Elephants, Jaguars, and Tortises, Oh my!

This APICS Extra just graced my inbox and it's just too good not to share with the general Supply Chain community. There are some good, solid, basic principles here that sometimes get forgotten. Take a read. (More info at www.apics.org/extra).

Leading the Way to Agile Inventory

In the current cash crunch, it is particularly important to achieve responsive and flexible inventory management practices. Most inventory segmentation approaches involve ABC classification based on the amount or value of the inventory. While this may help manage inventory, the approach is not as useful when it comes to improving agility.

Inventory is the cumulative effect of demand and supply variability. As such, in order to advance a company’s processes and capabilities, it is necessary for businesspeople to identify the root causes that govern the supply-and-demand interaction. If professionals don’t focus on underlying issues, there may be less inventory—but there also may be fewer customers. The challenge is to understand more precisely what actions to take.

I recommend an inventory-classification system based on both sales and inventory turns. It provides decision makers with a clear plan by making it easier to focus on the items that matter. First, let’s classify the four types of products as

* elephants—items that are big and slow-moving
* jaguars—items that are big and fast-moving
* tortoises—items that are small and slow-moving
* rabbits—items that are small and fast moving.

Once inventory items have been divided among these categories, it’s time to ask the following questions:

* What are the products that make up the elephants? What is the difference between these products and the jaguars? How can elephants be migrated into jaguars?
* Are there differences among distribution centers or plants? What cross-learning can be facilitated in order to spread best practices?
* Are the tortoises consuming more than their fair share of managers’ time and attention? Is it worth it?
* Can rabbits be migrated into jaguars via special promotions or pricing?

The next step to the segmentation approach is to plot on a matrix all the products, product families, and stockkeeping units (depending on the level of analysis). Find the inventory turn for every product, and use an appropriate time frame.

Create a scatter plot, charting all products’ sales value on the Y axis and inventory turns on the X axis. Find the average for the industry and the average revenue per employee. Multiply the value by the number of employees in the company, and divide by the number of products to determine the industry average per-product sales value.

The final step is to see which of the following industry standards describe the business:

* Leader: Most products have above-average inventory turns and above-average industry sales. Professionals whose companies fall in this category should continue doing what they are doing to sustain and enhance their competitive edge.
* Laggard: Most products have below-average inventory turns and below-average sales. Anyone in this situation must act with a sense of urgency. Think of how Compaq lost to Dell because its velocity was lagging. Be careful to avoid the same fate.
* Average: Those situated in the middle must make targeted actions. Few companies remain in the Average category for very long. In time, they will gravitate toward either Leader or Laggard. Head in the right direction.

Strategies for improvement
What can professionals at Laggard and Average companies do to improve? Businesses in the Laggard category likely have too much variety. Few businesspeople realize the true cost of adding new products to the mix. Fewer still grasp the importance of regularly pruning product portfolios and keeping them trim. As a result, their efforts become diluted. Henry Ford understood the critical importance of variety when he said, “You can have any color car as long as it is black.”

While eliminating variety may not be an option, it’s certainly possible to manage it more effectively. Begin by asking the following questions:

* Can processes be streamlined to cope with variety? While many strategies, such as postponement, have been attempted, experience indicates that most Laggard companies don’t have the foundations to implement them.
* Can the number of packaging options be consolidated?
* Can the number of styles and colors be reduced?
* Are there products disrupting the flow that can be copacked?
* Are there any “yesterday’s winners” being carried far beyond their intended life spans?

Average companies likely have islands of best practices. The challenge will be to find these islands and make them enterprisewide practices. Identify the most natural way of segmenting performance—by plant, distribution center, store, product family, division, market, and so on. Draw the agile inventory chart for each segment, and find the segment that has Leader characteristics. Identify the systems, processes, tools, policies, and practices that result in superior performance. Some common themes including the following:

* Leaders plan, replenish, manufacture, and distribute frequently.
* They have sophisticated tools for rapid planning, simulation, and decision making that enable quick response to changing situations.
* Leaders have systems that offer visibility on the true state of affairs. Creating an environment in which people know their highest responsibilities are to be objective and provide real visibility can drastically improve performance and predictability. Specifically, Leaders invest in information systems (to provide visibility) and reward systems (that encourage the right kind of employee behavior).

It’s also important for those at Average companies to use a simulation or optimization tool to better understand the impact any changes will have on sales, operations, and finance. Make sure every choice is well-thought-out and balanced. Time and again, businesspeople make lopsided decisions. For example, executives at one business eliminated all loss-making products, considering only the financial impact. This choice resulted in a spreading of the same fixed expenses over a smaller revenue base. Products became more expensive to make, there was more loss, and the firm got caught in a vicious downward spiral. It’s crucial to consider all factors, simulate the implementation in a virtual environment, and dissect a change from all angles before deciding to move ahead.

Finally, maintain a continuous-improvement mindset. Start with a baseline set of measures across sales, operations, and finance. Make a few changes. Test their effectiveness. Measure the impact of the changes on sales, operations, and financial metrics. Are they in line with expectations? What are the differences? What are the reasons for the differences? What can be changed the next time around?

Keeping a sense of urgency is vital on the way to becoming a Leader. Once the goal is achieved, focus on sustaining momentum.