Issues stemming from inventory management, or, more broadly, supply chain planning, can have a profound effect on logistics operations.
Consider the following examples:
A consumer products manufacturer has difficulty allocating inventory across its regional mixing centers, resulting in additional transportation cost from inventory rebalancing and the use of costly outside storage when inventory levels exceed mixing center capacity.
When demand planning goes awry for an automotive manufacturer, the company must then ship heavy axles via international airfreight from another plant’s inventory to keep its production lines humming.
These examples underscore the need for logistics professionals to have an active and informed voice in decisions regarding inventory management. However, for most industries, there’s a significant gap in inventory performance between bottom- and top-quartile performers.
This gap cannot be bridged solely by the efforts of the supply chain planning team. It requires effective collaboration between logistics and planning. Put another way, in order to be successful, companies need to take an end-to-end view of the supply chain, managing the relevant trade-offs and synchronizing planning and logistics to drive value.
The end-to-end planning and fulfillment framework
Two key concepts underpin effective inventory management: 1) clearly defined decision-making responsibilities and processes at strategic, tactical, and operational levels, and 2) coordination across enterprise supply chain functions, particularly between planning and logistics.
The end-to-end planning and fulfillment framework shown on page 44 illustrates the different levels of capabilities and decision-making required for inventory management. Although time horizons can vary by industry, the strategic level generally has a horizon of more than one year and may be associated with significant capital investment. The tactical level has a short to medium horizon of two weeks to 18 months, while the operational level has an immediate horizon of typically less than two weeks.
Companies need to approach the supply chain and inventory management first at the strategic level, where fundamental decisions are made with respect to the company’s business objectives. Once decisions are made at the strategic level, business decisions at the tactical level and, finally, the operational level can be addressed, with each level informing the objectives and decisions of the next level.
Moreover, decisions and objectives made at each level must be aligned; otherwise, the company’s strategy will not be realized, and conflicting policies will create sub-optimization. Now, let’s elaborate on the decisions and cross-functional collaboration required at each level of the framework for effective inventory management.
The primary objective of the strategic level is to establish an end-to-end performance strategy that will guide supply chain network design and inventory deployment strategy and will inform objectives and decisions at the tactical and operational levels.
The performance strategy should align with the company’s relative prioritization of the key end-to-end supply chain attributes: responsiveness, agility, reliability, asset efficiency, and cost. These attributes must be prioritized due to the implicit trade-offs caused by intrinsic supply chain dynamics.
Different industries and companies will emphasize different supply chain attributes, depending on market demands and how the company chooses to compete. A high-tech manufacturer providing aftermarket parts and services to business customers may prioritize speed and reliability over cost and asset efficiency, so its supply chain will be structured such that parts are readily available despite increased inventory costs and the cost of expedited orders.
By contrast, a consumer packaged goods (CPG) company may focus on cost and reliability, seeking to balance a low cost to serve with sufficient inventory to fulfill customer orders on time in full.
The companies in these examples each have a single strategy; however, it’s common for companies to define distinct performance strategies for different customer segments. Whatever the strategy may be, a company’s priorities will influence various trade-offs between inventory management and logistics.
In particular, the supply chain performance strategy directly informs supply chain network design and inventory deployment strategy. Network design considers the number, location, size, and mission of distribution centers, as well as product flow paths associated with alternative routes to market. And inventory deployment is concerned with how inventory is deployed across the network to address performance objectives.
In general, having more DC locations places inventory closer to market locations, which reduces lead time to fulfill customer orders and may also reduce transportation cost, but typically increases safety stock. This scenario, however, increases network capacity requirements and fixed cost overhead.
Conversely, for a given fill rate, inventory can be reduced by consolidating DC locations, with the use of premium freight mitigating the impact on customer lead times. There are many approaches to network design and inventory deployment that depend on the company and its performance strategy.
Analytical tools can help a company identify the preferred network structure and inventory deployment strategy. Network modeling and optimization tools help define the network footprint, while multi-echelon inventory optimization tools help to optimize inventory deployment across the network.
The right metrics and goals must also be established to enable the end-to-end supply chain to deliver the strategy. In the example of the high-tech parts manufacturing company, the key metrics might be order fulfillment cycle time and perfect order fulfillment to drive speed and reliability, respectively—whereas the CPG manufacturer might use perfect order fulfillment and cost of goods sold to drive reliability and cost management, respectively.
The tactical level also requires tight coordination between the planning and logistics functions to achieve effective inventory management aligned with supply chain performance objectives. This level is complex because there are two time horizons involved: a mid-term layer, which usually looks six months to 18 months in advance, and a short-term layer, which usually looks two to eight weeks in advance.
The mid-term tactical layer includes medium-term inventory buildup strategies and logistics capacity planning. From a planning perspective, the demand forecast drives production planning and inventory deployment so that finished goods inventory will be at the right place, at the right time, and in the right quantities to satisfy demand.
Sales and operations planning provides coordination between the commercial and operational parts of the enterprise to drive balance between supply and demand. Logistics must be involved in this process to evaluate the feasibility of demands on the logistics network and to communicate the cost required to maintain desired customer service levels. Importantly, the logistics team can proactively leverage plans to secure transportation capacity with carriers and manage staffing levels within the DCs.
Predictably, the plans generated for a medium-term horizon frequently must be adjusted in the short term based on unforeseen changes in demand or capacity. While most companies currently make these adjustments, the decision-making process can be siloed and is often reactionary instead of forward-looking.
A formal, cross-functional organizational structure for these decisions enables a holistic approach to adjusting demand plans, production plans, and inventory levels, and supports alignment to the supply chain performance strategy.
This short-term adjustment process provides an opportunity for logistics to not only collaborate with other functions to analyze changes, but also adapt short-term logistics capacity planning as demand becomes more certain. Optimization at this layer includes opportunities for logistics to further manage costs for activities such as rebalancing inventory across DC locations.
Tools employed at the tactical level of the framework support supply and demand planning and may incorporate scenario analysis capabilities. Technology includes forecasting models, production and distribution resource planning modules, and network and inventory modeling tools incorporating multiple periods of demand.
Performance metrics used at the strategic level should not only be cascaded to the tactical level to measure performance against targets for the given time period, but also be broken into component metrics for each function. For example, perfect order fulfillment, a strategic-level metric associated with reliability, can be cascaded into fill rate for logistics, forecast accuracy for planning, and schedule adherence for production.
At the operational level, key logistics capabilities, including order management, inventory visibility and inventory allocation, play an important role in the effective use of inventory. Assuming a simple, make-to-stock scenario, customer orders are received, inventory is allocated, and orders are fulfilled to arrive in full at the customer by the promised date.
However, in spite of diligent planning at the tactical level, inventory may still not be available at the right time, place, and quantity to achieve perfect order fulfillment. Having real-time visibility to inventory, whether in-transit or at stocking locations, helps to manage potential issues.
For example, knowing the position and estimated arrival time of an inventory replenishment shipment can enable expedited fulfillment of the customer order once inventory arrives. Alternatively, a replenishment order could be diverted while in transit from its original destination to a higher-priority location.
In the case of distributed order management (DOM), orders can be fulfilled from alternative stocking locations, which could include a different distribution center, a vendor, or even a retail store location, depending on the situation. A sophisticated technology, DOM leverages visibility across the extended supply chain network and business rules to determine how best to fulfill customer orders across multiple channels from multiple inventory sources.
Its embedded business rules consider inventory availability across stocking locations, fulfillment costs, and capacity constraints to make the appropriate fulfillment decisions. These business rules also help manage decisions regarding inventory allocation by customer segment, so the decisions are aligned with strategic priorities.
Ultimately, having real-time
visibility to inventory and the means to fulfill orders from multiple nodes in the extended supply chain can help to reduce safety stock requirements across the network.
Keep in mind
Effective inventory management is vital for a company to achieve its performance objectives, and there is an important role for logistics at each level of the framework described above.
Although inventory management can be a complex topic, there are a few key points to keep in mind:
Understand the strategic performance attributes for your company and how they influence your objectives, decisions, processes and metrics at each level.
At the strategic level, seek to understand and balance the trade-offs between inventory and logistics relative to your supply chain network and inventory deployment strategy.
At a tactical level, be part of the process to assess the feasibility of short- to medium-term plans that affect inventory and logistics.
Assess and communicate the impact of plans—or changes to plans—on logistics costs and utilize plans to secure transportation and
At the operational level, leverage technologies, including visibility and distributed order management, to increase flexibility and drive perfect orders in a cost-effective manner.
In this scenario, logistics professionals need to take an end-to-end supply chain perspective to help their companies achieve their inventory management and supply chain performance objectives.
Jim Morton is a senior manager with Ernst & Young, LLP; Rodrigo Cambiaghi is a principal with Ernst & Young, LLP; and Nicole Radcliffe, is a senior consultant with Ernst & Young, LLP.
The authors wish to acknowledge the contributions of Can Dogan, Claudio Menegusso, Alex Bajorinas, and Mark Johnson.