Finding the right distribution inventory management plan

In this expert tip, learn the different approaches toward perfecting distribution inventory management.

The distribution chain is made up of warehouses that store inventory and pass it on to downstream customers, such...

as warehouses, distribution centers, stores or end-consumers. The amount of inventory at each location and how it is replenished is the primary concern of distribution inventory management.

There are several approaches to distribution inventory replenishment. The obvious goal is to have enough inventory to deliver a desired level of customer service -- the ability to ship what the customer wants when they want it and no more. The major difference in approach is who controls the replenishment process and how replenishment is managed.

Two general approaches to distribution inventory management are characterized as "push" and "pull." In the push approach, the central factory determines what to ship, in what quantities and when to ship it. Theoretically, the factories can develop the most efficient and effective production schedules and do the best job of minimizing inventory in the distribution chain. But, since they are the furthest removed from real customer demand, they probably won't have the visibility of demand at each endpoint to be able to deliver the highest service level.

With the pull approach, the retailers or dealers -- the lowest level of the chain -- order goods from the next level of the chain to suit their needs, presumably yielding the best availability and customer service. Each successive level orders from their supplying warehouse as they determine best. Since all higher tiers in the distribution chain are now reacting to orders from below, their planning is limited to forecasts and is subject to the variability of a random demand process, so they must have relatively high levels of safety stock or they will suffer from shortages despite high inventories. Thus, pull yields a better service level at the customer end, but less efficient management of distribution inventory.

The pull approach often leads to the so-called "bullwhip effect," where small fluctuations in demand, as they are translated up through the chain, become large swings in replenishment orders and shipments that result in serious inventory problems -- too much inventory and too many shortages -- and chaotic production demands. The cure for the bullwhip effect is collaborative forecasting and making detailed point-of-sale information available to the factory and distribution planners.

Hybrid distribution inventory management

In actual practice, distribution chains will use a hybrid approach where upper tiers are push-controlled and lower tiers pulled. Supply chain theory encourages the intersection point between push and pull to be as far back toward the factory as possible for best customer service. Again, collaboration and information sharing do a great deal to overcome the limitations of pull while preserving the efficiencies of push.

A third approach is distribution requirements planning (DRP). DRP uses time-phased planning logic similar to material requirements planning to determine the timing and size of replenishments. Starting with a forecast, DRP works up through the distribution network tiers, building a schedule of shipments, level by level, that minimize inventory while targeting the desired service level with the appropriate amount of safety stock.

Advanced supply chain software takes a more sophisticated approach under the moniker "inventory optimization," or "multi-tier inventory optimization," which can consider more factors such as different transportation modes -- e.g., rail might cost less than truck, but may be slower and is not available everywhere -- or alternate sources of supply -- if several factories make the same products, it determines which should be supplying what warehouses. Inventory optimization is often available as a feature or optional module as part of a supply chain planning suite.

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This was last published in May 2014

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Unless a manufacturer owns the entire distribution chain, their products are always going to be pulled. Our suppliers would love for us to take whatever they've produced, but all we're going to bring in is what we need. Normally our replenishment is based demand forecasting using historical sales data and taking current demand from booked orders. Your last paragraph touches on the decisions that our inventory management department makes every day as we strive to maintain high service levels with the minimum investment in inventory.
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True, you can only manage and optimize what you have within your control (what you own). Nevertheless, companies are increasingly working together - collaborating - to improve supply chain performance for the benefit of both the supplier and the customer with programs like Collaborative Planning Forecasting and Logistics Replenishment (CPFR) in the retail segment.
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