Inventory management involves balancing the tradeoff of stock-outs – a Voice of the Customer performance measure versus inventory control – a Voice of the Business cost-control performance measure. Inventory optimization is one of the most controllable and important aspects of supply chain management.
Inventory Optimization uses a computer math modeling and inventory optimization software that allows for the swift evaluation of trillions of choices for inventory levels. these findings help determine the most profitable inventory level for every item (known as a stock keeping unit – SKU) that you stock and sell. Inventory Optimization includes proven inventory management techniques and mathematical optimization algorithms to maximize your profit-return-on-inventory-investment for real-time results. These methods build on the popular ABC inventory control method, and use the latest mathematical and computer technology to achieve optimal results.
Steps to Optimize Inventory
Demand Forecasting
Any company that carries inventory is forecasting, whether they think so or not. Many companies claim that they don’t forecast, but if you are stocking raw materials, work-in-process or finished goods in anticipation of fulfilling demand, you are forecasting. At Supply Velocity, we run multiple, proven forecast algorithms to determine if each SKU is trending up or down, and/or if there is a seasonality factor. These algorithms are optimized to maximize forecast accuracy.
ABC Inventory Classification, Safety Stock and Service Levels
ABC Analysis or SKU Classification is an important first step in inventory planning. To differentiate SKUs, and the customer service level (or expected fill rate) applied to safety stocks, we utilize multi-criteria inventory classification (MCIC). This model, plus inventory classification, allows the organization to determine what criteria defines a high performing SKU for their business. Often, we see organizations choose either profit, sales, or volume, but these criteria may not provide a holistic picture. Using multiple criteria specific to your organization, the MCIC model determines high and low performing SKUs for your business. The lowest performing SKUs will not be stocked and will only be produced or replenished on-demand. The remaining SKUs will be stocked based on their ABC Classification with greater service levels and safety stock for A SKUs and less for C or D SKUs.
Demand Forecasting is an important component of inventory optimization because it “looks” forward to anticipated customer demand and eventual customer satisfaction. Another aspect is safety stock, which protects against stock outs due to variation. Safety stock looks backward at how well the forecasting algorithms were able to anticipate demand. Highly accurate forecasts need very little safety stock while SKUs with high forecast error need more safety stock. Supply Velocity’s inventory optimization solutions use forecast error, the item lead time, SKU classification, and service level goals to set each SKU’s optimal inventory level. Our method and model maximizes the overall profit-return-on-inventory-investment.
Inventory Holding Cost
An important input to the inventory optimization algorithm is inventory holding cost. This is different for every company and is based on three criteria which influence cas flow and company profits:
- The cost of borrowing, or cost of money. Since the year 2000, this has been very low, with most companies being able to borrow at 5% or less. However, since the pandemic and associated inflation pressure, borrowing costs have gone up and are likely to stay elevated.
- Obsolescence – often caused by holding excess inventory. For example, food companies such as cheese producers and the perishable food supply chain, this cost is very high because of the product lifecycle. For hard-goods companies such as machine-tools and OEM supply chains, this cost is very low because their parts only slowly go “out of date” or deteriorate.
- Storage. If your products are very small and don’t require temperature control, this cost is very low. Our team of consultants at Supply Velocity have calculated the inventory carrying costs in supply chains can vary between 10% and 45% of revenue.
Target Service Levels
The next step in inventory optimization is determining your target service levels. This will allow you to choose the tradeoff between inventory costs (impacting working capital) and your inventory targets or service levels. The higher you set your service levels the more inventory you will hold, and more demand you can fulfill from stock. However, your inventory costs will increase. Another consideration is the cost of a stock-out. In hospital supply chains, the cost of a stock-out may be critical, including the loss of life. Service levels and safety stock levels in these supply chains are very high. In retail supply chains, the cost is possibly the loss of that sale or maybe the loss of the customer forever. Exploring supply chain strategies, stock out costs, and creating an efficient inventory, will inform how your company establishes safety stock service levels.
Reorder Points, Reorder Quantities, and your ERP System
The final step in inventory optimization or inventory management is connecting the demand forecast with your SKU classification, lead time, and target service levels. These results will determine your SKU level inventory targets. In your ERP system, this can be managed through MIN / MAX levels, Reorder Point / Reorder Quantity, or Safety Stock and an order-up-to policy using MRP. Min/Max or ROP/ROQ work best for distributors that sell to end-users. Safety stock and MRP work best for manufacturers that sell to other manufacturers or distributors.
Monthly Updating of Inventory Levels
To support your supply chain and ensure robust inventory management, the forecasting process and calculations of reorder points and order quantities, should be updated monthly. This will ensure your inventory strategy is based on the most up to date customer demand and that your inventory levels support your supply chain strategy. Inventory optimization also supports a supply chain planning process. To keep your supply chain operating efficiently, it is important to have the right inventory and also to achieve high inventory turns.
Your replenishment team will trust their inventory levels and can promptly react to changes in the supply chain such as shortages, variability, and overstock.
Our founder, Mitch Millstein, Ph.D., is a widely recognized researcher and teacher in the area of Supply Chain Optimization, Supply Chain Analysis, and Supply Chain Decisions. His research includes e-commerce and omnichannel supply chains, supply chain network design, supply chain performance measurement, inventory management, and inventory optimization.
Multi-Echelon Inventory Optimization (MEIO)
Best in class inventory management includes optimizing inventory across all echelons of the supply chain. This includes working with suppliers to optimize their WIP and finished goods inventory that you purchase, your purchased materials and components, WIP and finished goods, and those carried by your distributors and customers. If the entire supply chain uses multi-echelon inventory optimization everyone wins, including the ultimate customer of the supply chain.
Taking Emotion out of Inventory Decisions
We often find that inventory decisions become very personal within companies. Planners, Buyers, and Analysts think they have special insight that is required to decide when to buy or produce more, and how much to buy or produce. Consequently, we often see companies with people making inventory decisions for thousands of items. People in the business often have special insights, but this is only needed for a very small subset of items. We believe the inventory optimization / inventory planning modeling and automation should set target inventory levels and decide how much to buy or produce for the majority of your inventory items. However, new items, or products that are difficult to forecast due to intermittent demand, can be moved to an Analysts or Planner’s queue for manual evaluation. This takes advantage of the speed of computer modeling with the intelligence of people working in the business.
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“I am thrilled to provide this testimonial for Supply Velocity and their outstanding work in implementing Lean Warehouses and processes at Crescent Parts & Equipment through the COVID pandemic. With their data-first focus and Mitch’s exceptional coaching and experience, they transformed our business into a more supply chain-oriented organization, enabling us to grow while prioritizing employee safety and creating a better work environment. Supply Velocity’s expertise in Lean methodologies and their comprehensive evaluation of our customers have been instrumental in optimizing our operations and increasing customer satisfaction. We highly recommend Supply Velocity to any company seeking to implement Lean processes and enhance their supply chain efficiency.”
“Supply Velocity created visibility within our Assurance Services Group… visibility of performance, Client-service, employee satisfaction and processing time. Using the Supply Velocity System, Audit Report Cycle time is down over 50%. We are using his strategies to create greater Client loyalty.”
“Supply Velocity is driving instrumental change in our inventory management processes. This is critical for us to be competitive in a supply chain environment with numerous disruptions. They are making change happen, which can be challenging in a 182 year old organization.”
“We used Supply Velocity on our Warehouse optimization project. One of the key characteristics of Supply Velocity is that they listened to our requirements and provided a clear path for our Warehouse processes using lean tools and our future sales growth as objectives.”
“Myerson engaged Supply Velocity, specifically Ray Davis to visit our plant in Trinidad to conduct a two day assessment of our production procedures and provide us feedback on areas for improvement and where applicable, areas for future analysis.Put simply, we got everything we paid for and in addition to more in depth analysis, we got specific tasks that were immediately actionable. Our local management team found Ray to be engaging, highly credible and insightful based on his wide experience. In other words the cultural differences and lack of specific industry knowledge weren’t impediments to things we could implement immediately and on our own. In a nutshell it was money well spent and will pay itself back many times over.”
“Our experience with Supply Velocity was one of the best values we have ever had from a consulting project. Cyril Narishkin brought a structured lean methodology, invaluable experience and engaging facilitation skills to help us streamline a very complex and disjointed sales order process. Just as importantly, our team now has the knowledge and process competencies to address other business improvement opportunities going forward.”
“The role of the Erie Insurance Marketing Department has been evolving over the past several years – from a support role to a more critical role of driving growth in our organization. Because of our increased workload and desire to prioritize the most critical projects, we hired Supply Velocity to teach us the skills of Lean Six Sigma.Participants included the Promotions, Market Research and Agency Licensing sections of the Marketing Department.
We learned valuable tools to help us to prioritize based on the voice of the customer.
I firmly believe these skills made a difference in how we work every day. We are moving new projects forward, eliminating or changing ineffective processes, and we are a much stronger department. We continue to use the tools to help us with our highly-complex and time-consuming projects. Supply Velocity helped us to accomplish our goals.”
“Your process encourages this group to work together, better communicate and have fun doing it.”
“We are using Supply Velocity’s Lean Six Sigma methods to analyze a variety of processes including rationalizing SKUs (stock-keeping-units). By using math to evaluate SKUs we took some of the emotion out of our decisions. We expect significant increases in sales and productivity from reducing poor performing SKUs.”
“We are pleased that Essex selected Supply Velocity, Inc. as our Lean Implementation Partner. At one facility, we have saved over $350,000 in work-in-process inventory, reduced throughput time from 2 weeks to minutes and increased inventory turns 3 to 8 times per year. All these results are in just 6 months. Our return of investment is very high.”
“In 2015 we began working with Dr. Mitch Millstein to optimize our inventory locations supporting e-commerce and in-store inventory needs. From this work we developed a new omni-channel warehousing and inventory plan that entirely redefined our approach to warehousing, inventory management, store distribution and fulfillment. As a result of the analyses by Dr. Millstein we have begun the move to an improved omni-channel design by reassigning MSAs to new warehouses, greater leveraging of in-store inventories to satisfy e-commerce demands, and exploring acquisitions of new warehousing space in strategic locations. We have already seen an improvement of $300,000 from both more efficient shipping strategies due to better inventory management.”
“For several years we have worked with Supply Velocity to support us with their expertise on Lean Operations and Supply Chain Management. Supply Velocity has helped us implement Lean, improve our inventory systems, and educate our people. They are professionals who are always available to help us as needed.”
“In thirty years of hiring consultants, Supply Velocity, Inc. was the first to tell me what they were going to do, set a price they stuck to and substantially exceed my expectations. I have recommended them to friends and acquaintances. They were true partners in assisting with the turnaround of an acquisition we had been struggling with for two years.Their math-based technology, solid down-to-earth facilitation skills, and positive, patient and enthusiastic attitude combined to make our implementation of Lean a very rewarding experience.
We increased our production by 50% in the first month of implementation and continue to see improvements. Improvements have not only been realized in productivity, but also in quality and morale. We have increased profitability by $2M on flat sales of $10M.
Based on Supply Velocity, Inc.’s integrity and our results, I will continue to refer them to others and utilize them in the future as we expand our company through acquisitions.”
“Supply Velocity has helped Clean succeed in a number of ways. First, they provided the education that kicked off our Lean Process Improvement journey. They also facilitated a number of large supply chain and process improvement projects including: 1) building quality into our direct-labor productivity incentive program, 2) designing the layout of our garment warehouse, and 3) streamlining our route service process.We have integrated the methods that Supply Velocity taught us into our management and strategic planning. In the process our quality measurement has improved 22% from 2013 to 2015, we have reduced required annual labor by 2200 hours from the garment facility layout project and we’ve seen 50% decrease in error rate. Obviously the numbers speak for themselves, but just as important, Supply Velocity has been fun to work and have become true partners. They have “taught us how to fish” so our internal teams are able to implement change on their own, with the skills we learned from Supply Velocity. This relationship has been invaluable.”
“Anheuser-Busch Precision Printing had been implementing Lean Operations on our own for the past two years. We needed to move faster and partnered with Supply Velocity, Inc. Through Supply Velocity, Inc.’s mathematical workflow balancing and visual management tools, dramatic improvements were achieved. The entire converting operation was rearranged based on Lean principles. The result is a 20.6% productivity improvement, enabling us to operate with 23 fewer people in production.”
“Supply Velocity has provided the technical expertise and political capital to move our project forward. They have just the right amount of push and the right amount of support. Supply Velocity has helped us make real changes to improve efficiencies in logistics without jeopardizing our performance. We’re happy and our customers are happy.”
“Closure Medical recently completed a major reorganization in order to enhance our ability to rapidly create innovative medical devices. We hired Supply Velocity to help us map out the process and service flows of the new organization that would maximize our product development process (PDP). In four weeks, Supply Velocity helped us envision a new PDP structure, develop measures and accountability for each step, and gain consensus within the organization. Supply Velocity’s focus on speed and accountability helped us complete a critical project in a timely fashion.”
“Supply Velocity’s Lean Six Sigma System has given us new tools to help improve our sales performance. We have learned new ways to analyze our business which makes problem solving more accurate and has made us better leaders.”
“Many thanks to all three Supply Velocity presenters. I think you guys took a very difficult time for learning and capitalized on everyone’s time and training needs. I truly hope this helps your business as this was a considerable undertaking on the part of Supply Velocity. Outstanding!!”
“Mitch Millstein and his team helped guide our shop fabrication division in the re-layout of our custom pipe and steel fabrication facility when we moved into a new building. It is not only the results but how he helped. We were involved in every step. I personally did time studies and was able to see the non-value added steps required to manufacture in our old layout. When we created our new layout, everyone was involved, from the executive team to our direct labor force. With Mitch’s help we increased our throughput by a 3x multiple, while providing more competitive prices to our clients as a result of the efficiency improvements.This has enabled us to not only make more money but also to expand our commercial reach and serve more, and larger customers. I would recommend Supply Velocity to any company that wants to make improvement in supply chain and operations.”
“We used Supply Velocity to rethink our sales process. By analyzing the entire process we found wasted time in our Sales, Admin and Operations departments. Streamlining this process created extra time for each Sales Rep, allowing them to spend more time with Customers and increase the value we add. Gross profit margins are up 40%!We are now using Supply Velocity to help us rethink our entire Strategic Plan.”
“Supply Velocity gave us the tools to analyze our business and processes based on the facts and numbers versus our perceptions. Our common quote was “Let the numbers lead us”. The key for our organization was how quickly we moved from classroom to actual project initiation. We were able to jump in, start using the tools and see a difference right away.
The get-into-action approach was good for our culture.”
“We engaged with Supply Velocity to help us embed process improvement at all levels of the business. Our team learned from Mitch to let the data drive decisions, to use Lean tools to help us see our processes critically and objectively, and to create a control plan to manage all of the tasks that were the outcome of the data study.The project turned out to be very significant to the company and most importantly, our customers. We reduced our customer wait times by 40%, and cut in half the labor cost to fulfill customer orders.
Some results are not able to be measured. However, as a result of this project, we have started to build a Lean mindset and culture, which is part of our strategic mission to save our customers money. Supply Velocity has been a valued partner in this mission.”
“Isolating a problem, finding short, and long term solutions with measurable results is what was promised and results is what was delivered by Supply Velocity. Upon launch of the Lean Six Sigma Selling System, we knew more about our customers, our products, and were able to create a solid plan to increase sales of our most profitable products. Within months of implementation, our booked sales jumped 60% and our most valued customers were getting direct, active, and calculable attention.”
“In a time of volatile supply chain disruption, Supply Velocity is helping us develop Demand and Supply Planning processes to proactively tackle these new challenges. They are genuine partners, working with our team, facilitating and teaching.”
“C&R was struggling with labor productivity. The construction crews were often missing materials that they needed to do their work. This caused significant idle time. Supply Velocity, Inc. and C&R used value stream mapping and visual management tools to make dramatic improvements in operations. Most importantly, two years later C&R is sustaining and improving on the implementation. C&R’s return on investment was 11:1. C&R had a record year last year in both sales and profits and would not have been able to pull it off without the changes Supply Velocity, Inc. helped us make.”
“In the spring of 2003, the St. Louis Area Chapter of the American Red Cross engaged Supply Velocity, Inc. to perform a study and make recommendations to streamline office processes, maximize cash flow in purchasing and warehousing and restructure and enhance our maintenance department. Supply Velocity, Inc.’s process was methodical, flexible, staff-oriented, inclusive and, above all, trackable.In the last six months, our Chapter has realized expense savings of over $380,000 annually, and significant improvement in intra-company service levels has been attained. Supply Velocity, Inc. will return to the Chapter periodically throughout the next 18 months to audit our newly implemented processes. We have been pleased with our results and Supply Velocity, Inc.’s professionalism.”