Are You Concerned About Your Inventory? Look After Your Forecast
It does not matter what is your industry segment—but especially if you are part of a public company—you probably have heard about cash conversion cycle or cash to cash cycle. Simply put, how fast is your organization moving the money from paying your supplier to cashing out from your customers?
Cash Conversion Cycle (CCC) is a metric that Wall Street has been paying more attention over the years, since it is recognized as a mayor source for working capital. Now, why am I talking to you about CCC when the theme of this CIOReview issue is demand planning and forecasting?
I am not an expert on forecasting by any means, but I have worked long enough on the inventory management for the specialty chemical industry to understand how the forecast (or lack of thereof) can help or hurt any given organization to get a better hold on inventory or take the whole organization for a not-so-funny ride.
On any supply network there are two buffers against variability: stock or redundant manufacture capacity
Bram DeSmet in his new book “Supply Chain Strategy and Financial Metrics: The supply chain triangle of service cost and cash” enunciate the reasons to hold inventory: strategic stock, anticipation stock, pipeline stock, safety stock and cycle stock. Most of these layers of inventory can and will be impacted by forecast. In this article I would like to focus on safety stocks, since the safety stocks or buffers are there to manage uncertainty. In the manufacturing industry, most of the uncertainty comes from the demand and the supply.
More so, I have witness on my industry segment that the effect of demand variability on sizing safety stocks is about 10 to 1 compared to supply variability. In a world where limited resources are the norm, if you have to prioritize the activities of your team, you will get way more bang-for-your-buck tackling forecast variability and not supply variability.
S&OP, SiOP or IBP
Approach to inventory needs to be switched, most times we think about it as a liability but if we were able for a second to think of inventory as an asset, the whole thought-process changes. When you invest in an asset you expect a return on investment and rightfully so. But in order to get the ROI, we need to right-size our stock position and understand the purpose of the stock. Therefore, stock is not longer just stock, now it has a purpose and a given lifespan.
In an increasingly complex environment where SKU proliferation is the norm and demand is coming at you from a whole host of channels, demand planning and more importantly demand sensing becomes the first line of defense to keep your inventory under control. Demand planning well framed under a consistent S&OP (SiOP or IBP, whatever your process of connecting the planning functions of each department in the organization to align operations and strategy with the organization's financial performance is named) will pay off great benefit in reducing your inventory numbers and generating cash flow from within the organization.
In my particular case, the demand review happens in the first 15 days of the month, where we generate and distribute a statically generated forecast to sales, incorporate any market intelligence from the field into the system and aggregate all the inputs up to the SKU-DC level before proceeding to inventory and production review, where we integrate demand with supply and identify potential gaps.
Regardless of what you set up is, what holds true every time is the fact that demand planning if not integrated into the business processes and if the result of the demand planning process is not a consensus forecast between planning, operations and finance, then your chances of success are subpar.
Inventory is not against shareholder value
Lastly, I want to bring a bit of sense to the whole inventory reduction and CCC improvement craze going on. On any supply network there are two buffers against variability: stock or redundant manufacture capacity. Unless you are Inditex or any other company sitting on a lot of idle manufacturing capacity, stock is your best insurance against stock out and the cost associated with it. And when I am talking about costs, I am not necessary talking about the lost sales only, but everything that comes with that: lost market share, brand loyalty damage, potential customer late penalties, etc.
Buffer stock, cycle stock, demand sensing and demand planning are all tools that will help you get better to do what we are all supposed to be doing: delivering great products or services, when needed, where needed, as needed. A word of caution: technology can be an enabler for all these things to happen, but if you do not have a process to support the technology, do not expect that the software by itself will be a silver bullet, it is not going to work.
Shareholders will always demand more value out of the stock and that is ok. It is on us to convey the message of what is the right level of inventory and how that inventory is bringing value to the organization.