Inventory Optimization: Responsibly Meeting Reliability and Service-Level Expectations

June 2015

How can inventory growth be controlled without compromising reliability or service-level requirements? To start, we should level-set on key definitions and concepts.

What is “inventory”? In North America, the definition you select for inventory depends on where you sit from an accounting perspective. However, from a practical sense, inventory can be considered as any materials or supplies that are processed by warehouse personnel.

What is “inventory optimization”? Inventory reductions have been one of the top actions supply chains have taken to lower cash outlays (buying less) and reduce inventory to free up working capital in the last three years. The term “reduction” has, in some areas, been replaced with “optimization.” Optimization seeks to identify the least amount of inventory required to achieve a desired level of customer service—“just enough” rather than “just in case.” The components that must be balanced to achieve optimization include not only customer service, but also operating and inventory costs.

So, what’s the catch? Achieving high levels of service requires maintaining more of the right inventory and improved planning. The challenge is that “more” does not equal “better,” and there is a cost to achieve high-service levels as the graph below shows. Knowing the right parts necessary to maintain high-service levels is critical to the optimization equation and is based on a number of factors, including inventory item standardization, criticality, visibility to historical usage (at the highest level of a company possible), and known future work orders.

A crucial tension in organizations that exhibit leading inventory optimization practices is the balancing act between cost and service. One way these organizations encourage managers to strike the right balance is to select cost and service metrics and, in concert with organizational stakeholders, set performance expectations to maintain this necessary tension. Some examples of useful metrics are listed in the table below.

Without an active focus on balancing the dimensions of cost and service through an ongoing awareness of efficiency and effectiveness results from optimization efforts, it is impossible to gauge success.

If you would like to hear other insights on how to optimize your inventory investment, please contact us.

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