Daily Archives: April 5, 2010

The Basics of Inventory Optimization

Inventory optimization can be defined as the act of balancing supply and demand uncertainty to meet desired services level at a minimum level of investment. In addition to all of the basic factors of inventory management covered in our last post (namely, production, stock, location, transportation, and information), inventory management also considers all of the associated costs — carrying costs, stock out costs, alternate distribution costs, and lead time costs, and tries to balance them.

As such, an inventory optimization solution will allow you to define:

  • your current production & distribution networks, and any flexibility you have
  • the modes of transportation available to you and associated fixed and variable costs
  • the lane options available to you and impacts on transportation costs
  • current and projected demands by SKU, family, and location by time period (month, week, or day)
  • storage and carrying costs
  • desired service levels by SKU, family, and location
  • projected cycle times
  • production capacity constraints and feasible schedules
  • network and storage constraints
  • current contractual commitments
  • upcoming promotions
  • compliance requirements

As well as your flexibility in terms of service levels and working capital and produces optimal inventory recommendations at different trade-off levels. You can then analyze costs and projected losses at 90%, 93%, and 95% service levels (defined in terms of product availability) and make the best decision that balances working capital tied up in inventory and revenue potential.

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The Basics of Inventory Management, Courtesy of SYSPRO

As a precursor to my future post on SYSPRO’s new Inventory Optimization solution, I thought I’d provide a brief review of their free e-book on Supply Chain, Inventory Management, & Optimization: Skills for Small Businesses, available on request to clients and prospects. While it doesn’t delve deep into inventory (and related supply chain) optimization, it does a great job describing the basics of inventory management and serves as a great introduction to the subject to small and mid-size businesses just beginning to tackle the issue.

When beginning to delve into the issue of inventory management, there are five factors that need to be considered: production, stock, location, transport, and information requirements. Associated with each factor are a number of decisions that need to be made, which are summarized in the following table:

Production capacity



SKU vs Job Lot vs. Cross-Docking

Stock basic vs seasonal vs safety



Location supplier proximity

customer proximity

Transportation mode



Information collection


More specifically,

  • should you centralize production, and increase shipment times to remote locations, or decentralize production and minimize shipment times to any particular customer location?
  • should you maintain high levels of stock to prevent a stock-out, or implement flexible manufacturing and JIT delivery?
  • should you organize inventory by SKU, by Job Lot, or implement Cross-Docking?
  • how does seasonality affect your safety stock levels?
  • ship, rail, truck, air, cableway, pipeline, conveyor, or wire?
  • should you centralize your warehouses, or distribute them?
  • should you implement POS or rely on traditional back-room systems?

The goal is to balance trade-offs to maximize agility, adaptability, and alignment in your supply chain which balances customer service levels and internal operating efficiencies to make sure that you can provide your customers with the right goods, at the right price, at the right time.

As such, you need to be concerned with stock assortment, level, turnover, and associated costs. More specifically, what is the right mix of product at any particular time to maximize turnover and minimize associated costs? Then, you have to acquire the inventory, within working capital constraints, and track real-time utilization to improve future forecasts. This should all be done in accordance with comprehensive inventory management policies, which should be designed to quickly identify and eliminate overstock (before the product spoils or becomes obsolete) and replenish popular items in a timely fashion. These policies can use one or more inventory control methods, which can be manual (like ticker, click, and stub) or automatic (like pos terminals).

And once you’ve got the basics of inventory management down, you can move on to inventory optimization.

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