maximizing working capital without crippling your supply chain

An Optiant White Paper

The Executive Guide to

Maximizing Working Capital without Crippling Your Supply Chain

How to stop brute-force inventory reductions and position your company for the coming economic recovery

2 7 New England Executive Park Suite 130 Burlington MA 01803 www.Optiant.com 1‐888‐OPTIANT

Slashing Inventory Now May Cripple Your Supply Chain—and Your Business.

The Importance of optimization, rather than brute-force cutting, to free up working capital now while enhancing responsiveness during the recovery

The severity and rapidity of the economic downturn caught just about every

business by surprise. Although it’s normal for demand changes to cause inventory

to “overshoot” the demand curve, this sharp and deep cycle has pummeled those

who did not have the necessary disciplines and competencies in place to

proactively managing their process,.

Not surprisingly, the crisis-management reaction has included brute force

reductions in inventory, headcount, sourcing and production capacities.

Unfortunately, the continued need for working capital during the downturn creates

perfect conditions for potentially disastrous decision-making. Mandates such as

“cut inventory by 20%” can indeed produce liquidity—while leaving the supply

chain less able to function efficiently and unable to meet higher customer demand

during the recovery. Bad inventory management today makes the company less

competitive during the upswing and amplifies the damage caused by the economic

crisis. By contrast, market leaders work these cycles to gain share and strengthen

their people, process, and technologies.

Competency. Corporate performance during today’s volatile economy, credit

crunch, and financial crisis is intrinsically connected to supply chain competency.

Successful companies will analyze all the factors that led them to hold inventory in

the first place, such as supplier lead times, demand fluctuations and uncertainty,

production capacity, sales forecast errors, etc. The smart move is to enhance

supply chain infrastructure through intelligent decisions about where to cut

inventory and by how much, right down to the SKU-by-location level. To do this,

the organization needs to enable its people, process, and technology around

inventory management.

Consider the impact of inventory management on availability of working capital. In

a business that can’t control inventory, any time demand falls the supply chain will

keep building when it shouldn’t. The result is excess inventory that sits until

discounting or obsolescence finally moves it off the shelf, which causes a drop in

the balance sheet and a loss on the P & L. For a company in need of working

capital, this is not a preferred strategy for “converting” inventory to cash.

In today’s uncertain economy demand is harder to forecast than ever, yet

somehow the supply chain must deliver the working capital that is key to the

company’s short-term health and long-term strategic vision. As modern business

cycles become faster and more severe, winning companies depend on inventory

efficiency to provide investment dollars during the down cycle.

“Inventory optimization is now among the top three priorities for many supply chain organizations as they seek to create increased efficiencies during the continued global recession..”

Manufacturing Insights, June 2009


The Recessionary Economy’s Double-edged Sword

While too much inventory traps and diminishes working capital, too little results in

missed sales, lost revenue, and lost customers. Both scenarios can occur during

the business cycle.

A plunging-and-recovering economic cycle poses double danger to complex,

vertically integrated businesses. First is the cost of sluggish reaction to dropping

demand. Many manufacturing

teams are measured on building

products and using resources as

efficiently as possible. This can

lead to a supply chain strategy

that is “determined” to keep

building to the plan long past the

logical stopping point. Excess

inventory builds up during the

lag period and saps working

capital at the time it is most

scarce. The potential arises for massive channel-stuffing and obsolescence as

overstock sits for months. When the inventory cuts do come, they take the form of

brute-force mandates rather than intelligent decisions.

Unprepared. After the effects of across-the-board cuts set in, we come to the

second danger. Eventually demand recovers, leaving organizations that manage

inventory by “rule-of-thumb” completely unprepared to take advantage and

rebound quickly. Forecasts change rapidly and unpredictably. “Gun-shy”

managers are slow to ramp up. Suppliers who not long ago were shut off are now

unable to quickly revive themselves. Some suppliers and contract manufacturers

will go bankrupt. When demand

recovers, having fewer suppliers

can create a bottleneck in

capacity, especially in cases of

long international lead times.

What is a 90-to-120-day lag in

response costing your business?

Way too much. The cost comes

in many forms: lost revenue,

poor return on assets, bad cash

position during a crucial time,

inability to take market share away from slower competitors.

Although you can’t manage the economy to create more demand, you can chart a

“course of lowest cost” by successfully managing inventory. To navigate this

difficult passage, the supply chain must minimize its costly tendency to overshoot

changes in the demand curve. Someone has to balance out the uncertain demand

“Most companies have mastered the basics of Supply Chain execution. Where they struggle is designing supply chains that are as flexible as their market requires.”

Senior Manager, Accenture

“Increasing the productivity of assets has taken on more importance because of its direct relationship toward maximizing working capital and improving the bottom line.”

Simon Ellis Supply Chain Practice Dir. IDC Manufacturing Insights

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ExcessInventory

Original Build Plan

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Plan vs. Demand Drop

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Rule‐of‐thumbinventory adjustments

Lost Revenue

Manual Response

Excess Inventory


and inaccurate sales forecasts. But how can they know what to cut, what to keep,

what to order, what to postpone? Where is it smart to reduce and where is it

suicidal? Where does the confidence come from to ramp up manufacturing, take

maximum advantage of increasing demand, and grab more market share? The

key lies in reacting to demand signals early enough and positioning sufficient

buffer inventory in the right locations.

Bouncing back. Rules of thumb and spreadsheet calculations are not up to the

job, but there is a higher level of analytical power available that has proven over

and over that it can minimize the “overshoot” effect both during the plunge and the

ramp-up. Optiant’s inventory optimization technology applies proven mathematical

algorithms to model the overall supply chain and map the interdependencies of its

components. The analysis predicts exactly how different supply chain

configurations will behave in

response to possible changes in

the demand curve. Greater

inventory competency lets the

organization respond with

confidence—quickly adjusting

inventory targets and policies to

minimize costs, maximize profit,

and maintain required service

levels.

This means the avoidance of

excess inventory and obsolescence during a demand drop and very little missed

sales revenue during an upswing. Faster response improves competitive

advantage during the recovery and a growth in market share. In an exaggerated

plunge-and-recover cycle, good inventory management means the difference

between bouncing back from the downturn and being run over by it.

Becoming Recovery-Ready and Uncertainty-Proof

Great demand uncertainty breeds little confidence in how to get back on top of the

demand curve. Normally, when demand exceeds the safety stock, managers

resort to tactics such as expediting, subcontracting, premium freight transportation,

or overtime to accommodate the

demand windfall. But in a plunge-

and-recover scenario, if vital

inventory is not on hand at

multiple stages of the supply

chain, sales will be lost at the

precise time they are most

crucial.

Even as demand changes over

time, the degree of uncertainty is

“A multi-echelon inventory optimization application can be a powerful lever in optimizing overall supply chain performance.”

AMR Research

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Rule‐of‐thumb

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Optimized Response

Optimized

Avoidable Excess Inventory


predictable and can be managed. Using existing demand data, a smooth demand

curve can be generated, with variability shown as high and low bounds: in effect,

uncertainty forms an envelope around the demand signal. Inventory planners can

choose how wide an envelope to plan for, given their service level requirements

and business goals. Managers can confidently hold more raw materials and sub-

assemblies at lower-cost stages, ready to produce high-cost finished goods in

multiple variants quickly when needed. Selected long-lead-time items can be

stocked at higher levels than other SKUs so as not to impair response to a sudden

increase in demand. The SKUs associated with high-profit goods can be given

preferential treatment while low-value stock gets lesser priority.

Optiant inventory technology is uniquely focused on handling uncertainty. It is the

leading—and only—decision support solution that creates confidence and

predictability in the face of both demand and supply volatility and uncertainty.

The Difference Between Operations and Optimizations

It’s a common misperception that operational supply chain tools such as ERP and

Advanced Planning Systems somehow improve the strategy and tactics of

inventory management. This is not the case. Operational tools in a deterministic

planning system actually amplify inventory overshoot because operational and

transactional systems do not address the issues of how much inventory is optimal

or where it should be held within the overall supply chain.

For instance, inventory is often located using the same structure defined in the

ERP/APS system, even when these stock-holding locations are physically close to

one another. Pooling inventory could reduce runs between the stock-holding

positions and improve fill rates. Optimized stock pools are an excellent technique

to maintain consistently high service levels while saving between 30%-50% of

safety stock cost—but stock pooling is beyond the scope of ERP and APS

systems.

In another example, simple "days-of-supply" inventory targets often cause stock to

build up earlier in the supply chain than needed, causing a tendency to miss high-

demand peaks where maintaining fill rates is a crucial task. Inventory optimization

maintains fill rates by intelligently allocating the right amount of stock to each

location, week by week and month by month (whether the inventories are pooled

or not).

ERP and APS systems do not address uncertainty. Instead, ERP systems

should be used as a source of supply, demand, forecast and production data for

an inventory optimization solution such as Optiant’s PowerChain suite, which

models, analyzes, and recommends smart inventory targets and policies.

Optiant technology models the complex supply chain as a multi-stage network,

incorporating production lead-time at each stage and “dollarizing” the impact of

different supply chain decisions (such as how much buffer stock should be held

and where it should be located). The analysis takes into account transaction data

Optiant’s advanced

mathematical optimization

technology—nonlinear, integer

programming originated at the

MIT Sloan School of

Management—provides

strategic and tactical decision

support, versus the operational

support provided by ERP

systems.


as well as uncertainty in demand, volatile supply costs and delivery timetables,

inaccurate or inconsistent forecasts, and more.

Trying out alternative what-if scenarios helps planners see clearly which decisions

will produce a successful outcome (service levels met or improved) while

minimizing costs across the entire supply chain. Optiant’s technology is flexible

and easy-to-use, focusing planners’ attention on “exceptions” from the norm that

should be corrected. It can feed updates to the ERP system on a regular basis so

that inventory is optimized routinely.

Alignment Must Begin at the Top

Supply chain mandates come from the senior staff, and supply chain leadership

needs to come from the same place. The questions senior executives should be

asking of their supply chain teams include:

What’s the most profitable way to bring inventory back into alignment with

the demand curve?

How should we position inventory and capacity throughout the chain to be

ready for a recovery while handling demand uncertainty?

How can we position our people and competencies to take full advantage

of increased demand while minimizing losses during future downturns?

Supply chain managers should be able answer to these questions based on hard

data and facts. If they can’t, it’s because wise inventory decisions (that minimize

costs while maximizing customer service levels in spite of uncertain demand)

require a specialized decision support system that provides one accurate picture of

the entire supply chain and pulls managers together in understanding its efficient

operation.

While manufacturers should ideally design, model, and optimize their supply

chains in a collaborative environment, many decisions are in fact made in silos of

Sourcing, Manufacturing, Distribution, and Customers.

In many companies, these teams have directly conflicting systems of goals and

rewards. Taken individually their decisions may be justified, but the totality creates

massive overstocks and lag times (as well as other inefficiencies), and these

contribute directly to the company’s inability to dig its way out of a deep demand

trough as quickly as it must.

An end-to-end optimization solution (such as Optiant’s PowerChain suite) allows

companies to take a “cross-silo,” holistic approach to designing and optimizing

their supply chains, rather than viewing them as a series of local decision points.

Led by a broad initiative from senior management, collaborative decisions can be

made from the perspective of what’s best for the overall supply chain, rather than

individual sites striving to “have enough on-hand so we won’t have to expedite.”

For instance, Optiant may recommend replacing safety stock held at each and

every stage in the supply chain with a decoupled approach to lower total safety

“People in the functions are usually busy with their own business and don’t take time to understand and focus on how they impact inventory in the overall supply chain. There is nothing like simple, visible data to bring people together in problem solving, agreement and decisions.”

Senior supply chain exec

One Optiant client was able to

reduce finished goods

Inventory by 36%, raw

materials & WIP by 47%, and

improve delivery performance

by 17%.


stock while maintaining service levels. Armed with one, fact-based representation

of how the supply chain works, the executive staff can provide confident leadership

that cuts across the silos.

Cross-functional cooperation and vision regarding the end-to-end supply chain

should be a game-changing initiative driven by senior management.

Preparing for Change—and Greater Profitability—in Just 90 Days

A time of uniquely low demand is like an auto race running under the yellow flag: it

is an opportunity to prepare both the supply chain and all of its stakeholders to

prosper when full-speed competition resumes.

The perfect time to implement a more efficient decision-support solution is

as early as possible in the plunge-and-recover cycle. Optimization tools set in

place now will create a lean inventory environment that responds to demand—

especially volatile demand—with speed and confidence. Inventory optimization

solutions are much easier to implement than, say, an ERP system, and can quickly

create savings in the millions. Optiant routinely implements in just 90 days, with no

disruption to existing ERP and APS systems (the independent Optiant solution

feeds optimal recommendations to supply chain managers and the enterprise

systems).

The goal of any inventory management system is to provide the best possible

customer service within the constraint of the lowest practical inventory cost. This

improves company performance during any business cycle, but sharp downturns

provide a special opportunity for excellent companies to free up working capital,

become stronger, and gain market share during the recovery.

Here are the key guidelines:

Reform your inventory rather than slashing it through brute-force

reductions.

Free up working capital by intelligently reducing excess inventory—but

avoid cuts that hurt your ability to gain market share during the recovery.

Correct the tendency for inventory to badly “overshoot” the demand curve.

Become able to react to demand changes faster than your competitors

can.

Provide supply chain stakeholders with one accurate overview that helps

them understand the big picture.

Empower managers to follow recommendations that strengthen the entire

supply chain and improve the company’s ability to compete and win.

Exercise senior leadership to drive inventory improvement during “yellow

flag” period.

“The ability to optimize inventory across multiple echelons, with global visibility of customer service commitments, costs, and demand and supply variability, is an inherent need in every complex supply chain.”

AMR Research

“With quite reasonable acquisition cost and attractive ROI, inventory optimization applications are quite compelling…the level of benefit may surprise you!"

IDC Manufacturing Insights


Optiant’s PowerPoint Suite of Inventory Optimization Solutions

Optiant provides an innovative solution for determining optimal safety stock

locations and levels in a complex supply chain. Using the PowerChain platform, a

user can design and model a supply chain as a network, where the nodes of the

network are the stages of a supply chain. Each stage uses a base-stock policy to

control its inventory levels and quotes a service time to its customers, both internal

and external. The PowerChain optimization engine then determines optimal safety

stock locations and levels for minimal cost of the safety stock of the supply chain.

The benefits include lower investment in safety stocks, higher return on assets,

lower on-going inventory holding cost, higher customer service levels and

increased revenue. In addition, the PowerChain suite serves as an effective

communication tool across the many functional and geographical divisions within a

typical supply chain, enabling collaborative decision-making.

For more information on how inventory strategy and tactics can be improved within

your organization, email [email protected] or visit www.optiant.com

Optimizing Supply Chains. Maximizing Results.

maximizing working capital without crippling your supply chain

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