn't be something that people would find ways to work around.

Partway through 2005, the team had narrowed the list of potential candidates. Optiant was on the shortlist; coincidentally, the software provider was already at work within Gillette, which P&G was then about to acquire. Optiant got the thumbs-up from Gillette; another round of evaluation made its PowerChain tool the choice for P&G's new multi-echelon inventory initiative.

In 2006, Tarlton led a pilot MEI project in one Beauty segment: the cosmetics business. This was something of a departure for P&G, which had conventionally piloted in less cyclical categories such as paper towels or toilet paper—part of the Household Goods unit. But the new argument was that if the software brought value to P&G's most complex businesses, it would be much easier to expand its use to the company's other businesses.

The first step was to configure the existing cosmetics supply chain in the Optiant model, pulling in the previous 18 months' demand history and using the previous three months' demand variability. Next, the tool was used to optimize the inventory strategy within that supply chain, with a constant eye on target service levels greater than 99 percent. A third step applied the software to identifying and evaluating alternate supply chain designs. And a final step yielded an optimal redesign of the supply network.

Tarlton is delighted with the results to date. The pilot demonstrated the potential to reduce total inventory in cosmetics by more than 5 percent—and closer to 10 percent in some product lines—with no deterioration in service levels and with the more stable work processes and faster, more fact-based supply chain analytics and decision support.

He expects that further optimization of inventory policies could yield an incremental one or two percent reduction. Overall, the largest percentage cuts have been in finished goods inventory. In one product line, the optimization outcome saw a slight increase in work in progress but an overall drop in net inventory dollars across the supply chain.

The Optiant tool is in the process of being expanded to all other supply chains in the Beauty segment. Indeed, the initiative has been so successful that the MEI approach and tools are being rolled out companywide—an effort that will take several years. “We do view this as a very successful technology project at P&G,” says Tarlton. “We did a great job of aligning all the stakeholders. The key was that this initiative was led by the business—it was not an IT project. We also identified the right users—the analysts and planners who had the right backgrounds.” Tarlton has not needed to add headcount or invest in extensive re-training; nor has his unit had to change any of its supply chain metrics.

Inventory optimization for everyone?

Procter & Gamble clearly had laid the groundwork for the success of its MEI venture. It had unambiguous business objectives, accurate and available master data, the necessary skills among IT staff and business users, and the full support of senior management. Those factors made it much easier to accommodate the quirks of the relatively immature MEI software sector.

While industry experts point to MEI payback periods inside a year—and sometimes less than six months—they caution that companies need to be prepared to work with smaller technology vendors with immature marketing capabilities because the emerging MEI category is largely the province of best-of-breed providers. “While compelling, the market itself is fragmented, sales efforts are aggressive, and the concepts are still new for many,” says AMR's Cecere.

A precondition, then, is for companies to look inside at their own capabilities and their understanding of inventory. “Most supply chains are inherited, not designed,” notes Cecere. Thinking deeply about inventory is new for many organizations, she adds, and current MEI technologies are far more available than organizations have the skills to use them. Ad hoc summaries of inventory are no longer effective; today, they can only be based on clean and accessible data that is updated frequently. Then it's time for a broader perspective of not only where inventory is—including suppliers' raw materials and finished goods at retailers' facilities—but where it should be. With those perspectives clarified, supply chain managers can turn attention to evaluating providers of MEI tools.

The challenge is to avoid what AMR's Cecere terms “math holy wars”—the tendency of software providers to dazzle prospects with math models rather than emphasizing the clarity of the business problem to be solved.

Don't let vendors inundate you with their better science; be clear and true to the problem you are trying to solve, matching their functionality with your problem,” advises Cecere.

A framework for selecting MEI tools