Inventory optimization is the practice of having the right inventory to meet your demand, and buffer against unexpected disruption, while avoiding wasteful surplus. At its best, inventory optimization is an agile practice that not only responds quickly to risk and opportunity but also has the capacity to predict and prepare for it.

Why inventory optimization is more crucial than ever

As any business leader can tell you, inventory optimization is a particularly difficult component of supply chain management because it is vulnerable to so many factors, including social trends, natural events, politics, economics, and competition (to name just a few). When the pandemic arrived, it was the mother of all global supply chain disruptions and shone a bright and unwavering light on the volatility of old-school supply chain practices.

Furthermore, when consumer tolerances were for delivery times of a week or more, companies could get by with just a couple of large warehouses. Whereas today, the Amazon Effect sees same-day or next-day delivery becoming an increasing consumer demand. This has had an enormous impact on inventory optimization because it means businesses now must have multiple distribution centers and require multi-locational inventory management. To top it off, online shopping is at an all-time high and consumer brand loyalty is eroding in the face of increased online choice. This has led to unprecedented levels of competition for many businesses and a shrinking margin for profit and error.  

“The supply chain stuff is really tricky.”

Elon Musk

The difference between inventory management and inventory optimization

Both are part of the same inventory-related supply chain operations, but when it comes to defining the specific practices, the overall category is ‘inventory control,’ beneath that lies inventory management and within that lives inventory optimization.

Inventory optimization is a key component of inventory controlc
Inventory control encompasses all inventory management operations, including inventory optimization.
  • Inventory management refers to the goal of setting high productivity and efficiency targets for all inventory operations. Modern business and supply chain planning technologies support these processes by giving supply chain managers greater visibility across all the links in the chain. The Internet of Things (IoT) and cloud-connected devices and assets can be automated for greater efficiency in manufacturing. Production, warehouse, and logistics processes also achieve more efficiency through the application of intelligent technologies like artificial intelligence (AI), machine learning, robotics, and robotic process automation.
  • Inventory optimization is a subset of inventory management that refers more specifically to profit margins and minimizing loss. Carrying surplus inventory causes loss and waste. It takes up space, becomes obsolete, and often doesn’t sell or must be sold at reduced prices. On the other hand, as we saw during the pandemic, shortages and unexpected demand are the flip side of the inventory coin, where the costs come in the form of loss of potential profit and damage to the brand. Therefore, the goal of inventory optimization is to best forecast demand and maximize the financial output of the inventory for the company.

The different types of inventory

From the consumer’s point of view, inventory primarily consists of finished goods. But for a business, inventory is anything they have to keep in stock, maintain, and replenish. If a company makes soup, then “inventory” could be anything from the seeds used to grow the tomatoes, all the way to the fuel in the company delivery trucks that take it to the grocery store. Looking at inventory management in this more holistic way gives a greater appreciation of its complexity. 

There are four basic inventory types:

  1. Raw materials: All inventory that eventually ends up in the finished product.
  2. Work-in-progress (WIP): As the name implies, this is all the inventory that is currently being prepared and packaged. This is an expensive and risky stage, so inventory optimization solutions can be applied to help find the most cost- and time-effective processes.
  3. Finished goods: The most commonly perceived meaning of what inventory is, in its packaged ready-to-sell state.
  4. Maintenance, repair, and operating supplies (MRO): All the inventory needed in the manufacturing, production, and delivery of the items. Inventory optimization is applied to best balance surplus and shortage of these not-for-consumer items.

The challenges of traditional inventory optimization

Since there have been supply chains and warehouses, one of the greatest challenges to achieving inventory optimization has been the balancing act between “just enough” and “not too much.” Demand forecasting has traditionally been a backward-looking practice. Even though inventory optimization and demand forecasting experts are very skilled, there is only so much that human analysis and prediction can accomplish. Therefore, linear supply chains that are powered by legacy systems will always be vulnerable, no matter how much expertise is applied. Some of the most common challenges include:

Building on fundamental inventory optimization forecasting processes

There is a wide range of inventory optimization challenges from business to business. For certain seasonal or B2B products, the process may be fairly straightforward, whereas large retailers, for example, may have hundreds or thousands of SKUs and a highly mercurial market and customer base. 

The fundamental practices that underpin inventory optimization have not changed for decades – even centuries. But, what has changed are software solutions that augment these processes and the specialists who perform them. But even the most sophisticated digital systems are still grounded in many of the familiar and traditional inventory optimization protocols and formulas:

Inventory optimization systems: Benefits and outcomes 

Historically, the benefits of even small improvements to strategic inventory optimization could be realized in lowered costs and better profit margins. With the application of integrated business processes and inventory management software, these benefits become more robust and measurable – and only improve over time as the software learns and adapts. 

Woman using inventory planning software

Going above and beyond with multi-echelon inventory optimization (MEIO)

Complex (especially global) supply chains benefit from MEIO solutions, which build on the basics of traditional inventory optimization but use modern supply chain and cloud technologies to get a more centralized, real-time picture of global operations. An effective MEIO solution recommends the optimal inventory levels at each link – or echelon – in the supply chain by simultaneously optimizing inventory balance across multiple locations.

With an MEIO approach, manufacturers can analyze demand forecasts with an end-to-end view of the supply chain. And as businesses grapple with the Amazon Effect, MEIO solutions help them cope with today’s more geographically distributed, smaller inventories.

Get started using inventory planning best practices

Modern technologies and smart solutions can deliver enormous benefits to every area of supply chain management, but, in the end, it’s practices and people that run a business. Cloud connectivity helps you connect to your teams and supply chain partners around the world, so put that visibility to work by sharing and rewarding sound practices and efficient inventory planning strategies.

  1. Use robust demand forecasting techniques.
    Demand forecasting is a key factor in informing how businesses strategize inventory management and other processes, such as resource purchasing, inbound logistics, manufacturing, financial planning, and risk assessment.
  2. Make your inventory budget a Q1 priority.
    Every business has cycles and shifts throughout the year. By establishing a quarter-by-quarter inventory budget, supply chain planners can set more realistic and deliverable targets and KPIs.
  3. Implement standard inventory reviewing systems.
    Reviewing systems can be customized for different types of inventory and help to improve efficiency and streamline workflows. It is not uncommon for complex organizations to use different systems within their business. The main point is having consistency and putting a plan in place.

There are two main types of inventory reviewing systems:

  • Continuous review system: In this model, the same quantities of items are ordered in each cycle and inventory managers must monitor inventory levels continuously and replenish stocks whenever the quantity of an item drops below a set level. 
  • Periodic review: In this model, inventory managers order products at the same time within each business cycle. At the end of the cycle, necessary stock is ordered based on quality levels at that point in time. This system does not use fixed reorder levels and is more efficient for slower moving products.
  1. Listen to your customers.
    Many businesses only listen to the squeakiest wheels and end up making decisions based upon the loudest feedback. The best inventory management software solutions will be able to regularly gather and analyze data from all your customers and buyers and offer insights and recommendation – in real time – about that input. This helps inventory optimization efforts by ensuring that inventory management decisions are informed and data-driven.
  2. Use just-in-time (JIT) and on-demand principles.
    Shorter-than-ever product lifecycles and growing consumer demand for speed and personalization mean that inventory optimization must be fast-moving and agile. Technologies like 3D printing and robotic automation allow businesses to carry virtual inventories. Supply chain manufacturing and logistics increasingly operate using networks of on-demand providers and suppliers. With intelligent software, inventory managers can make real-time inventory optimizations decisions, confident that the data is backing them up.

Next steps to better inventory planning and optimization

As with any business transformation, it’s important to establish good communication across your inventory optimization and supply chain team. Start by breaking down silos, developing strong change management and communication strategies, and talking to your team leaders. Within your workforce is a gold mine of information about current risks and opportunities, which can be leveraged to establish actionable inventory planning and optimization strategies. Your software vendor can also help you develop a road map to help you get your inventory optimization journey underway.

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