In a down economy, opt for demand-pull strategies that lead to inventory reductions

Inventories—especially for finished goods—are a major concern for everyone in an extended supply chain, especially whenever there's threat of an economic downturn. Such a scenario seems to patently justify the adoption of demand-driven or “pull” fulfillment strategies tied directly to customer orders.
By Frank O Smith, senior contributing editor (fosmith@thewritinggroup.com) April 1, 2008

Inventories—especially for finished goods—are a major concern for everyone in an extended supply chain, especially whenever there’s threat of an economic downturn. Such a scenario seems to patently justify the adoption of demand-driven or “pull” fulfillment strategies tied directly to customer orders.

But management of finished goods inventory is hugely complex. With durable goods, historical data indicates the use of demand-pull strategies will increase inventory levels, according to John Layden, president and CEO of Indianapolis-based Prevel Consulting .

Looking at consumer goods versus pharmaceuticals, the supply of finished goods might average 30 days with the former, but 150 to 200 days with the latter, according to Roddy Martin, VP and general manager of value chain strategies for Boston-based AMR Research .

Clearly one size doesn’t fit all.

“Looking at finished goods inventory is seeing just the tip of the iceberg,” Martin says. “It’s the complexity that lies beneath the surface that sinks ships.”

Finished goods inventory must be viewed in the context appropriate for each industry, market, and individual company’s strategy, adds Martin. In the case of pharmaceuticals, for example, unit costs are low, margins high, and the need to ensure availability for health safety reasons warrants large finished goods inventories.

“It comes down to ‘the moment of truth’ for the customer,” Martin says. “In consumer goods, it’s whether the item is on the store shelf. For a jet engine, it’ll be different.”

Management of inventories has been made vastly more complex by shrinking product life cycles, product SKU proliferation, growing complexity and extension of supply chains, and escalating pressure to meet customer expectations. As companies move toward centralized planning with decentralized execution—rolling more plants and distribution centers into the mix—it all becomes that much more complex.

Inventory-to-shipment ratios based on U.S. Census Department data depict generally how much inventory in month’s supply manufacturers have on hand to meet orders. Lean and demand-driven strategies have effectively reduced all forms of inventory, including raw material; work-in-process (WIP); and finished goods. But where finished goods inventory on hand has trended downward since the early 1990s, those strategies have been more effective in reducing raw materials, and significantly more so in reducing WIP.

Yet some companies are making gains using demand-pull strategies to reduce finished goods inventory. While inventory turns in durable goods have lengthened over the last two to three years, consumer goods manufacturers like Proctor & Gamble (P&G), and high-tech producers like Dell and Apple are achieving annual turns upwards of 30 to 50 a year.

For P&G, it comes in mastering the base fundamental of demand pull: gaining visibility to real-time consumer point-of-sale (POS) information. With many high-tech electronics manufacturers, it’s a combination of dramatically reducing production cycle times, coupled with innovation and demand-pull strategies.

“The challenge for many is managing data they’re not used to dealing with, and don’t have systems capable of handling,” says Julie Fraser, a principal for Cummaquid, Mass.-based Industry Directions . “Some companies might be using sales & operations planning [S&OP] solutions, but they’re replanning only once a month. As you move close to real demand pull, you’ve got to be replanning much more frequently—even daily.”