No one wants to hold inventory. It is necessary because of variation: variation in demand, variation in lead times, variation in raw and finished good quantity, variation in yield (production line reliability), variation in transit times, and of course random shocks from weather to other factors that effect raw and finished good availability. Let’s call this normal or Systemic Variation. Good supply chain managers will work to reduce this kind of variation to improve costs and over all supply chain reliability. This kind of variation is primarily in the hands of the Supply Chain. It is on us, the Supply Chain Team, to constantly be working to reducing the variations in these variables. When done right, with a sound system of management, the result is that inventory is optimized and constantly improved upon.
This is another source of variation. Let’s call this Variation Due to Internal Errors. This kind of variation is a killer. Let us call this V-DIE. This variation is due to self-inflicted wounds that cause us to carry more inventory. V-DIE causes us to make faulty assumptions when it comes to planning: Demand Planning, Production Planning, Inventory Planning. The communication of those plans to suppliers just passes and amplifies the variation . Inventory inaccuracy is also attributed to V-DIE. The kind of errors can create spikes in inventory that could take months to draw down especially if they are over forecasts which result in over procurement of raw materials, or over production of finished goods.
When inventory gets out of control because of errors,because of V-DIE, the levels of inventory will not decrease and will probably continue nudging up until these kinds of errors are fixed. V-DIE should be dealt with equal vigor as the Systemic Variation can be addressed. V-DIE can and will bias the analysis of Systemic Variation. For sure, V-DIE limits the improvement that a company can achieve in terms inventory. We will go far to say that in our experience that for a company mired in V-DIE, the culture is corrupted as well. Strong leadership is required to set the tone to eliminate this kind of variation.
What do we mean when we say that V-DIE limits the improvement a company can achieve in inventory management? Many companies task the supply chain management with reducing working capital. The supply chain team works diligently to reduce supplier lead times, implementing pull systems, working on lean manufacturing in general, and implementing new KPIs if needed. The team drives changes and takes the slack out of everything they can control. Here lies the rub or the limitation. There is only so much the supply chain management can do.
There are three major areas where the supply chain cannot drive improvement by themselves:
- Forecast accuracy
- Reducing Excess and Obsolete (E&O) inventory
- Month and quarter end peaking
We have written about each of these in this blog and will touch on them again briefly.
[1] Forecast accuracy is based on two things: The forecast itself and the execution against the forecast i.e. sales. In both cases, the supply chain must work with sales and marketing to determine the forecast. Then it is up to sales to deliver sales to the forecast and the supply chain to make sure the right products are available in the right quantities to fulfill orders should the forecast be realized. [2] If inventory is “out of whack,” there will undoubtedly be too much E&O in the system. Poor decisions in the past will have invariably led to having the wrong quantities or the wrong mix of products in the wrong places at the wrong time. This leads to inventory accumulation mostly in goods that are not selling. The stocks of these products build and become excess and invariably obsolete. Then… the inventory just sits there. The supply chain is beaten up for not reducing it. Without sales trying to sell the E&O and finance agreeing to write-off and scrap some of the excess, the E&O will not go down and, worse, will continue to grow. [3] Many companies have a sales cycle that results in a large percentage of their monthly or quarterly sales taking place in the last few days of the month or quarter. These spikes can be as high as 50-60% of the period sales. No matter how lean a supply chain is or how well a pull system is designed and run, peaking of this magnitude requires advanced planning and building inventory based on forecast. In short, it requires operating in a push based system. Many companies that claim to be lean and operating in a pull environment only do 80% of the time. When this happens demand variation is a large factor in inventory planning. The supply chain cannot reduce this. Only sales can.Optimal inventory can be calculated but unless V-DIE is addressed at the same time as Systemic Variation inventory will never achieve optimal results. V-DIE will flare-up and cause inventory to go up. Senior management will react and pressure those responsible for inventory in the supply chain to improve. But, because the V-DIE issues are not entirely in control of the supply chain, improvements are harder to come by. If all the slack has been taken out the Systemic Variation parameters, further gains in inventory reduction can only come from V-DIE parameters.
At DemandCaster, we advocate our concept of Supply Chain Physics. In brief, at any given times, there are Laws of Physics that govern the behavior of our Supply Chains. The laws are:
- The law of interdependency
- The law of constraints
- The law of information
V-Die squarely impacts the first two. V-DIE is a good measure of cross-functional cooperation within a company. When this kind of variation is present and dominant, it is a measure of the lack of coordination between functions. The Law of Interdependency is at work. Forecast accuracy at every level requires the cooperation of the supply chain, sales, marketing, and finance functions. Reducing E&O inventory again requires the cooperation of the supply chain, sales, and finance. In fact, measures to not increase E&O starts with improved forecasts and the even harder part: execution against the forecast. Lastly, breaking of the month and quarter end sales peaking pattern is dependent on sales, finance, and general management working hard to change the well established sales patterns which are ingrained in the minds of customers. Assigning these objectives only to the supply chain does not acknowledge the interdependency at work here and thus limits the improvements that can be made. The limits set are a constant source of frustration in the organization and reinforces the walls of the silos that already exist. It is that simple and that complex.
As a result, constraints are established. It is the constraints that set the level of improvement.
- Forecast accuracy is < 60% is repsonsible for X-amount of inventory that will always be in the system
- E&O > $Y Million truly means that you will always have at least $Y Million of inventory in the the system
- 50% of your sales in the last week of the quarter means you have to order and build to forecast, which means you end up with Z (on top of the aforementioned) X amount of inventory because of the chaos in the operations caused by such a sales spike.
Hammering, tasking, and incentivizing just the supply chain will not change the physics of the situation.
Variation is indeed the enemy. Reduction of variation is the goal. It is the goal in quality improvement. It is the goal in lean manufacturing. It is the goal in inventory management. The tools and skills needed to address variation reduction are the same. They exist in most companies. In the case of inventory management, V-DIE is the enemy. If your V-DIE is low or non-existent, we will guess that you are probably already managing your inventory quite well. If you have no clue, you are probably not happy with your inventory management. In this case, measure and begin to look at the three major V-DIE components: Forecast Accuracy, E&O, and Sales Peaking.
