September 3, 2002

Small Steps, Big Results

The transition toward the demand-driven supply chain is now best achieved through small, well-planned steps

by Jeff Kavanaugh

The "holy grail" for products companies is being able to offer the right product in the right place at the right time for the right price. But getting these "four Rs" just right can be as elusive as the mythical sacred cup.

Huge IT investments have been poured into this problem, first via the wave of ERP systems and then with advanced planning and scheduling (APS) and supply chain execution systems. However, these huge investments haven't resulted in corresponding improvements in inventory and product availability. In 2001, U.S. private inventories totaled nearly $1.4 trillion dollars; even a slight increase in the effectiveness of that inventory investment would free up substantial funds to drive higher product availability and lower working capital. It's, therefore, not surprising that there are myriad supply chain improvement pitches trumpeting the virtues of operational excellence and, often, how a technology vendor's toolset can make it happen. But how does a company get from here to there, from today's realities to supply chain nirvana?

This article focuses on inventory effectiveness and discusses how organizations can improve supply chain performance by establishing Capability Maturity Models (CMMs), distinctively deploying process improvements, and institutionalizing them with prudent application of technology.

Strategic Inventory Fundamentals

Inventory strategy is a key component of operations strategy, and it's useful to review the linkage between corporate strategy and inventory. Dr. Michael Porter is the definitive thinker on the subject of strategy. His principles of strategic positioning include superior long-term return on investment through sustained profitability, as well as delivering a distinctive value proposition to provide differentiation. Sustained profitability is driven by a combination of revenue optimization and operational excellence. Inventory targeting and positioning optimizes revenue by buffering demand that occurs within supply lead times so that fill rates can be maximized.

Inventory effectiveness drives operational excellence by using knowledge of business drivers to minimize the finished goods and work in progress required to meet anticipated demand. For some companies, such as Caterpillar, inventory is also essential for differentiation — it allows the company to charge premium rates for high levels of service and position products at key points in its physical network.

The ultimate promise of technology and e-business is highly integrated, demand-driven value chains. Well thought out inventory strategy and deployment can help companies achieve competitive advantage by designing supply chains to optimally support their customer-facing processes.

One Step at a Time

In the pursuit of inventory improvement, companies moved from large ERP initiatives in the 1990s to supply chain initiatives that often focused on APS. Unlike the ERP programs, which were often justified by strategic infrastructure needs and Y2K concerns, supply chain initiatives were funded by promises of cost reductions, lead time reductions, and customer service improvements. A recent report by AMR Research indicates that while supply chain initiatives can yield significant ROI, the majority of them take a long time to realize benefits. Furthermore, another study by AMR Research states that unrealistic vendor implementation and ROI estimates are the chief reasons for frustration among unsatisfied companies (AMR Research, "Supply Chain Software Yields ROI — But It Takes Time," January 2002).

There's good news here, however. First, companies are seeing benefits from their massive investments of money and effort, even if these benefits are taking longer to realize than originally planned. Also, now that better supply chain infrastructures are in place, companies have the opportunity for additional, incremental improvements. Inventory cost reduction is consistently rated as a key ROI driver, along with cycle time reduction, fill rate improvement, and better visibility. Inventory-related processes lend themselves to an incremental improvement approach just as much as they do a "big bang" initiative.

Companies can take advantage of investments they've made in their supply chain planning and execution processes. Spurred by a slower economy and tighter budgets, the pendulum has swung back in favor of steady, incremental improvements.

One example of this phenomenon is the resurgence of Six Sigma teams at many companies and their application outside of traditional production processes. Nearly all supply chain improvement programs contain inventory reduction goals, but seldom is inventory addressed directly except for management dictates such as "We must reduce inventory levels by x percent." Exactly how inventory is to be reduced, or the corresponding impact upon customer service levels, is another matter and one that a top-down approach poorly addresses.

CMM: Necessary, But Insufficient

One means of achieving incremental improvement is through the practical use of inventory-related CMMs. The original CMM was created for the software industry as a model for judging the maturity of an organization's software processes and identifying the key practices that are required to increase the maturity of those processes. The original CMM for software has become a de facto standard for assessing and improving software processes. (See Figure 1.)

The concept of a qualitative, stratified framework also has applicability for supply chain processes. For years, the supply chain domain was missing a framework such as the CMM. The Supply-Chain Council was formed in 1996 as a grassroots initiative open to all organizations interested in applying and advancing state-of-the-art supply chain management systems and practices. The supply chain operations reference (SCOR) model is a process reference model that has been developed and endorsed by the Council as the cross-industry standard diagnostic tool for supply chain management. SCOR enables users to address, improve, and communicate supply chain management practices within and between all interested parties.

However, SCOR only addresses processes operating at Level 5, where they are optimized. It doesn't easily accommodate identification of intermediate performance levels. What's missing is a multilevel framework that companies can use to identify their current positioning, as well as their ultimate goals. Benchmarking databases help to a degree, but they can be numerical and not adequately descriptive.

By combining the best attributes of CMM and SCOR, an inventory-focused CMM can be developed, and the same approach can be taken for inventory drivers and related processes. Realistically, few companies are operating at Level 5, so it's important that Levels 1 through 4 are addressed as well. All improvement initiatives need a vision to constrain scope, and a process-based CMM can help stratify components of the vision. Thanks to its stepped-level format, a CMM also allows progress to be tracked, and it can serve as a program management tool to maintain direction.

One example of such a tool is the CMM for Inventory Effectiveness. The Inventory CMM describes the principles and practices underlying demand forecast and response process maturity. It's intended to help companies improve the maturity of their inventory-related processes in terms of an evolutionary path from ad hoc, chaotic processes to mature, disciplined inventory targeting and positioning. Once a firm has determined the level of current performance, it's easier to determine the processes and tools it must put into practice to achieve desired improvements.

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