A few years ago I received a phone call from one of the world’s most advanced supply chain CPG firms. They wanted our assistance with inventory optimization. I was quite surprised by the purpose of the call because the firm is widely known for its excellence in inventory management. I expressed my surprise and curiosity and asked them why they reached out to us. They shared that in their research of inventory models the RightStock™ model was one of the very few that incorporated buckets of inventory as their model did and they wanted to benchmark and utilize our model. I asked them what them meant by buckets of inventory. They explained that they allocate inventory into three buckets – safety stock inventory (SSI), lot size inventory (LSI), and pipeline inventory (PI); and that they wanted to see if the RightStock™ model would suggest the same inventory allocations into those three buckets that their model did. I was encouraged by the call because nearly all of our clients lump all inventory into one bucket, yet all inventory is not the same; it is not all their for the same reason. Safety stock inventory (SSI) exists because demand is not perfectly predictable and supplier performance is not perfectly reliable. Lot size inventory (LSI) exists because there are economies of scale and discounts related to manufacturing run quantities and purchase order quantities. Pipeline inventory (PI) refers to inventory that is fiscally on the books but is not physically available for sell.
To the extent we can allocate inventory into those buckets we can develop cause and effect models for those types of inventory. For example, we can optimize safety stock inventory by trading off the cost of forecast accuracy and supplier reliability improvements with the costs of implementing the same. We can optimize lot size inventories by trading off reductions in manufacturing setup times and ordering costs with the investments required to do so. We can optimize pipeline inventory by considering the tradeoffs in inventory investments and carrying cost with costs of leadtime reductions.
An example comparison of current safety stock, lot size, and pipeline inventories with RightStock™ optimal values for a large industrial supplies client is illustrated in the figure. Note that for nearly every SKU the safety stock levels are too high, most likely indicating a bias in the forecasting process.
Safety Stock Optimization for a Large Aerospace Company. RS = RightStock™, SSI = Safety Stock Inventory
Lot size inventories can be optimized by trading off reductions in manufacturing setup times and ordering costs with the investments required to do so. An example lot size optimization for a large bottler is illustrated below. Note that their lot sizes are consistently too small. The small lot sizes reflect their overly aggressive move into lean manufacturing and their SKU proliferation which cut sharply into manufacturing capacity. Contracting the SKU base and increasing lot sizes yielded a 15% reduction in total supply chain cost, adding over $29,000,000 per year to their bottom line.