What This Article Covers
- How do two major industries relate to inventory optimization and multi echelon planning (MEIO)?
- What are the different types of high-tech firms?
- What are some of the demands of meeting the requirements of the retailers in consumer packaged goods?
- How have problems with cost optimization impacted the acceptance of a second optimization method?
How Inventory Optimization and Multi Echelon Planning Applies to CPG and High Tech
A frequent question within companies is how inventory optimization and multi-echelon planning (MEIO) relate to their particular industry. At a high level and regardless of industry, MEIO applications are appropriate for any company that wants to manage their supply chain on the basis of service levels. However, there are important distinctions with respect to the opportunities presented by MEIO applications that differ per industry. Not being an industry specialist myself I turned to SmartOps that was nice enough to put me in touch with their industry experts.
In this article we will discuss how MEIO helps manage the supply planning challenges in two industries; consumer product goods (CPG) and High Tech.
Consumer Product Goods
CPG covers a broad spectrum of products and is one of the largest industry segments globally. Historically CPG companies have tended to have high margins. Their marketing focus has led to product proliferation for the supply chain organizations of these companies. Through extensive work with CPG companies, SmartOps has observed that there are key features that are especially relevant for their CPG customers. These are the following:
- A tendency for these companies to vacillate in their emphasis between inventory costs vs service level, but with a general tendency to favor service levels over inventory costs.
- The desire to set a service level for overall product mix
- The ability to deliver products to different channels based upon different service levels
- The desire to change service levels depending upon the time of year
- A need for more sophistication in product prioritization beyond ABC classification
Current Challenges in CPG
The CPG industry is current facing a change in its circumstances that creates a requirement for enhanced supply planning techniques over what is currently the general practice in CPG. CPG companies are seeing increases in some of their most important costs, fuel and raw material. Unfortunately, many CPG companies have designed their supply chains for the higher profit environment that they historically enjoyed. Generally, through interaction with clients, SmartOps has observed that many CPG companies are struggling to meet their fill rate objectives.
CPG and MEIO
Inventory optimization and multi echelon planning (MEIO) holds benefits for a number of which match the key drivers of CPG and can help mitigate their current challenges. In the area of addressing key drivers, MEIO software has the ability to provide a transparent understanding of the relationship between inventory costs and service level. While all supply chain professionals can relatively quickly grasp the standard inventory cost of service level curve, to be able to interact with this curve, to change service level or inventory cost caps interactively and perform sensitivity analysis, with the company’s actual data is a different matter. It is the difference between understanding a general principle and having actionable intelligence. SmartOps has performed this type of analysis for a number of CPG clients and has found that promotes a more logical policy regarding service levels that are selected by the company. On a personal note, I can say that it is surprising to me how many companies think they are hitting a higher service level they actually are. This is because non-MEIO systems do not have the ability to model the service level-inventory trade-off. Furthermore, I have discovered from working on a number of cost optimization projects that the costs which are input into the model would never result in minimizing costs in any real sense, because the costs are set too high in one area, usually the cost of missed demand. This discovery is described in this post. Off-line analytical tools can get a close to this value, but no other application can model the service level-inventory trade-off as accurately as a MEIO application. This is one reason MEIO applications can be used either in production, or as simulation environments so successfully.
Without the feedback of the cost of maintaining the different service levels, there is a tendency for executive decision makers to set the service levels unrealistically high and to either incur extremely high costs, or to promote gaming behavior in the organization in order to attain these unrealistic service levels. This tendency exists because the company simply does not know, and does not have transparent control over its service levels. Analysis that can be performed by using SmartOps, lays bare the reality of what can be afforded.
Meeting the Demands of Retailer
CPG companies sell to retailers and just a few retailers like Wal-Mart and Target can represent large percentages of overall sales of many CPG companies. These retailers dictate specific service levels. This means that CPG companies must be able to provide their family of products at an overall service level, much like a service level contract. SmartOps allows CPG companies to meet the overall objectives of these retailers by working backwards from the aggregate service level requirement to define each of the individual product location service levels. How this is done is not discussed sufficiently with regards to MEIO application in general. Most often MEIO is discussed in terms of setting service level targets at a product location. However this capability happens to be one of its most powerful area functionality of this class of software.
Meeting the service level requirements of retailers not only means deriving different service levels for the product mix the same way in all time periods, but making changes depending upon the time periods, for instance depending upon the seasonality of the products. CPG companies can use the SmartOps solution to set a service level that varies depending upon the time of year. This means that the company can more intelligently deploy its inventory, and move these inventory dollars not only between products locations, but also by the time of year.
High Tech and MEIO
Another industry to showcase is one that is quite different from GPG. High Tech. High Tech is identified with the following supply chain features.
- Deep bills of material (i.e. complex products)
- Long lead times for materials
- High demand volatility
- Short product life cycles
A product that is purchased by a consumer in a Best Buy has a lengthy supply chain in which a wide variety of component specialists participate. Anyone who purchases consumer electronics is familiar with how quickly products turnover and how often new products are introduced. However, what is less well-known is how this issue of short product life cycles extends to electrical components. A good example of how quickly things change can be taken from a current event. There is now a heated competition in computer tablets. This is an emerging technology market that did not exist in any volume prior to one year ago. No doubt some of these tablets will become popular, but many of them will not. It is very difficult to forecast those that will become popular, and those do not will result in few components being demanded to support the finished good. Another example of how fast things change is the new iPod Nano. This device shrunk my more than 1/2 meaning that a new internal design was required and new, smaller components, and even a consolidation of several components into one component was effected in the product’s bill of material.
Types of High Tech Firms
It can also be said that there are at least two different categories of High Tech firms. There are firms like Intel and Samsung that are very capital-intensive and which have higher profit margins, and then firms like Flextronics and Celestica that are less capital-intensive and have lower profit margins. Each category faces different challenges. Flextronics and Celestica must be able to respond quickly to the demands of the major electronics brands, which include effectively managing their inventory of components and their procurement.
In the capital-intensive semiconductor firms (Intel and Samsung), there are thousands of die are on one wafer, and a huge array of different products into which these product serve as subcomponents. However, their typical raw material lead-times of 10 to 16 weeks. These firms also have long development times the requirements of with large capital investment.
The Hangover of Cost Optimization in High Tech
Many companies in High Tech were among the leading edge of companies that attempted cost based optimization back in the 1990’s. (cost optimization differs from inventory optimization in that costs are what the system attempts to minimize, rather than inventory optimization which minimizes inventory per specific service level.) The problem is that few High Tech companies saw very much value from cost optimization. Many issues surfaced during cost optimization projects, from the difficulty in interpreting the results to the difficulty that companies encountered in developing their costs to be used by the optimizers. I am occasionally asked what the difference between cost optimization and inventory optimization is, and whether the same implementation problems can be expected that arose with inventory optimization. My answer is that they are quite different. Inventory optimization is a far better defined form of optimization and much has been learned since the first attempt at optimization, which was cost optimization. However, this fact is not well understood, and therefore the stigma of cost optimization remains. It negatively impacts the acceptance of inventory optimization generally, but particularly within the High Tech industry. This has caused many companies that could benefit from cost optimization to hold off on implementing this type of software, and this is supported by the fact there are few inventory optimization vendors that have made much headway in the High Tech industry.
At a high level, the answer to the question of “why inventory optimization and multi echelon planning” can be answered by the statement that this method of supply planning is beneficial for any company interested in planning their supply chain based upon service level. However, as one becomes more immersed in different industries, it is clear how MEIO solutions address different industries differently. However, one of the most powerful trends that becomes more apparent the different industries are analyzed. That is that supply networks are becoming more complex, with more partners and more echelons being added. This has been the case for some time in High Tech, but is growing in CPG as well. While this complexity is added, it can be an afterthought as to whether the present supply planning software the company is presently using, is designed to manage this complexity. It is important to align changes in the supply network with the solutions used to plan them.
Was this article clear? Do you have any experiences you would like to share regarding inventory optimization and how it may apply to your industry? If so comment below.