Inventory. For those of us not in operations, supply chain, or logistics, it’s a vaguely familiar line item we learned about in finance class. We know it’s important and that we’re supposed to reduce it by increasing “turns.”
But inventory is not a minor issue. By some estimates, the world is sitting on roughly $8 trillion worth of goods held for sale, and nearly $2 trillion in the U.S. alone, according to a report by the Council of Supply Chain Management Professionals (note: the full report requires membership, but this number is mentioned about 9 minutes into the video at the CSCMP site).
That’s a lot of capital tied up in warehouses. It also represents a tremendous amount of environmental footprint “embedded”: logic suggests that this inventory stock, since it represents a healthy percentage of our economic output, required a good percentage of our energy and water to produce (so billions of tons of carbon emitted, for example). If we could permanently reduce the amount of product sitting idle, we’d save money, energy, and material.
So managing inventory well is both a financial win and a sustainability victory.
Perhaps the most powerful lever over inventory levels is predicting how much product customers will want, or what’s called “demand planning.” I recently delved into this meld of art and science when I spoke at a meeting held by Terra Technology, a relatively new and successful player in the “demand sensing” world (the difference between “sensing” and “planning” is about gathering data as close to real-time as possible and feeding it back up the supply chain quickly).
While I know little about the field of demand estimation — or what tools companies are using — my interest was in learning about anything that helps companies save money and reduce their environmental footprints. (Full disclosure: Terra Technology was my client for this event.)
At the meeting were representatives from many of the world’s largest consumer product (CPG) companies. The giants in the field, such as P&G and Unilever, spend a lot of money on demand planning, each employing hundreds of people, many with advanced math degrees…and for good reason: P&G’s 2010 total inventory, for example, was valued on the balance sheet at $6.4 billion.
Even though predicting the future is devilishly hard, I figured that the explosion of point-of-sale and operational data over the last 20 years, would give companies a good handle on how much of something they’ll sell. I was wrong.
As I learned at the conference, according to Terra Technology’s benchmarking study, the error rate for CPG companies on estimated vs. actual sales is shockingly high. Even with the fastest-selling, most predictable products, the estimates are off by an average of more than 40 percent. Imagine that a CPG company believes that 1 million bottles of a fast-turning laundry detergent will sell this week. With 40 percent average error, half the time sales will actually fall between 600,000 and 1.4 million bottles. And the other half of the time sales will be even further off the mark.
The repercussions of all this uncertainty are dramatic in terms of cost and material use. Companies have to keep much more inventory, since going out of stock is really unpleasant to explain to consumers, your CEO, or, say, Wal-Mart. The buffer is called “safety stock,” and its sole purpose is to mitigate this risk. There’s a lot of safety stock out there — nobody knows exactly how much, but what stock level would you keep on hand if you didn’t know whether sales would be 1 or 2 million units?
As we’ve found so many times before, data and software can play a critical role in making operations more efficient and sustainable. For example, using both demand sensing software and good management practices, P&G has cut 17 days and $2.1 billion out of inventory. All that production avoided saves a lot of money in manufacturing, distribution, and ongoing warehousing. It also saves a lot of carbon, material, and water.
Like many companies that realize there’s a green element to their offerings, Terra Technology is now making this footprint-reduction case as part of its pitch for better demand prediction. As Robert F. Byrne, the company’s CEO, puts it, “I want people to think of inventory as not just piles of cash, but also piles of carbon and piles of water.” It’s smart positioning, especially because it’s true.
The definition of what makes a “green” initiative is broadening, and that’s a good thing. Companies would certainly include a lighting retrofit at a warehouse in their list of sustainability or eco-efficiency projects. But until recently, it probably hadn’t occurred to logistics execs that reducing the inventory itself could be the greenest thing they do.
(This post first appeared at Harvard Business Online.)
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