Chapter 1
Creating Demand-Driven Supply

When people talk about inventory optimization I am always surprised at the number of definitions that are rolling around out there. Most C-level executives know it has something to do with reducing or right-sizing inventories and that it really helps control supply chain costs. The career path of that C-level executive can morph her viewpoint about where that optimization resides. Indeed, the closer you get to the customer, the more optimization means replenishment. This means a retail executive has a far different view of optimization compared to that of a manufacturing executive.

For many, the focal point of supply chain efficiency projects is to uncover and exploit cost discrepancies positioned by supply chain partners in the name of "optimization." For instance, in the article "Optimizing Replenishment Policies Using Genetic Algorithms for Single Warehouse/Multi-retailer System," W. Yang, T. Felix, S. Chan, and V. Kumar cite how huge savings can be achieved by adhering to a methodology of quantity discounts in transportation cost models.1 This technique of uncovering supply chain inefficiencies to fill the void with cost savings shifts costs onto another portion in the supply chain. It is rampant inside companies and between external trading partners in almost all industries. Obviously, the whole point of optimization is to take advantage of every opportunity of cost savings, not just taking advantage of trading partner inefficiencies. Optimization is not simply shifting the costs from one location to another. Optimization is all about the actual elimination of costs and the savings enjoyed by either the network as a whole or the end customer satisfaction.

This is why we oftentimes find supply chain executives perplexed about where to start in developing a fact-based pathway to better supply chain dynamics. There seem to be a million different definitions of what inventory optimization is, depending on what flavor of optimization is in vogue. At one time the flavor might be network design to drive best positioning at the moment of a warehouse. Another time it might be a theory of constraints project to uncover bottlenecks in the company supply chain that can be smoothed out. Conversely, it might even be a project about SKU (stock keeping unit) rationalization for overall portfolio profitability. I have heard them all batched under the banner of inventory optimization. However, nothing has created more confusion than a definition driven out of the just-in-time wave of supply chain efficiencies-the idea that a company that practices pull supply chain methodologies will suddenly enjoy massive inventory savings and replenishment nirvana. Nothing could be further from the truth.

There is nothing wrong with the assumption that replenishment is what drives supply. In fact, given my background I would almost wholeheartedly agree. Over the past 30 years supply chains are shifting from being supply-driven (push) to being demand-driven (pull). While the theory is easy to imagine, the devil is in the details. There are decades of supply-side or push-style supply chain practices in place throughout organizations. You can't simply flip a switch and make your supply chain work in a new way.

Originally, the thought of most companies was to make a complete shift from push to pull as a way to have a nimble and/or agile supply chain. In an article written back in 2003,2 Erik Kruse talks about some of the disastrous results companies incurred when they took perfectly good operating systems that insured efficiencies when producing large quantities of standardized products and attempted to make smaller batches of products to quickly react to customer demand. He points out an AMR Research study that supports his claim of inefficiencies. In that study, it was shown that companies tend to reconfigure their physical networks without introducing new processes that would help in the transition. Kruse points out that if customers don't buy what the efficient operations are producing, then the efficiency metric isn't really measuring true efficiency.

This brings up an interesting paradox. If you only use supply-side/push methodology, your operations can be extremely efficient. Large amounts of standardized product can be positioned, but if the customer is not buying the product at the same rate, the real efficiency is lost. In turn, if you shift to a demand-side/pull methodology, you reduce the production cycle and produce just enough to satisfy customer demand. When this occurs, you lose your manufacturing efficiencies, and you run the risk of not fulfilling unexpected customer demand.

Various large-scale supply chain movements like just-in-time, efficient consumer response, and collaborative planning, forecasting, and replenishment have all been rolled out in the name of creating a more responsive organization. The introduction of enterprise resource planning (ERP) and supply chain management (SCM) solutions in the late 1990s helped these movements gain traction, as technology interacted with methodology. Oddly, as technology and methodology interconnected, it seemed as though the supply chain industry was simply creating a bigger, better, and faster replenishment engine as a way of having an optimized supply chain. What is becoming more and more apparent, though, is that replenishment can only do so much in an effort to become demand driven. In the end, replenishment can only attempt to compensate for out-of-balance inventories.

The Path to Demand-driven Supply

This book is designed to take business practitioners through the fundamentals of inventory optimization so that they can attain a demand-driven supply. If you are looking for a book that will spell out stochastic algorithms, you're in the wrong place. Virtually every book written on the subject of inventory optimization (IO) seems to be done by academics with complete focus on proving that the stochastic algorithms they used during their studies are sound and repeatable. The rest of the inventory optimization publications could be categorized as "snake oil" whitepapers. Why snake oil? From the early 2000s through 2010, various inventory optimization vendors tried to differentiate themselves by claiming their "math" was superior or they had proprietary algorithms no one else could provide. There was little wonder the industry had confused the market.

The business world has heard about the subject of inventory optimization, but has trouble linking the solution to the many supply chain problems they might have in their organization. My goal is to provide a business perspective on why current inventory systems suboptimize the supply chain and why faulty replenishment processes lead to wasted time and effort. In the end, I hope the reader would come away with a good understanding of why optimized inventory and replenishment helps overcome in-system weaknesses and deliver results. We've come a long, long way, and it seems as though we only have a few more hurdles to go before we become part of the end game known as demand-driven supply.

When I am in front of executives who think replenishment cures their supply chain, I often ask the question: "If replenishment takes care of inventory ills, what caused your inventory to be sick in the first place?"

Although it is not the only place of supply inefficiency, let's take a look at the grocery supply chain in the United States. Because of the normal interactions people have with their grocery stores, they can recognize some of these push-style methods that companies use to entice you to buy products you wouldn't otherwise have purchased in the name of pushing products through the supply chain.

Shifting from Supply-driven to Demand-driven Methodologies

Thirty-five years ago, just before the demise of the so-called push supply chain in grocery products, I made a personal transition from being a supply-driven buyer to being demand-driven buyer. First of all, at the time I didn't know what any of this supply-demand mumbo-jumbo meant, and, second of all, I never set out to be a buyer in the first place.

So You Think You Can Do Better?

I was working as a key account manager in Portland, Oregon. My job was to manage grocery headquarter accounts for best results in sales. It was getting close to the end of the fiscal year, and we were slightly below the numbers I needed to bring in. One of my accounts was a co-op wholesaler who supplied almost all of the large, independent grocery stores in the northwest region. My buyer, Joanne McBride, did not have any direct responsibility for the advertising, but purchased for both turn and promotional merchandise. I was good friends with her. I was also really needling her to order a little more so I could make my year-end numbers. What she did next changed my life forever.

She looked at me and said in a very tired and very sarcastic voice, "Bob, you think you're so hot stuff. Why don't you do it?"

I was stunned. Now what am I going to do? However, never being the one to back down, I said, "Okay," and picked up the two orders so that I could get the heck out of there. I went downstairs to the lunchroom with a calculator and a very sharp pencil. The only instructions I got from her that day were the following:

• There are four numbers that show the running "as-is demand" by week with the most recent on the left.
• If there are any ads planned for the product,...