Distribution

Inventory Optimization

What Is?

What is Inventory Planning?
Inventory planning is the process of determining the optimal quantity and timing of inventory for the purpose of aligning it with sales and production capacity. Inventory planning has a direct impact on a company’s cash flow and profit margins, especially for smaller businesses that rely upon a quick turnover of goods or materials.
The following sections discuss the reasons why it is necessary to plan and optimize inventory effectively, and the benefits that flow from it.

Why Optimize Inventory?
Reasons to optimize inventory are:
-Inventory costs a lot to acquire and is often in the top two assets on the Balance Sheet.
-Inventory costs a lot to keep. Typically, storage costs for inventory are 20% to 40% of its cost value. Inventory performance is often measured in stock turns (which will be dealt with in a later section). Low stock turns mean a poor return on investment.
-Inventory affects service levels, which are key to customer satisfaction.
-Supply chains don’t work without inventory.

Benefits of Inventory Planning
Inventory planning has the following benefits:

1. Improved forecast accuracy
An accurate forecast has a tremendous impact on the supply chain as a whole:
-Service levels increase
-Out of stocks decrease
-Logistics costs decrease
-Inventory levels decrease
-Obsolete stock decreases
-Direct distribution costs decrease
For these reasons, forecast accuracy is considered to be one of the key benefits of Inventory Planning as it also has a very positive effect on cash flow.

In SYSPRO, the additional benefit is that we can get lower safety stock levels.

Note: Safety stock and how you use it, are covered in a later section.

2. Reduced investment in inventory
Typical reductions are 20% – 30%, but this will vary with the circumstances.

3. Improved stock turns
Reducing inventory will in itself improve stock turns, but improving the dynamics of the supply chain can lead to dramatic improvement in stock turns.

4. Improved achieved service levels
Typical increases are 3% – 30%. There is an improved sales turnover resulting from better availability of fast moving items, as well as improved Return on Investment from reducing stock outs and over-stocks, and improving the dynamics of the supply chain.

5. Identification of supply chain waste
Inventory is considered a form of waste and also results from other forms of waste.

6. Value delivery is the focus
The tools in SYSPRO are designed to help identify where the greatest benefits can be obtained with the least effort.

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SYSPRO Solution

Inventory in the Supply Chain
Inventory often forms a major portion of the assets managed within a company. There are many reasons why inventory is held; some good and some bad. In order to manage inventory effectively, it is important that the reasons why it exists within a company, as well as the role that it plays within the supply chain, are understood.

A supply chain exists to bring goods to the customer in response to demand. Inventory occurs at different points in the supply chain and the parameters that govern the flow of inventory through the supply chain can make it work well or poorly. The fundamental reason for holding inventory is to balance supply and demand at different points in the supply chain, within the constraints operating at a particular point.

IO 6.png

The table below shows the inventory variables within the supply chain:

​Supply Demand
​Order frequency ​Target Service Level
​Lead Time ​Demand Forecast
​Order or Lot Size ​Actual Forecast
​Delivery Reliability ​Forecast Accuracy

Causes of Inventory
Inventory is necessary to provide a buffer between uncertainty in demand and uncertainty in supply. The first two items listed below are the prime cause of inventory, with the others having a secondary role:
• Uncertainty in demand: Demand does not occur according to our expectation (forecast). It can be greater or less than expected, or may not occur at the time expected. Uncertainty in demand can be quantified by the forecast error, or in situations where it is not possible to get a reasonable forecast, by the variation in demand.
• Uncertainty in supply: Supply can arrive late or early, or be incomplete. These different scenarios each have an impact on inventory. Uncertainty in supply can be quantified by the error in the expected lead time.
• Demand and supply quantities not equal: When the quantity that the customer required is different from the quantity supplied, then inventory is held to deal with the difference.
• Limitations on order frequency: A simple tactic to reduce inventory is to re-order more frequently (i.e. to have a smaller cycle stock). This may not be possible if the manufacturing batch size (or the minimum re-order quantity for a bought out item) is larger than the desired cycle stock.
• Higher service levels: To provide higher service levels, it is often necessary to hold more inventory. The relationship between the level of inventory and the resulting service level is not linear and it depends on the characteristics of the particular SKU-Loc (stock keeping unit in a location). For example, to double service levels may mean that safety stock has to be quadrupled.

Dynamics of a Supply Chain

Ideally, you would like to hold no inventory at all, as it represents waste (or is the result of other forms of waste). Not all stock codes need be held in inventory to service customer demand. If an item is made or procured to order, then no inventory of the finished product need be held. For a make-to-order item, it may be necessary to hold raw materials or components. Many finished goods do, however, need to be held in stock in order to properly service customer demand.

IO 7.png

When can zero inventory be achieved?
The ideal situation is to hold no inventory at all, and match demand and supply exactly. This can only be done if the following two situations exist:
• If the quantity made (or produced) is equal to the customer requirement
• If the lead time (make or procure) is less than the customer expected service time

 

The Wrong Reasons to Hold Inventory
The following are the wrong reasons to hold inventory:
• Long setup times
• Poor quality
• Large batches
• Breakdowns
• High plant utilization
• Excess handing
• Poor forecasting
• Poor stock accuracy
• Poor planning

​The Three Kinds of Inventory
You can think of inventory as having three parts, referred to here as the three ‘kinds’ of
inventory. The three ‘kinds’ therefore represent a conceptual way of seeing the total inventory
that is held for any one stock code in a location. How much, if any, of each of these three
kinds of inventory is held for an SKU-Loc is determined by the policy applied for that stock
code.

IO 8.png

Safety Stock

Safety (or buffer) stock is employed to offset variability in supply and demand. Safety stock lowers the risk of stock outs, but it comes at a cost. Determining the right amount of safety stock for a particular stock code in a particular location (a SKU-Loc) is often a trade-off between the level of service that is desired against the cost of obtaining and holding the stock. Safety stock can vary enormously as a percentage of the total inventory, depending upon how variable demand and supply are for that item, the service level that needs to be achieved, and the dynamics of the supply chain. Typically, safety stock represents between 40% and 80% of total inventory holding per stock code.

Where minimum and maximum levels are being used to manage stock holding, the safety stock is equal to the minimum. This is because the safety stock is what you expect to have in the warehouse at the time when a replenishment arrives.

​Cycle Stock

Cycle Stock is the amount of stock held to meet the demand within the planned order frequency. Hence if it is planned to order stock monthly, then the cycle stock would be equal to the expected demand for a month. Cycle stock may also be driven by economic batch quantities (EBQ) in a manufacturing environment or the minimum order quantity dictated by an outside supplier. In these cases, the resulting cycle stock may be much higher than ideal.

Where minimum and maximum levels are being used to manage stock holding, the maximum
stock is the sum of the safety stock and the cycle stock.

​Excess Stock

Excess stock is any stock that is above the safety stock and cycle stock requirement at any time. It is the result of poor forecasts, policy settings, or management. In order to evaluate whether or not a stock code has excess inventory in a particular location, you need to know the future demand for the SKU-Loc and the stock policy applied to it. Excess may be temporary and be present for only a short time, or it may be persistent and be present for many months. A simple way to evaluate excess is to calculate what the current stock holding represents of the expected future demand, compared to the target stock holding.

For example, you have a stock code expected future demand of 10 units a month that is replenished monthly. You wish to hold one month of safety stock so our, ideally, stock will vary between 1 and 2 months, an average of 1.5 months of stock. If you currently hold 120 units in stock, then this amount represents 12 months of future demand. The excess here is anything above our maximum requirement (2 months) – which in this case is 10 months. Often you will not just consider excess as being anything above the maximum, but perhaps as anything more than, say, 2 months above the maximum. With that view, the excess would then become 8 months of stock.

In many cases, the objective is to drive inventory between minimum and maximum, as illustrated with a seasonal product below:

IO 9.png

In concept, a stock level below the minimum is considered a shortage, even though it is not a stock-out. As discussed above, a stock level above the maximum is in excess, while a stock level between the minimum and the maximum is considered to be in balance. You would like to have stock levels that result in as many stock codes as possible being in balance for the whole of the sales cycle for the lowest possible investment in stock holding. The next section gives some simple steps to achieve this.

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Process Flow

Inventory planning and optimization do not operate in isolation. They form part of an overall business planning process that includes:

1. Understanding the business and its supply chain

2. Classifying stock codes

3. Forecasting

4. Setting stock policy and modeling policy effects

5. Running the Requirements Calculation

The sections that follow provide details on each of these steps.

​Step 1: Understand the Business and its Supply Chain
It is important to understand inventory in the context of the type and nature of the business in which it is employed. This may seem obvious, but unless you clearly understand where and how value is added in the business, it is difficult to optimize the inventory that is part of that value chain. Also, it may be useful to draw a diagram of the supply chain for the business with all the significant combinations of material flows. This supply chain should include points within the business, as well as points outside the business (suppliers and customers).

If the supply chain is sufficiently complex, a high-level network optimization design may be necessary to optimize the supply chain and determine whether any benefit can be gained from strategies such as risk pooling (the process of consolidating inventory at a location that can supply stock to selling locations on a short lead time in order to reduce the overall amount of safety stock necessary, and ensure a given service level). The Inventory Optimization (IO) solution in SYSPRO would then be applied to implement and manage such a design. The image below illustrates what is involved in gaining an understanding of the business and its supply chain:

IO 1.png

SYSPRO Modules:
• SPM = SYSPRO Process Modeling
• IF = Inventory Forecasting

The outcomes of this step may include:
• A representation of the structure of the business
• The value chain or chains within the business
• A graphical representation of the supply chain with material flows
• A high level analysis of the number, type, and value held of stock codes at each location in the internal supply chain
• An assessment of the planning maturity of the business to see if it has sufficient experience and capability, as well as data of appropriate quantity, to implement an Inventory Optimization solution effectively.

Step 2: Classify Stock Codes
Stock code classification is the process whereby every SKU-Loc (every stock code in each stocking location) is categorized according to its nature, importance and behaviour in the business. This is an essential process which needs to be re-visited periodically (as demand changes all the time through the life cycle of a stock code as well as due to changes in technology and varying competitive environments) to ensure that stock codes are managed to the best overall benefit of the business. The Pareto Analysis program in the Inventory Forecasting module in SYSPRO is an excellent tool to assist in this process.

The image below depicts what is involved in categorizing stock codes:

IO 2.png

SYSPRO Modules
• IF = Inventory Forecasting
• F&G = Families & Groupings
• IO=Inventory Optimization

The outcomes of this step are:
• A stock code classification decision tree that identifies all the decisions necessary to fully classify all SKU-Locs. This would include decisions such as:
• Is the SKU-Loc made to order or stocked?
• Is it a raw material, finished good, or component?
• Will it be managed by a forecast and a policy, or by policy only?
• All stock codes classified by location according to the decision tree
• Data selection sets set up in SYSPRO to manage the stock codes with the Inventory Planning module

Step 3: Forecast
Create a Forecast for all SKU-Locs identified as forecast items. Forecasts are created periodically to help in determining the best estimate of future demand for each SKU-Loc. Typically, forecasts are created monthly, but in some businesses, it may be necessary to create at some other time frequency, say weekly or quarterly. The SYSPRO Inventory Planning module incorporates calendars to assist in setting up the appropriate time bucket for the forecast.

The image below illustrates what forecasting involves:

IO 3.png

SYSPRO Modules
• IF = Inventory Forecasting
• F&G = Families & Groupings

Typical outcomes of this step are:
• A draft forecast that is discussed with all people within the business on which the forecast has an impact (e.g. sales & marketing, production, procurement, finance etc.)
• A modified draft forecast that is acceptable to all people within the business on which the forecast has an impact
• An approved modified draft forecast for use in requirements planning

Step 4: Set Stock Policy and Model Policy Effects
In this step, you do the following:
• Set stock policy to provide the target stock holding for each SKU-Loc. Stock policy determines how much stock will be held for each SKU-Loc, if any. SYSPRO allows policy to be set in two ways:
• Fixed, either in quantity or the number of days of cover of future demand (forecast)
• Risk based, where the amount of stock is a function of what service level is desired to meet future demand (the target service level). For this method of setting policy, SYSPRO provides three approaches, namely:
• Poisson distribution based on the forecast quantity
• Poisson distribution based on the forecast hits
• Normal distribution based on forecast quantity
Note: A Poisson distribution is intended for erratic or intermittent demand items, while a normal distribution is better for items with more regular demand patterns.

• Model the effects of each policy to see that acceptable outcomes are achieved in the balance between service level and investment in inventory.
• Calculate draft stock levels which can then be reviewed before approval
• Approve draft stock levels to requirements planning to be used in the calculation of replenishment. This replenishment could be a job (for made-in stock codes), a purchase order (for bought-out stock codes) or a supply chain transfer (for transfer supplied items, typically between different warehouses in the same company).

The image below depicts what is involved in setting stock policies and modeling the effects
of each policy:

IO 4.png

SYSPRO Modules
• IO=Inventory Optimization

Typical outcomes of this step are:
• A time-phased minimum/maximum level and target stock holding for each SKU-Loc.
• An acceptable policy setting
• Draft stock levels that are discussed with all people within the business on which the stock level has an impact (e.g. sales & marketing, production, procurement, finance etc.)
• Modified draft stock levels that are acceptable to all people within the business on which the stock levels have an impact
• Approved modified draft stock levels for use in requirements planning

Step 5: Run the Requirements Calculation
Calculate material requirements by running the Requirements Calculation to determine what replenishment is necessary and when to meet the stock holding plan.

The image below illustrates what is involved in calculating the material requirements:

IO 5.png

The typical outcome of this step is suggested replenishment (i.e. when to order what) for each SKU-Loc. This suggested replenishment may be a job, a purchase order, or a supply chain transfer (SCT). If the first three steps are carried out carefully, MRP has all the correct parameters (lead time, batching rule, supply chain setup etc.), and data is accurate (stock on hand, on order, on back order etc.), then the suggestions made by the Requirements Calculation should not need revision.

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Integration

​The inventory planning process is fully integrated within SYSPRO within the following modules:

​Inventory: The Initial History Creation program builds forecasting sales history using Inventory Movements as its source.

​Sales Orders: Once the Initial History Creation program has been run, sales forecasting data is kept current automatically by SYSPRO. As sales orders are written to the Inventory Movements table, the forecast history is simultaneously updated. Currently, only sales transactions (not issues) are extracted from the Inventory Movement table into the Forecasting Sales History tables.

If insufficient history exists in Inventory Movements, additional history can be imported using the IOPSSL – IO Forecasting Sales History Setup business object. After an initial take on of sales history movements, SYSPRO will maintain the sales figures automatically.

​Inventory Forecasting: This module allows the creation of a forecast at the SKU-Loc level. In order to optimize inventory, it is usually necessary to have the best possible view of future demand for a stock code. If the stock code is a finished good, then, if appropriate, this stock code is forecast. This is independent demand. If the stock code is a raw material or a component, then its demand can be calculated through a bill of materials from the demand of its parent item or items.

​Families and Groupings: This module allows forecasts to be produced at collection level. Forecast products in the Inventory Forecasting module can be used and reviewed in Families and Groupings and vice versa.

​Requirements Planning: The approved forecast from Inventory Forecasting becomes the current forecast in Requirements Planning.

Note: Any changes made to the forecast within Requirements Planning does not change the forecast within the Inventory Forecasting solution. Changes should rather be made in Inventory Forecasting and then written to Requirements Planning through the approval process. The stock levels defined by any stock policies can
be applied through requirements planning to keep stock levels within the desired range.

The integration discussed above is illustrated in the diagram below:

IO Integration.png

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