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CPFR Collaborative Planning Forecasting and Replenishment

1) Definition

CPFR is not a technical standard but a collaborative approach allowing the SupplyChain's partners, whose objectives might be opposite, to have visibility of theforecasted demand in order to satisfy the future needs.

This is obtained through a process of sales forecasts and supply planning informationsharing.

This information sharing process synchronizes the Supply Chain's partners. It allows thereduction of inventories and improvement of service and product availability rates.

CPFR applies to all business sectors. A buyer and a seller work together to satisfy a finalcustomer's request.

In order to get all the CPFR advantages, it is necessary to share "win-win" strategiesbetween partners, which will assure coordination and information sharing.

2) History

CPFR was launched in 1995 by Wal-Mart with the pharmaceutical group WarnerLambert. The approach was then named CFAR (Collaborative Forecasting AndReplenishment) and aimed at developing the existing tools: SCM (Supply ChainManagement), EDI and Category Management.

The pilot's scope was a Warner Lambert plant and 3 Wal-Mart stores.


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The objective was to define a process linking the customer demand with resupplyingneeds of the whole Supply Chain and this:

analyzing the procedures of the whole Supply Chain in order to reduce cycle timeand inventories, through a collaboration between manufacturers and retailers,

organizing the collaboration to enhance reliability of the forecasted demand,improve the resupplying and build common commercial plans betweenmanufacturers and retailers,

handling discrepancies and anomalies, developing information systems adapted to these new procedures.

The result was an improvement of the product availability rate from 87 % to 98 %, areduction of lead time from 21 to 11 days and consequently a $8.5 million increase insales over the test period.

The results were presented to the Voluntary Interindustry Commerce Standards ( VICS)board of directors in 1996. The VICS decided the deployment of the CFAR as aninternational standard. The standard was afterward renamed CPFR to emphasize therole of planning in the collaboration process. VICS directives for the CPFR were

published in 1998 and revised in 2004.

3) Process

The principal point of this approach lies in the implication of the customers and thesuppliers in all steps of the sales forecasts establishment process, this in order toimprove the reliability.

CPFR process depends on the comparison of data:

comparison of an organization plan with an other one, comparison of a new organization and the previous one, comparison of the plan and the actual results.


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3.1.) Collaborative Planning

The first step consists in defining the collaboration context between retailer and

manufacturer:

set the business goals fore the relationship, define the collaboration scope, assign the roles, responsibilities, and procedures.

This first step gets to a cooperation agreement signed by the partners and whichspecifies processes, roles, KPIs... to be set up.

Afterward is drawn up the Joint Business Plan. It goal is the improvement of theforecasts quality reducing particularly exception situations. It specifies, among others:

the categories and their tactics, significant elements of the products lifecycle (launching, end of life, promotion

(see spec sheet Free-Logistics.com Product Lifecycle ), and of sales networkevolutions (opening, closing of retail outlets, works...),

planed modifications of inventory control and replenishment policy.

3.2.) Collaborative forecasting and replenishment
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The strategic goals are broken down into sales forecasts at SKU level (see spec sheetFree-Logistics.com Sales Forecasts ).

This forecast is generally built by the retailer due to its knowledge of the various retailoutlets sales.

It is transmitted to the manufacturer who proposes modifications according to his

knowledge of the market, of its promotional plan and products launching / end of life.When sales forecasts cannot be satisfied by inventories and production capacities, anaction plan is defined between manufacturer and retailer (forecast correction if it iserroneous, forecast modification for example by postponing a promotion,...).

Sales forecasts and replenishment data (see spec sheet Free-Logistics.com Procurement methods ) consideration allows the construction of the supply planning,determining the future orders at a SKU level and allowing the manufacturer to build hisproduction program.

Some orders can be out of the defined limits: forecast error beyond tolerance,insufficient service rate...

The manufacturer compares the orders planned with the available resources,determines the impact on the production program and on inventory and communicateswith the retailer.

Then the partners look for an agreement or solutions to the problem.

The forecasted orders are then transformed into firm orders.

3.3.) Reporting

It is fundamental to control the quality of exchanged forecasts implementing a controlprocess based on the analysis of this function specific KPIs (see spec sheet Free-Logistics.com Sales Forecast KPIs ).

On the other hand achievement obtained through the CPFR implementation areevaluated through partners performance KPIs (transit times, service rate, productavailability, inventory level...) in relation with the objectives determined in the strategicplan.

An animation process allows to share short term action plans to improve theperformance, anticipate the changes of trends and set up alternative strategies.

4) Benefits

We can quote as main contributions of the approach:

implementation of a partnership reduction of inventories and of their cost (see spec sheet Free-Logistics.com

Procurement and Supplying Costs ) reduction of inventory obsolescence risk improvement of service rate and products availability rate reduction of supplying lead time sales growth thanks to a better products availability and to successful promotions improvement of the trucks capacity utilization rate ....
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5) Requirements

The main requirements are:

implementation of a customer oriented inter-enterprise organization

o involve the company's top managemento generate the cultural change

implementation of the resources dedicated to the project definition of the project leader and guarantee of his support to the project establishment of a win-win model on the whole Supply Chain processes reengineering

Data interchange systems homogenization

MRP 2 Manufacturing Resources Planning

Evolution and goals

In the 1970s the model MRP (see spec sheet Free-Logistics.con MRP), evolved to MRP2 (Manufacturing Resources Planning). In MRP2 is taken into account :

the past activity in order to update the forecast the human resources, financial resources and available machines

It aims at balancing workload and working capacity.

It allows, among others:

a better activity forecasting, providing forecasts and planning data to all thechain's actors and actualizing it according to the manufacturing cycle realization

a bigger collaboration with the suppliers a better control of inventories level

Information produced through MRP 2 method

There are 4 main information in a MRP2 model:

the Manufacturing and Sales Plan the Master Production Schedule the Material Requirements Planning the Scheduling (procurement and manufacturing resources planning)

Manufacturing and Sales Plan MSP

It is an estimation of long term manufacturing needs. It is related with the company'sStrategic Plan.

It is established at an aggregated level of the product hierarchy (at product familieslevel) and details:

sales forecasts and commercial ranges evolution (launching, end of life-cycle ...) manufacturing needs
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machines and Human Resources, raw materials and components, cash flowneeded

It is a real simulation tool and allows to confirm the company's strategy operationalfeasibility by verifying the adequacy :

between commercial objectives and

manufacturing capacities and financial resources.

It is regularly updated to take into account the trend evolutions and so remain areference for the various activities (commercial, financial, plants, HR...).

Master Production Schedule MPS

The Master Production Schedule elaboration leans on the following data to determinethe manufacturing medium-term forecasts:

the Manufacturing and Sales Plan MPS the customers orders portfolio the available materials and resources the objectives and management rules

Material Requirements Planning MRP

It allows to determine the quantities necessary to realize the Master ProductionSchedule MPS. It leans on the Bill Of Material BOM and the operating sequences tocalculate the quantity of components needed.

It uses the quantities in inventory, the work-in-process productsand pending suppliersordersto determine, by article and by period, the necessary purchases andmanufacturing orders to fulfill the customers' orders.

Scheduling

It is a scheduling of the purchasing orders and the manufacturing orders.

It is realized considering an infinite capacity and takes into account :

the time necessary to manufacture the product the moment in the product manufacturing cycle when the component is

consumed

To take into account the real available capacities, the scheduling includes the workloadevaluation used in the Master Production Schedule and the Material RequirementsPlanning.

This approach is particularly used today through the ERP (Enterprise ResourcesPlanning) .

MRP Material Requirements Planning

Evolution and goals

MRP, Material Requirements Planning was defined in the 1960s by Wight, Orlicky andPlossl.
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This method aims at achieving 3 main goals:

assure the availability of materials and components necessary to manufacturingand customers delivery

maintain an inventory level as low as possible plan the manufacturing, supply and delivery activities

It is based on the distinction between:

the independent demand (depends on the external demand, generallymanufactured products, the highest level of the Bill Of Material BOM). It is notpossible to estimate or plan it.

the dependent demand (depends on internal demand; they are components),generated by the independent demand decomposed according to the Bill OfMaterial BOM, and thus calculable.

It allows the detailed calculation of required components using the Bill Of Material BOM.These are planned according to production planning and available inventory.

It allows to answer three fundamental questions:

What (which articles) manufacture ? How much manufacture? When manufacture?

Information produced through MRP method

The information produced with this method is:

the Master Production Schedule MPS the Material Requirements Planning (components needs calculated using the Bill

Of Material BOM)

This model afterward evolved to MRP 2 (see spec sheet Free-Logistics.con MRP 2 ).

Procurement methods

Procurement and supply planning

It consists in organizing, planning and controlling a company's inventory levels.

Its main objective is the balance between quality service and holding costs (see spec

sheet Free-Logistics.com Procurement and supplying costs).

The main inventory management elements are :

the orders issuing frequency the orders issuing time
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the quantities to order

The main factors influencing the procurement management are:

the demand. It is necessary to know the characteristics of demand in order toadapt the procurement method. For example, in case of an erratic demand it isnot relevant to use classic forecast methods like the Wilson formula (see spec

sheet Free-Logistics.com Wilson formula). It is preferable to work according toorder point method .

the procurement costs the procurement times and their reliability the Information System data updating frequency (inventory, consumption,

forecast, reception, past orders...)

See spec sheet Free-Logistics.com Supply Planning for more details on this function.

The main procurement methods

To define the procurement policy the procurement manager will attempt to answer thefollowing questions:

What article to order? When to order? How many items to order?

Then, according to his company's organization and the article characteristics, he willdefine if the orders must have fixed or variable dates and quantities.

The classic procurement methods are thus among four:

Calendar Fixed Period Requirement : fixed date and fixed quantity, Order point : variable date and fixed quantity, Periodic replenishment Period Order Quantity: fixed date and variable quantity, On demand : variable date and variable quantity.

The policy must be adapted to each article characteristics, it is thus frequent tocombine the various policies in order to manage a global inventory.

Calendar Fixed Period Requirement

Products are delivered to fixed dates in fixed quantities, often determined according tothe Wilson formula (see spec sheet Free-Logistics.com Wilson formula).

Order point

The order point corresponds to the inventory level which, once reached, will trigger an

order.

See spec sheet Free-Logistics.com Order point method .
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Periodic replenishment - Period Order Quantity

The periodic replenishment consists in defining a supply calendar.

See spec sheet Free-Logistics.com Periodic replenishment method .

On demand

Products are delivered at variable dates and in variable quantities, according to theneeds.

Which procurement method to choose?

It is fundamental to adapt the procurement method to:

the type of product the manufacturing process and its consumption (in case of industrial

procurement) the commercial process and its consumption (in case of retail / distribution

procurement)

See spec sheet Free-Logistics.com Which procurement method to choose .

Which procurement method to choose

It is fundamental to adapt the procurement method to:

the type of product the manufacturing process and its consumption (in case of industrial

procurement) the commercial process and its consumption (in case of retail / distribution

procurement)

Advantages Drawbacks

Calendar - Fixed PeriodRequirement

Simplified management forthe procurement team and

the suppliers

Risk of over inventory orshortage in case of demand

modification

No flexibility in case of

emergency

Order Point Shortage risk reduction Permanent follow up by theprocurement team
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Periodic replenishment -Period Order Quantity

Planning of the procurementteam workload

Reduction of over inventoryrisk

Shortage risk in case ofdemand modification

On demand Adapted in case of

speculative purchases

Permanent follow up by the

procurement team

Periodic replenishment method Period Order Quantity

The periodic replenishment (Period Order Quantity method) consists in defining a supplycalendar.

At the planned date, an order is launched on which the quantity will be related to:

the average consumption (km) the duration between 2 orders (P) the procurement time (d) the safety stock (Ss)

An inventory replenishment level is defined, then, by difference with the inventory levelat the planned order day, we calculate the quantity to order (q) taking into account theprocurement time.

The replenishment level (NR) is calculated the following way:

NR = km (P + d + dSs)

km = Average consumption

P = Duration between 2 orders

d = Procurement time

dSs = Safety stock expressed in time
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Order point method

The order point corresponds to the inventory level which, once reached, will trigger an order.

In case of regular consumption, the origin inventory decreases in a linear way, up to thesafety stock, which will be reached at the end of a given t time.

In order not to consume the safety stock, the order has to be made in a way that at t

time, the inventory is again at its original level.

The order point, corresponding at the inventory level which trigger the order, allows thedemand satisfaction without consuming the safety stock, during a period going from theorder date to the delivery date.

At the end of the procurement time, the order is delivered and the inventory supplied.

This method is also called "min max inventory control".

The order point (S) is calculated the following way:

S = km ( d + dSs )

S = Order Point

km = Average consumption

= Q/ t

Q quantity in inventory after the supplier's delivery Safety Stock Ss

t time necessary to consume Q

d = Procurement time


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dSs = Safety stock expressed in time

The quantity to order (Q) is calculated the following way:

Q = Km .

Q = Economic quantity to order

K = Annual consumption

Ca = Acquisition cost

Pu = Unit price (or order price)

C = Holding rate

The economic number of orders (N) is calculated the following way:

N =

K = Annual consumption

Pu = Unit price (or order price)


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C = Holding rate

Ca = Acquisition cost

Kanban mechanism is close to the order point method (See spec sheet Free-logistics.com

Kanban ).

Inventory turnover and stock cover

Both notions constitute good indicators to evaluate a company's procurementmanagement, purchase management or inventory management.

They can be calculated on the global inventory but also allow in order to establish aninventory mapping: for example, dividing the inventory value into different inventorycover classes, then working firstly on highest cover classes...

See Free-Logistics.com Spec Sheet on Obsolete inventory control

The inventory turnover corresponds to the average frequency of consideredinventory renewal during a given time.

For example an annual turnover value of 12 means that the considered inventory is 12times renewed a year, once a month.

The annual turnover is the annual consumption C (past or projected according to thecontext) divided by the average inventory Sm.

Rs = C / Sm

Numerator and denominator units of measurement must be identical (units, value,volume...).

The stock cover (or days of inventory, inventory cover) indicates the number of

days of consumption which the stock can cover.

For example, if the stock is 30 units and if the daily average consumption is 5, then thestock cover is 6 days.

The cover is the average stock Sm divided by the average daily (to obtain a result innumber of days) consumption Cj (past or projected according to the context).

Cs = Sm / Cj

Numerator and denominator units of measurement must be identical (units, value,volume...).

See Free-Logistics.com Spec Sheet on Inventory Management KPI
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Procurement and Supplying Costs

There are 4 major costs in relation with supplying and procurement:

the purchase cost the management cost, which consists of the ordering cost and the holding cost

(inventory ownership cost) the total cost of supply the shortage cost

---> Recommended bibliography for Procurement and Supplying Costs

1) Purchase cost = CP

It includes the purchase price and extra purchase costs.

2) Management cost = CM

CM = Ordering cost (or acquisition cost, CAc) + Holding cost (CI)

The ordering cost or acquisition cost / year = CAc

It is the total amount of preparation, launching and orders follow-up expenses to which

are added the logistics costs necessary for the acquisition of inventory (variablesaccording to the INCOTERM used for purchase - See the spec sheet Free-Logistics.com Incoterm 2010 ).

Must be included in the acquisition cost:

Transportation, commissions, customs clearance, insurances costs.... in relationwith the supply operation

Receiving and Unloading of goods related expenses All costs in relation with procurement and supply function (salaries connected to

suppliers selection, purchasing, estimate and orders, suppliers invoices control,

telephone, postage...)

Must not be included in the acquisition cost:

The additional transport costs from a warehouse to another one within the samecompany

Storage expenses, excepted when the storage is directly related to theproduction process or goods upgrade process

The holding cost / year = CI

They are costs corresponding to the investment in the inventory and in the sqmsurfaces necessary for its conservation:
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Cost of the capital (credit interest, capital investment absence, insurances...), SeeFree-Logistics.com spec sheet about WACC

Storage surfaces cost (rent, fixed costs, equipments, warehouse furnitures...) Warehouse handling cost (forklift truck operators and warehousemen salaries...) Inventory depreciations (inventory shrinkage, depreciation due to goods

obsolescence...)

It is common, in the course of the year, to apply a percentage to the average inventoryvalue : an annual ownership rate, beforehand calculated.

See also Free-Logistics.com spec sheet about 'Inventory concepts amd calculation'.

3) The total cost of supply

It corresponds to the purchase cost increased by the management cost (holding costand ordering cost).

CS = CM + CP

4) The shortage cost

In case of non compliance with the main inventory function which is to assure theproducts availability, the company is confronted to a shortage situation.

This situation generates a cost which is calculated each time, integrating urgentdeliveries cost, lost sales cost, penalties payment, purchase of increased pricesaccessories, supplementary administrative costs (alternative sourcing research, crisismanagement...)...

Lost sale calculation is difficult to approach. Generally, we distinguish 2 basic situations:

The sale is lost

The shortage cost for the period is proportional among articles for which the demandwas not satisfied.

The cost of unitarian shortage is expressed in monetary unit by article.

The sale is postponed

The shortage cost over the period is proportional to the articles in shortage situationand to the delivery delay of these articles.

The cost of unitarian shortage, is expressed in monetary unit by article and by unit oftime and take into account an hypothesis of sales postponement.

Definition and role of inventory

A company 's inventory generally consists in materials, waste, semi-finished products,finished products, goods, parts and packagings which are its property. The mainfunction of an Inventory is the flow of material regulation along the supply chain, inorder to satisfy future needs (at the right time, in the good quantities and at best global
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cost). It is basically a buffer protecting the customers service level against theenvironment constraints.

Thanks to a good inventory level, the downstream part of the supply chain (sellerswhich needs finished products), will be provided according to its needs, whileconsidering the rationalization imperatives of the upstream industrial-like activities(manufacturing or logistics activities optimization).

---> Recommended bibliography for Definition of inventory

General functions of inventory

Inventory has globally the following general functions :

regulation (regulation of the production, buffer inventory, seasonal demand...) commercial (as soon as possible delivery, service level, demand anticipation...) economic (speculation, favorable conditions for purchase in big quantities...)

Typologies of stock

Product type classification

We can distinguish 8 types of inventory :

Production or distribution inventory :

raw materials inventory

It is the basic materials that has not yet be supplied to the production process inorder to be transformed. The purpose of this inventory is to uncouple theproduction process and the purchasing process so that delays of raw materialsupplies may not cause a production delay.

work in process inventory

Materials supplied to the production process, but this one is not finished yet. Thepurpose of this inventory is to uncouple the various production processoperations so that the machines breakdowns and work stoppage related to anoperation do not affect the other production operations.

finished goods inventory

They are products which can be sold. The purpose of this inventory is to uncouplethe production process and the commercial process to assure the necessaryproduct availability.

products inventory

In case of trade activity, products are resold without transformation by thecompany.

Out of production inventory :
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spare parts and accessories inventory

They are accessories of the main products, necessary for it sale or it after-sale.

packagings inventory

They are packagings necessary for logistics and commercial operations (palettes,

boxes, bulks...).

machine maintenance parts and office items inventory

These parts do not intervene in the finished product production but allow themachines maintenance and repair. The office items also enter into this category.

and waste inventory.

Inventory function classification

We will also find the following inventory notions :

safety stock

See Free-Logistics.com spec sheet Inventory concepts and Calculation

anticipation inventory

Sometimes, companies buy and hold in inventory more products than necessary

at this given moment. This inventory stock called anticipation inventory can bejustified by an increase in prices, a seasonal increase of the demand, a new rangeor campaign future implementation, or even a threatening strike.

This tactics, generally used by the retail, which created a high inventory coverbefore the demand became exceptionally high (Christmas, back to school,Halloween...). The spreading out of the deliveries necessary to constitute thisinventory also allows to smooth the workload of the upstream supply chain and ofthe production. It is so preserving a constant level of production and a stablemanpower.

speculative inventory

Inventory constituted with the aim of generating a profit thanks to a variation ofthe aimed product's purchasing price.

decoupling inventory

This inventory eases the desynchronization between the various production (oreven distribution) sub-processes. It allows a functioning smoothly withoutmaintaining for that a high level of inventory. It is thus necessary to check thatthe cost of storage does not exceed the system efficiency gain.

cycle inventory

According to the principle of the Wilson formula (See spec sheet Free-Logistics.com Wilson Formula Economic Order Quantity ), the economic order quantity Q is calculatedby taking into account the purchasing cost, the storage cost and the ordering cost.
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When we order big quantities, the storage cost increases, but the ordering costdecreases. On the contrary, an increase of the order frequency (by a lot size reduction),and the storage cost decreases, but the ordering cost increases because more ordersare necessary to satisfy the demand. When both costs are equal, the total cost (the sumof both costs) is reduced at least. The cycle inventory results from this research forbalance: it is ordered in excess with regard to the strictly necessary material with theaim of reaching this point of costs minimization.

Inventory concepts and Calculation

Average inventory

It is the safety stock (SS) to which we add half of the quantity launched at eachresupplying (Qe).

Average inventory Sm= SS + Qe/2

It is also calculated as the average between two inventory values:

Average inventory Sm= (Sinitial + Sfinal) /2

Safety stock

The safety stock allows to protect from shortage situations generated either by a delayin the supplier's delivery, or by a higher real demand compared to the forecasteddemand.

The safety stock is thus the quantity below which it will never be necessary to go down.It is calculated by taking into account the quantity of necessary products to cover aconsumption hazard and a supplier risk:

Safety stock:

Average demand Dm Demand standard deviation Dm Procurement lead Time D Procurement lead time standard deviation D Service factor (in relation with service level) u

Reorder point

It is the quantity level that which trigger an order. It varies according to theprocurement lead time. It is calculated in the following way:

Safety stock + Average demand x Procurement lead time
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SA = SS + Dm x D

See also Free-Logistics Spec Sheet about Order point method

Minimum inventory

It is the quantity relative to the demand during the average procurement lead time. It iscalculated in the following way:

reorder point safety stock, Smin = SA - SS

Maximum inventory

It is the maximum quantity which the inventory can represent.

It is determined appealing to specific criteria for each company (storage cost, spaceavailable for storage, product criticality, service level...).

Service factor applicable to the safety stock (in case of demand responding toNormal distribution)

This factor follows an exponential evolution.

We thus should rather choose relatively weak values for service level (90 in 95 % forexample) in case of A articles which consumption value is important (only on thecondition of controlling permanently those critical articles and having a high reactivity incase of emergency need).

On the contrary for C articles having a weak value of consumption, we can chooseservice level of 98 or 99 %, because their safety stock will remain weak in any case : wecan not worry too much about these articles which are many but do not weigh in theglobal inventory cartography.

Service level (%) Service factor(Coefficient)

50 0

75 0,67

80 0,84

85 1,04

90 1,28

93,32 1,5

94 1,56
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94,52 1,6

95 1,65

96 1,75

97 1,88

97,72 298 2,05

98,61 2,2

99 2,33

99,5 2,57

99,6 2,65

99,7 2,75

99,8 2,8899,9 3,09

99,99 4

Flowcasting

Flowcasting is a recent approach of Supply Chain Management in the retail sector.

It is based on the following observations:

limits of the DRP model applied to retail, which in spite of years of existence,does not allow to resolve the shortage on shelves problem (the average shortagerate is estimated between approximately 8 and 9 %)

in this sector , the supply process is frequently managed directly by the point ofsales (process based on relatively manual or rough methods)

local phenomenas are difficult to forecast (promotions, competition, shortage,geographical specificities) when forecasts processes are managed at higherlevels

Unlike the classical approaches that consider the point of sales as a demand point andthe distribution center as a supply point (which result is to disconnect points of salesfrom the supply chain), the flowcasting considers points of sales as the most importantcenters between the final customer and the producer.

---> Recommended bibliography for Flowcasting

The forecast is only calculated at the point of sales level, on the final customer salesbasis, then aggregated to constitute the demand forecast for higher supply chain levels(distribution center, supplier, production plant).
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The under constraint planning calculation is done on a long term basis (12 monthsminimum).

Every day point of sales data are integrated to take into account the operationalchanges and sales variation.

The players of the chain are connected and integrated into a collaborative initiative:from the final consumer in the point of sales up to the producer. All work on a uniqueforecast database. Each calculates then its supply planning and sizes its logistics(teams, surfaces, material, equipment) on this base.

This initiative, paying all the attention on the point of sales in the forecast process, andassuring the collaborative work of all the players on a unique database, allows toresolve the difficulties in planning the activity at a so detailed level, and has forconsequences:

a better integration of the local promotions and lost sales phenomenas and abetter management of the end of life in supply planning

the safety inventories reduction on all Supply Chain points a real collaboration between the players (thanks to more reliable forecasting

data) sales increase by shortages on shelves reduction, the shortage rate being

returned to 1 - 2 % (thanks to more reactivity in front of demand variability)

a reduction of logistics operational costs between 1 and 6 % of sales volume (byaggregating demand forecasts, it is possible to give to each player more visibility on its

forecasted activity, and so to model / to size the future activity in a more reliable way).

Inventory methods

Having a controlled and reliable inventory is an important objective to companies.

Indeed, it allows to:

Minimize the invested capital in inventories Reduce the financial cost due to overinventories Control the risk of scheduled or unscheduled mark-down Limit sales lost due to inventory shortages. Reduce the annual stocktaking cost

---> Recommended bibliography for Inventory methods

What is it necessary to include in inventories?

When defining an inventory process, it is necessary to identify what are the elements tobe included in inventory.

The inventory has to include all goods belonging to the company, available or underproduction which will be used in the commercial process.
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Generally, we identify the followings types of products:

Raw materials Under production products Finished products Production consumables directly linked with products sale (packaging)

The product enters the inventory when a change of ownership or of responsibilityregarding the integrity of the product takes place .

So, to know which products must be included in the inventory, it is beforehandnecessary to identify on contracts agreed with suppliers, customers and operators thevery moment of the ownerships transfer of ownership, and to specify what Incoterm isassociated to the commercial relation.

Furthermore, other commercial situations can influence the notion of responsibilityregarding the goods:

Sale at given date with ownership delay: the responsibility is transferred to thebuyer once the totality of the products is delivered (Even if the responsibilitytransfer is not done immediately, if there is no insolvency risks, movements ofexpedition and sale follow the goods physical flow.

Sales from secondhand store (deposit and sale)

Generally, according to most used Incoterms, goods to be booked in inventorycorrespond:

In products being physically stored in company warehouses (proper or sub-contracted),except:

The outstanding discounted bills of reception Products received in deposit on behalf of the suppliers (goods delivered to a

customer but the supplier remains the owner) Products received in deposit on behalf of the suppliers Products in deposit on behalf of the customers

In products delivered to the customers in deposit

In products in transport towards the customer, not yet received.

In products under delivery to the company and for which the responsibility transferalready took place (the transport is organized by the company)

The various notions of inventory

The physical inventory


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Corresponds to the photo of the inventory physically present in the companyswarehouses (or sub-contracted warehouses)

The accounting inventory

The inventory which appears in accounts (in assets of the Balance). Its valuation variesaccording to the method chosen by the company.

The final inventory / initial inventory

The inventory corresponding to the quantity measured at the end of the accountingyear. This reference value is also the initial inventory of the following exercise.

So, an error of inventory on the final inventory affects the valuation of the inventory oftwo consecutive years.

The periodic inventory

Consists in a punctual inventory in the course of which, the inventory belonging to thecompany, independently from its location, is physically counted.

It is then checked that the counted units are in accordance with the informationsystems inventory values. In case of discrepancies, counter-checks are down untilbeing able to validate a quantity corresponding to the physically counted quantity.

The permanent inventory

With this method, the inventory is constantly updated by recording movements ofinventory entry and release (exit).

The cycle counting

It consists in scheduled (or programmed) countings in regular intervals throughout theyear, by selecting each time different items. It must allow controlling the wholeinventory at least once a year.

It is possible to prioritise the references counting by using, for example, the ABCmethod in frequency or value, or by identifying the critical products (in customersmark-down terms, customers availability).

How to set up a cycle counting system

1. Identify products to be included in the process of cycle inventory (during theprocess definition)

2. Define the products categories according to priorities criteria (ABC, criticality)
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3. Allocate to every product / category a frequency of objective counting (byrespecting the principle according to which every article must be counted at leastonce a year)

4. Realize the counting.5. Note the date of the counting on every article in the article database.6. Analyze the possible discrepancies between the physically counted inventory and

the permanent inventory (and count again physically if need be)7. Validate the quantities in inventory8. Analyze and correct the causes of discrepancies

Key points to organize a periodic inventory

The process of inventory has to respect the legal terms and the accounting standards ofevery country.

To be effective, the inventory process has to include staff, not only from warehouseexploitation but also, for example, accounts, commercial and purchase departments

If the size of the company does not allow such organization, the chief accountant willoversee the process.

The presence of the chief accountant is, whatever are the resources allocated to therealization of the inventory, a factor of the result reliability.

The areas where are located products to be inventoried must be ordered: productsgrouped together by homogeneous lots clearly isolated from each other, producedcorrectly labeled, isolated from not inventoried inventories.

The process will have to mention storage addresses and the areas affectation for everycounting team.

The inventory data reliability handed back on the counting forms is directly linked to agood products knowledge and identification (clear and reliable visible references onproducts, knowledge of products, precision of the counting units on forms (weight,linear meter, square meter, unit).

Every article in inventory must be booked only once. To assure the fulfillment of thisrequirement, the activity must be stopped during the inventory period. During thisperiod, it is thus necessary to forbid any activity of production or warehousing(expedition or reception). Furthermore, it is advisable to mark already counted lots inorder not to take them into account twice.

In case of management by permanent inventory, it is necessary to make sure that allthe movements of products previous to the start of the inventory are registered in thepermanent inventory follow-up system.


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If there is a discrepancy between the permanent inventory and the result of thecounting, it is necessary to count again. If the difference is effective, it is necessary toanalyze the reasons of this discrepancy to validate the inventory result.

Out of inventory evaluation

Entrances to inventory are valued with goods acquisition price or with the production

cost.

Exits from inventory intervene at various moments, either for sale, or for incorporationin the production process.

In case of fixed acquisition price of all goods which enter the inventory, the acquisitionprice A is applied to the total quantity in inventory X.

Stock value is then X x A

But, the economic reality makes that acquisition prices vary. Furthermore it is notalways easy to identify which exact product is taken out inventory. So, the inventorycan, at some point, be composed of:

X quantities of an article acquired at a price A, and Y quantities of the same article acquired at a price B

In most of the companies, every product in stock is not identified alone. We do not know

if the outgoing product is the first one that had been bought, the last one or theintermediary.

It is thus necessary to use a method which allows estimating inventory exits at anymoment by taking in a consideration the changes of products acquisition prices orproduction costs.

The rule recommends applying the MAP (Moving Average Price) method. But it isallowed to choose FIFO or LIFO methods if the company considers that it can improve

the global management.

Once chosen the valuation method, the company will have to conform to the uniformityin the management method principle. Changes in this method will be accepted only inexceptional and justified cases.

MAP ( Moving Average price). The prices moving average is calculated taking intoaccount the received quantities at a given price.

FIFO (First In, First out). Last exit valuation is made using the first receptionacquisition price. So shipments are valued in the same order as the inventory wasconstituted. Inventory is recorded with its receiving value respecting the

chronological order.

LIFO (Last In, First Out). Last exit valuation is made using the last receptionacquisition price. So shipments are valued in the inverse order as the inventory


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was constituted. Inventory is recorded with its receiving value respecting thechronological order.

Example

Date Quantity Value

Initial inventory 1-1-2008 1.000 4.000

In 1-12-2008 500 3.000

Out 1-13-2008 700

Out 1-15-2008 700

In 1-22-2008 900 6.300

Final inventory 1-31-2008 1.000

o MAP (Moving Average Price)

There are two ways to calculate it:end of periodbefore every exit. The example belowcorresponds to this more common way of calculating the MAP.

In Out Inventory

Qty Price Value Qty Price Value Qty Price Value

Initial inventory 1.000 4 4.000

In 500 6 3.000 1.500 4.67 7.000

Out 700 4.67 3266 800 4,67 3.736

Out 700 4.67 3266 100 4,67 467

In 900 7 6.300 1.000 6,77 6.767

Detailed MAP calculation:

[(1.000 x 4) + (500 x 6)] / (1.000 + 500) = 4,67

[(100 x 4,67)+(900 x 7)] / (100 + 900) = 6,77

Inventory value at 1-31-2008 is 6.767

o FIFO

In that case, we build a board with two dimensions (Prices and Quantities by movementtype). For each product reception with different price we open a new column. To coverthe exit needed quantities, we consume firstly the most former units.Price 4 6 7

Initial inventory 1.000

In 500

Out (700)

Out (300) (400)

In 900

Final inventory 0 100 900


o LIFO

We apply the same principle as FIFO. But to cover the exits needed quantities, weconsume firstly the last entered units.


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Price 4 6 7

Initial inventory 1.000

In 500

Out (200) (500)

Out (700)

In 900

Final inventory 100 0 900


o Inventory value according to each method is:

LIFO 6.700

FIFO 6.900

MAP 6.767

FIFO and LIFO methods lead to extreme values while the MAP method produces anintermediate value.

FIFO method leads to a stronger valuation of assets in case of inflation, because itvalues inventories at the last acquisition prices. Observation is inverse with the LIFOmethod.

Using FIFO method while the market is rising, while profit is serving for dividendsdistribution, risks to uncapitalize the company because sales income would not allow

supplying the inventory.

Supply Planning

The supply function (or procurement function) mission is to satisfy a demand with a delivery,taking into account the company objectives and the environment constraints. Optimize thisfunction is the object of an increasing interest, particularly the planning part, highly criticalbecause of its direct influence on sales, logistics costs and inventories financial cost.

During the 10 ultimate years we noticed a strong growth of IT offers relative to supply chainplanning, and for these last years we identified the development of advanced offers of APS(Advanced Planning and Scheduling).

Among the main IT offer we find JDA, Manugistics , ILOG , i2 Technologies, Logility, SynQuest,InterTrans, , Numetrix.

Moreover, the main ERPs (Enterprise Resource Planning) have develop very efficient specificmodules in this field. We can list in particular SAP (SCOPE / APO), PeopleSoft (ERO), Baan-LN(SYNC), J.D. Edwards (One World completed with ILOG technology).

See Free-Logistics.com spec sheetSupply Chain Planning SCP

---> Recommended bibliography for Supply Planning

The supply function

The supply function intervenes on 3 types of flows:
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physical: products or provided services, information: sending and receiving of follow-up data administration: orders, invoices, delivery notices, receiving orders, delivery disputes

The supply function goals vary according to the context of each company.They can be, forexample:

Improve the service rate

Reduce lead times Increase profits or margin

Reduce costs (see Free-Logistics.com spec. sheetProcurement and Supplying costs) Optimize the production device

The supply function will be generally driven by three main indicators (see Free-Logistics.com spec. sheet Supply Control KPI):

service rate or product availability rate stock level

costs relatives to the supply activity

The supply process

This process intervenes at strategic, tactic and operational level.

Strategic Supply Planning (Supply Chain Network Design)

Realized annually, generally for the annual budget building. It allows the supply chain andlogistics network dimensioning.

See Free-Logistics.com spec. sheet Supply Chain and Logistics network dimensioning

Tactic Supply Planning (Supply Planning)

Realized quarterly to monthly according to each company. It aims at the Supply Chainoptimization, without modification of the existing logistic network structures. It allows, forexample, communication of supply plans to suppliers, Collaborative Planning Forecasting &Replenishment(CPFR) in order to insure the suppliers capacities availability, warehouse andtransportation resources sizing and communication with 3PLs

Operational Supply Planning (Supply Scheduling)

It contains planning and execution activities and is realized, according to companies, with aweekly, daily or even multi-daily rhythm. We detailed after the execution steps of this process.

The demand forecast

The operational planning process is based on demand forecast process results (see Free-Logistics.com spec. sheet Sales forecasts).

The operational supply planning

After sales forecasting intervenes supply planning function.It consists in translating the demand

forecast in a realistic supply plan taking into account:

existing inventory levels, orders sent to suppliers not received yet, suppliers purchasing conditions (lead times, minimum order quantity, packaging,

discounts)
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planning horizon determined by the defined stock rules service level goals by customer material and capacity constraints (warehouses, transport)

And this, looking for optimization according to the company objectives (reduced costs,profitability, service). The supply person will have to decide on the best planning option. For that,he will have to answer to the following basic questions:

When and how much supply from this supplier? When must the product be available?

Taking into account the environment constraints:

Supplier capacity (tools and human, taking into account seasonality) Production capacity (tools and human, taking into account seasonality) Warehouses capacity (surfaces and human, taking into account seasonality) Transportation capacity (trucks and human, taking into account seasonality)

(see Free-Logistics.com spec. sheet Procurement method).

The supply planning execution, Order Management

The ultimate step is the supply planning execution, also called Order Management. This last oneprocess consists in:

produce the orders pass on them to the suppliers follow the delivery or manage the transport (according to the chosen Incoterm), solve eventual disputes

facilitate the invoices matching

See Free-Logistics.com spec sheetSupply Chain Execution SCE

It is highly recommended to set up Electronic data interchange (EDI) to enhance reliability andmake more productive this part of the process. See Free-Logistics.com spec sheets ElectronicData Interchanges EDI and EDIFACT main Messages

See also spec. sheets:

Which procurement method to choose ?

Simple Exponential Smoothing

It can be used in Logistics and Supply Chain as a forecast method.

In Simple exponential smoothing, the new forecast is the former forecast plus a times theformer forecast error (errort = Dt-Ft)

This formula can be written as follows:

Ft = Ft-1 + a (Dt-1- Dt-1)

Where:

Ft = Forecast at time t.
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Dt = Actual demand at time t.

Ft-1 = Forecast at time t-1 (previous period)

Dt-1 = Actual demand at time t-1

a = smoothing constant or adjustment factor between 0 and 1

If a 1, adjustment compared to last actual value is important.

If a 0, adjustment compared to last actual value is weak.

Forecast with a =

Period

Actual

Demand 0,1 0,5 0,9

1 1700

2 1800 1700 1700 1700

3 1900 1710 1750 1790

4 1850 1729 1825 1889

5 1775 1741 1838 1854

6 1450 1744 1806 1783

7 1100 1715 1628 1483

8 1500 1654 1364 1138

9 1800 1638 1432 1464

10 1750 1654 1616 1766

11 2000 1664 1683 1752

12 1698 1842 1975

Simple exponential smoothing

Wilson Formula Economic Order Quantity

TheEconomic Order Quantity Wilson FormulaorWilsonFormula (created in 1934) allowscalculation of order optimal quantity and the time between two orders of aproduct for agivenentity(plant, logistic centre)

Introduced for the first time in 1913 byHarris, it is sometimes known as the Harrys-WilsonFormula.

The hypotheses on which this model is based are the followings:


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1. Inventory management horizon is unlimited; consequently, we consider that the processis constant in time.

2. The demand is continuous, known and homogeneous in time; according to this concept,we suppose that the annual consumption is X units/year.

3. The supply lead-time, L, is constant and known.4. Inventory shortages are not accepted.5. The acquisition cost variable seems constant, CA $/unit.6. The order entrance into the system is immediate once the supply lead-time is over.

7. We consider a launching cost of CL $/order and a stock ownership cost of CP $/unit.8. The order size will always be the same, to keep constant the model parameters.

The most economic, in these conditions, is that an order enters the system when the inventorylevel is at zero. It supposes that the order must be made at a moment where the inventory levelis sufficient to cope with the demand during the supply lead-time.

This very inventory level is called control point Pc

The control point Pc is calculated the following way:

Pc = X*L

Qis the quantity of every order.

The number ofnecessary annualorders to satisfy the demand, the frequency ofresupplying(N),will be:

N=X / Q

The opposite of N is the time which passes by between two orders; it is the lead-time of a cycle

which repeats throughout the horizon of management.

This lead-time is called supply cycle time (TC)

The economic lot is the lot associated to theminimalcostsrelative to inventory which means thelot which minimizes the function ofthetotal annual inventory cost.

To calculate this lot, we must know at first which function we have to minimize.

Thetotal annualinventory costisconstituted by the following costs:

1. Annual launching cost: KL=CL*N=CL*X / Q $/year2. Annual variable cost of acquisition: KA=CA*X $/year3. Annual cost of inventory ownership : KP=CP*Q / 2 $/year

The annual total cost will be K=KL+KA+KP

But, according to the model, the annual variable cost of acquisition KA doesnt depend on the lotsize nor on dates at which orders are emitted; for this reason, to find the lot minimizing thefunction of total cost, we shall disregard the KA cost.


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K=KL+KP=CL*X / Q+CP*Q / 2 $/year

To minimize the function we have toderivate by Q and equal to zero:

DK / dQ =-CL*X / Q2+CP / 2=0

The economic order quantity ofHarris-Wilson,that is theoptimum order quantitywill be:

Q + = ( 2*CL*X / CP ) units/order

Theoptimallead-timeof resupplyingbetween two orders will be:

T + = Q + / right = ( 2*CL / CP*X )

Sales Forecasts

Sales forecast is a requirement to any attempt on Supply Chain planning .

We often notice the following characteristics:

The forecasts are not reliable The more we work on a forecast at an aggregated level, the more reliable it is. The more the horizon of forecast is long, the less it is reliable

A- Forecast methods

1. Forecast horizon

Forecast horizon varies depending on its utilisation:

Short term forecasts (days) for:o Shipping planningo Short term sales

Medium term forecasts (weeks) for:o Resources dimensioningo Supply

Long term forecasts (months) for:o Budget establishmento Resources dimensioningo Trend identification

2. Subjective forecast methods
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In certain sectors, ones use subjective forecast (established on opinions and not onmathematical evaluations). Among these methods, we have:

Opinion of the concerned individuals (ex: salesmen) Polls among potential customers

Domain experts opinion or Delphi method

3. Objective forecast methods

Mostly used by companies, integrated into the demand forecast and planning tools.

3.1. Temporal series

They use sales historical data and models the future behaviour based on the past..

They use the analysis of:

The trend : growth or decrease stability in the time (linear or non-linear) The seasonality: an particular event occurring on a regular basis (weekly, monthly, annual

)

Erratic characteristic: is said from a very irregular and un-forecasted event.

3.2. Stationary series

A series is stationary when each event can be represented by a constant plus a randowfluctuation

Two methods are mainly utilized:

Mobile average

A level N mobile average is the arithmetical average of the last N observations. Inforecast methods, this average becomes the next forecast.

Exponential smoothing

A popular and classical forecast method, the current forecast is a weighted average of thelast forecast and the actual demand.


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SeeSimple-Exponential-Smoothing

3.3. Trend Analysis

Linear regression

It allows data analysis and trend calculation based on a first degree equation (equation of type Y= a.X+b)

See Linear regression

Holt's Double Exponential method

Holts method is based on a double smoothing to evaluate temporal series with trend factors.

3.4. Seasonal series

A seasonal series is a series which profile repeats itself every N periods during a given number ofperiods.

Seasonal factors

The best known method is to evaluate multiplication factors of each season and weight the trendin function of these factors.

Winters method

Winters method is a triple exponential smoothing.

B- Forecast reliability control

=Minimisation of the following values

Be et the error on forecast at time t, we define et as the difference between estimated valueof forecast and the actual demand value.
http://www.free-logistics.com/index.php/Spec-Sheets/Forecasts-Supply-and-Inventory/Simple-Exponential-Smoothing.htmlhttp://www.free-logistics.com/index.php/Spec-Sheets/Forecasts-Supply-and-Inventory/Simple-Exponential-Smoothing.htmlhttp://www.free-logistics.com/index.php/Spec-Sheets/Forecasts-Supply-and-Inventory/Linear-Regression.htmlhttp://www.free-logistics.com/index.php/Spec-Sheets/Forecasts-Supply-and-Inventory/Simple-Exponential-Smoothing.htmlhttp://www.free-logistics.com/index.php/Spec-Sheets/Forecasts-Supply-and-Inventory/Linear-Regression.html


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et = Ft - Dt

Be e1, e2, e3, ... , en the observed error on n periods,

Hence:

The mean absolute deviation (MAD) will be:

And the mean square error (MSE) will be:

Finally, the mean absolute in percentage will be:

Linear Regression

This very brief definition, aims only at giving a concrete example (through formulas) of simplelinear regression calculation.

In statistics, it happens that two values X and Y seem bound by a linear function relation of thetype Y = a X + b.

The linear regression consists in determining an estimation of the a and b values.

Let us take the following X and Y data as example:

X 10 15 5 50 75 25 90 100

Y 50 45 55 200 300 150 450 500


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We have Y = a.X + B

We need the following data to calculate a and b:

XY 500 675 275 10000 22500 3750 40500 50000

X2 100 225 25 2500 5625 625 8100 10000

Y2 2500 2025 3025 40000 90000 22500 202500 250000

X Average = 46,25 Y Average = 218,75

Average of x2 = 3400 Average of y2 = 76568,75

Variance x = Average of x2 square of x average = 1260,94 Variance y = Average of y2 square of y average = 8717,19 Covariance = Average of products products of averages = 5907,81

a = Covariance / Variance x = 4,69

b = y average - a * x average = 2,06

Y = 4,69 X + 2,06

Excel utilisation


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If:

X values are in cells A1 to A8 Y values are in cells B1 to B8

a is obtained with the following formula =LINEST(B1:B8;A1:A8)

b is obtained with the following formula =AVERAGE(B1:B8)-LINEST(B1:B8;A1:A8)*AVERAGE(A1:A8)

Obsolete inventory control

Not focusing on its obsolete stock leads to important costs for the company, among which:

Financial asset Valor and margin loss (products are less and less in line with market expectations) Marking down (goods damages risks due to long storage period...)

Transport (goods sales on another site, return to supplier...) Storage (surfaces utilization)

Destruction, recycling (in worst case, the company will have to take care of destructionexpenses and if need be, product recycling costs)

Usual steps of obsolete inventory control are:

1. Prevent2. Identify3. Plan actions4. Act5. Measure and control

1. Prevent

To run out an obsolete stock requires a lot of energy on behalf of the logistician.

This is why its wiser to act upstream in the supply process to avoid the obsolete stock built-up.

Simple rules shared by various departments of the company allow limiting it:

Identify in advance the item oddment (end of life date) with a notice corresponding at least to the procurement lead time

with an end of life management plan shared between purchasing and sales departments

1. Stock exhaustion2. Item replacement3. Back to supplier4. Sales...


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Program the supply according to the end of life date and to the action plan

Regularly communicate the inventory position to purchasing and sales departments and decide.

2. Identify

Set up a stock cartography showing details of the composition of inventory on cover criterions:

Calculate stock coveritem by item taking into account stock exits forecasts (based onsales forecasts analysis)

Separate items in groups:

dead inventory : items without movement since more than 1 year, 6 months, 1 month(according to turnover standard levels)

overstock: items which stock cover is higher than the inventory objective (dissociatevarious classes of cover for more visibility on priorities: more than one year of stock, 6months, 1 month....)

in line inventory (conform) : conform with the objective shortage

Valorize the inventory of each item and constitute the following cartography (example):

Detail the cartography according to activitys criterions:

detail by product family,

by flow, site, supplier, by ABC class ...

Example:
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Identify most penalizing items in value, age... belonging to dead stock (for a priority action plan)

3. Plan your actions

Company must keep a daily watchfulness on dead stocks. It is necessary to organize a dailycommunication of inventory levels on the most penalizing items.

Punctually, in the event of massive stock reduction actions, it will be necessary to organize ataskforce including Sales:

Purchasing departement

back to supplier

Sales department (for finished products)

promotions sales outlet

sales kits including an obsolete product and a product with high turnover (succesfullproduct...)

Sales forecast department

to take into account the impact of commercial action plans

Supply planners

knowledge of supply constraints

Cost control

depreciation provisions

Tip : Instead of proceeding to the destruction of the remaining inventory, the best option is tosell to a discounter. If so, it should be wise to ship the product only after receiving the payment.You can also choose to make a donation to an NGO.

4. Act

People in charge for inventories elimination must receive a daily communication informing themof items and stock levels to be reduced through a given action plan.

A regular reporting allows related functions to follow-up achievements.

5. Measure and control

The stock cartography and its detailed elements are to be included in the company KPIs and tobe monthly followed-up by the Board of Directors.
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