We recently discussed the criticality of optimization in
It’s Not Optimization, It’s Strategic Sourcing, explained that Even “Simple” Categories Hide Extreme Complexity, and pointed out Why Your First Generation Platform is Not Ready for Modern Sourcing in the hopes that you would understand that you need to be ready for Complex Sourcing.
But Strategic Sourcing Decision Optimization (SSDO) is only one area where optimization can be applied to add organizational value. There are at least half a dozen other areas where optimization can be successfully applied in a progressive organization that is a leader in its industry. In this post we’ll outline some of the best opportunities, a few of which have been covered before, and in future posts over the next year we will dive deeper as we introduce you to some of the companies exploring the use of optimization in these areas to bring your operations the same level of savings that your SSDO vendors are bringing the Sourcing and Procurement organization.
Inventory optimization can be defined as the act of balancing supply and demand uncertainty to meet a desired services level at a minimum level of investment. But this is easier said then done. Not only do you have to consider the myriad of carrying costs that need to be balanced — warehouse rental costs, labour costs, and depreciation costs — but also take into account the costs associated with stock outs, alternate distribution costs if inventory is improperly distributed, and lead time costs, and try to balance them all.
Optimizing inventory is a good start when it comes to reducing overhead costs, as inventory carrying costs can be as high as 25% by some estimates. However, production costs can also be unnecessarily high if production is not optimized. Production line down time is costly, and a production line goes down every time it is switched up to produce a new product (or a new variation). Thus, it’s not always best to plan production by order volume, but by total volume for a period, optimizing production runs to maximize throughput (and worker time), minimize downtime, and, most of all, minimize switching times. Especially if order volumes vary and part of the year would otherwise require overtime to meet demand.
The counterpart to production optimization is demand optimization. Not only does it cost the organization hard dollars to carry inventory unnecessarily or use poor production plans, but it also costs the organization hard dollars to product unprofitable product lines or cater to unprofitable customers. For each product line there is a production cost, a marketing cost to increase demand, a cost of goods solds (COGS), and an opportunity cost from not producing a potentially more profitable product line. Demand optimization is optimizing what product lines to produce, how much to invest to shape demand, and when to produce those product lines. It optimizes organizational profit by focussing on profitable product lines and marketing activities versus marginally profitable or unprofitable activities.
And these are only a few categories where optimization can increase performance, and profit. In part II, we will tackle three more areas. Stay tuned.