How to Reach the Efficient Frontier

When Gartner released their Supply Chain Top 25 they noted that successful companies were investing in “a more rigorous and data-driven approach to supply chain and operations strategy” and in particular in “A New Frontier of Performance.” One of the many ways to create a new frontier is to use analytics to optimize the supply chain in order to move the trade-off curve.  Operations affect three measures of performance: Cost, time and service levels. All of these objectives are conflicting. The figure below, from Operations Rules represents the trade off between efficiency and responsiveness. The curve is called the efficient frontier. And it represents a range of possible strategies each with a corresponding cost and response time.  The current strategy moves on the high curve so it increases in responsiveness and increases cost along the curve. However, through use of supply chain optimization the whole curve can move down to provide overall better performance.

How to Reach the Efficient Frontier image tradeoff4How to Reach the Efficient Frontier

  We see this trend among our clients who are pushing the boundaries of their supply chain organizations and discovering new opportunities. Many are including sourcing analysis as part of their process and some are even including their product planning. Inventory Optimization is a way to reach the efficient frontier. By developing a model that enables the firm to analyze and optimize inventory across multiple echelons, we can determine the appropriate inventory levels (cycle stock, safety stock, intransient stock) at different locations. The key drivers of inventory are  

  • Demand: Average and Variability
  • Lead Time: Average and Variability
  • Fill Rates Objectives
  • Order frequency, Order size, Minimum order quantity
  • Supplier performance

The idea of building a model that globally optimizes is illustrated in the figure below. The Y axis is inventory cost and the X axis is committed lead-time to customer. The blue line is the traditional trade off between inventory levels and committed lead time. As you increase lead time, you can reduce inventory as you respond faster, you need more inventory. These tactical changes mean moving along the blue tradeoff line with no structural change in strategy. However, when you focus on global optimization, the end-to-end model that represents your entire business and we are able to move from the blue line to the pink one. This implies that for the same lead time you can significantly reduce inventory or for the same inventory level you can reduce response time to the customer. There are many strategies where you can cut inventory and reduce time to market and still improve supply chain performance.

How to Reach the Efficient Frontier image SafetyStock4How to Reach the Efficient Frontier

To understand the true inventory drivers, inventory is not the problem it’s a symptom. The ability to change your strategy and move from local optimization to global optimization (from the blue line to the pink one) associated with global optimization allows companies to improve on multiple KPIs. It allows you to reduce inventory significantly and at the same time increase service level and fill rate significantly. To quote Gartner again: “Many companies are working on building out the foundational components of an end-to-end supply chain across disparate businesses, focusing on improving core supply chain functions, and creating more common processes and systems across them. More-advanced companies describe a wide range of initiatives that build on the foundation, including end-to-end supply chain segmentation, simplification, cost-to-serve analytics, multi-tier visibility and supply network optimization.”

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Written by Edith Simchi-Levi, VP of Operations at OPS Rules Management Consultants

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