Replacing Inventory With Information

The West Coast port slowdown and eventual longshoreman lockout last October focused national attention on the delicate condition of America’s supply chain. An estimated $300 billion worth of goods flow through West Coast ports every year, and as the giant container ships that carry it all sat bobbing, anchored at sea and unable to off-load for 10 days, companies across the country started to run out of inventory and assembly lines began to grind to a halt.

Mitsubishi, out of engines and transmissions (which it imports from Japan), suspended production of Eclipse convertibles and Galant sedans at its plant in Normal, Ill. GM and Toyota ceased operations at a shared assembly facility in Fremont, Calif., for one week until parts could be flown in. Boeing’s production of 767 and 777 airliners was disrupted because Asian-built cargo doors and fuselage panels were delayed at sea.

Those and other interruptions were the product of a 20-year-old, 180-degree about-face in the business world’s approach to inventory management. Companies used to measure their muscle by the size of their inventory. Bigger was better. Vast warehouses filled to capacity ensured efficient assembly lines and guaranteed that, come hell or high water, production would never stop. Who cared about carrying costs? They would be erased by sales.

But now that equation has changed. Today, most inventory is considered excess, and overstuffed warehouses represent missed opportunities and, worst of all, wasted capital. Inventory has become such an anathema that companies regularly risk shutting down their assembly lines in order to hold less of it. Which is why the relatively brief port shutdown had such a profound impact.

In the big picture, American business has succeeded in its quest to run lean. U.S. Department of Commerce figures show that from 1981 to 2000, inventory as a percentage of gross domestic product (GDP) fell 46 percent, from 8.3 percent to 3.8 percent. During that same period, the total GDP more than tripled (from $3.1 trillion to $9.9 trillion) while the total amount tied up in inventory didn’t even double, rising from $747 billion to $1.48 trillion.

But almost all these gains in inventory reduction happened from 1981 to 1991, and the past 10 years have not seen much improvement. The inventory carrying rate (a way of expressing the money spent to store inventory as a percentage of its value), which was 34.7 percent in 1981, fell to 22.7 percent in 1992 but rose to 25.3 percent in 2000. And inventory as a percent of GDP held steady at 3.8 percent from 1992 to 2000.

Playing Hot Potato with Inventory

Rather than being eliminated, inventory has been pushed down into the lower reaches of the supply chain?from manufacturers to top-tier suppliers to lower-tier suppliers. GM, for example, improved inventory turns?a common metric that measures total cost of goods sold divided by average inventory, and serves as a valuable indication of how often a company sells out its inventory (the higher the better)?55.2 percent between 1996 and 2001. However, the company that supplies its tires, Goodyear, saw its inventory turns decline 21 percent during that same time. In other words, GM left Goodyear holding the bag.

But now, after 10 years of passing the inventory hot potato around, manufacturers and suppliers are realizing that this is a game no one wins. If a manufacturer attempts to reduce inventory by refusing to accept parts until a certain point in its production cycle, it has to let its supplier know?in advance?when that moment will come. Otherwise, the supplier’s warehouse costs will skyrocket. And those costs will eventually be bounced back to the customer, the manufacturer.

The lesson here is that when you get rid of inventory, you must replace it with information.

Of course, that’s easier said than done.

Up until now, companies have tended to confuse information with IT, but after a decade spent throwing big money?via large ERP-type systems?at the inventory problem, they are beginning to identify the information they really need in order to make their supply chains work for everyone concerned. CIOs now are focusing on smaller projects that target specific information gaps in the supply chain. And new technologies are helping them do just that. These projects generally cost in the tens of thousands or low-hundreds of thousands as opposed to millions of dollars. They address either the supply side, using information to sync with suppliers, or the demand side, using information to right-size and right-time production. Individually, they help drive out cost. Together, they can revolutionize a business.

CASHMAN Big Rigs, Big Money, Big Problems

Cashman Equipment, a $250 million Las Vegas-based Caterpillar dealership, sells and leases construction machinery ranging from the large (backhoes and bulldozers) to the enormous (mining vehicles with 7-foot tires and beds large enough to hold 32 pickup trucks). Recently, a drop in gold and silver prices caused many Nevada-based mining companies?Cashman’s customers?to move their operations to South America where the ground is softer and the cost of digging lower. The slumping economy also means that rentals are up and sales are down.

“We need the right mix of machines in order to have the best margin,” says CIO Bill Glassen. “We can’t have machines languish in the yard.” Each piece of Cashman’s large equipment costs between $250,000 and $1.5 million, and when the company can’t sell it in a timely manner (a few weeks to six months, depending on the product), it has to pay annual finance charges, which can add up to $54,000 for every million dollar’s worth of inventory.

Glassen figured the best way to reduce inventory was to use all the sales and trend information trapped in Cashman’s database to get a more accurate read on demand. At the time, the data was available only to people willing to spend hours burrowing through ceiling-high stacks of computer printouts, or as Glassen says, “The information was available but not accessible.”

Rather than overhauling Cashman’s systems and databases to throw IT at the problem, Glassen spent about $12,000 in September on a demand-planning system from Sunnyvale, Calif.-based Hyperion. The software has a specific goal: Dig out the information buried deep in Cashman’s databases and turn it into reports on sales and rental trends. For example, the company recently ran a report forecasting how many skid-steer loaders?a one person mini-loader used in landscaping?it could expect to sell this year. The report culled and analyzed, among other pieces of information, past sales, the number of contractors in Nevada that use the machines and the rate at which they are traditionally replaced.

Once the information became accessible and Cashman was able to predict how many skid-steer loaders and other machines it could expect to sell, the company could adjust its orders appropriately. In the first month after the system became operational, Glassen says, Cashman reduced inventory by $8 million without adversely affecting sales.

PALM When Is a Sale Not a Sale? When Nobody Knows About It.

The best system in the world is worthless if no one uses it. A bad system no one uses may be even worse. That was the situation at Palm, the Milpitas, Calif.-based handheld computer maker. “When we spun away from 3Com [in 2000], we were very successful very quickly,” says Senior Vice President of Global Operations Angel Mendez. “We went through hypergrowth. Then [in 2001] we hit a very difficult period. Poor product introduction and a stall in sales concurrent with a slowdown for PDAs left us with a huge glut in inventory. We took a huge inventory write-down in the $240 million range.”

Palm never saw it coming. Its forecasting system relied on regional sales reps to dial in and enter sales reports and forecasts. Their information wasn’t inaccurate, per se, but it was usually late and often incomplete. Salespeople found it too difficult to input information. That, Mendez says, resulted in a 30 percent compliance rate. As a result, forecasts were unreliable, and Palm had to carry excess inventory in order to guarantee that it could meet orders.

In response, Palm added the demand-planner module to its existing SAP system starting in April 2001. Although Palm considered integrating another vendor’s demand-planning software with its SAP ERP system, Mendez says that because Palm already had a major investment in SAP, and since the demand planner was easy for salespeople to use, it was the right investment.

All that was left to do was to make sure the sales force understood the importance of complete and timely forecasts. Between June 2001 and November 2002, Palm reduced inventory from $240 million to $38 million. Inventory turns jumped from three to 15 by the end of the first quarter.

JUNIPER Decisions in the Dark

Juniper Networks, an $887 million Sunnyvale, Calif.-based data storage company, outsources the manufacture of all its routers to contractors that ship the finished goods to Juniper’s customers. So, says CIO Kim Perdikou, it doesn’t actually have any inventory. “But we have a responsibility to share that burden” with the contract manufacturers, she says. And that sharing affects the bottom line: If Juniper can help its contractors lower their inventory charges, it stands to share in the savings.

Perdikou says that Juniper is philosophically opposed to big projects where the scope of the software and the time it takes to integrate it can distract from a project’s business goal. So in 2001, when Juniper wanted to get better inventory information from its suppliers rather than attempt to integrate their ERP systems with its own Oracle system, Juniper purchased and deployed a supply chain visibility system from Palo Alto, Calif.-based Valdero. (Juniper won’t say how much it paid, but Valdero says that the system typically sells for between $300,000 to $500,000.) Among other things, the software tracks inventory levels at partner companies, either tapping EDI transmissions or through daily updates. Since Juniper now has this information updated continuously, rather than in printed monthly reports, it can make design decisions that take its partners’ inventory into account.

For example, Juniper could study 40 proposed engineering changes with the goal of finding the five that would best reduce product cost. “We may decide in engineering that we are going to change a component that on paper makes [a product] more cost-effective,” says Perdikou. “But that isn’t taking into account the effect on inventory at the contract manufacturer.” In other words, Juniper may want to replace a particular part with a less expensive option, but if the contractor has a large stockpile of the old part, then it stands to take a huge financial hit?and ultimately pass that cost on to Juniper.

“If you don’t understand what the inventory is, you are really making a lot of these decisions in the dark,” says Perdikou.

NETWORK APPLIANCE A Disk in Time Saves Nine

Network Appliance, the $795 million Sunnyvale, Calif.-based enterprise storage solu- tions provider, is currently in the middle of a year and half long ERP project. Yet when it had to reduce its service inventory?the parts it uses to replace broken devices in the field?it stayed away from big supply chain names like i2 Technologies and Ariba, and instead cobbled together smaller, more targeted pieces of software.

“If you have big problems, you may need a big project,” says CIO Scot Klimke. “In this case, however, we had a problem that was very specific.” The problem the service unit faced?how to reduce inventory while still guaranteeing that it could make field repairs within the two to four hour window?was unique to its business unit. Plus, says Klimke, “you get things done faster when you do things smaller.”

Network Appliance has 195 geographically dispersed service depots worldwide, with 95 in North America. These depots are supplied by a main service hub in Louisville, Ky., which in turn gets parts, such as disk drives and data caches, directly from its factories. With a field parts planning module from Baxter Planning Systems in place, Network Appliance spent June 2000 through July 2001 installing two pieces of quick-hit software from Fairport, N.Y.-based Xelus and Fremont, Calif.-based WorldChain that would turn the information in the Baxter system into inventory reductions.

After the Xelus demand-planning system comes up with a forecast, Network Appliance uses replenishment-planning software from Baxter to determine how much inventory it needs to keep at its depots and at its Louisville hub. When a customer initiates a service request, it is routed through WorldChain’s supply chain execution software to the nearest depot, which services the customer. The Baxter and Xelus systems then in turn automatically tell the hub and the factory that they must ship out another part to replace the one used. Now that the depots, and the hub, can rely on being expeditiously restocked, they can carry minimal inventory.

Since the new system was implemented in July 2001, Network Appliances has seen on-time service responses increase from 70 percent to 98 percent. Furthermore, despite a 430 percent growth in its customer base since it first started the demand-tracking project in 1999, its inventory level has increased only 120 percent.

HOWMET CASTINGS You Take It. No, You.

Until the mid-1990s, the airplane engine manufacturers (Boeing, GE, Rolls Royce and others) that bought metal castings?rotating engine foils and body parts for wings?bought generic parts and customized them in their own shops. Then, in order to reduce their own inventory, Howmet’s customers began de-manding finished pro-ducts, sending How- met scrambling to find subcontractors who had the tools and skills to do that. The Darien, Conn.-based Alcoa subsidiary’s cycle time doubled, and inventory turns were cut in half.

In order to cut its cycle time back down from 10 weeks to five, Howmet needed to improve communication with the small shops that do the final casting customization. “If I make a casting and simply ship it to a machining supplier, he may get up in the morning to find 100 castings on his [loading] dock,” says Prime Operations Director Kevin Mullowney. “That creates delays.” Mullowney realized that Howmet needed to figure out how to let its suppliers know in advance what it would need and when.

In December 2001, Howmet launched a supply chain visibility project using software from Cupertino, Calif.-based Exemplary. The software extracts timetable, quantity and parts-type information from Howmet’s purchase order system and automatically routes it to the appropriate supplier so that it can plan in advance. The system cost $500,000 and went live in October.

Mullowney says that Howmet gets about 80 percent of the system’s benefits, principally in cycle time reduction, while its suppliers get the remaining 20 percent, as they can now plan for the arrival of Howmet’s castings, staff their shops accordingly and turn them around more expeditiously.

“Two months ago, I may have carried $10 of safety-and-buffer stock” to guard against late deliveries from subcontractors, says Mullowney. “But excess inventory is waste. By having better visibility, I may be able to reduce that to $6.”

Small Is Beautiful

The assumed advantage of enterprise software is that what it lacks in specificity, it makes up for in breadth. But the CIOs in this article learned that the trade-off isn’t always worth it. “The majority of people buy very large applications,” says Juniper’s Perdikou. “But they are only getting about 15 to 40 percent of the functionality out of it. You’re better off buying something smaller and really using it.”

Network Appliance’s Klimke says that when you have a specific problem you need a specific solution. If the problem is unique to a business unit or involves a small number of business processes, then it probably needs a targeted solution. However, Klimke suggests that CIOs make sure that similar problems aren’t popping up in other business units before going small. “Requests that come from the business are typically narrow in focus,” he says. “They come from directors who have a narrow responsibility. If we see requests with a common thread, we group them together, and that is when you should end up with enterprise solutions.”

Finding the right software is another challenge. Typically, business managers have a long list of functionality they want the new system to have. In order to keep the project small, says Perdikou, “you need a truthful businessperson who will tell you where 80 percent of the benefit is. All these other parts might get you 5 percent of the benefit and take you a year to do it.”

The more focused a small project is on a specific goal, the faster it can be completed, the easier it is to get internal buy-in and the sooner the payback. There is a danger to small projects, however, warns Klimke. “You end up with a lot of solutions,” he says. “And you have to keep careful track of that.” Otherwise you wind up with disparate systems all over the place?the very problem enterprise software set out to remedy in the first place.