Supply chain optimization is the application of processes and tools to ensure the optimal operation of a manufacturing and distribution supply chain. This includes the optimal placement of inventory within the supply chain, minimizing operating costs (including manufacturing costs, transportation costs, and distribution costs). This often involves the application of mathematical modeling techniques using computer software.
When we are talking about Supply chain optimization, there are 2 kinds of optimization i.e. local optimization and global optimization. By optimizing we mean here balancing the supply chain for efficiency and responsiveness at lowest total cost. Supply chain is a complex interaction of different functions. Local optimization means one function is optimized without regards to how it affects the entire supply chain. As an example, transportation function decides to transport full truckloads in order to get TL discounts, but this increases inventory and hence inventory holding costs. Another example of local optimization is manufacturing does long production runs in order to reduce per unit costs, but this decreases the flexibility in responding to changes in demand. As you can see from these examples, efficiency is traded off for responsiveness. With global optimization, what the supply chain seeks is to find a balance between desired responsiveness and efficiency at the lowest total cost. This might mean that costs may increase for some, but for the overall supply chain the costs are decreased . All the functions collaborate with each other, share information and data among supply chain partners and work together to find that balance at the lowest cost. Nowadays there are tools to help companies do simulations and modeling with different scenarios to find the optimal solution for supply chain at the lowest cost.
Approaches and solutions
The classic supply chain approach has been to try to forecast future inventory demand as accurately as possible, by applying statistical trending and “best fit” techniques based on historic demand and predicted future events. The advantage of this approach is that it can be applied to data aggregated at a fairly high level (e.g. category of merchandise, weekly, by group of customers), requiring modest database sizes and small amounts of manipulation. Unpredictability in demand is then managed by setting safety stock levels, so that for example a distributor might hold two weeks of supply of an article with steady demand but twice that amount for an article where the demand is more erratic. Universally accepted statistical methods such as Standard Deviation and Mean Absolute Deviation are often used for calculating safety stock levels.
Then, using this forecast demand, a supply chain manufacturing Production Planning and distribution plan is created to manufacture and distribute products to meet this forecast demand at lowest cost (or highest profitability). This plan typically addresses the following business concerns: – How much of each product should be manufactured each day? – How much of each product should be made at each manufacturing plant? – Which manufacturing plants should re-stock which warehouses with which products? – What transportation modes should be used for warehouse replenishment and customer deliveries?
The technical ability to record and manipulate larger databases more quickly has now enabled a new breed of supply chain optimization solutions to emerge, which are capable of forecasting at a much more granular level (for example, per article per customer per day). Some vendors are applying “best fit” models to this data, to which safety stock rules are applied, while other vendors have started to apply stochastic techniques to the optimization problem. They calculate the most desirable inventory level per article for each individual store for their retail customers, trading off cost of inventory against expectation of sale. The resulting optimized inventory level is known as a model stock. Meeting the model stock level is also an area requiring optimization. Because the movement of product to meet the model stock, called the stock transfer, needs to be in economic shipping units such as complete unit loads or a full truckload, there are a series of decisions that must be made. Many existing distribution requirements planning systems round the quantity up to the nearest full shipping unit. The creation of for example, truckloads as economic shipment units requires optimization systems to ensure that axle constraints and space constraints are met while loading can be achieved in a damage-free way. This is generally achieved by continuing to add time-phased requirements until the loads meet some minimum weight or cube. More sophisticated optimization algorithms take into account stackability constraints, load and unloading rules, palletizing logic, warehouse efficiency and load stability with an objective to reduce transportation spend (minimize ‘shipping air’).
Optimization solutions are typically part of, or linked to, the company’s replenishment systems distribution requirements planning, so that orders can be automatically generated to maintain the model stock profile. The algorithms used are similar to those used in making financial investment decisions; the analogy is quite precise, as inventory can be considered to be an investment in prospective return on sales.
Supply chain optimization may include refinements at various stages of the product lifecycle, so that new, ongoing and obsolete items are optimized in different ways: and adaptations for different classes of products, for example seasonal merchandise. It should also factor in risks and unexpected constraints that often affect a global supply chain’s efficiency, including sudden spikes in fuel costs, material shortages, natural disasters such as hurricanes, and instability of global politics.
Whilst most software vendors are offering supply chain optimization as a packaged solution and integrated in ERP software, some vendors are running the software on behalf of their clients as application service providers.
Optimizing Supply Chain
ways you can begin to optimize your end-to-end supply chain – and start spending less while getting your customers what they want when they want it.
Tier 2 Supplier Management – Your end-to-end supply chain doesn’t begin with your suppliers. No. As they say in the toilet paper industry, your end-to-end supply chain goes from “stump to rump.” Your Tier 2 suppliers are the suppliers who provide components, raw materials and sometimes services to your suppliers.
If you don’t know who your Tier 2 suppliers are – and don’t understand the products they supply, what their costs are and what their lead times are – your end-to-end supply chain needs optimizing. By negotiating with your Tier 2 suppliers, you can lower your suppliers’ cost of goods and lead times. Oftentimes a Tier 2 supplier might supply more than one of your suppliers.
And with that visibility, you can negotiate volume pricing – where your individual suppliers don’t have that leverage.
Or you can help your multiple suppliers to find a single Tier 2 supplier, where that Tier 2 supplier consolidation makes sense.
Supplier Cost of Goods Sold (COGS) Management – COGS management is like auto maintenance. Just because you’ve changed the oil and rotated the tires at 10,000 miles, that doesn’t mean your car will run smoothly for the next 100,000 miles. And just because you’ve negotiated a low price with your supplier, that doesn’t mean you shouldn’t renegotiate once your suppliers have optimized their own internal production processes.
In fact, when you’re negotiating prices with your suppliers, you should be able to negotiate year-over-year price reductions – in the order of 3%-5% – that are built into your supply agreement. Your suppliers should be optimizing their own internal costs so that they’re not losing money with this arrangement, year-over-year.
And within your own organization, you should be driving your own process costs down – by using six sigma, lean and other process optimization tools – so that you can drive your own year-over-year costs down. Your ERP system should be telling you if that’s happening – or not. But it’s up to you to do something about it.
Supplier Inventory Management – Your own suppliers are doing what they can to supply you what you want when you want it – and accomplish that by spending as little money as possible. But if you and your suppliers aren’t sharing demand information – they run the risk of not carrying enough inventory to meet your needs.
Or – just as bad – carrying too much inventory. If your suppliers are carrying too much inventory – that means that they spent too much money manufacturing to meet your demand. And that cost will get passed along to you (whether you know it or not).
By sharing demand information with your suppliers, your suppliers can do their own demand planning to ensure that they are optimizing their inventory management.
That demand information can be in the form of forecasts, with defined time fences that convert those forecasts to order, or blanket orders.
Be careful to understand the financial implications of both those scenarios – i.e. what you will be obligated to if you have to cancel or revise down your demand.
Understanding your suppliers’ lead times is also critical in managing your suppliers’ inventory. If they have a three-month lead time on a raw material, you need to understand that they may not be able to react if you increase your demand within a 90-day horizon.
Logistics – Contrary to what the age-old adage, “poor planning on your part, does not constitute an emergency on mine,” might suggest – poor planning throughout your end-to-end supply chain does constitute a logistics emergency.
Actually, “emergency” might be the wrong word – it’s more like “expedited and overnight fees” which can be worse, if you’re a CFO, than an emergency. If your goal is to ship a customer what that customer wants, when that customer wants it – then you might fall into the trap of relying on expedited and overnight shipping fees to make up the delays in production or purchasing.
Those expedited fees are a sign that you’re not accomplishing customer delivery by spending as little money as possible. Robust demand planning and lead time management can help minimize the amount of money you might be spending on logistics expedite and rush fees. It can also help reduce the amount of air shipments you might need from low-cost suppliers in Asia. Understanding lead times and having access to long-term demand are the top two ways to help reduce logistics costs.
Inventory Control – How can you be sure that what your warehouse management system or resource planning system tells you what you have on hand is actually what you have on hand? Every company’s goal should be 100% inventory accuracy and the only way to accomplish that is by conducting regular, systematic cycle counts and physical inventories.
Without 100% inventory accuracy, you may or may not be able to ship to your customers on-time. Lack of inventory accuracy also means that you’re buying inventory that you already have on hand or you’re buying items you don’t need.
Implement a cycle count program now – and make sure you’re counting floor-to-sheet and sheet-to-floor – to pressure test your inventory accuracy.
Customer Demand Planning – Yes, your customer might send you forecasts. And, yes, your customer might even send you long term or blanket orders. But does your customer know what it actually wants – and when it wants it? You might know better than they do.
You can use your customer’s demand information (forecasts, orders) as a starting point. But you can do so much more in a robust demand planning environment. You can use history, market analysis, seasonality, competitive landscape and other factors to understand your customer needs better than they do.
And robust demand planning helps to minimize those expedited fees and other logistics costs that drive the costs up in your end-to-end supply chain.
Other ways
- Think Globally but Act Locally – This is not only a geographic reference; but it is also an important point to consider when thinking strategically about supply chain or value chain planning. Companies increasingly must think in terms of global opportunities for procurement of goods AND services, and when considering the global needs of the corporation. Manufacturers should consider multiple channels and determine the optimal levels of inventory within the echelons of the supply chain process. This is also critical to consider carbon footprint levels and ensure the greening of the supply chain. However, during the execution of the supply chain it is important to optimize locally to maximize your investments in critical resources: infrastructure, assets and technology.
- Focus on Core Strengths and Outsource all other Activities – Many organizations try to do too many things or don’t realize that they can outsource repetitive or tasks or one-off projects (for e.g. determining the optimal distribution network; the payment and audit of freight bills or supporting enhancement of its information systems). Quite often it seems as though an organizations’ internal resources are able to do better job in the short run. Most often, by relying upon a specialized third-party provider, a better value will be realized in the long term. Focusing on your organizations core competencies will help you grow your business.
- Improve Collaboration Between Manufacturer/Supplier and Retailer for Demand Data Driven Forecasting and Inventory Management – This will help organizations reduce inventory, improve fulfillment rates and product availability at point of purchase and ensure a lean supply chain improving margins and profitability. Today, technology provides myriad opportunities to collaborate, there is a proliferation of data available to be mined and advances in computing power and connectivity allows us to test for optimality in ever increasing areas.
- Utilize Mobile-Based Technology – This technology can help improve field sales, merchandizing and marketing, and enable direct services to the consumer (through customized location-based coupons or services that improve employee productivity in the field). Providing information such as provenance, origin, item contents and specialized information on demand about sustainability, local content or manufacturing methodology enhances the brand and allows companies to connect directly with the consumer.
- Build a Responsive Supply Chain – Utilize source data such as POS sales, as well social media information to identify trends and demand changes much earlier and enable your supply chain to respond faster to increase sales, improve service levels and reposition inventory to maximize true benefits. Multi-channel programs will change expectations from supply chain forecasting/planning paradigms to building responsive supply chains.
