Inventory allocation: Dealing with shortages in supply chain

BANGALORE, INDIA: No one wants to admit to inventory problems, especially to customers, but ignoring the problem is the worst decision possible.

Whether caused by planned, poorly planned or unplanned events, inventory shortages do occur. Customer impact and long-term account relationships depend on a company's ability to handle these shortages in a routine and organised fashion.

Increased demand volatility and cash-flow requirements are placing greater pressure on organisations to manage available inventories. Leaders have created an advantage by formalising a strategic and profitability-based response in times of inventory shortage. Laggards are not prepared to profitably manage available inventory in a way that decreases the negative impact to customers and shareholders.

While part of good planning is planning for times of failure, many companies do not have an established, formal and cross-functional process to manage the allocation of insufficient inventory to mitigate the impact to customers and shareholders. The unfortunate reality is that inventory shortages of varying degrees occur within a normally operating supply chain.

Regardless of the cause, unless there is a formal process to deal with all types of shortage, there will be an increase in customer dissatisfaction.

Effective inventory allocation

Companies that are able to establish an effective inventory allocation process possess the following:

1) Network awareness

A good outward-facing inventory allocation process starts with great internal knowledge. Essential to determining when and how much inventory is or will be available for customers, is having a handle on supply chain constraints. This includes not only manufacturing, but also supplier, transportation and warehousing constraints and limitations.

2) Supply modeling

The ability to model the appropriate ramp-up of supply based on changing capabilities and changing demand is paramount. This can best be achieved through the use of a constraint-based supply planning tool, where constraints and the picture of demand can be adjusted dynamically to reflect reality.

3) Demand insight

Equally important is an understanding of demand and the impact of fulfilling orders to individual customers has on your organisation's profitability. In times of short supply, the allocation process should reinforce filling orders that maximise profit and/or fulfill a greater strategic goal. This requires an understanding of customers that allows teams responsible for setting up the allocation strategy to easily sort and prioritise customers and customer orders to be filled.

4) Cross-functional collaboration

The unfortunate reality in many companies is that the supply function is on an island as the focal point for resolution. The quickest way out of an allocation situation requires a cross-functional solution.

 

A well structured sales and operations planning process serves to use the information from network awareness, network analysis and demand insight to bring limited supply back into balance with expected demand. In an effective process, it is just as important to control and shape demand as it is to accurately predict supply. This may mean removing or reducing planned promotions for items with limited supply, promoting items not short of supply as a replacement, forgoing spot sales opportunities and/or delaying/restricting a product launch. These decisions cannot be made if the supply function is left to deal with the problem of allocation on their own.

Determining root cause

To keep your business out of the never ending firefighting loop, it is important to address a number of questions and determine the root cause.

What caused the shortage? Was it due to manufacturing-line failure, supply failure, poorly executed new product launch, item discontinuation or an unplanned spike in demand, etc? How often do you have to enact your materials allocation process?

The following five pillars of the business operating strategy can help determine the root cause:

1.Customers and demand

Was the shortage of inventory due to an unplanned spike in demand? If so, why didn't the organisation know about it in advance? Was the aggregate forecast accurate, but the mix incorrect, or did the demand materialise in locations different from what was forecast? If so, is demand forecasting being performed at the right level of granularity? Was there an internal breakdown in communication or a breakdown in communication with the customer(s)? Is there an opportunity to create joint-value relationships with these customers to better sense sudden shifts in demand?

2.Innovation and products

Was the issue caused by a new product launch or item discontinuation? Which part of the launch or discontinuation process failed and why? Is there too much complexity involved in managing this process? Is there a lack of internal or external coordination? Is supply chain involved early in the new product introduction (NPI) process to ensure a smooth launch?

3.Profitable and reliable supply response

Was there a supply disruption? Was this due to a supplier failure? Line failure? Was there failure to properly plan around manufacturing capacities?

4.Organisation structure and systems

Does company culture discourage root cause analysis by rewarding firefighting over problem solving and planning? Is there an issue in organisational alignment preventing critical information from passing to/from critical functions of the organisation? Has the talent of the organisation kept up with the changing requirements of the position? Have the systems evolved with the increasing need for business information?

5.Collaborative joint-value creation

Have the flexibility requirements of your business been communicated to your supply base? Do you know about shifts in demand, but your key suppliers are just expected to react?

Root causes become so difficult to address because the solution very rarely exists within a single functional group. The best thing to do is create a road map that continuously alleviates the root causes.

Inventory shortages do occur

Whatever the root cause, inventory shortages do occur. Leaders recognise that the health of their long-term account relationships and the business's profitability depend on their ability to handle these shortages in a routine and organised fashion.

A defined and repeatable inventory allocation process shortens the time needed for reliable information to be disseminated through the organisation and back into the customer base. Business risk is lessened by ensuring orders are being filled for customers with the highest strategic and profitability impact.

Implementation of customer segmentation, demand shaping and supplier collaboration allows rapid adjustments to plans that allow a faster inventory recovery. Those that fail to implement a defined and repeatable inventory allocation process languish in frustration, stay in allocation longer and alienate their customer base.

The author is research director in Gartner's AMR Supply Chain Research group.