If you're a corporate financial officer, one of the ways you are measured is by your company's return on invested capital. If you're a private equity investor, you live and die by your ability to free up cash from a business. Either way, it's pretty much the same thing: you've got to turn assets into cash.
Inventory = Cash
Inventory is an untapped, cash-rich asset. Most manufacturing companies have installed supply chain systems to manage inventory from production through delivery. But these systems typically focus on transactions. These solutions have the ability to control what happens and provide visibility into the supply chain. But what these supply chain systems are missing is optimization and analytics functionality -- that extra logic that drives the supply chain to operate more efficiently and throw off more cash.
Believe it or not, that missing piece can cost a lot. For example, an executive from Cadbury Schweppes' Americas Beverage division, speaking at the SAP Logistics and Supply Chain Management (SCM) conference in February 2007, detailed more than $7 million in inventory savings (more than 12%) within the first three months after implementing an inventory optimization bolt-on solution, not counting inventory savings from process changes associated with the project. This was specifically for their finished goods division, which included bottled product of popular brands such as Dr. Pepper, Motts and Snapple. The company also identified additional millions (3% - 4%) in expected savings from use of inventory optimization software, based on incremental improvements slated for the year ahead.
Of course, every manufacturer of goods needs plenty of inventory. Inventory is product -- it is what you make and what you sell. If you slash it too much and don't have what customers want, when and where they want it, you may lose that sale. In today's world and explosion of the Internet, customers now have more choices and are less captive than ever. The rule of thumb is customers will switch to another product 50% of the time if yours is not in stock. That is a gross margin loss on any particular sale and money that does not go to the bottom line.
A Balancing Act
That is where inventory optimization comes in. It balances inventory and customer service levels -- order fill rates, the percentage of time you deliver goods to customers as ordered and promised -- to calculate the optimal mix of where to put your cash. Inventory is like any investment -- it requires the right mix of risk and return. The risks are locking up cash in too much inventory or losing revenue because of stock outs. The return is rapid asset turnover into cash.
Inventory optimization systems calculate inventory and service levels automatically and dynamically to meet your business objectives on an ongoing basis, and direct your supply chain accordingly. These systems let you specify the aggregate inventory and service level balance that works right for your company -- even vary it across products, customers, time intervals and geographies.
A key reason for this is inventory optimization systems use advanced logic and analytics to model and understand your forecasted demand. Behind the scenes, millions of stock keeping units (SKUs) are modeled statistically against variables like volumes, lead times and lot sizes to identify the right stock level and replenishment rate for each product in each location.
The systems hedge for the daily demand and supply volatility and random behavior across your supply chain, from finished goods assembly to the end consumer or retail shelf. They can handle challenges like promotions, product phase-in and retirement, expiration and shelf life, end of season closeouts and new product launches -- all crucial in an age of product proliferation and shorter lifecycles.
A Tweak, Not A Replacement
Inventory optimization systems bolt on to your existing management solutions. They provide a new logic to drive the systems and are cost effective since you do not have tear out and replace your information systems, with all the cost, man-hours and lead time that entails. You can just apply the new logic on top of the current one. It's like adding a thermostat or control system to already installed infrastructure. That means inventory optimization solutions go in fast, in typically three months or so. You can expect fast payback, too -- reductions in working capital employed will recoup your investment in six to nine months.
You can measure that return on investment -- count that new cash -- several ways. One is by the amount of cash generated from lowering inventory -- a dollar of reduced inventory is a dollar of cash generated. Another way is by the cash generated from fewer lost sales, which can greatly improve your bottom line.
It all adds up to better return on working capital and more day-to-day liquidity, based on significant, sustainable improvements to underlying operational efficiency.
Joseph Shamir is the CEO of ToolsGroup, a company that offers inventory optimization software for demand-driven supply chains, from assembly of finished goods all the way to the end consumer or retail shelf. For more information on ToolsGroup and its solutions, please visit www.ToolsGroup.com.