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Why inventory is a key metric in sales and operations planning

Inventory is just one output of sales and operations planning, but it's also a measure of how well a plan is working and serves as a shock absorber between supply and demand.

Sales and operations planning is the process wherein company leadership maps out a plan for the operation of the...

business over the intermediate term -- a rolling plan that typically spans 18 to 24 months. First, the sales and marketing team formulates a demand plan and passes it to the supply planning team. Then, production plans are generated and tested against available resources. The two teams -- demand and supply -- then get together and work out the best overall plan for operating the business that satisfies customer demand while supporting efficient and profitable production and operations. The final plan is reviewed and approved by the executive S&OP team, which consists of senior executives responsible for all aspects of operations: materials, production, design and engineering, sales and marketing, customer service, finance, human resources, and more.

The most important aspect of sales and operations planning is that it is an agreement both sides commit to. Supply -- sales and marketing -- and demand -- production and operations -- can then each be judged by their actual accomplishments compared to the plan they agreed to.

But where does inventory belong in this picture?

Finding the 'I' in sales and operations planning

In some parts of the world, S&OP is actually called SO&IP, with the "I" standing for inventory. And even where inventory is not explicitly included in the acronym, it is still an important factor in planning and operations. In sales and operations planning, inventory is both a measurement and an objective.

Think about it this way. Demand planning involves actually identifying what product (inventory) needs to available for sale and shipment. Supply planning identifies what product will be made available to meet demand. In a perfect world, supply and demand would be perfectly in sync, and there would be no finished goods inventory on hand -- it would be sold and shipped the very day it is made. Note that this discussion is limited to finished goods. Raw materials and work-in-process inventory are two entirely separate discussions, although they certainly are influenced by the requirements of the S&OP plan.

Obviously, the actual world we live in is not perfect in terms of supply and demand synchronization, except in certain very special circumstances, and even then we have to be aware of supply chain risk and provide the appropriate buffers. Nevertheless, inventory is a part of every manufacturer's world, and in most companies, it acts as a decoupling point or buffer that absorbs the differences between the cycles, quantities, and timing of supply and demand.

In fact, one of the main outputs of the sales and operations planning process is an inventory plan. But don't think of the inventory plan as a major objective of S&OP; it is more of an output or measurement of the supply-demand plan. It is simply a projection or forecast of what the finished-goods inventory will be when the plan is carried out as written.

The projected amount of inventory may be unacceptable, however. There may not be enough space to hold it or not enough money to finance the investment or maybe even too little inventory to give company executives confidence that they can meet customer demand. (The latter shouldn't be a concern if the plan is well constructed to accommodate expected demand and reasonable estimates of risk.) Nevertheless, the S&OP team may decide to change the plan specifically to adjust the expected quantity of inventory.

Outside of that kind of plan manipulation, the inventory forecast should be considered a benchmark that offers a great overall measurement for the S&OP plan. If the forecast were to call for, say, $1 million worth of inventory at the end of April, and the actual amount on hand on that date is $1.2 million, something is not going according to plan.

Here's where the S&OP plan can help avoid confusion and finger-pointing. First, compare sales to the plan. Then, compare actual production to the plan. It should be immediately obvious where the source of the inventory growth is and where to focus your analysis and problem solving. No more finger-pointing: Each side, marketing and sales, along with production and operations, can be held responsible for achieving its goals.

While inventory planning is not a principle objective of S&OP, it is an important factor in validating the plan and a great tool for active management of sales and operations. As an overall health check on whether the plan is being achieved, it can provide a global view of sales and operations that leads to a quick focus on which side of the business needs attention. 

Next Steps

Read a case study about S&OP software

Understand how S&OP can encourage cooperation

Learn how to implement S&OP software

This was last published in July 2016

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