Inventory Optimization is a Loaded Term

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And you do not have to do it every day!

Just because a particular phrase is used often out of context by Business Managers, software firms seem to be quick to ‘launch’ a ‘module’ with similar name, often repackaging something that was already there.Quite often poorly drafted conjectures promoted based on indicators like finished goods inventory turnover or inventory as a % of revenues says very little about how 'optimal' the inventory is. It is at best quarter of the story. This then leads to buying an Inventory Optimization ‘software’ without really going into the depth of what it really does.

There are tens of things that any firm needs to fix to DO inventory optimization. Many firms do make rational decisions to implicitly ‘optimize’ inventories all the time since there is no (cannot and need not be) generalized inventory optimization problem construct in theory. It is driven by motivations like service levels or ending inventory positions or costs of carrying /storage. Rarely all.

Depending on the size, age, # business partners (customers, vendors), # products, #recipes (BOM’s and ways of producing it), #‘echelons’ in distribution network, #channels, and # selling and buying organizations in the supply network, many things contribute to ‘unhealthy’ inventories over time. Most notably variability of demand and lead times. Then there are half a dozen or more ‘modifiers’ between actual demand and procurement, incl. lot sizes motivated by several tens of reasons and several 10’s of policies within each reason. All of them with some historical context that is perhaps now stale. Valid for finished products, semi-finished and even externally procured items. Sometimes unique by product. Sometimes unique by source of supply. Sometimes by time of year. Sometimes motivated by contracts. From as simple as x days of supply to something like part period balancing within economic lot sizing or may be some generic algorithms that attempts to meet multiple objectives in re-ordering.

Then of course there are proliferating SKU’s. Something I personally dislike. Many of them with gross contribution margin not even worth the set-up costs to make them at the first place. Even if they must be produced, the manufacturing resource commitment must be thought out well. It is perhaps more profitable to lease out spare capacity and make more of what sells. Pruning SKU’s is a step that is a last thing on anyone’s mind when it comes to inventory optimization. There is proven research to establish that a firm is better off with fewer SKU’s than more.

Inventory optimization should be a ‘clean-up project’ that planners need to engage in once in year or 2 years. Depending on the firm, these are some activities can constitute scope of such a project?

Service Level Vs Actual Inventory - Finished Goods- What was the average excess inventory? What was the average shortfall? Each location, each product.
Review of Planning Processes. - Why did the planning system not propose a location of continuous excess inventory as source of supply? What is wrong with the ‘settings’ of my MRP?
Review of Master data like Lot Sizes, Reorder Quantity, Min Order Quantity and Lead times. – Is the lead time maintained higher or lower than the actual lead times?
Inventory Situation – Raw materials. How much of it is really worth now and how long will it last. Is it commensurate to the likely demand in next n weeks? Why not promote A, J and P now to exhaust some really expensive inventory that will go stale at current rate?
How about getting some vendors replenish just in time or have them own part of whole of the stock?
How about some consolidation of regional warehouses?
How about some dedicated warehouses for certain type of products or customers?


What will be the expected inventory now given the demand in next n periods? What is the cost of capital now?