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Supply Chain Optimization is the application of processes and tools to ensure the optimal placement of inventory within the supply chain. This usually involves the application of mathematical modelling techniques using computer software.
What need is being addressed?
Typically, supply chain managers are trying to maximise gross margin return on inventory invested (GMROII), balancing the cost of inventory at all points in the supply chain with availability to the customer (referred to in supply chain as "service level" and in retail as "on shelf availability"). Supply chain optimization addresses the general supply chain problem of having the right inventory in the right place at the right time, starting with a notion that what is "right" is to have the quantity of inventory at each point in the supply chain that meets service objectives at best cost.
Supply chain optimization has applications in retail as well as consumer packaged goods (CPG) and other manufacturing industries.
What approaches and solutions exist?
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.
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, for example Manhattan Associates. Other vendors have started to apply stochastic techniques to the optimization problem: for example, SAF AG and 4R Systems 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. Another vendor, Optiant, claims similar capabilities for its PowerChain tools, applied to Consumer Packaged Goods suppliers.
Optimization solutions are typically part of, or linked to, the company's replenishment systems, 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 optimised in different ways: and adaptations for different classes of products, for example seasonal merchandise.
Whilst a few software vendors are offering supply chain optimization as a packaged solution, others are running the software on behalf of their clients as application service providers.
What are the claims for supply chain optimization?
Firstly, the techniques being applied to supply chain optimization are claimed to be academically credible. Most of the specialist companies have been created as a result of research projects in academic institutions or consulting firms: and they point to research articles, white papers, academic advisors and industry reviews to support their credibility.
Secondly, the techniques are claimed to be commercially effective. The companies publish case studies that show how clients have achieved reductions in inventory whilst maintaining or improving availability. There is limited published data outside of these case studies, and a reluctance for some practitioners to publish details of their successes (which may be commercially sensitive), therefore hard evidence is difficult to come by.
Recent Developments
In May 2006, the influential Extended Retail Industry Journal (ERI) has adopted the term flowcasting to describe the operation of an optimized supply chain in the retail industry.
See also
Supply chain
"Supply chain optimization"