Some have recently expressed surprise to learn that demand forecast error (DFE) might not be the significant driver of inventory they previously thought. After all, DFE is cited as the primary root cause for nearly every supply chain challenge, including inventory, in most of Gartner’s research surveys. Other commonly-cited causes are product complexity and risk.
The beauty of these simplistic ‘inventory sound bytes’ is that they are partially rooted in truth and usually sufficient to shift the conversation away from the topic. However, the issue never really goes away and the CFO eventually acts out of frustration by mandating a 10 or 20% reduction in inventory.
Positioning and managing inventory in the supply chain is a complex topic beyond what can be determined with average benchmark comparisons or correlations against DFE. While statistically undeniable, single-variable correlations have contributed to an oversimplified understanding of the topic and led to disappointment with technology investments and other reduction efforts.
Does improved forecasting benefit inventory performance? It would be unwise to say that it plays no role, but the truth extends far beyond a single driver. The need for inventory starts with the relationship between supply and demand lead times, compounded by risk, variability, forecast error and bias. It should also depend on the economics of your supply chain, including the risk-adjusted cost of carrying inventory relative to the opportunity cost of a service failure. Blend in some other supply constraints (both physical and economic) relative to event-based demand peaks, and you’ve got a wicked problem to solve.
Some of the more persistent problems we are seeing relates to a gap between stand-alone financial analysis of inventory versus the interdependence of inventory operating drivers with other supply chain performance metrics.
– Most supply networks have been designed for low unit cost, which impairs the supply response with longer supply lead times and other constraints.
– In an attempt to remain competitive and responsive, companies are compensating for long lead times by making speculative supply commitments (well in advance of firm demand).
– Alternatively, a focus on book profitability (rather than cash flow) contributes to over-production for fixed-cost-absorption purposes to reduce the unit cost of supply.
The result of these complex dynamics tends to be dismay with inventory levels, yet no clear path to resolution given the combination of design choices and operating incentives in play. What is the answer to all of this complexity?
– Supply chain leaders must embrace their roles as the stewards of inventory health by becoming ambassadors of inventory knowledge.
– They must advocate and lead the analysis, governance and implementation of decisions that impact all three categories of inventory: structural, operating and situational.
This will be the topic of future writing. In the meantime, feel free to contact me if you’d like to discuss or share your views.