Editor’s Note: Last year ToolsGroup became Microsoft’s partner for Multi-echelon Inventory Optimization (MEIO) in Industrial accounts. Microsoft and I collaborated on a blog introducing the basic concept of MEIO, comparing it with Inventory Optimization. You can see Microsoft's version here on their and my slightly modified version below.
The subway system is the lifeblood of New York City, carrying an average of 5.7 million people per day across 472 stations. Each station is part of a larger system and operates on a set schedule under one management umbrella. Imagine what would happen if each station optimized its schedule and traffic independently: city-wide chaos would ensue. Now consider that by not optimizing your inventory from a global vantage point you may be creating, if not outright chaos, a much less efficient network than you could have.
There are many pieces of the modern manufacturing supply chain, and when it comes to inventory management, each one must operate as a part of a global single system to be most effective. To truly serve the end customer, all manufacturing echelons, such as raw materials suppliers, factories, distribution centers, and wholesalers, need to ensure that the right stock is at the right place at the right time. This is no easy task.
Making matters worse, many manufacturers are currently using legacy systems with rules of thumb, outdated algorithms, or personal instinct to manage inventory. For example, an organization may set inventory targets for a specific SKU-Location based on average demand for a broad product family across a wide geographic region. This approach does not account for variability: individual products may have a similar average demand but dramatically different incoming order patterns.
To stay competitive, manufacturers are turning to two types of solutions to handle their supply chain: inventory optimization (IO) and multi-echelon inventory optimization (MEIO). The overarching goal of both IO and MEIO solutions is to efficiently match inventory levels to accommodate forecasted demand. This enables manufacturers to keep inventory levels low, move inventory as quickly as possible, and ensure high service levels for customers. Let’s first look at how inventory optimization (IO) solutions tackle effective supply chain planning, then compare it with MEIO.
The basic approach to inventory optimization
A good inventory optimization solution utilizes identifies optimal inventory levels at individual stages in the supply chain. With advanced analytics, statistical algorithms, and sometimes machine learning, manufacturers can accurately address demand volatility and manage even slow-moving products in the long tail.
Inventory optimization models demand and determines appropriate inventory for individual echelons in the supply chain. For example, if a supply chain contains raw materials suppliers, factories, and warehouses, most inventory optimization solutions manage stock at each stage separately—optimizing supply at warehouses distinctly from factories. By bringing to bear statistical demand forecasting, advanced analytics, and intelligent inventory adjustments, manufacturers see significant improvements over the old rules of thumb, arbitrary segmentation, and one-size-fits-all approaches. The results are powerful and usually immediate: improved service levels, increased working capital, and decreased operational costs. These solutions greatly improve business outcomes and are an important first step to modernizing inventory management.
The Multi-echelon Approach
MEIO solutions take inventory optimization a step further for complex supply chains. An effective MEIO solution suggests the right levels of inventory at each stage of the supply chain by simultaneously optimizing inventory balance across multiple echelons and locations. Picking up from our previous example, with an MEIO approach, manufacturers would analyze demand forecasts across an all-encompassing view of the supply chain.
So how does this approach further help plan inventory? MEIO enables manufacturers to strategically stock individual inventories across all echelons of the supply chain, further increasing customer service levels while simultaneously decreasing costs. For instance, the MEIO software might suggest the right “decoupling points” and adequate levels of materials, components, subassemblies and finished goods in any location of the entire supply chain. It can optimize the balance of inventories across different locations for optimal “staging” and different Bill-of-Material (BOM) levels for optimal “postponement”. It also enables manufacturers to achieve the optimal replenishment frequency for individual products at each locations.
The increased visibility MEIO provides empowers centralized demand planning, reducing costs across the supply chain and streamlining operations. Inventory optimization (IO) is a great first step to improving overall supply chain performance, but for companies with complex supply chains, MEIO goes further towards optimized service levels with minimized inventory costs.