The New Wave of Inventory Policy

The New Wave of Inventory Policy

 How can a manufacturer cope with unpredictable market demands? And how can assessing market needs help a company achieve cost savings? This article is followed by a Case Studyin which we discuss this matter in practice, based on a project conducted by Tefen

Inventory image

Written by Ilya Makovoz, Consultant

Keeping inventory stocks is a policy employed by those who are afraid to take risks. And as we know, if there is no risk there is no reward. In today’s competitive marketplace we all must take risks if we want to survive and prosper. But which risks are worth taking? In an uncertain marketplace, how may a manufacturer cope with fluctuating and unpredictable market demands?

The increasing competition resulting from the globalization of the marketplace is changing the entire supply chain. With many companies having successfully implemented many cost saving programs such as lean, there is a mounting pressure to find more savings. Working capital is the new frontier in cost reduction and everyone, from the consumer to the manufacturer, are looking to reduce their inventories.

With all the players shifting their inventory stocks up the supply chain, how can businesses cope with the mounting pressure? It seems necessary that somewhere in the supply chain the shifted inventory should accumulate. Logically it would seem that this inventory would alleviate the pressure from the other links in the chain but no company should shoulder the burden. The optimal solution for companies in this position can only be achieved in assessing market needs to set the optimal inventory policy.

Let us consider how a manufacturer acts when confronted with seasonality and insufficient capacity during the high season. The only way to handle these high season sales is to produce excess stock in the low season.  The only way to handle these high season sales would be to produce excess stock in the low season. However, when the forecasts are inaccurate, it is very easy to produce the wrong stock and to suffer not only the holding cost of the wrong amount of inventory, but also potentially missing sales if the stock of demanded stock keeping units (SKU) is insufficient.

Traditionally, inventory was based either on make-to-stock (MTS) or on make-to-order (MTO) policies but both have large drawbacks that should be considered. The traditional make-to-stock policy was originally used in traditional markets with low seasonality and a high level of predictability to be lean. The biggest drawback to an MTS policy is that unexpected sales can cause inventory to go unsold and production unable to meet service level agreements with customers. Thus, costs and missed opportunities can skyrocket from an MTS policy especially when faced with unpredictable demand.

Charts and Graphs

Today the make-to-order (MTO) policy is growing in popularity as players in the supply chain are seeking to reduce their working capital and holding expenditures. MTO has a significant advantage over MTS intrinsically since with a true MTO there should be no inventory without a sales order. This significantly reduces inventory volumes but at the cost of increasing the lead times to customers and thus is best suited for companies with large scale product such as the aviation industry. For today’s lean and fast-paced markets neither of the approaches are entirely suitable. 

No lean inventory policy can prepare a company for an unpredicted demand that is significantly larger than capacity, nor should it. A fine-tuned inventory policy should mirror demand as closely as possible to minimize the holding costs but also to provide a service level to the customer that meets company’s goals. This means not only is it ok to be out of stock occasionally but unless the goal is a 100% service level then we expect stock outs.

So what kind of new approach is necessary? It is a positive indicator that the policy in place is lean, but that’s not the only key performance indicator (KPI). How can a company predict inventory demand and prepare for it? Today’s technology allows the players in the supply chain to prepare more accurately than ever before, anticipating unpredictable or seasonal demands, by utilizing big data and analytics tools. 

It might seem paradoxical but a fine-tuned policy can reduce inventory and increase service level simultaneously. This can be achieved by shortening the production planning window, setting production quantities based on actual sales, and increasing production capacity. It seems counter-intuitive but incredible savings that can be achieved by under-utilizing production capacities. The free capacity creates an increased responsiveness to customer demands and reduces the likelihood of a stock-out or the production of an undesired SKU.

Want to see how this works in practice? Take a look at the Case Study following this article!

Brian Hsing

Director and Head of US Operations at Tefen USA

Monopoly Building, Operational Excellence, Change Management & Supply Chain Expert

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