Aggregate Inventory Management

Overview				people think about the effect of constraints and
				decisions (just another form of constraint) on
In spite of the great advances in industrial				inventory. Then, work on changing the rules!One
management in areas such as JIT, Flow				company had a 14 month buildup curve, which
Manufacturing, Lean Manufacturing, MRP/MRPII,				was reduced to 4 months. At another company,
ERP and Supply Chain Management, and now,				the longest lead time material item accounted for
Electronic Commerce, inventory investment				only 20% of the product cost, so stocking only
management continues to be a major issue for				that item, instead of finished goods or instead of
many organizations. Installing the latest software				only reacting to orders, enabled them to radically
and mouthing the most popular buzzwords is no				reduce the response time for orders by 70%. It
guarantee of good inventory management. As				also added the flexibility of being able to use that
with almost all Best Practices, it is the effective				raw material to make a number of different end
use of available tools by properly educated and				items.How to Identify and Control Inventory
trained people that creates the desired result.This				Drivers
paper covers how to set up and maintain
Aggregate Inventory Management for improved				Inventory drivers are things that tend to make
investment and operations management. It is a				inventory go up or down. Identify them and you
"macro," top-down approach that complements a				will have some clue of why inventory changes.
company's "micro" SKU (part number) level				Understanding them is the beginning of gaining
management techniques.Definition, Goal and				control. I've stated things that would drive
Objective				inventory up, e.g.: more SKU's. I refrain from
				stating the obvious: doing the opposite would
- Definition -- the APICS Dictionary defines				reduce inventory. e.g.: reduce SKU's to reduce
Aggregate Inventory Management as "Establishing				inventory.Key Drivers are covered briefly, as
the overall levels of inventory desired and				follows:
implementing controls to ensure that individual
replenishment decisions achieve this goal."It				Number of SKUs
includes:
				The more items you have, the more inventory
- How to assess overall investment levels and				you will need, in most cases. If you sell 500
set targets.				widgets a year of A, then replace it with 250
- How to identify inventory investment level				year of A and 250 of B, you will probably need to
"drivers" and help control them				carry more inventory. Why: demand and supply
- How to link aggregate inventory management				variability and total economic order quantities are
"macro" strategy to "micro" controls and develop				likelier to be higher for 2 items than for one.The
accountability				more SKU's in a product, the harder it is to bring
- Performance measurements				matched sets of parts together at the same
- Specific techniques, such as ABC analysis,				time. Because there are multiple items, with
control parameters, inventory buildup charts, and				multiple vendors, kept and routed through multiple
input-output control.- Goal -- Helps manage assets				places or paths, with more opportunity for delays,
and make money.- Objective -- Optimize				defects, etc, more inventory will be needed.The
inventory levels within the parameters of service,				more operations there are and the longer that
cost, logistics, process and investment objectives				they take, the more inventory you will tend to
constraints. Inventory management should be				have. More operations mean a longer supply chain.
exercised to keep the lowest level of inventory				It may also mean differing lot sizes per operation
consistent with achieving the objectives. Too				and more places for delays and defects to occur.
much inventory reduces Return on Investment				Process simplification helps reduce inventory.The
and Return on Assets (lower profits). It also tends				more facilities that inventory passes in and out of,
to increase expenses, in the form of interest				the further apart those are and the harder they
payments, handling and storage, management,				are to reach and pass material in and out of, the
damage, loss, obsolescence, tracking, taxes,				more inventory you will tend to have.The more
insurance, etc.Although most managers,				times inventory passes from the control of one
accountants and taxing authorities regard				system or organization to another and the less
inventory as an asset, treating it as such for				efficient the transfer is, the more inventory you
operational purposes may create liabilities. You				will tend to have.Lot/Batch Sizes
have probably heard stories about factories
working to "keep people busy" or maximize				Lot/batch sizes greater than customer order
"efficiency" and other similar nonsense. If they are				delivery sizes tend to increase inventory. If
making inventory that is not needed now, they				customers order a product one at a time, but
are often wasting money. If they work just to				economics, handling or process considerations
keep people busy, they are still consuming				suggest that you make 1000 at a time, then you
material, energy and other resources that may				will have more inventory available than will be
not earn adequate profits. They may use				consumed per order, resulting in an accumulation
resources that could better be used for more				of inventory. If you need to order things in cases,
immediate and profitable needs. If inventory is				dozens, carloads, tons or weeks' supply, but they
deployed improperly, it may create liabilities. A				are needed downstream in the supply chain in
customer of one of our clients had branch				smaller increments, you will tend to accumulate
managers who would "hoard" products at their				more inventory.The longer the lead time, the
remote branches so that they "wouldn't run out."				more inventory you tend to have. If something
This created an excess of material in the wrong				takes 16 weeks to get instead of 16 days, there
places.How to Assess Inventory Investment				is more inventory needed in process to cover the
Requirements				"pipeline" time. Whether it belongs to you or your
				vendor, it is increasing somebody's cost, which
Survey				ultimately will affect your cost and your
				customer's cost. Longer lead time also means
First, understand market, customer needs and				more chance of running out or having something
service expectations; your own company needs,				go wrong out while waiting for it, which is usually
expectations, process, abilities; supplier abilities and				dealt with by having additional inventory.Carrying
mindset; industry norms and mindset; world-class				cost
best practices.From this, you should learn how
fast and reliably customers expect to get their				This refers to the cost of owning inventory. For
shipments, what is involved to get raw materials				a closer look at these costs and the topic of
and production completed, what the best in the				inventory reduction, please see my article
industry are doing and plan to do, and what might				"Inventory Reduction - A How to Guide".How to
be possible. For instance, if all competitors are				set Inventory Targets
shipping from stock, then you will either need to
duplicate that feat, or determine how to				After considering the current situation, drivers,
manufacture very fast, or convince customers				and external situation, estimate what inventory
that your product is so great or so cheap that it				levels should be, given certain sets of
is in their interest to wait while you make it to				circumstances. There are impressive supply chain
order. Or, you might figure out how to procure				modeling tools to help you do this. Our experience
better or manufacture better in a way that allows				is that developing an accurate detailed inventory
you to carry less inventory.The result of this step				behavior model is quite a chore to create and a
is to establish what industry inventory standards				major task to maintain, so we usually don't.
might be and what is possible. Make sure you				Normally working on projects with limited budgets,
have an "apples-to-apples" comparison: there may				we study past behavior and focus on the main
be significant differences among				drivers, seeking to change a few with the
companies.Measure Current and Historical				greatest potential impact to achieve assigned
Inventory Levels and Performance				objectives- sort of a "delta' approach.Don't let us
				talk you out of sophisticated modeling tools,
Measure current and historical company inventory				though. They have their place. When there are
levels and performance, not just overall statistics,				very large amounts of money involved and/or
but broken down into levels of responsibility,				tricky constraints to work around, modeling tools
commodity, area, type (raw material,				will sometimes help. Many of the detailed control
work-in-process, finished goods, consignment) and				methods presented below contain elements of
market. Do this to help isolate figures down to				modeling.Warning: Calculating or modeling inventory
levels of accountability and to show inventory				behavior solely by using the rules and parameters
investment performance by market, process or				will nearly always be wrong. Why: If, for example,
even product line. You may find that your				you assume that inventory will be an average of
systems are unable to do that, meaning that it is				Â½ times the order quantity plus safety
past time to make changes to them, whether				stock, you'll most often be wrong. Actual supply
that be to replace them, modify them or put in				and demand variability will differ. Defective items
separate inventory tracking and control systems				customer returns may result in buildup.
(recommended as a last resort).The result of this				Unmatched sets of parts due to shortages will
step is to establish how your own company is				result in buildup. Generally, it is higher than the
doing and has been doing with inventory				model would indicate.Even the best laid plans can
management.Establish Performance Metrics				go off track if something changes unexpectedly-
				a major customer cuts orders, unexpected
Establish performance metrics - Inventory is				defects occur, requiring ad-hoc reaction, rather
usually measured in currency value, such as U.S.				than careful, deliberate, advanced planning.There
Dollars ($USD). Another, complementary way is				are two major directions to approach inventory
to measure it in velocity. For example, you might				management from-- Top-Down and Bottom-Up.
measure it in "turns" which relates to how many				Most successful companies use a combination of
times it moves or "turns over" per year. For				both.- Top-Down - this is the "macro" approach.
example, if there was an average of $100 in				Start with a goal, objectives, ABC (Pareto)
inventory in the last year and annual cost of sales				analysis of estimated or historical usage,
for the last year was $2000, that would be				knowledge of overall processes and lead times.
calculated as cost of sales ($2000)/average				Set overall targets, by business unit at a
inventory ($100)= 20 turns.More turns (or				minimum, preferably at a lower level, so that
"turnover") is usually good, provided that cost,				middle managers or even individual supervisors,
service or quality aren't unacceptably affected. If				work teams or administrative control personnel
they are, the answer is not simply to increase				might be held more accountable. It takes more
inventory, but to try to improve the underlying				effort as the control is moved to a lower
"drivers" influencing it instead, if possible and				level.Establish a tracking system, such as actual
cost-effective. There are variations of the				inventory versus target level. Compare numbers
turnover (this term should not be confused with				to actual sales, forecast. Monitor commitments
the European "turnover," which usually refers to				and production plans against targets... Hold
total sales for a period) formula, mainly in				managers accountable for results and make them
addressing how to calculate average cost of				come back with reasons why targets cannot be
goods sold or inventory.Sometimes, turns are				met and solutions to the problems. Motivate them
calculated by comparing full sales value with				to solve underlying problems. Help them with
average inventory cost or even equivalent sales				problems outside of their scope of
value. To maintain easily comparable figures, state				authority.Another good tracking tool is
all numbers in fully "burdened" costs, using industry				Input-Output Control. Simply build a time-phased
standard overhead/burden calculations, unless this				table of planned starting and ending inventories,
is contrary to the standards of your industry or				showing starting, input, output and results. Then
locality.It is becoming more common to measure				task employees to make the "delta's" happen and
inventory performance in days coverage instead				track the actual values per period.-
of turnover. People seem to relate to it				Bottom-Up-Look at each item- determine cost,
better.Inventory and sales may also be commonly				lead times, supply and demand reliability/variability,
measured in more industry-friendly terms, such as				defect rate, transportation, storage, set-up/batch
tons (steel), bushels (corn), housing units				size considerations, buffers, process, handling
(construction or real estate) or ounces (gold).A				considerations. Then set the proper planning
further refinement is to stratify the inventory by				methods and control parameters, to either default
"Quality," as asserted by Gary Gossard of IQR				down from the enterprise, product line,
International. The idea of classifying inventory as				commodity or department level to default down,
active, slow-moving or obsolete has been around				or just establish them at the item/part level.This
for a long time. Constantly track it, to highlight				takes a lot more effort than merely exercising
any change in inventory quality or condition, such				Top-Down control, but it can deliver better
as a new requisition for an item which is already in				results.Educate and train people in inventory
excess or obsolete. The active, weighted "good"				management and control approaches.How to
inventory not exceeding your "days coverage"				Control Inventory
target, divided by the total inventory, multiplied by
100, it equals the Inventory Quality Ratio (IQR)				After you do all your research and analysis, set
number. 33-40% is typical for mediocre				targets and establish your control system, then
companies. 66% is considered pretty good.All of				you get to the hard part - actually making it
these numbers can be time-phased, to show				happen.Quick hits - Simply establishing the
changes over time, due, for example, to seasonal				aggregate targets, understanding drivers,
supply and demand changes, or planned				educating and training, setting up responsibility,
improvements. These can then be applied in still				establishing accountability and tracking results
more detail to the appropriate organizations,				usually has significant effects. I have seen greater
product lines, trade channels, warehouses, planning				than 50% reductions from this alone. This can be
groups or other responsible entities and then				the cheapest, fastest way of making some
monitored for results.The numbers should be				change happen, but it has a limited effect,
capable of being "drilled" down or up, from the				because the approach lacks detail and won't make
entire enterprise level to an individual SKU				major permanent changes in the ways that the
(Stock-Keeping Unit) transaction or part number.				business works without additional actions.What is
Managers or employees should be able to look at				"Control?" - Control means to make something
total figures for their areas of responsibility and				happen or to know why if it doesn't, so that
readily identify specific problem areas down to				something might be done about it. Using that
lower levels and finally to specific items, policies,				definition, there is no such thing as an
orders and decisions that accounted for				uncontrollable situation. Someone once told me
them.Here are typical Inventory System Metrics,				that he couldn't control service inventory, because
which should be broken down by organization				of unreliable vendor lead times. Nonsense!
responsibility, area, type, commodity, market				Unreliable lead times might be controlled by
product, and time phased, with targets and actual				several strategies, such as: multiple sourcing,
values:				re-sourcing, safety stock, exhorting supplier to
				improve performance, ordering sooner, improving
- Inventory Turnover or Days Coverage				your own planning and reaction times, changing
- Inventory value or other unit of measure, such				designs, alternate routing, training customers to
as tons				order differently, having vendors stock raw
- Inventory "Quality," including IQR and				materials. At least some of these would work in
summaries of amounts of each type				almost any situation.Pitfalls of using control
- Customer service level, expressed how the				parameters
CUSTOMER perceives it
				With the use of MRP, MRPII, ERP and now
ABC Analysis				"Supply Chain Management " systems, there are
				more opportunities to improve inventory
Perform an ABC analysis, a simple, common and				management, but also more chances to lose
powerful tool for inventory management. It is				control! Unless there is a clearly stated Aggregate
based on Pareto's law of "80-20." The most				Inventory Management approach imbedded in the
common approach is to calculate demand in units,				system, through education, training and
preferably for future periods, then calculate the				parameters, yes- I said parameters!, you will likely
total usage value at cost for each item (total cost				fail.War story from George Miller: "After I left a
of sales multiplied by units required) for a given				specialty niche MRPII/ERP company for the
future period. If future demand data are not				consulting world, a customer of that company
available, the next best thing is to use history, but				called to inform me that the "software wasn't
this won't work well for items with major swings				working." The problem was that the system was
in demand over time. Sequence these in				carrying out their instructions at the speed of
descending value. Typically, the top 10 to 15% of				light, spewing forth recommendations to acquire
items account for 75-85% of value ("A" items),				inventory, based on their unrealistic parameters.
the next 20-30% account for 10-20% of value				Most of these systems have various 'gauges' and
("B" items) and everything else accounts for the				"levers," to set control parameters to tailor the
rest, about 60-70% of the items, usually about				operation of the system to the company,
5% of the total value ("C" items). Your inventory				products and process. These might be set, for
should be less than these percentages for the "A"				example, system-wide, but can usually be
items, because they are much more tightly				overridden at the business unit, plant, department,
controlled and a little higher for B's and significantly				product line and/or part number level. Each level
higher for C's.Then compare the list to actual				normally defaults down to the lower level, unless
values in inventory, plus actual and planned				you override it."For example, they used
commitments. The answers will often suggest				unrealistically long process times in the item
immediate corrective actions!An ABC list suggests				master planning records and had safety stock and
what to concentrate on to control most of the				scrap factors planned at multiple levels in the bill of
inventory investment. What it doesn't tell you is				material, "pyramiding" (increasing) demand
that being short of a $.10 screw might prevent				calculations considerably. No surprise then, except
the shipment of a $5,000,000 radar unit, so				to them, that they were well upon their way to
ensure that there are control systems for all				doubling their inventory investment in record time,
items, just control the expensive ones much				without significant benefits. The prescription was:1.
more carefully. Err on the side of caution for the				The management team to get personally involved
cheaper items, allowing a safety stock coverage				in setting the system parameters.2. Educate
or "two bin" approach to avoid stock outs, but				employees in inventory management concepts
keep inventory from getting out of control.Create				and train them in proper use of system tools.3.
an Inventory Buildup Chart				Establish and monitor a special report to assess
				the effect of "order modifier" parameters, such
Another good analysis tool is the inventory				as safety stock, scrap and attrition factors, order
buildup chart. Use a standard x-y coordinate chart.				planning method, order quantity rules, order
Plot the cost build-up over time, by product				multiples, lead time, review time, inspection
group, with cost on the "y" (vertical axis) and				time."Conclusion
time on the "x" (horizontal) axis. Normally, raw
material cost accumulates first over time,				Inventory can be systematically managed. It
followed by labor and overhead application. Allow				doesn't happen on its own. Needed is a rationale, a
for safety stocks, lot size inventory, transit				plan, education, training, organization, tools, policies,
stock, defects/rework/scrap, and normal finished				procedures and management willpower.This article
goods and distribution pipeline stocking. Show the				is also available in full on our website: PROACTION
affect of consignment arrangements. Some				- Generating Best Practices. It is an excerpt of a
people also treat accounts receivable as sort of a				paper originally written by George Miller, Founder
de facto inventory, until it is paid for. Once this				of PROACTION. It has been modified and updated
chart is completed, show it around for shock				by Paul Deis, PROACTION CEO.
value. Presented correctly, it will really make

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Aggregate Inventory Management