Multi-echelon Inventory Optimization for the Uncertain World: the What, the Why & the Benefits

May 24, 2023 · 8 minutes
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If there’s anything that the last few years have taught us, it is that a butterfly flapping its wings in one part of the world can actually stir up a tornado in the other. That’s how interdependent the entire world is. And our supply chains are no exception!

Interdependency is at the heart of supply chain operations.

A downtime on the production floor, a delay in lead time from suppliers, fluctuation in customer demand, just about anything can have a multi-level impact on your supply chain – sometimes bringing it to a crashing halt, other times eating into your working capital and ability to service customers.

That’s the reason why multi-echelon inventory optimization is becoming a much preferred approach to inventory management. It is one of the only approaches that takes into consideration the interdependency and trade-offs in the supply chain and also supports agile operations.

Let’s dig deeper into multi-echelon inventory optimization.

The Role of Inventory Optimization in Today’s Business

The greatest benefit of inventory optimization solutions is that they enable free cash flow and material flow. Accurate inventory optimization significantly cuts costs associated with owning, storing, and moving inventory and boosts revenue.

Think about it: An overstocked inventory shaves off your precious capital and an understocked one leads to missed revenue generation opportunities for your business. 

On the other hand, when done right, inventory optimization can help you determine the “just right” level of inventory to meet demands at the least cost and risk. In this way, it affords businesses a better level of control over the entire inventory management process.

With accurate demand forecasts and well-planned inventory purchases, there is minimal risk of overstocking or understocking, while also ensuring a sufficient buffer against supply and shipping risks.

Now, that’s the best case scenario.

The reality though is that most businesses across industries are struggling with empty shelves or dead stock!

The growing complexity of the supply chain, the speed at which the customer demand changes and unpredictable market conditions are creating major cracks in the inventory optimization process. Even the most familiar and once best inventory optimization models are failing in the post-covid world.

Why are Most Inventory Optimization Models Failing?

Yes, supply chains were always complex and large. But they were also more predictable before, which means agility, interdependency and trade-offs weren’t important markers for the success of inventory optimization.

But today, they are. And this is the gap that’s not being addressed in most inventory optimization models.

Single-echelon inventory optimization, for example, focuses on optimizing one level of the supply chain independent of the others.

Demand forecasting, determining safety stock levels, SKU tracking, calculation of reorder point, and decentralized inventory distribution can all solve specific problems along the supply chain, but optimizing material flow from end to end is nearly impossible while operating in silos.

And that’s exactly where this model can fail. Single-echelon inventory optimization doesn’t account for the interdependencies of inventory levels at different echelons/levels of the supply chain and this can lead to suboptimal results.

On the other hand, rule-based inventory optimization works best when the demand is relatively stable and supply chain conditions are predictable. Unfortunately, given the uncertain era that we live in, rule-based approaches have become less effective too.

What businesses need right now is an inventory optimization model that can account for the interconnectedness of the supply chain and is adaptable to the volatile market conditions. Multi-echelon inventory optimization does both.

And that’s why it has gained popularity as a holistic inventory optimization solution.

What is Multi-echelon Inventory Optimization (MEIO)?

As an inventory optimization model, multi-echelon inventory optimization leverages advanced algorithms to analyze inventory data and suggest optimal inventory levels at each echelon of the supply chain network.

It goes further than the other models in managing interdependencies and trade-offs between multiple levels.

Further, when driven by artificial intelligence, a multi-echelon inventory optimization model can identify inventory patterns, and via rich dashboards, visualizations, and event-driven notifications, enable continuous improvements in demand fulfillment, logistics costs, and customer experience.

It also enables detailed scenario analysis of the trade-offs between costs and service levels.

For instance, ThroughPut’s inventory planning solution deploys an AI-powered multi-echelon inventory optimization approach that determines the inventory at each level by taking into consideration the entire supply chain and the material flow across the value chain.

This way, ThroughPut’s solution can prep inventory at one level for any disruption that may happen at another level. It can also proactively predict potential bottlenecks and enable you to respond to it before it brings your entire network to a halt

At its core, multi-echelon inventory optimization is all about finding the right balance between having enough inventory on hand to meet customer demand while minimizing excess stock that ties up capital and increases carrying costs.

By optimizing inventory at granular levels with a big picture view, you can reduce waste, improve cash flow, and enhance their ability to respond quickly to changes in market conditions.

What are the Benefits of Multi-echelon Inventory Optimization?

Multi-echelon inventory optimization is a powerful tool that can help you reduce inventory costs. By optimizing the supply chain across echelons, MEIO ensures that the right products are in the right place at the right time.

Reduced Inventory Costs

This means that companies can avoid overstocking and understocking, which lead to rather costly inefficiencies.

One of the key benefits of MEIO is that it allows you to reduce your safety stock levels. Safety stock is the extra inventory that companies keep on hand to protect against unexpected demand or supply chain disruptions. However, maintaining high levels of safety stock can be expensive and wasteful. With MEIO, you can optimize your safety stock levels based on real-time data and demand forecasts, reducing unnecessary inventory holding costs.

Another way that MEIO reduces inventory costs is by improving order fulfillment rates. By ensuring that your products are available when customers want them, you can avoid lost sales and backorders. This not only improves customer satisfaction but also reduces the need for emergency shipments and rush orders, which, again,can be costly.

Improved Customer Service Levels

Customer service is a critical factor in business success, and MEIO can improve it significantly. By optimizing inventory levels across multiple echelons of the supply chain, you can ensure that you have enough products on hand to meet customer demand while minimizing stockouts.

With MEIO, you, in fact, gain greater visibility into your entire supply chain network. You can track inventory levels at each stage of the process and adjust accordingly to prevent shortages or overstocks. This level of control allows for more accurate forecasting and better planning for seasonal fluctuations or unexpected changes in demand.

In addition to reducing stockouts, MEIO also improves delivery times by streamlining logistics processes. When products are available where they are needed most, you can fulfill orders faster and with greater efficiency. This leads to happier customers who receive their orders quickly and accurately – a key factor in building brand loyalty and repeat business.

Increased Supply Chain Efficiency

MEIO is not just about reducing inventory costs or improving customer service levels – it also has a significant impact on overall supply chain efficiency. By optimizing inventory levels and streamlining logistics processes, you can reduce lead times, improve order accuracy, and minimize waste.

One of the ways that MEIO improves supply chain efficiency is by reducing the need for expedited shipments, for instance. When products are available where they are needed most, you can avoid rush orders and emergency deliveries.

This not only saves money but also reduces the risk of delays or disruptions in the supply chain.

Another benefit of MEIO is that it allows companies to better manage their production schedules. By aligning inventory levels with demand forecasts, you can optimize your manufacturing processes to ensure that you are producing the right products at the right time.

This leads to greater efficiency and productivity across the entire supply chain network.

Better Demand Forecasting Accuracy

Finally, MEIO improves demand forecasting accuracy – a critical factor in effective inventory management. With real-time data from multiple echelons of the supply chain, you can gain greater visibility into customer behavior and market trends.

This allows for more accurate forecasting and better planning for future demand.

By using advanced algorithms and predictive analytics tools, MEIO can identify patterns in customer behavior that might otherwise go unnoticed.

For example, it can detect seasonal fluctuations or changes in product preferences that could impact demand forecasts. Armed with this information, you can adjust your inventory levels to avoid stockouts or overstocks.

Optimized Distribution Centers and Points

Another important benefit of MEIO is its consideration of the entire supply network, including distribution centers and points. By analyzing data from across your network, MEIO can develop effective replenishment strategies that better manage stock levels.

This enables more efficient supply planning, reducing the risk of excess or insufficient inventory.

Wrapping up

The end goal – and lifeblood – of any business is generating continuously growing revenue via an expanding base of returning customers.We’ll unanimously agree to this!

And an optimized inventory management system like the multi-echelon inventory optimization approach makes it possible to streamline all business processes and operations toward this singular goal through fully optimized demand fulfillment, which in turn accelerates customer satisfaction.

In unpredictable times when market and supply chain disruptions can destabilize the largest of businesses, an inventory optimization model and that too an effective one is a much-needed safety net that enables continued operations and demand fulfillment momentum.

In fact, going forward, businesses that lack automated, AI- based inventory optimization solutions that take into consideration the interconnectedness of the supply chain and volatility of the market will find it increasingly challenging to not only insure themselves against potential crises, but also acquire a competitive edge in the market.

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Anita Raj
Vice President of Product Marketing