Inventory Optimization

How Best-in-Class Stack Up on Customer Service Performance While

Optimizing Their Inventory




March 2012
Bryan Ball


This document is the result of primary research performed by Aberdeen Group. Aberdeen Group's methodologies provide for objective fact-based research and
represent the best analysis available at the time of publication. Unless otherwise noted, the entire contents of this publication are copyrighted by Aberdeen Group, Inc.
and may not be reproduced, distributed, archived, or transmitted in any form or by any means without prior written consent by Aberdeen Group, Inc.




March 2012
Inventory Optimization: How Best-in-Class
Stack Up on Customer Service Performance
While Optimizing Their Inventory
Why should we be concerned about customer service (complete and on-
time order delivery to customers) when discussing inventory optimization?
Whats the relationship? Often inventory optimization is twisted to mean
inventory reduction. But reducing inventory blindly may result in shortages
and degraded customer service. Any possible risk to customer retention is
heresy, particularly since the downturn in 2008. Companies are fighting for
every scrap of business they have, and are focused on improving their
relationships with customers.
Pressure to Reduce and Improve
Today's supply chain professional is asked to reduce inventory costs while
improving customer service. This is a difficult task. The increasing number of
sales channels and the growing globalization trend further complicate the
situation. Together, these trends demand that inventory must move faster
and further than ever before. It is important to understand how Best-in-
Class companies are balancing inventory reduction with customer service. In
a January 2012 Aberdeen Inventory Management survey, the top two
pressures identified by respondents were the need to reduce inventory
carrying costs (60%) and improve customer service levels (42%).
Figure 1: Top Pressures

Source: Aberdeen Group, January 2012
19%
35%
56%
19%
42%
62%
25%
54%
61%
0% 20% 40% 60% 80% 100%
Corporate need to improve
return on invested capital
Need to improve service
levels
Need to reduce inventory
carrying costs
Percent of Respodents n=160
Best-in-Class
Industry Average
Laggard
Analyst Insight
Aberdeens Insights provide the
analyst's perspective on the
research as drawn from an
aggregated view of research
surveys, interviews, and
data analysis
3 Rules of Inventory
Management
Three simple rules capture the
essence of inventory
management:
Rule 1: Always have enough!
Rule 2: Never have too
much!
Rule 3: Never let Rule 2
overrule Rule 1!!!
Best-in-Class Performance
Definition:
Cash to Cash Cycle - Best-
in-Class companies had
cash to cash cycle of 58.6
days
Finished Goods Inventory
Turns - Best-in-Class
companies averaged 15.1
turns per year
Change in perfect Orders -
Best-in-Class companies
increased their perfect
order rate by 3.1%

Inventory Optimization: How Best-in-Class Stack Up on Customer Service
Performance While Optimizing their Inventory
Page 2

2012 Aberdeen Group. Telephone: 617 854 5200
www.aberdeen.com Fax: 617 723 7897
Balancing Act
A balancing act is played out every day, in every business, between
inventory and service level, as orders are received. Inevitably, orders vary
from the original forecast. If lead times were instantaneous and forecasts
were always 100% accurate, there would be no need for inventory. But that
is not the case in the real world. There is an old adage in operations that
sums it up pretty well the first thing you know about a forecast is - that
it's wrong. The key issue is finding that point of balance and maintaining it
(see the 3 rules of inventory management, sidebar, page 1).
Real inventory optimization is about right sizing rather than reducing. The
ultimate outcome may be a reduction in the money tied up in inventory, but
the objective should be having the right inventory in the right place at the
right time to properly service the customer.
Best-in-Class Performance
Aberdeen's research has identified a group of Best-in-Class companies that
have significant advantages over the rest of the field in terms of business
performance and their process excellence in the areas relevant to inventory
optimization. From the business perspective, these companies are more
profitable, turn inventory more frequently, and manage cash more
effectively. They also have more accurate forecasts, which reduces the
possibility that they will produce the wrong things. They have also shown
significantly more improvement in obsolescence and carrying costs, which
demonstrates their focus on driving down the cost metrics typically
associated with inventory.
Table 1: Performance Metrics
Type of Metric
Best-in-
Class
Industry
Average
Laggard
Finished goods inventory turns 2.5% 2.8% 3.2%
Inventory carrying costs relative to
revenue -4.7% 0.4% 5.5%
Inventory obsolescence cost -2.1% 0.3% 0.1%
Gross margin 34.2% 29.2% 29.7%
Finished Goods Inventory Turns
per year 15.1 10.0 10.1
Average cash conversion cycle 56.8 71.7 90.6
Forecast Accuracy (at the SKU
level) 75.2% 55.0% 22.4%
Source: Aberdeen Group, January 2012
How does the performance advantage the Best-in-Class hold over the rest
of the field in financial and process metrics impact service for their
particular businesses?
Best-in-Class Performance
Definition:
Cash to Cash Cycle - Best-
in-Class companies had
cash to cash cycle of 58.6
days
Finished Goods Inventory
Turns - Best-in-Class
companies averaged 15.1
turns per year
Change in perfect Orders -
Best-in-Class companies
increased their perfect
order rate by 3.1%

3 Rules of Inventory
Management
Three simple rules capture the
essence of inventory
management:
Rule 1: Always have enough!
Rule 2: Never have too
much!
Rule 3: Never let Rule 2
overrule Rule 1!!!
Inventory Optimization: How Best-in-Class Stack Up on Customer Service
Performance While Optimizing their Inventory
Page 3

2012 Aberdeen Group. Telephone: 617 854 5200
www.aberdeen.com Fax: 617 723 7897
Service Impact
Now that we understand what constitutes Best-in-Class performance, we
can examine the Best-in-Class approach to service. We found that the Best-
in-Class were less affected by negative service costs (fines, lawsuits,
penalties etc.) related to inventory management issues than were all other
companies. Similarly, the top companies were less affected by negative
operational costs (rework, overtime, scrap etc.) related to inventory
management issues than were all other companies. The data indicates that
the top performing companies do let their inventory management policies
get in the way of good service. In fact it is just the opposite.
The Best-in-Class demonstrate superior service performance across the
board. The majority (68%) have documented a positive improvement in
their service level, a strong response to the number two pressure, and are
over 65% more likely to have a favorable service improvement than the
Industry Average. For the Bestin-Class, inventory optimization results not
only in better financial performance, but also improved service. But what
are the Best-in-Class doing to make that happen?
Table 2: Metrics
Type of Metric
Best-in-
Class
Industry
Average
Laggard
Percentage of each class showing
an Improvement in service
68% 41% 21%
Actual Service level change 3.1% 1.5% 0.9%
Negative service costs (as a
percent of the operations budget)
1.2% 2.2% 2.6%
Negative operational costs (as a
percent of operations Budget)
3.3% 4.5% 4.9%
Source: Aberdeen Group, January 2012
What are the Best-in-Class Doing Differently?
We have already discussed two process capabilities that have a direct
bearing on service: improved forecast accuracy and effective obsolescence
management. However, the Best-in-Class have a comprehensive approach
to service, as shown in the following table.
Table 3: Capabilities
Type of Capability
Best-in-
Class
Industry
Average
Laggard
Ability to view end-to-end
inventory while providing
available-to-promise 43% 32% 24%
Inventory Optimization: How Best-in-Class Stack Up on Customer Service
Performance While Optimizing their Inventory
Page 4

2012 Aberdeen Group. Telephone: 617 854 5200
www.aberdeen.com Fax: 617 723 7897
Type of Capability
Best-in-
Class
Industry
Average
Laggard
Ability to respond quickly to
market events while executing to
inventory requirements 61% 34% 27%
Measurement of customer service
levels during the planning phase 56% 32% 28%
Measurement of customer service
levels during the execution phase 74% 57% 50%
Source: Aberdeen Group, January 2012
As the data indicates, the Best-in-Class are better able to make confident
commitments, and respond quickly to market events. Visibility to upstream
inventory allows companies to base a commitment to a promise date on
actual data, rather than a rule of thumb. The ability to respond quickly
reduces the lag time in the response process, and minimizes the negative
impact to the overall supply chain business. The Best-in-Class are 79% more
likely to have this capability than the Industry Average (61% to34%), and
over 125% more likely than the Laggards (61% to 27%). A similar gap exists
between Best-in-Class, Average, and Laggards in their ability to view the
impact of being able to measure customer service leves during both the
planning and execution phases of their business. The margin for the Best-in-
Class compared to the other maturity classes in process capabilities is
compelling, and consistent over a wide range of capabilities in response to
the pressure they feel to improve service.
Recommendations
Not only does inventory optimization drive better overall business results,
but it drives better service as well, as shown by the Best-in-Class in
Aberdeen's study. Supply chain organizations should concentrate on
process capabilities as areas for improvement and possible investment. In
this case, following the leader will pay dividends. Lets review some of the
capabilities that businesses should concentrate on.
1. Ability to view end-to-end inventory while providing available-to-
promise dates and making commitments.
2. Ability to respond quickly to market events while executing to
inventory requirements.
3. Measurement of customer service levels during the planning phase
4. Measurement of customer service levels during the execution phase
5. Ability to create more accurate forecasts at the SKU level
The path to adopting these capabilities can take many forms. The first and
most obvious would be to see what measurements exist around these
processes. If improvement is needed, does the business already have tools
to provide that capability? For example, responding quickly to market events
Inventory Optimization: How Best-in-Class Stack Up on Customer Service
Performance While Optimizing their Inventory
Page 5

2012 Aberdeen Group. Telephone: 617 854 5200
www.aberdeen.com Fax: 617 723 7897
might require robust supply chain planning tools, better visibility to
upstream inventories, or improved collaboration with suppliers. The same
may be said for establishing visibility to service during the planning and
execution phases, which indicates the need for a multi echelon solution to
evaluate and set targets, or a more robust warehouse and distribution
fulfillment system. Depending on the organization, its industry and its
shortcomings, any or all of these enablers might be required. There is
usually no one silver bullet that solves all problems. The Best-in-Class
data shown above makes the case that improving processing capabilities will
lead not only to better financial performance but also to better service.

For more information on this or other research topics, please visit
www.aberdeen.com.






Related Research
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Integrated Transportation in a
Capacity Constrained Global Market;
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Transportation Procurement
Management: Best Practices for the
New Normal; June 2011
Supply Chain Visibility: Fostering
Security, Resiliency, and Efficiency;
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Collaborative Inbound Transportation:
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International Transportation: Optimize
Cost and Service in a Global Market;
July 2010

Author: Bryan Ball, Director, Supply Chain Management Practice,
(bryan.ball@aberdeen.com)
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This document is the result of primary research performed by Aberdeen Group. Aberdeen Group's methodologies
provide for objective fact-based research and represent the best analysis available at the time of publication. Unless
otherwise noted, the entire contents of this publication are copyrighted by Aberdeen Group, Inc. and may not be
reproduced, distributed, archived, or transmitted in any form or by any means without prior written consent by
Aberdeen Group, Inc. (2012a)