ERP systems prove their worth in financial crisis

Inventory optimisation software is paying dividends in tough times

Whether it is a truck, a tsunami or an economic downturn, the same general rule applies: You are better off if you can see it coming from a safe distance.

There are few companies that understand this notion better than Cisco Systems. White-hot during the 1990s, the company was pummelled after its vaunted inventory forecasting system could not – or did not – predict the dot-com bubble's collapse.

The result of this miscalculation was that sales were halved, the company lost 25 percent of its customers in a matter of weeks, and it ultimately wrote off more than US$2 billion in inventory. After that experience, Cisco's supply chain team vowed it would never get blindsided again.

"There is a huge difference cutting head count between now and 2001," says Karl Braitberg, Cisco's vice president of customer value chain management. Back then, Cisco's supply chain model was built on a "push" system, where products were made and inventory was built up in anticipation of market demand based on best-guess forecasts. "Then, when demand dropped, the supply chain froze. Nothing happened," Braitberg says. "We knew we had to build a new system that reacts better than just 'push'."

Every company is tasked with matching its supply to consumer demand. In a normal business cycle, how well that job is accomplished determines whether the company is profitable. But this current economic downturn is anything but normal, and businesses are struggling to simply stay liquid. There are various strategies to help preserve working capital, including cutting head count, outlets and manufacturing lines. But for most companies, the key to capital preservation will be how well they can reduce their inventory levels.

Companies are essentially in survival mode and they're looking to their supply chain management team to free up precious capital to help them do that. While it may not fall directly on IT executives to make that happen, their role in the equation is strategic.

With globalisation, outsourcing and increased compliance and security concerns, managing supply chain operations becomes increasingly complex. And shorter, more frequent product cycles targeting more-sophisticated markets create a need to manage more products and parts from remote locations. Add the pressure of shorter cash-to-cash cycles – from when a business extends credit to build inventory until the time it gets paid – into the equation, and the need for an intelligent, nimble and timely flow of information becomes critical.

To have visibility as well as command and control, supply chain operations must be tightly integrated with the IT infrastructure.

Like bloodletting, reducing inventory is a delicate matter most people would prefer to avoid. Inventory can range from materials, to parts, to fully assembled products. Nobody wants to run out. If there is too little, customers won't get orders in a timely manner and market opportunities will be missed. Yet, if a company carries too much and demand drops, then the inventory must be "bled down", or reduced in price, until it has a buyer.

During a strong economy and when cash flow is loosened, many companies can get by without rigorous inventory management practices, says Larry Lapide, director of demand management at the MIT Centre for Transportation & Logistics. But during a recession, he adds, "companies had better bleed down inventory to reflect the downturn in sales. If they don't, it just sits there."

Inventory optimisation is so critical now because of its impact on available cash, Lapide says. In accounting terms, inventory is an asset. So inventory that is on the books through manufacturing, assembly and distribution represents credit-funded inventory. With credit at a premium, it is in a company's best interest not only to keep inventory levels tight, but also to sell goods as soon as possible.

Reducing costs and squeezing maximum utility out of fixed assets is nothing new to Black & Decker's Hardware and Home Improvement Group. The unit supplies hardware to big-box retailers that have responded to the economic downturn with new low-price strategies. It now falls on Scott Strickland, vice president of IS, to help the group squeeze down its own costs and maintain profit margins.

"We had been loath to drive inventory down to this level," Strickland says. However, the company had gained invaluable experience by deploying an integrated inventory management system prior to the downturn. The result was that the key decision-makers throughout its supply chain were operating with the same information, planners focused only on exceptions, as well as supplier and material issues getting quickly resolved. The system, Strickland says, does the heavy lifting. As a result, the unit has cut planning cycles from weeks to days and improved forecast accuracy by 10.4 percent.

"If someone had told us nine months ago that we could lower inventory as fast as we could to address a sales decline, we would not have believed it was possible," Strickland says. However, "because of the impetus on freeing up working capital, we have been focused on lowering our inventory and levels. We figured we could do this and it turned out to not be the bad experience we had imagined."

The effort to lower inventory levels to free up working capital has proved so effective, the Black & Decker unit and its partners are jointly considering making it standard practice even after the economy recovers, Strickland says.

Companies say that driving costs out of the supply chain is an important goal, but the big question is whether – especially during a recession – they can afford to invest in their supply chain IT infrastructures to help make that happen.

Dwight Klappich, an analyst at Gartner, says he expects IT spending on supply chain applications to decrease through 2010 and that spending won't pick up again until 2011. Between now and then, IT departments are likely to focus on tactical investments, such as forecasting or transportation management systems, rather than on strategic supply chain transformations.

Klappich calls that a short-sighted and, in the long term, a costly approach. "If this trend continues," he stated in a report, "this myopic focus on short-term tactical issues, while necessary for many businesses, could widen the gap between the best-performing organisations and lower-performing organisations."

You have to spend to save

Despite some celebrated failures, most companies do realise cost efficiencies, if not competitive advantage, by using supply chain management software. Yet the cruel irony is that most businesses can't afford to buy the software when they need it most.

A recent study of inventory optimisation software, which helps determine what inventory should be where in the supply chain, underscores this dilemma. A study by IDC Manufacturing Insights found organisations that deployed inventory optimisation systems saw a meaningful return on investment in a relatively short period of time. Results varied by company, but some of them reduced their inventory levels by up to 25 percent in one year, while others enjoyed a discounted cash flow above 50 percent in less than two years.

However, in this recession, companies are cutting spending wherever possible, including software purchases. So it is not clear whether they can afford to buy a tool that could help them loosen up cash by optimising inventory levels.

MIT's Lapide agrees. Companies need to pay more attention, not less, to using cross-functional collaboration to get a better view of demand variability, he says. "IT is needed to get these operational and system silos connected," he says. "IT, supply chain, sales – you name it – they all have a common enemy. They have to join together and work to get rid of these silos."

Cisco understands this. After the 2001 downturn, it made major system investments to transform its "push-driven", siloed supply chain model into an integrated "pull system" that can extract timely data from suppliers and downstream partners. This reorder data is sent to Cisco after being triggered by specified parameters and algorithms, to shape "demand signals".

The system doesn't operate in a vacuum. Cisco has optimised its forecasting algorithms by bringing together representatives from its marketing, finance, sales, supply chain and IT departments, and from key customers, as part of its sales and operations planning process. This group collaborates to create a common view of demand signals. This input drives an agreed-upon plan of action to align manufacturing capacity and inventory deployment, and meet customer service levels. In short, they work together with the same data to optimally match supply and demand.

"Now, if there are no pull signals, nothing gets brought into the system," says Cisco's Braitberg. Manufacturers don't continue to source and build inventory that may sit in some warehouse waiting for customers who may never buy it. Cash is freed up for other purposes.

While Braitberg acknowledges events from the past can't be used as a template for this downturn, Cisco is confident it has better visibility into market demand when it goes down, and that the company will be ready when the green shoots emerge.

"We now have the techniques in place to be hypersensitive to demand changes," Braitberg says, "and we can manage our way through a downturn."

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Tags managementblack and deckerERPinventory optimisation

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