Working capital optimization during a supply chain crisis
Over the last three years, companies have been hit by a big supply chain crisis. Most companies experienced (or are still experiencing) high demand and supply fluctuations. All this has put enormous pressure on supply chain organizations to increase inventory levels to maintain high customer service. Stock levels are at an all-time high due to companies’ start-stop production strategies of the last two years and the bullwhip effect it has caused. In times of high inflation, which causes rising interest rates and will likely lead to a slump in demand, the bullwhip effect is waiting for its next turn to hit supply chains.
Having in mind the mistakes many companies have made after the financial crisis in 2008 and COVID-19 in 2020, it is key now to not make the same mistakes again. Inventory reductions are needed – but don’t do it rigorously, do it smart! In this blog, we’ll explain what (not) to do in the short term and how to effectively deal with the bullwhip in the long run.
Seemingly effective short-term actions to reduce inventory that turn out to be a slippery slope
When being under pressure to reduce inventory, one thing that companies often do is lower the safety stock levels for all products. It is an easy-to-implement action and it has a direct effect since replenishments for the short term are postponed and inventory will drop accordingly. Don’t do it! It will lead to lower service levels – amplified by the demand and supply uncertainty that most companies currently face – and a further increase of the bullwhip in the supply chain, with all its well-known consequences.
Another easy-to-implement reduction of inventory can be achieved by reducing the portfolio, for example by creating an ABC-XYZ portfolio categorization and then stopping to supply products with a low margin and a high demand volatility (CZ). Although many companies have complex portfolios, it should not crash actions to rationalize. A lot of companies, especially one-stop-shop companies, own their right to exist by being able to deliver all products. Hence, by lowering service levels for C-products the margin on high runners (A-items) might be negatively impacted too.
Truly effective short-term actions to reduce inventory during supply chain crisis
A bottom-up analysis of your product portfolio, customer service offering, and supply chain dynamics will help you detect the inefficiencies in your supply chain without negatively impacting customer service. We’ve supported a lot of inventory reduction programs and typically concluded that 50% of the inventory reduction potential are quick wins, for example:
- Reduce lead times: Companies often adhere to lead times in their master data, which were put in there by planners a long time ago and do not reflect current supplier agreements (i.e. safety and cycle stocks can be reduced).
- Reduce lot sizes: If demand slows down, capacity becomes available. When inventories are getting more expensive, smaller lot sizes than what we have been used to, are a logical consequence.
- Rebalance inventory: Companies with multiple inventory locations can often solve understock of a product in one location with overstock at another location, of course considering the costs of rebalancing.
- Remove duplicate safety stocks: In multi-echelon supply chains, companies often keep safety stock at consecutive stages of the supply chain. Usually, the analysis shows that keeping (a lower) safety stock at one of the locations is possible.
- Differentiate service levels: Smart differentiation of service levels over the product portfolio can help to reduce the total safety stock whilst increasing the total customer service level, of course, considering the importance of the product in the total customer service offering.
Effective ways to reduce the negative impact of the bullwhip
In the long run, the best way to mitigate the negative effects of the bullwhip is by focusing on more sustained actions.
The most resilient supply chain is a short supply chain: Reduce lead times by reshoring, near-shoring, and regionalizing. Other than that, here are the main three actions you can take to confidently handle supply and demand fluctuations:
Improve forecasting: Combine baseline statistical forecasts (time series) with driver-based forecasts (events), and share this forecast throughout the entire supply chain.
Reduce lead times: Lead times consist of psychical delays and information delays. Information delays can be reduced via improved communication technologies (EDI) and by creating end-to-end supply chain visibility and planning; Exchange true demand data with supply chain partners and utilize this to set up a collaborative ‘planning and forecasting agreement’ or, if you want to go one step further, a ‘vendor managed inventory contract’, to utilize the supplier’s economies of scale (not to only offload inventories to another balance sheet!).
Create ‘flow’ in the supply chain, i.e. reduce batch sizes: A reduction of set-up, order, and handling costs will lead to lower (optimal) replenishment batch sizes and in that way reduces the bullwhip effect.
Moving from words to action
Nice words, but many supply chain managers need to reach their inventory reduction target towards the end of this year already. EyeOn can help to swiftly get insights into quick wins utilizing our state-of-the-art forecasting and inventory models.
Reach out to us to learn about our approaches. Let’s solve your inventory challenges together!