Exiting Chapter 11 just one process expedited by inventory optimization software

To Arturo Albanesi, inventory optimization software holds out a simple promise: better customer service levels, lower inventories—or both.

A Denver-based supply chain solutions engineer with electronics measurement equipment maker Agilent, Albanesi implemented Oracle's Inventory Optimization application nine months ago.

Choosing to go with an “inventory-neutral” finished-goods policy—holding inventory levels constant, in other words, to avoid the P&L hit that can come from abrupt reductions in inventory, but more precisely targeting those levels based on likely demand—Albanesi's division improved customer-service levels 12 percent in seven months.

Within the manufacturing supply chain responsible for the goods, adjustments to safety-stock levels suggested by the software significantly reduced reported material-availability issues, notes Albanesi. Once a number of recent supply chain changes—including major new product introductions and manufacturing plant relocations—have bedded down, he adds, other Agilent divisions will throw the switch, too.

Nor is Albanesi alone is his newfound enthusiasm. These days, the inventory optimization application market is seeing resurgence based on rising inventory costs and a new generation of software focused on intractable inventory problems.

One such is example is multi-echelon inventory management, which optimizes inventory held at various stages throughout the supply chain. This new software has better algorithms and mathematical approaches for treating operational realities that bedevil more simplistic assumptions found in general-purpose ERP suites without added inventory-optimization capabilities. Oftentimes, say inventory-optimization vendors, fluctuations in demand that less sophisticated systems ascribe to random demand volatility actually are caused by factors such as seasonality.

“A monthly demand for 50 units arriving as 50 orders for one unit versus one order for 50 units can have very different inventory-holding implications—but standard ERP systems don't typically go to this level of sophistication,” says Jeff Bodenstab, a company VP at ToolsGroup, which boasts more than 100 customers spanning 29 countries—surpassing any other dedicated inventory-optimization software vendor, it claims—including Colgate-Palmolive, Cadbury Schweppes, Georgia-Pacific, and Diageo.

Standard ERP systems without inventory optimization capabilities typically regard service levels and safety stocks as inputs defined by users. For inventory-optimization vendors such as ToolsGroup, they are outputs calculated by exhaustively analyzing demand data with advanced mathematical techniques. “For example, we don't just measure demand variability. We also calculate the percentage probability—using stochastic techniques—of incurring specified levels of demand,” says Bodenstab.

Inventory optimization solutions also take a more realistic approach to modeling costs associated with inventory holding. While GAINsystems' patented algorithms—developed in conjunction with Stanford University—also mine manufacturers' demand data for mathematically inspired insights, the company downplays their significance.

“We don't overemphasize the algorithms because we believe modeling the full costs of inventory management is more important,” says Will Benton, GAINsystems' executive VP of professional services and product development. For example, the GAINS solution not only takes into consideration missed-profit opportunity from lost sales incurred through inventory outages, but also the impact of manufacturing constraints that lead to larger-than-ideal batches that conserve capacity.

Expediting costs also are taken in to account, Benton adds, especially when manufacturers bring inventory from overseas production facilities, necessitating special measures such as air freight when stocks run low.

“If you're bringing in parts from China on an 85-percent service level, what's the true cost of the 15 percent requiring expediting—and what would happen to the total overall cost if service levels and inventories increased, thus lowering expediting costs,” asks Benton.

Indeed, most inventory-optimization vendors are focused on optimizing inventory levels within the supply chain, rather than just at a finished-goods or raw-material warehouse.

“While ERP solutions optimize inventories locally, we optimize across the supply chain, helping companies decide—for example—if they should deploy postponement strategies to stock product in a distribution center in, say China, or closer to the point of end-use in Europe or North America,” says Bob Ferrari, a company VP with Optiant. “As more and more manufacturers seek to become demand-driven, more sophisticated tools are needed to provide the answers.”

The answers can contain surprises, adds Nadeem Syed, Oracle VP of advanced planning products. Oracle's optimization capabilities also include a Strategic Network Optimization application in addition to the Inventory Optimization module deployed by Agilent.

“When manufacturers see how much additional inventory they need in place to hedge against the higher level of uncertainty involved in sourcing over greater distances, they realize that sourcing from Mexico can be cheaper than sourcing from China,” says Syed. “The direct cost may be higher, but the total landed cost—including the inventory implications—can be lower.”

While most inventory optimization vendors can cite impressive blue chips as customers, these examples generally comprise the enlightened exception rather than the general rule.

Inventory optimization, rues Sridhar Tayur—CEO and founder of SmartOps, which counts as customers blue chip manufacturers Caterpillar, GlaxoSmithKline, Hewlett-Packard, and Kellogg's—is a religion that's hard to get. “Until quite recently, inventory optimization wasn't a focus,” he says. “Inventory was an outcome of separate decisions made regarding forecasts, capacity planning, and sourcing—and inventory was what resulted.”

One executive who's definitely got the inventory optimization religion is Daniel Maheu, president and chief operating officer of Hamilton, Ohio-based Smart Papers Holdings. The organization found itself in Chapter 11 in early 2006, reportedly caused by a flawed acquisition. Shortly after signing on with GAINsystems, Smart Papers reduced inventory holding by 3,000 tons of paper—without affecting service levels—in the first two months of using the solution.

“If you're building inventory levels while you're in Chapter 11, the bank looks at you like you've got a third eye,” says Maheu. “We had very little money, and the GAINsystems software allowed us to make best use of every dollar we could get our hands on. I can't tell you how much help that was.”

These days, he adds, inventory turns on Smart Papers' faster-moving items “are in double digits”—thanks to inventory optimization.