5 Reasons Businesses Should Use Simulations Instead of Formulas or Algorithms to Determine Optimal Inventory Levels
5 Reasons Businesses Should Use Simulations Instead of Formulas or Algorithms to Determine Optimal Inventory Levels
A startup learning to effectively manage day-to-day inventory demand. A mature Fortune 100 business simply pushing for improvement. Regardless, when a company requires inventory, simulations – not calculations – can accurately determine inventory stock levels. This saves money and resources, allowing the business to spend more time focusing on strategic initiatives.
1) It’s Impossible for Formulas to Account for the Required Parameters to Accurately Determine Inventory Levels
Whether custom Excel spreadsheet or expensive enterprise software application, when a business runs traditional inventory calculations/algorithms, these yield the wrong inventory settings. Why? Such traditional methods cannot take into account required supply chain variables to accurately determine inventory levels; however, simulations can! Here are just a few examples of supply chain variables that traditional calculations/algorithms cannot account for:
Lead Time Variability: the time to replace the item that was just consumed
Statistical Best-fit to Demand Pattern: accurately model the way the item is consumed
Probability of Demand Cancellation: likelihood that a customer buys somewhere else when you are out of stock
Fixed Reorder Interval: how often your buyers or planners actually look at their systems and place an order to replace inventory
2) Formulas Cause Companies to Have Inventory Imbalances
(Too Much AND Too Little Inventory)
By not accounting for these and other supply chain variables, why do traditional calculations/algorithms generate wrong results? These methods essentially do not represent each inventory item’s individual, unique variation and constraints. Formulas or algorithms may create inventory deficiencies or surplus. Frankly, if such methods provide correct results, it’s sheer coincidence. Companies attempt to compensate for these inventory management shortfalls with complex home grown system approaches which are rarely effective. These fundamental flaws of formulas result in two dangerous inventory imbalance scenarios:
Too Much Inventory, which ties up cash
Too Little Inventory, which risks on-time delivery and introduces lost sales/clients and/or costly expedites
3) Simulations Can Resolve Inventory Imbalances
Simulation models can take into account all required supply chain variables to accurately determine inventory levels. Such models recreate each item’s unique supply chain environment and run thousands of simulations to test what happens at various stocking levels. Each of these thousands of simulations randomly varies key parameters like demand and lead time based on the item’s consumption and replenishment profiles. Each simulation iterates the item’s inventory level up or down until converging on the minimum needed to achieve the company’s strategic supply requirements. Leveraging this simulation model approach quantifies and accounts for all types of demand patterns and replenishment fluctuations, correctly predicting optimizing inventory levels and correcting the two dangerous scenarios. Using such a model instead of traditional inventory formulas allows businesses to:
Reduce Working Capital: free up cash by eliminating unneeded inventory
Eliminate the Risk of Stockouts: avoid lost sales or expediting costs due to product or component shortage
4) Simulations Can Enhance Your Existing Planning Process
If your company already uses particular planning methods/tools, you can leverage simulation model inventory optimization to enhance your current process. This makes your outcomes more accurate, saving your company money and avoiding potential demand fulfillment misses.
What’s great is that simulations also enable a business to simulate countless scenarios for proactively evaluating the impact of proposed supply chain changes before adopting and implementing them. For example:
What if a company wants to determine the impact on inventory levels next quarter if a specific supplier lead time is reduced?
Or a company might want to know how much working capital is freed up if an item is fabricated twice a month versus once a month.
Or, whether negotiating a reduction of the Minimum Order Quantity (MOQ) for their top 10 suppliers would result in a substantial inventory reduction by this time next year.
Or, suppose the company wanted to understand the impact on inventory if adjusting your service level from 95% to 99% for specific items?
Can the formulas in spreadsheets or other software applications easily accomplish these activities? Yeah, right! From a strategic planning perspective, you get the idea of how powerful a simulation model is!
5) Free Up Time for Planning Other Strategic Business Goals and Objectives
When your company isn’t weighed down by time-consuming, erroneous work of calculating inventory settings and double-checking your work (for the umpteenth time), you have more time to focus on OTHER vital areas. For example, a company that doesn’t spend days or weeks running formulas and tweaking results, instead using simulations to accurately determine inventory levels, can utilize that time to work on a strategic activity that has long been on the wish list. Your business is better off relying on accurate simulation technology that saves you energy and money.
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