Your Guide to Inventory Optimization: What It Is and How to Utilize It to Gain Value for Your Business
With a rising Consumer Price Index, uncertain supply availability, and a laundry list of other macroeconomic concerns, cost control is taking center stage in board meetings across the world. One of the biggest talking points is supply chain, and, more specifically, inventory management. It affects pricing, stockout rates, and many other key concerns.
A vital component of inventory management is inventory optimization. This optimization focuses on performing well relative to your service-level agreement while driving revenue and decreasing costs.
If you're a leader with ownership over the business concerns and/or operational processes involved with supply chain, this guide is a good introduction to the role inventory optimization solutions have in a global enterprise and how Coupa can help. We'll talk about current concerns, best practices, and things to look for when you're choosing inventory optimization software.
Key Takeaways:
- An informed best-practice-based approach to optimization helps leading enterprises solve real-world inventory problems.
- Effective software puts inventory optimization in the context of supply chain network design.
- Optimizing inventory can make positive impacts across your organization, from finance to procurement.
Inventory optimization and global enterprises
Successfully optimizing your inventory involves balancing a few key factors. The essence of the problem is to eliminate stockouts: You want to have the right product available at the right place, right time and right price, while increasing your margins.
In a business-to-business context, this usually has to do with meeting your SLA numbers. However, it’s not possible to maintain an infinite inventory level to have 100% service levels. Ideally, you want to increase service level while reducing costs.
There are a few moving parts here:
- The service level percentage in your contracts
- Your inventory levels
- Inventory-related costs (taking inventory, for example)
Essentially, you're optimizing cost versus service. The multitude of factors involved here makes it difficult to model inventory accurately, though. That, in turn, makes optimizing inventory against demand a complex effort.
Three of the most important metrics for supply chain executives are all related to inventory/working capital, and have performed far worse than expectations. Here is the percentage of companies that fell short of performance targets for most important metrics:
- Days inventory on hand — 64%
- Days sales outstanding (DSO) — 50%
- Percent on-time, in-full (OTIF) — 33%
- Excess, obsolete, expired inventory — 64%
- Forecast error (bias) — 45%
Solve contemporary challenges with cutting-edge solutions
Businesses are facing several key supply chain problems today:
- Supply chain disruptions that cause inventory issues
- A lack of supply assurances that makes ordering patterns less predictable
- Lower inventory turn rates (more dormant and slow-moving inventory)
- Rising cost of carry for inventory
These types of challenges have always existed, but what we're seeing these days is a higher level of uncertainty and a more rapid rate of change than before.
Still, many organizations are thriving. How are they doing it? Let's take a look at the best practices companies are using to navigate today's supply chain environment.
Planning for disruptions
To deal with supply chain disruptions, a best practice is to develop a planning process to help deal with underperforming inventory. To be effective, these planning processes have to be supported by the right types of tools and technology.
One of our success stories involves a Fortune 500 retailer. They mitigated their risks and reduced inventory pressure on working capital by using a cutting-edge inventory planning tool.
Managing lack of supply
Supply assurance can be low these days, depending on your industry and the complexity of your supply line. Best practices include developing alternatives to your primary sourcing plans for key items, proactively revising lead times, and modifying stocking levels to address stockouts, production downtime, and uncertainty in transportation.
Food and beverage is a classic example of complex supply assurance. One major enterprise navigated this by developing new data-driven inventory category strategies for critical ingredients. They also set up alternate suppliers to manage risk.
Increasing inventory turn rate
Although the exact numbers vary widely across industries, a good inventory turn is a key indicator of an optimized inventory. To decrease slow-moving or dormant inventory, the best practice is to develop and track an inventory health metric that takes into account the contextual factors that make up the overall inventory performance.
A leading industrial parts manufacturer needed to drill down into the details to get an idea of their inventory health. They ended up segmenting their inventory to reveal excess, obsolete, and stagnant items. This increased working capital, reduced inventory costs, and raised their overall capacity.
Navigating rising costs
Contracts and capital assets across the supply chain are becoming more expensive. To navigate these challenges, many organizations are taking a closer look at service level. A common strategy is inventory segmentation:
- Class A: Critical items that cannot go out of stock and hence require very high service levels
- Class B: Non-commodity but non-critical items — relatively challenging to procure but not high in unique design content or custom-designed for the organization — requiring a high service level
- Class C: Commodity items that, for one reason or another, require a slightly higher service level
- Class D: Widely available commodity items, such as enzymes or fasteners, that do not require the same high level of service as the other categories
As an example, a major healthcare provider with seven hospitals and hundreds of physician practices was having procurement trouble due to fragmented ERP implementation. They brought all of their spend management to Coupa. They are now running 100% paperless for procurement, giving finance better insight into spending. Their new, improved approach to inventory and procurement also helps providers spend less time on orders and more time helping patients.
Contemporary inventory optimization software
People often include inventory optimization functions in the larger discussion of inventory management. However, there are key differences, and certain business goals are easier to reach when you use the right tools for the job.
Holistic spend tracking for better demand forecasts
The number-one pain point in many product-focused organizations centers on inaccurate forecasts. If you do not predict demand accurately, you risk:
- Stockouts
- Excess inventory
- Excessive transportation costs
- Rush fees
- Lost sales
Optimizing your inventory reduces all of these risks. However, it is difficult to do when factors such as shifting consumer attitudes, seasonal trends, and material availability all have the potential to disrupt your predictions.
Business spend management software helps organizations make better demand predictions by using holistic, up-to-date information about spend across the enterprise. To understand how, let's look first at the key metrics that these platforms track:
- Stock-keeping-unit allocation
- Inventory productivity
- Inventory positions
- Safety stock levels
- Service levels
This holistic approach puts a lot of data at your disposal when you are making strategic changes to your supply line. Those data points help you build accurate forecasting processes, which in turn will help you pursue strategic inventory optimization goals.
Organizing enterprise data for up-to-date, accurate inventory insight
Another major pain point for optimization efforts is a disorganized data center. This common issue results in various risks and inefficiencies:
- Junk data input resulting in useless demand projections and supply-chain models
- Double-entry and human error causing inaccuracies in inventory value
- Multiple errors increasing discrepancies between accounting and inventory
To dive deeper, let's look at some problems with the enterprise tech stack that can lead to disorganization. There are two main pitfalls here.
The first is an overdependence on enterprise resource planning platforms. ERP might already perform some of the functions you need, but you might over-depend on building customized solutions or find yourself wrangling disparate inputs.
On the other end of the spectrum, organizations often have a highly fragmented technical environment. There are simply too many data touchpoints with nothing to bring them together in a meaningful, actionable way.
If you depend too much on ERP, you risk losing functionality. If you fragment your analytics stack, you risk making things too complex to gain timely, actionable insight. Both of these issues impede your optimization efforts in various ways:
- Slowing user adoption and increasing learning time for optimization tools
- Increasing development time and cost (hard-coding optimization solutions and supporting interoperability)
- Increasing error and labor costs by tracking inventory manually (via spreadsheets, for example)
BSM provides a focused spend management tool that integrates with ERP. It also shares critical data across platforms, bringing it all together in one place through configurable, intuitive app-building capacity. This flexibility and power helps you organize your efforts, empowering you to achieve even the most challenging inventory optimization goals.
Explore inventory optimization solutions for your business
Strategic inventory optimization is about more than simply having the right products at the right price at the right time. It has the potential to accelerate cash-to-cash cycles, reduce tax spend, and lower your cost of goods sold. With automation, you'll also free up time and resources to focus on your core business objectives. Achieve your optimal inventory levels with data-driven insights — get a Coupa demo now.
