5 Steps to Tackle the Excess Inventory Challenges
In the recent months, several leading retailers reported mounting inventory challenges. This current inventory issue is due to three major factors:
- Seasonal merchandise arriving late
- Retailers’ forward buying of merchandise in a move toward Just-in-Case inventories
- Slowdown in consumer demand due to the inflationary environment
While late arrivals of seasonal merchandise may be specific to retail, the problems of mounting ‘just-in-case inventories’ and slowing customer demand are impacting several other industries as well.
Inventory challenges cross industries and geographies
The semiconductor industry, which is evolving from a cyclical industry to a secular industry, is entering a downcycle. A number of companies are warning of a slowdown in demand, citing reductions in both corporate and consumer spend. The inventory impact is no longer a U.S.-only issue, but is turning into a more widespread global concern and is impacting several industries and geographies as well. As an example, inventory build-up has been observed in China as well, due to its closure of various regions and ports due to zero-covid policy. Even Europe is witnessing excess inventory as demand slows.
The limits of the traditional MEIO approach
Given this backdrop, organizations need to right-size inventories. In order to do this, they often resort to Multi Echelon Inventory Optimization (MEIO) as an approach. While MEIO is an important step in setting the right inventory policies and stocking levels, it is limited. Without a comprehensive review of the upstream and downstream policies that impact inventory (such as sourcing policies, manufacturing policies, and replenishment policies) and the dynamic nature of our networks, one will end up with myopic actions that don’t deliver sustainable value.
5 steps to right-size inventory
Here are the steps organizations need to take in rightsizing their inventories, which can free up precious resources like working capital, warehouse storage space, and the labor required to manage inventory, while potentially improving service.
1. Sense and respond to market shifts
With rapid shifts in economic conditions, organizations need to bring in external data around consumer price indices, interest rates, GDP trends and other macroeconomic indicators to make demand projections with appropriate sensitivity analysis. One needs to understand the correlation between changes in macro environmental factors and how their customer demand reacts to these factors.
While no one has the perfect crystal ball in an environment where visibility remains patchy at best, organizations can benefit from modeling a variety of demand scenarios to understand how well their inventory plans will perform in changing environments.
2. Segment SKUs and set service objectives
Studying and understanding SKU behaviors at a product-location-channel level helps one to segment the portfolio and set service objectives in a more surgical manner. For example, high volume, low variability SKUs can be algorithmically optimized to the right levels to achieve reliably high service levels. In contrast, ultra slow movers can be targeted to be managed through simple rules of thumb at lower levels of service. Or, they can even be made-to-order with sufficient lead time factored in. Such simple segmentation in itself can provide insights into setting the right service strategies.
Beyond this, optimization technologies allow for working capital to be considered as a constraint, to establish the right service levels, and to test sensitivity around levels of service for increased inventory investments. If the CFO wants to increase or decrease inventory investment by a certain amount, the technology will identify the cost implications of the change and the projected service level that can be achieved. This type of sensitivity analysis helps leaders assess the right changes to inventory levels at the right times.
3. Review and tune supply chain policies that directly impact inventories
During a recent conversation I had with a battery manufacturing executive, she mentioned that procurement was obtaining raw materials in bulk due to volume discounts, while manufacturing was running out of space with inventory buildups. Misaligned objectives, wherein procurement was measured on unit costs while manufacturing is tuned to align to downstream demand, caused the discrepancy. An escalation to the senior leadership called for a review of the purchasing practices and necessary adjustments were made to relieve the pressure on manufacturing. Ensuring one understands policies that have upstream or downstream implications is critical to managing inventories to the right levels.
Similar to this, even manufacturing policies focused on overall equipment efficiency can give rise to downstream inventory risks. As an example, if the manufacturing function is measured to an Overall Equipment Efficiency of 85%, this can lead to fewer changeovers, building excesses in some categories and shortages in others. Yet another example is replenishment frequency. If one uses a three-day replenishment cycle to a downstream customer location vs a five-day replenishment cycle, that will have a bearing on the levels of inventory. These are all examples of policies that have implications on inventory levels.
4. Review inventory policies in tandem with the network design that has the latest market data
In a world full of disruptions, supply paths are constantly getting disrupted. The port to which products are imported may be congested, in which case, alternate flowpaths and distribution centers need to be factored in. As the flow paths change, so should the inventory policies and stocking locations.
Also, as one performs inventory carrying cost trade-offs with others, such as transportation costs, understanding the latest market rates and lead times will be very important. Variability in demand and supply, and in associated lead times, are also important inputs towards setting inventory policy. Form and function of inventory is a very important consideration. Any such inventory recommendations should include not just safety stock but also cycle stock.
Network design can no longer be an episodic, project based activity but will need to be continually refined, along with inventory policies that support the network design. In an ever changing world, one cannot ignore the symbiotic relation between the two.
5. Stress test inventory policies
Use scenario planning and discrete event simulations to subject the inventory policies set per the above practices to stress tests. While scenario planning helps establish a range of possibilities and a playbook on how one manages inventories, discrete event simulation helps organizations test the robustness and stability of inventory recommendations. Optimizing inventory targets without subjecting them to stress tests can leave organizations exposed in a world full of disruptions.
By embracing the above recommendations, organizations can be better prepared to manage their inventories effectively.
Right-size inventory for a competitive advantage
Beyond these steps, at a more tactical and operational level, demand shaping practices such as dynamic pricing, promotions management, and markdowns can help organizations tackle the inventory challenges head on. Rightsizing inventories is not just a cost management play. By embracing the appropriate inventory strategies, organizations will benefit from ensuring business continuity and gaining market share over competitors when the next disruption strikes!
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