One of the major problems that warehouse managers face is achieving a balance between service level goals and cost. While a business’s sales department will demand a high level of finished goods inventory to better serve customers, its supply chain team would want to have high levels of raw material inventory to better respond to uncertainties in supply. Given that more raw materials and finished goods would mean high inventory carrying costs, the finance department will demand low inventory levels. To cater to these conflicting demands, inventory managers adopt inventory optimization practices.
What is inventory optimization?
Inventory management focuses on helping businesses reduce their inventory without having a negative impact on service levels. Simply put, inventory optimization stresses on helping reduce inventory carrying costs while avoiding stock-outs.
There are two different types of modeling tools for inventory optimization: deterministic and stochastic. In the deterministic model each variable set is defined, whereas in the stochastic model the variables are defined by probability distributions.
Since it is designed to account for supply chain uncertainties and demand volatility, the stochastic model is considered to be more accurate than the deterministic model. The stochastic model uses computers to calculate input variables within a set timeframe.
Components of IO
Inventory optimization is an involved task. When working on an action plan to optimize the business’s inventory, its inventory management team has to tread cautiously. To help avoid ambiguities and confusions, many experts recommend dividing IO into three steps.
Assess the business
The first step involves understanding the business’s order to delivery process. The team must collect information related to inventory, order processing, and consumer trends. People and teams responsible for performing different tasks related to inventory management must be identified. Inventory maximization goals must be defined. The team working to optimize inventory should forecast demand and determine service level target and the inventory timeline.
Come up with an inventory plan
The next step involves coming up with operational definitions. In this step, inventory must be divided into three categories: raw materials, goods in process, and finished goods. The inventory optimization team must calculate minimum and safety stock. When setting inventory goals, the team must take into account the insights revealed and information provided by data.
The inventory optimization team must define key result areas and establish key metrics and standards to measure inventory performance. The team should work towards having a system that facilitates inventory comparisons between different periods in place. Conducting these comparisons helps a business identify factors that contribute to inventory optimization.
Benefits of IO
- Helps reduce inventory carrying costs
- Can help reduce inventory levels by up to 25 percent
- Several companies that have optimized their inventory report a discounted cash flow above 50 percent in a couple of years.
- Helps increase profit
- Helps address demand volatility and supply variability.
- Helps improve delivery reliability and customer satisfaction.
Best practices for inventory optimization
Wondering how to optimize inventory? To help you get your priorities right, we have compiled a list of inventory optimization tips. Take a look.
1. Opt for an omni-channel software
Use an omni-channel software that provides an accurate overview of inventory at different stages. Look for software that can process large volumes of data related to critical activities such as forecasting, and safety stock replenishment. The software must promote seamless communication across different channels and teams. The tool must help your managers model what-if scenarios and predict the impact of alternative solutions.
2. Develop exception rules
If you have high-value items, consider developing exception rules sacrosanct. The holding cost of such things is usually higher than other products. To keep a tab on inventory holding cost, managers must come up with a series of complex exception rules and alert thresholds. If you’re concerned about getting stuck, relax! Most warehouse management systems include workflows to direct exception rules.
3. Have systems in place to track your supply chain functions
A business cannot do everything itself and must partner with third-party service providers such as logistics companies and customer delivery service providers. To track their partners’ performance and receive updates from them, businesses need to adopt new technologies such as barcode scanners, mobile devices, and tracking devices.
These technologies help by providing an overview of the supply chain. Data captured by these technologies can help your managers make informed cost-cutting and other decisions.
4. Identify your inventory drivers
Before introducing any changes to your supply chain, you need to identify the factors that drive inventory demand and supply. Some familiar inventory drivers include raw material constraints and inventory seasonality. Once your team has a clear understanding of your inventory drivers, it can determine where optimization issues exist.
5. Evaluate your supply chain components at regular intervals
To optimize your operations, you need to regularly review your internal processes and analyze the performance of your suppliers and logistics partners. When evaluating performance, use industry, and in-house developed KPIs. Additionally, have a system in place to track the performance of automatic benchmarks such as low stock alerts.
6. Address inefficiencies in your warehouse
To control inventory holding costs, adopt efficient storage methods. Evaluate your layout at regular intervals and tweak it, if required, to ensure optimum utilization of the available space. To help your warehouse management team members save time, opt for the latest material handling equipment.
7. Develop advanced and accurate forecasting models
When it comes to improving inventory accuracy, an advanced forecasting model can be a gamechanger. When working on a forecasting model, use software tools to collect data and information related to manufacturers and suppliers. Develop a clear understanding of how a change in the seasonal cycle impacts demand.