How to Reduce Inventory & Working Capital
Welcome to this S&OP MasterClass.
These MasterClasses have the purpose of diving into Integrated Business Planning and Supply Chain Planning in general, hopefully giving you some good inputs on the way.
Inventory levels, working capital, safety stock.
Everything related to supply chain planning is a hot topic. However, the real question is: How do you optimize your supply chain without sacrificing service levels?
We will discuss all this and much more in this episode of S&OP MasterClass™, where the guest speaker is the knowledgeable Benjamin Obling.
Benjamin will share his insights on:
- The influence of internal and external factors on supply chain planning
- Stock policies and strategies
- Balancing inventory with data and gut-feeling
- And much, much more.
Your host is Søren Hammer Pedersen
The podcast is produced by Montanus.
In This Episode
In This Episode
Below are the crucial timestamps from this podcast episode. You can jump to the topics that interest you.
01:29 Introduction to inventory optimization and balancing
05:14 How external factors influence supply chain planning.
08:19 How internal factors influence supply chain planning.
10:52 The importance of stock policies and strategies
14:31 The planning behavior impact on stocking strategy
18:40 Inventory optimization and balancing will be the responsibility of supply chain planning: How can this problem be fixed?
25:54 Fighting inventory optimization downsides and balancing with a fact-based approach
30:38 The results of choosing a data-driven assessment
35:26 Automation is critical to making it work in the long run
Full Episode Transcription
Søren Hammer Pedersen (00:08):
Hello everybody, warm welcome to this S&OP MasterClass from [inaudible 00:00:13], and from Perito IBP. My name is Søren Hammer Pedersen and I’ll be your host for this podcast here today. The purpose of these S&OP MasterClasses is to dive into hot and trending topics within supply chain planning, give you our perspective on this. What do we see from our clients, the companies that we talk to, and hopefully give you some tips and tricks along the way that you can utilize in your own planning. Today’s topic is no different. We are going to talk about inventory reduction, working capital reduction, something that’s really hitting a lot of companies out there and also supply chain professionals, and how to do that in a balanced way. But you are in luck. It’s not just going to be me here talking in the studio today, I brought in a true supply chain planning expert, my good colleague Benjamin Obling, who’s going to help us talk about this exciting opening. Very welcome, Benjamin.
Benjamin Obling (01:08):
Søren Hammer Pedersen (01:09):
People might not have touched upon you before, so before we get into it, maybe give a short introduction, who is Benjamin?
Benjamin Obling (01:16):
Yeah, so my name is Benjamin Obling. I’m COO with the Perito IBP. I’m been working with the Sales And Operation Planning, Integrated Business Planning for a lot of years in many different industries and companies.
Søren Hammer Pedersen (01:29):
Perfect. Benjamin, let’s just get right into it. Today’s topic, it’s not a new thing out there. If you go five years back, we were still talking a bit about how to reduce inventories. What is it that you see at the moment in the companies that makes this, so relevant also for the supply chain planning professional community at the moment?
Benjamin Obling (01:51):
Yeah, I agree. Inventory optimization and balancing has been important for almost for ages, obviously you could say going from a supply chain crisis, so the COVID as the good example, then the supply chain disruption after that, Suez Canal, et cetera, where the problem was material shortages. And you also had an increase in demand right there under and after the COVID in many industries. Then seeing that shortage, meaning that you would get a lot of goods, you would want to buy a lot of goods if at all possible, having that rolling in the inventories. Then in some industries seeing demand starting to decline and with long lead times, then the goods are still approaching. So now you might see, or some industries are seeing increasing inventories. And you can say another element in that, the reason for being that it’s more interesting or relevant now is of course the change in cost of capital. So obviously now with a high interest rate, cash is king again. It has always been king, but maybe not the biggest of the kings, and now it’s really back, because it’s expensive.
Søren Hammer Pedersen (03:01):
Yeah, so you say there’s a lot of external factors hitting the, or have been hidden in companies for a long time. But the difference maybe now is that you’re actually feeling the consequences quite a lot if you had that really significant growth and lack of components for quite a while. It might not have been a problem three years ago, but now?
Benjamin Obling (03:23):
Yeah, I could see the ones with the material shortage, for them, it certainly was a problem, because they were not able to support that demand. But then really increasing the inventory is just making sure whatever materials we can get almost, that was the situation, say one or two years ago. You just wanted to buy that. And then having basically a too high level when you get back into a normal state, which you could say that we are now in a different normal, where you have the lead times coming back again. You don’t have the supply chain disruption in the same sense. Of course, things are still volatile, changing, et cetera. That’s something we can handle. Now it’s all about rebalancing and making sure that you get the inventory is reduced. But on the other hand, keeping that resilience, so when something new happens, “Okay, are we then in control? Are we resilient?” So if suddenly supplies from region X stops, okay, how is that going to impact us? Building that resilience so you can cope with that without having too high inventories.
Søren Hammer Pedersen (04:29):
Yeah, and I guess also, staying on the external factors, another thing is cost of raw materials. In many industries that’s also been quite a new thing, not in recent ones, but if you go back, it has increased quite a lot out there. That is also, I guess, something that’s hitting the inventories, and the productions of course.
Benjamin Obling (04:53):
Yeah, certainly. Yeah, raw material prices going up, raw material inventories then going up in order to serve that excess, that additional demand that a lot of companies saw back sometime, like one or two years. But then now prices seems like stabilizing, and then it’s again about rebalancing that inventory back.
Søren Hammer Pedersen (05:14):
So from a supply chain planning perspective, we have a lot of different external factors hitting the companies, and in the end, it becomes the Planning’s problem, because we need to answer the questions and align to the pressure coming from C-levels in the companies to fix this. One external factor that we haven’t talked about, is something that actually goes the other way around. Something that we see from our clients sometimes, actually a new situation of sales dropping quite dramatically in recent months, and maybe the last half year. How do you see this affecting this situation as well?
Benjamin Obling (05:56):
Again, especially affecting when you have the long lead times obviously, or you have the production capacity you need to adjust. So when we start to see things dropping, like the external sales dropping, “Okay, how do you adapt in the fastest possible way?” On the other hand, not reacting, not overreacting, because that’s also what we see in many cases, when you see a sudden drop in demand for one, two months in a row, okay, should you then adjust the whole demand plan downwards? And then say, “Okay, this is the new situation, we’ll see a drop, then stop the different supplies, reduce the capacities and so on. Then it might just bounce back because we also see that.
That’s, you could say, the element about being agile and change fast whenever you have a durable or permanent change. But on the other hand, not overreact, which is easy to say, hard to implement. But you could say, in general, in many cases, looking at a bit longer perspective is an advantage, I would say, in many situations. Things tend to bounce back eventually. A bit like the very long lead times we saw, material shortages, that did bounce back. Now we have shorter lead times, et cetera. Increased demand over in COVID for example. Okay, went up to a very high level in some industries, and collapsed in others, but with the ones being really high, it also bounced back into the normal level.
Søren Hammer Pedersen (07:21):
Okay, [inaudible 00:07:24]. So the external is one thing, and I think the external factors is typically the ones we hear the most about. It’s the easiest to explain. It’s also where all the bad excuses lie for why we have it. So that sense, it’s really well-documented that it’s out there. But I also think that we see quite a number of internal factors within the companies who have actually helped, or, “Helped,” sorry, maybe the wrong word here, but have been a reason for building up these inventories. One thing that I have seen numerous times is the lack of focus on the actual supply chain footprint. Could you try to elaborate a little bit on how you see when you have the wrong inventory footprint, how have you seen that affecting the inventories within the company, and why this is a problem for many?
Benjamin Obling (08:19):
Yeah, it’s really, you could say a structural issue, and that’s why maybe sometimes don’t really see it, because you have whatever inventory structure you have, it’s placed in different locations. You have the very local warehouses, and if you have that, you have regional warehouse, global warehouse, one or two. We’ve even seen two global warehouses in some companies. And then, okay, how do you challenge that? And that’s really what you need to then take the step back, and then say, “Okay, but is that really the right footprint? Is that the way that we should place our inventory?” And also is that the flow we should have? So if you have everything flowing into a global inventory for example, and then redistributing to the local inventory or regional and then to the local inventories, is that the right way to go?
So if you have the demand in China, obviously that would be the easy example, right? Why don’t you just purchase it directly into China, if it’s actually produced or purchased there? Instead of flying that to Europe, or going by sea, and then sending it back, which is real examples. But you could say in some cases it does make sense to have it over the global warehouse, because you have very lumpy or scattered demand. So it makes sense to consolidate it in one or few central places, and then you’re distributed when it’s needed out there. In other cases, that doesn’t make any sense at all. If you have plastic gloves in China, you purchase in China, you use it in China, why would you ship it over Europe, for example? It doesn’t make any sense, but it can make sense in other situations. You really need to have that detail and data-driven analysis of what makes sense down to the item level.
Søren Hammer Pedersen (09:53):
Perfect, all right, and makes sense in this way. And I think it’s important to have this discussion also for the internal, because I think there’s a tendency for us to run for the external and try to fix everything. But if you have this structural problem within your company, then of course you won’t get anywhere with all your nice efforts. And another internal thing that is actually quite interesting, and something where we need to step back sometimes before doing all our corrective action, is around the strategy. Basically the inventory strategy and the whole supply chain planning strategy, where we have this situation where we actually have quite high inventories, but we have lost sales, we have still not living up to service level, things like that, because we have the wrong items. How have you seen that in the companies that you have worked with?
Benjamin Obling (10:52):
It’s a really fun question to ask, “What is your stock policy or your stock strategy?” And it’s really great being a consultant and then asking that question, because then you have a lot of silence in the room, and people sort of look embarrassed at each other, and, “Okay, so who actually runs that? What is our strategy? Where is it written down,” et cetera. And it rarely is. And it’s also very easy question to ask of course.
So very consulting frankly, but you could say what is really important is of course to actually build that strategy. And then say, “Okay, first question would be what do we need to stock? So what is made to order or buy to order? So what will we only purchase or produce whenever we have a customer order at the other end? If we can get by with that, that would of course be the optimal setup. We should do that. The question is, will our customer, will they actually accept the lead time which is then required in order to do that? Because when they place the order, we need to produce it, purchase it, et cetera.”
The next question is, okay, if that’s not acceptable, the long lead time of say 10 weeks for example, then the next question is, “Okay, but could we get by with two weeks for example? So if we purchase all the raw materials which have a longer lead time, and then we make sure we can actually produce it in two weeks instead, can we still get by, and then stock it at the semi-finished or the raw material level? That would be less costly for us to do.” So that would be the next question in the stocking strategy. Now we have something at raw material, semi. Sorry for being a bit detailed here, but you can say that’s really the key in the stocking policy.
And then the next step would be, “Okay, that’s still not acceptable. We need to have day-to-day delivery, or two weeks, that means including transportation time, et cetera. We need to have it ready on the shelf right now. Okay but then we need to have it as a make to stock.” And that’s our question, then say, “Okay, so now we need to stock it.” Yes, no, that’s the first question in the stocking policy.
And you could say that’s really also where you need to balance it with sales and the commercial perspective, because you could say, “What is the gross profit that we have on this item or this customer, et cetera? Do we have some cross-selling on this item for this customer for example, that we need to take into account?” So that’s really a commercial decision, but it needs to end up in say in the ERP system, the MRP, knowing there is a safety stock, yes or no. So it needs to go all the way down to the planning data in the material master, something as boring as that, but that’s really where you need to make the link to the commercial side.
Søren Hammer Pedersen (13:28):
Yeah, I think a very good example also why it is that you need to think before you act basically, because we see a lot of projects going ahead quite fast without having this step. What is the actually issue code basically that we are looking at? And maybe forgetting this step and doing a lot of other activities before you actually know what you’re looking at.
Benjamin Obling (13:52):
Yeah, adding to that, you could say that and I would say probably the majority of companies out there, the real stocking strategy that is there, is actually a trial and error. So when you have sales, or a customer hitting you in supply chain planning, that they couldn’t get there, they had a stock-out situation, a dry run, you would put some safety stock, or you would turn it up slightly. Then when you have the CFO in the next week coming in saying you have too much inventory, you would divide everything by two, or something like that. And that would be your strategy actually, not much of a strategy, but …
Søren Hammer Pedersen (14:29):
But not that uncommon.
Benjamin Obling (14:30):
Søren Hammer Pedersen (14:31):
No. Last point before we dive more into what do you actually do about this, then I think still one internal factor that’s quite important to bear in mind, is planning behavior, or what you can say the actual planning behavior. I think we have seen some example of really good systems, really good processes, well described, everything is ready and implemented. And then six months down the road, we are in the exact same spot. That’s not uncommon. How have you seen this out there with the planning behavior, and why do you see something that we need to take into account?
Benjamin Obling (15:11):
Yeah, so the behavior that you need to address is of course, so do we actually then set out to do and execute the plan that we agreed on? And if we go back to the stocking strategies, or we decided on what to stock, what not to stock, at which levels, and then the next step in that, just round that one off, would then be which service levels do we need at the different items? So optimizing having the least dry runs with the lowest working capital. Then we’ll say, “Okay, we’ll have 99% service level here, 95 here, et cetera,” calculating that into specific safety stocks, or safety days, et cetera. So that’s the total stock policy. And then you have that, and we’ll have it on the S&OP meeting, we’ll agree on it, and set out to do it.
That’s where the behavior kicks in, because will the planner then actually buy and produce according to those parameters that we have in the ERP system? And that’s really the behavioral side, which we see as a huge impact, because a lot of planners are used to looking at the MRPs, or the automated material flow calculation in the ERP system, but then they look at the Excel spreadsheets to the right of that, on the different screen. And then saying, “Yeah, okay, it says I should purchase it in four weeks, but I’ll go ahead and purchase it right now, because I had this situation with a key account manager yelling at me four months ago. So I don’t want to make a dry run again.”
So you’ll actually then override, or you will advance the proposals that you get in the ERP system, which was actually now set based on the right stocking strategy. It was set on the right service level that we want, optimizing the gross profit, et cetera, and the inventories. Now you do something else, because you are used to doing that because you’re used to not being able to trust the proposals from the ERP system, and then you start to have a discrepancy or difference between where are you and where should you be, and that’s the behavioral part we need to address.
Søren Hammer Pedersen (17:09):
Yeah, so we are fighting normal human behavior here in the sense that of course we try to cover ourselves, we try to work as good as we can, but from the company’s perspective, we just think, “They follow the process, of course they do,” but it needs to take into account.
Benjamin Obling (17:24):
Yeah, and then of course also making one point here is to make sure to keep the respect for the planners, because they also advance and postpone, do different things than the MRP, or the automated proposals for good reasons, and we need to keep those good reasons. Because if you’re just run by the MRP automatically, there might be some specific logic that you don’t take into account. So that could be that, “Okay, for this supplier, we know that he has a longer lead time right now. We’ll not change it in the system, but I know that I just talked with Peter over at the vendor et cetera, so it’s going to be a bit slower, so I’ll advance that.” And that’s the good changes that we need to take into account, where the human brain, the interaction, et cetera, can actually do something good for us. So that’s also important to keep that respect for the manual overrides, because they are sometimes there for a good reason. We just need to address the ones that are not good.
Søren Hammer Pedersen (18:21):
Yeah, to find out where the not so good reasons are in place.
Benjamin Obling (18:26):
Exactly, and then making sure we get the loop back to our model to make sure that we can incorporate these good reasons into the model, so that next time we’ll have an even better proposal, so we can go more and more automated, and be more and more balanced in the inventories.
Søren Hammer Pedersen (18:40):
Sounds good. Yeah, I think we have verbalized a lot of different reasons, both internal and external, and one question our listeners might have now, is why should I care from a supply chain planning perspective? The easy answer I think to that, is because if it had not become your problem yet, it will become your problem soon. Because we see a lot of companies out there now with pretty firm demands coming from the CEOs, from the CFOs, of working capital reduction, inventories reduction.
And maybe not having that much of a rational behind it, other than, “Now it’s too high, you fix it.” And I mean it when I say, “You,” because it won’t be them going into a long debate about how we do this, this will be Supply Chain’s problem to fix this. The underlying problem to that, is that the task is for Supply Chain to reduce inventories, reduce working capital, but do it in a balanced way so we don’t hurt service levels, we don’t hurt customer expectation, we reduce the Cap-Ex at the same times. All of these very positive things within the company remain, but fix it now, and it’s you. So if I was the listener now, Benjamin, and looking at you, I would say, yes, I have this problem, so how do I fix this?”
Benjamin Obling (20:15):
Yeah, and the thing is, seen from the Supply Chain point of view, that you actually need to get a bit of into the helicopter and look across the company, because here we really need to align what is the commercial perspective on this, on Sales, because obviously Sales looking at that isolated, they would like as high service level and availability as possible, because they’re normally getting their bonuses based on the total revenue, and of course losing revenue is not a good thing. And obviously they should be focused on the sales for a good reason. On the other hand, you have the CFO who would like to decrease or CEO, who would like to decrease the working capital you have, because there are more fun things to spend the money on like purchasing other companies, new machinery, et cetera, or getting money back to the shareholders.
So you really need to balance that, and that needs to happen in one optimization, and one also commercial balanced approach, and the way of doing that, is really to align to say, “Okay, so if we have these target service levels, this stocking strategy, and these target service levels in different product groups for different markets, et cetera, we align that with sales, and we know what will be the working capital impact of that.” Because then we can have, say a data-driven discussion, an fact-based discussion across the company on what is actually the most optimal inventory level for this company.
Because if we don’t do that, at some point the pressure on decreasing working capital will be so big that it will just be a, “Okay, well let’s just reduce the safety stocks by 30%, because now we just need to do something, a year-end is coming, we need to reduce it. Or stop purchasing, block new purchases.” Which can sound good in the sense that, okay, then inventories will go down, but it’s a bit like when you have an airplane and you shut down all the engines. At some point you will crash and that’s really not what we want to do. We want to fly a bit lower and more optimal, but we want to have that balanced with the commercial perspective on the company.
Søren Hammer Pedersen (22:16):
Yeah, so step one, what I hear you say, is that basically to demand that we have a fact-based project, or at least assessment around what situation are we in. We listed a lot of different situations, and I’m quite sure that the actions are not the same in all the situations we mentioned. So step one, stop, breathe, find out basically where you are, and insist on having facts on the table, and doing some, instead of those really quick, let’s just cut everything by 20%, kind of decisions here.
Benjamin Obling (22:52):
Exactly, because otherwise you’ll get around the table in the management team, and you’ll have this great discussion about should we increase availability, or decrease availability and then decrease the inventory levels. And you’ll have the COO, maybe the CFO advocating for reducing the inventories. Maybe you’ll have Sales advocating for increasing. And you could say, there is the saying that facts have ruined many good discussions, and even though it certainly would ruin some of the discussion, we really see that it changes the way the discussion goes when we start to add the facts. Because no one in Sales wants the inventories to explode, of course. They want to have as high availability as it makes sense. And on the other hand, no one wants to have a lot of dry runs and stock-outs, so it’s really a matter of balancing that. And when you have the facts there, then you can start to make different scenarios, and say, “Okay, well then maybe this is the level of working capital that we have, and can spend optimally.”
Søren Hammer Pedersen (23:49):
Yeah, so you’ll have this in-between step, where we get the facts on the table, we analyze the situation, do the supply chain assessment basically, and find out where we are. Then there’s an element of, okay, you’ve probably gotten a task from the CEO saying, “Yeah, please reduce inventories two months from now,” which in supply chain planning terms is like now. But the point being that usually there’s a bit of panic around this situation. We need to show that we have, how does the roadmap look for this basically? Can we do something quite fast? Or do we need to take a year out of the calendar to do these kinds of assessments or in-between steps before we actually implement something new in the organization?
Benjamin Obling (24:44):
You can do that fairly fast, or at least getting, say, first new automated figures. So to make sure, okay, we get the raw data we need in the model, set up a model for this. So use the right tool for it. And then balance the inventories, and then having that discussion, setting that up, is something that can be done in a fairly short amount of time. Then you can have the first optimized set of parameters and tools to address the behavioral side, and start to track and monitor that you do see the inventory reduction. And then of course adjusting and optimizing the algorithms afterwards so that you can see that it’ll also be a durable, or permanent change. Because that’s another pitfall you can fall into, is that when you put a lot of focus from the management team on reducing working capital towards year-end, or whatever, you’ll probably see it because purchasers will start to not purchase, et cetera. And then when you start to focus on something else, the inventories will just jump right up back again. So you need some tools and processes in order to keep that behavior.
Søren Hammer Pedersen (25:54):
Yeah, because I guess a problem that the supply chain professionals will have here, is that the quick-fix solution, let’s just keep with a simple example of 20% off of everything, basically, Green Harvest method, compared to something that will have an initial investment probably, will take longer time. How do you persuade the C-level to go for this, or the CEOs to go for this?
Benjamin Obling (26:24):
Yeah. One thing is you could take some good examples from the data, and then show exactly that, okay, if we go with this stocking strategy on these items, or these item groups, this is what is going to happen. So you’re going to have this many stock-outs and dry runs, et cetera, if you just reduce it. Because here you’re already too low, and you’re now going to reduce it even further. So that’s going to cost you X amount of dollars, or euro, in terms of lost gross profit because of the stock-out, the dry run. On the other hand, you can show some other examples saying, “Okay, here you’re way too high because the planner got burned some time back, because you had a dry run, it was over-steering. So you did too much of corrective action in this trial and error, which happens. So you increase the stock levels way above what is actually needed in order to have this optimum.”
And then in showing these examples is one way of showing that you really need to fight this at the detailed level, unfortunately. I mean that’s the bad news, right? You need to be at item level. When you get it right, you can of course set the target service levels, optimize the inventories, say on total levels, say, “Okay, how much work in capital can we spend? Or what is optimal from a financial point of view at different groups or markets?” But you need to have the model, the tool, which will take it all the way down to the single stocking point and single item, where you need to win. That’s where the customer will be annoyed if they don’t have the … They don’t care about the product group or market.
Søren Hammer Pedersen (27:59):
Obviously, no. Yeah, so you’re saying show result quickly, but do it like what can we do on a short-term, midterm, long-term? And focus on the facts. I guess also the assessment or the fact-based approach allows you to answer some, both answer questions, but also pose some questions back to the CEO. Meaning, “Okay, if we actually reduce this by this much, or change the service level quite dramatically, or remove the safety stocks all around, you will go stock-out on these A items, X amount of times during the year. Are you ready to have that in your [inaudible 00:28:46]-
Benjamin Obling (28:45):
Søren Hammer Pedersen (28:46):
… or will I have sales coming like the world has ended three months down the road?” I think those kinds of factual and questions you’ll also get out of the fact-based approach.
Benjamin Obling (28:59):
Exactly, and that’s really where you need to sit around the table and have the commercial side as well there, the Commercial Director, have the COO, have the CEO, et cetera, and the CFO around. And then saying, okay, look each other in the eyes and then say, “Okay, so what is actually optimum here? We have these four different scenarios.” And I think that’s really the way to go, that you need to be able to make the different scenarios on the different target service levels, and looking at how many dry runs are you going to get, what is commercially acceptable, and be able to take it all the way down to the single item. Because if you just do very rough cut, let’s say, external benchmarking, for example, you don’t get anything to discuss around. Or you’re not able to make scenarios. Because if you just say, “Okay, so we have a stock turn of X, and I can see in the industry comparing to five different companies, we should have Y,” so something which is a higher stock turn, for example.
So, “Go do and then we’ll just multiply everything by, taking it down 30%, but it really won’t help us because again, it will hit, how do we hit the specific item numbers? That’s why we need to win this.” So you need to be able to demand from the assessment, the data-driven assessment, that it needs to be able to take you all the way down to the lowest level, but you also need to be able to group it so that you can, from a management point of view, act on it. Because you cannot act on single item levels, obviously, but what you can act on, is, say, what are the overall target service levels in different groups and markets? What will be the gross profit we lose if we don’t increase the inventories? Or if we reduce the inventories, what will be the cost on the other side?
Søren Hammer Pedersen (30:38):
Yeah, I think maybe the last thing, is we have the fact-based, we have built the business case. Obviously, we were trying to get the approval. I think one question of course, is can you get enough out of this? You have to justify the Cap-Ex going into, you justify the delay maybe that will be because we are doing this analysis compared to just a quick panic solution here. So basically what can be achieved by having this approach, and going forward? So what is your experience of the optimization potential? What have companies in your experience gained from having this approach?
Benjamin Obling (31:26):
Yeah, so if you have a data-driven assessment as the step one in, you could say, you can have the overall benchmarks maybe as a step zero, just to see, “Okay, are we off in our inventories? Yes, we are. Okay.” Or maybe you just know it and you go directly to the data-driven, saying, “Okay, so now we need to know why are we off, and what can we do about it?” So instead of just starting with implementing some new process, or some new tool, et cetera, unless you really know what the problem is, then the assessment here, data-driven assessment will help you to say, “Okay, what is the problem?” So one thing could be the forecast, the demand forecast, is off. Okay, then you can make a benchmark there again at the lowest level to say, “Okay, how much can we actually increase demand forecast accuracy?”
And then we see whether we can reduce, in many cases, the errors here by 20%, or 30%, depending of course on where the company is coming from. But that will answer, “Okay, so do we gain anything here from improving the forecast method?” So that could be a tool and process combined in most cases will do the trick. The next question is, “Okay, so how will that impact the working capital?” So first of all, how does the improved forecast accuracy, but also how does the optimized inventories, can they be optimized? So the parameter side, so the parameters that we have in the ERP system, [inaudible 00:32:53] to plan after. So that’s the target inventories. Are they set correctly? Or are they completely off? Normally it’s somewhere in between. So you can do optimizations. I haven’t experienced yet that you cannot optimize it.
So the question is, “Okay, how much, and is that enough to justify the investment you would need in order to do it?” So that’s the second step. There we can see in many cases we can reduce inventories by 15 to 30%, even if … But again, obviously depending on where the company comes from, it could be that you actually need to increase your inventories, and that’s, “Okay, we won’t do that, but then now we know what is the cost actually on the lost sales, on the dry runs in terms of gross profit lost.” So here you can see, okay, so what will it actually give us in terms of higher availability or lost sales, reducing the lost sales? And on the other hand, the inventory, the working capital reduction.
So that’s the sort of hardcore business impacts. And then the next question is, “Okay, and what is it we need to fix?” So is it the demand planning, is it the inventory parameters, the targets, is it the stocking policy, or is it the behavioral side? In many cases, it’s a combination of all of those three, but those three would be the main drivers in most cases.
Søren Hammer Pedersen (34:15):
Yeah, and I guess if you are sitting out there being worried about, “I wonder if there is a business case in this for my company,” there’s a good chance if you got the assignment to fix this from your CEO, then there’s a business case because something is probably wrong. But we see these quite high improvements, and it is a vital point getting the investments, or the changes even, approved in the companies typically, to have this business case, and have the facts on the table.
Benjamin Obling (34:48):
And then also certainly coming out of the supply crisis that we’ve had over the last year, where you could say getting materials was sort of problem number one. We see in many cases that the target stocks are then too high, because they are covering for a lot of uncertainty and supply disruptions that we don’t have currently. Then of course you can discuss what resilience should you still keep in the supply chain, but still having, you could say, too high target service levels and inventories in many cases. So you can actually take that down. But again, if you just do it across the board, you are very sure to have too little on some, and still too much on many.
Søren Hammer Pedersen (35:26):
Yeah, maybe the final point on the business case, or the improvement potential we haven’t touched upon, is automation, because I guess that is the last point that’s missing in the business case, because one thing of course is setting all the parameters and making … But you need to make it stick in the long run. So you need to both have the process and the automations in place. How do you see that playing into many of the improvement processes that you’ve been working on latest?
Benjamin Obling (35:54):
Yep, we certainly see that there is a bigger and bigger automation potential in the planning processes. So the examples would be in the demand forecast side. So as example, some of the percentage improvements that I outlined just before, is actually without involving anyone, and any humans from the organization. So we can actually in many cases, improve forecast accuracy without having involvement. Then you can add involvement on top because that does make sense because sales people, the organization, they know things that we can’t see from the data. So new customers coming in, items that are going to be out-fazed, et cetera, obviously we need that input. But again, on the vast majority on the items in demand planning, for example, we can actually automate that to a very high degree, leaving out more and more time for more, you could say value-creating processes. Because the people who are doing this are normally very scarce resources that can do a lot of other good things in the company.
The same goes for inventory optimization. Setting the stocking policy and strategy is something you need to spend time on, obviously. But then you automate all of the different logic in what we call a decision tree. So you have a decision tree saying, “Okay, in these cases we do X, Y, Z because of this optimization.” And then you can actually automate it, and make sure that it’s updated all the time without spending a ton of time doing it. Whereas we see in many cases, you actually end up not changing your target service levels, or target stocks, for a very long time, even years in some cases.
Søren Hammer Pedersen (37:29):
Yeah, so what I hear you say is potential’s there, no worries, just get going. But I can see that time is running fast here. So maybe to sum up quite quickly, I think it’s a very interesting topic, and I think the key takeaways from this is of course to find out first what kind of situation has brought you into the situation you have been asked to fix now. What are the underlying, the internal external factors between this? Once you know that, make it fact-based. Supply chain assessment is a really good example of what you should do, or could do to get some perspective, get facts on the table, build the business case, and the roadmap, get the Cap-Ex approach of course, and start the process of implementing this. So I think on this topic, what probably the listeners again would like to know even more about, is this as a supply chain assessment?
And luckily that is the topic of our next podcast. So thank you so much out there for listening in on this podcast. I hope you got some good insights, and tricks and tips on this topic here. If you would like to, as I said, to know more on this supply chain assessment, how do you do it in practice? What are the element of this? How do you do it, and how long does it take, and what it does it require? Listen in to our next S&OP MasterClass, where we dive into this very specific topic with Benjamin. It’s going to be great. I promise. Have a good day out there. Thank you for listening in, and we’ll see you soon.