January 20, 2022

Manage supply chain disruption with inventory optimization

Protect profits and customer satisfaction with data-driven allocation


Authored by RSM US LLP


Retailers, manufacturers and other product-centric companies have been experiencing substantial supply chain disruptions for the past 20-plus months. Heightened trade tensions sparked the trend in 2019, and then the global pandemic hit, resulting in disruptions that are likely to linger into the second half of 2022.

Between lockdowns that closed plants and impacted supply and explosive demand in such categories as computers and consumer electronics triggered by the increased number of people working and learning from home, demand and supply imbalances became pervasive. Out-of-the-ordinary events — a fire at a key supplier in Japan (Renesas Electronics) — also played a part. Extreme winter weather in Texas further exacerbated the supply chain disruptions.

These disruptions have caused shortages and rising prices for both producers and consumers, and companies are grappling with how to meet customer demand and protect their profit margins.

One strategy that can help manufacturers and other industrial companies improve customer service levels while effectively managing working capital is inventory optimization. This process involves developing the analytical capability to understand product portfolios, supplier performance and customer order profiles to make informed decisions on inventory stocking levels. This will ultimately allow an organization to most effectively allocate limited resources to the products that maximize profitability and margin.

Managing inventory shortages can be particularly hard for manufacturers, as compared with other industries, because it’s more difficult for them to substitute items. Retail brands can simply order another product to fill empty shelves, but manufacturers can’t operate without parts and components. In addition, different types of manufacturers use the same types of items, increasing the demand for limited supplies. For example, computer chips are needed to make cars, personal electronics, production machinery, medical equipment, toys and lots of other goods.

Manufacturers also tend to use common parts or components across their portfolios of different products or product families. An automaker, for example, might use the same type of seats in all of its sedan models, putting further burdens on limited supplies.

Rethinking lean inventories

Inventories peaked at the onset of the pandemic and have been decreasing over time. Bottlenecks in supply chains caused by such factors as not having enough employees have been blamed, but escalating demand for certain goods is also causing lingering shortages.

The global shortage of computer chips, also called semi-conductors, demonstrates how spiking demand for one product can influence the availability of other products.

When the world started working and learning from home, demand for personal computers skyrocketed. At the same time, people weren’t buying as many automobiles, so suppliers in that sector let their inventories of components that use computer chips drop; some manufacturers even stopped or curtailed production. Limiting production seemed like a good strategy at the time because it freed up as much cash as possible during an economic downturn.

However, when demand for new cars and trucks started returning, there simply wasn’t enough inventory to meet demand. This dynamic is playing out in multiple industries as businesses and consumers return to normal activities. It’s translated to a lot of lost sales, and the experience has moved executive attention away from preserving cash through lean inventory practices to optimizing inventory for meeting demand while controlling costs.

This capability is especially important as people have come to realize that supply chain disruptions aren’t going away soon. While vaccines are alleviating a lot of pandemic pain, other potentially disruptive factors, such as climate change, outdated infrastructure and geo-political instability, persist.

Identifying the best options for limited inventory

One of the ways we’re helping clients adjust to the new normal is through inventory optimization for critical parts so that they’re allocated to the highest-revenue and highest-margin products. This helps companies maintain profits while also keeping customer satisfaction levels high.

We start with an inventory segmentation strategy based on the business value generated by the finished goods or materials (see A, B and C in the chart below) and the demand variability and predictability of the order or consumption patterns (X, Y and Z). Typically, we find that about 20% of the stock-keeping units (SKUs) fall into an even-demand, high-forecast reliability category (Stable); about 30% fall into a predictably variable and less forecast reliability category (Irregular); and the remaining 50% are in a sporadic-demand and difficult-to-forecast category (Erratic).

Each of the categories may require a different inventory planning strategy that allows your organization to maintain the adequate inventory levels needed to meet customer demands while also balancing costs.

Accuracy of production and inventory data is crucial, so we help clients look closely at each part or component to really understand demand and develop a stocking strategy that will maximize customer service levels and optimize inventory levels.

As we’re doing this, companies are seeing there’s a lot of opportunity to improve their product parameter settings within their inventory-related systems. Too often, we see middle market companies make substantial investments in ERP and manufacturing execution systems (MES) to help improve planning and operations, but they have too much homogenous data in the systems to truly optimize those systems. Parts and components just aren’t differentiated enough.

With inventory optimization, we’re encouraging clients to take a deeper look at their product level data so they can better manage inventories. The good news is that once the product planning parameters have been refined, they can be updated frequently to keep your organization ahead of ongoing disruption and change.

In a world where disruptions are not uncommon, improving your supply chain agility and resiliency is critical for sustainable growth. Inventory optimization is the place to start and can prove to be a competitive advantage for your organization.

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This article was written by RSM US LLP and originally appeared on 2022-01-20.
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