What are Inventory Optimization Algorithms?
There are a lot of inventory planning solutions available from all types of companies around the world. Many are designed for large enterprise companies as they cost hundreds of thousands of dollars and are highly complex. Some are so complex a math or science degree is required just to operate the system. Others at the low end may be just point solutions for just forecasting, as an example, or offer individual modules you need to buy separately.
Most of these solutions include a forecasting capability either their own platform or from an included third-party provider. They usually also offer min and max levels, safety stock and replenishment calculations. Most require you to manually set replenishment levels and have you select the appropriate forecast method.
But how many offer real inventory optimization and why is this important? There are many reasons why inventory optimization is critical for conducting business in today’s ever challenging economic climate.
First of all, what is the cost of carrying, holding and managing an inventory? The costs for most items are steadily increasing, real estate costs and taxes are up and shipping costs are through the roof. Inventory optimization provides a great balanced inventory to meet expected demand, while reducing costs and better controlling spend for additional stock purchases. Planning in a timelier manner reduces the need for expediting orders in from vendors, which in-turn reduces the need for expediting shipments to customers!
Secondly, optimization dramatically improves the financial performance of an inventory because buying and stocking are more in-line with expected customer demand. It helps to reduce and almost eliminate the future build-up of excess inventory and dead stock.
Third, there are too many known and unknown variables that can affect your inventory and subsequent customer service levels to manage properly. Just forecasting and planning your inventory leaves you wide-open to problems in meeting both your financial goals and customer expectations. Trying to plan with spreadsheets is even a worse situation that will eventually lead you to higher costs and lower service producing a higher level of customer dissatisfaction and lost business.
- Setting the re-ordering parameters (e.g., Safety Stock or Min/Max levels) manually is an extremely tedious activity. Hence, it tends to be done infrequently, and does not adjust to changed demand factors. Valuable buyer/planner time should not be taken up by such activity.
- Optimization of the re-ordering (replenishment) parameters can lead to dramatic cost savings. Computers can do it frequently, so the results dynamically reflect demand changes.
Basically, what inventory optimization does is balance the investment in an inventory with the fill-rate (service level) goals of a company. There are also financial considerations, constraints that can also be applied in the development of the algorithm. These highly complex algorithms work behind the scene so as not to confuse the user or make them fearful of using optimization to help manage their inventory.
We have determined that you can dramatically improve the effectiveness of the optimization algorithms by adding heuristics into the overall process equation. Heuristic refers to experience-based techniques for problem solving, learning, and discovery. Heuristic methods are used to speed up the process of finding a satisfactory solution, where an exhaustive search is impractical.
The customer results of using advanced inventory planning & optimization show they achieve:
- Reduced inventory by 20% to 40% or more usually within 6 months or less
- Reduced expediting and emergency shipments by 35% or more
- Improved productivity by reducing planning time by 60% to 80% or more
- Controlled and reduced replenishment spending by 15% or more
- Improved service levels by having the right items available when your customers want them by 5% to 15% or greater
- Reduced stockouts by 15% - 30% or higher
- Increased sales of 15% to 15% or more
- Reduction in cost of goods by 5% to 10% due to improved vendor relations
Make sure you review the inventory solutions carefully and find out if they include genuine inventory optimization algorithms. You owe it to yourself, your company and your customers to choose the right solution to help solve your inventory planning needs affordably.