Cost and Inventory Optimization Require More Than Financial Targets

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Meeting cost and inventory goals creates both operating ambiguity and management dysfunction within many organizations. This results from attempts to manage individual cost centers and functions in ways that overlook the complex impacts of constraints, variability and system interdependencies. Gartner observes symptoms that include:

  • Inventory is often confused with cost. While inventory is a working capital asset (which has a cost), it can be leveraged to protect and create value in ways that benefit both cost and service.
  • Inventory obsolescence, late delivery penalties or expediting costs are often treated as independent metrics, managed as standalone goals with focused action plans. The result is usually disappointment and possibly indictment of individuals who were assigned to pursue these futile approaches.
  • Any initiative to improve cost or inventory is met with pockets of resistance, both visible and passive. Commercial stakeholders will raise caution about the risk to service or growth. Operating stakeholders will raise alarm about the impact to their safety, reliability or efficiency objectives. Fear and cynicism stifle collaboration and innovation as individuals grow concerned about their job security.

These conditions do not prevent companies from attempting to manage cost and inventory directly, with high-level targets and simplistic metrics. Cost reduction targets of 10% or more are communicated, as though such a declaration could be considered a plan. Figure 1 below illustrates the logical impact of these practices, as supply chain organizations adopt short-term approaches that decompose into pressure on individual functions. Logistics leaders in particular cited challenges to achieve ongoing cost reduction targets as their second most pressing challenge behind talent.

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In the case of inventory, Gartner has established a framework that many clients use to identify and manage the clear line of sight between three decision categories and their impact on inventory performance. Clients can review Supply Chain Leaders Must Orchestrate Three Decision Categories for Inventory Excellence. Our advisory discussions with clients center on the need to act as orchestrators that go beyond the pursuit of inventory targets to cultivate organizational intelligence and use appropriate governance to master three decision categories:

  • Design choices that create structural inventory
  • Operating trade-offs that use discretionary inventory to deliver reliable, efficient supply
  • Business judgments that use anticipation or hedging stock to balance risk and opportunity

Inventory performance will not change until decisions change based on new insights, assumptions or trade-offs. Supply chains can help their organizations rise out of “analysis paralysis” by promoting a translation from these financial targets and conceptual discussions to an actionable sequence of potential actions. The themes for these actions are summarized in Figure 2 (clients can review the detailed analysis here: Gartner’s Top Actions for Supply Chain Inventory Reduction)

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Besides responding in good faith to work toward the chief financial officer’s dreams for reduced inventory, supply chain leaders adopting this approach can use the outcomes of these changes to deliver documented impacts that correspond to discrete changes. This fosters organizational learning about the complex trade-offs and the role of business judgment, which is required to achieve alignment for maximum inventory performance.

Supply chain cost is even more complex than inventory. First off, cost is an accounting artifact that does not correspond to a physical material or asset. Cost is an accounting valuation of resources consumed within a specific time period to deliver outcomes to customers or patients. The various allocation and accrual methods needed to comply with tax laws and financial reporting requirements do not correspond to the way that resources are committed to incur cost. More elaborate analysis and measurement do not immediately lead to cost improvement either. Some companies with recent investments in “cost to serve” modeling projects were not able to identify or agree upon actions that could be taken to reduce cost.

While better data granularity and visibility are valuable, making analysis the centerpiece of cost optimization creates a distraction that focuses stakeholders on cost (creating conflict), compared to outcomes that all stakeholders can align on. Figure 3 below illustrates Gartner’s emerging vision for cost optimization, which puts alignment with operating outcomes and strategic imperatives in focus.

 

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The purpose of this visual is to prevent supply chain leaders from pursuing (or stakeholders from perceiving) cost optimization efforts that put strategic imperatives, business objectives or customer outcomes at risk. Additional high-level messages:

  • There should be no reason to initiate a separate cost improvement program or organization within supply chain. Cost optimization is the result of planning and execution that optimally balances supply and demand.
  • Periodically review and reconfigure the elements of supply chain to maximize alignment with market demand, business strategy and product offerings. This includes design of the network, organization and operating model. Leading companies take this further to review the entire business, configuring its product design and platforms, service offerings and market strategies for cost-optimized supply.
  • At some point, investment to upgrade operating capabilities is required to enable continued efficiency improvement. It is also imperative as product portfolios, networks and service offerings become more complex. Too many companies attempt to operate with capabilities that were sufficient to compete in the past, but cannot efficiently manage the complexity introduced to support today’s business strategy.

Gartner has published a collection of Cost Optimization Playbooks to equip clients with content to operationalize their cost optimization aspirations. More importantly, we advise them to ensure that cost optimization efforts are properly positioned in support of operating outcomes that align to strategic imperatives. We look forward to your feedback and the learning we can both discover by pursuing excellence in supply chain cost and inventory.

Paul Lord, Senior Director, Supply Chain Research and Advisory, Gartner

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