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October, 2009

Inventory Management in Dealer-Oriented Industries Sector Insight

Aberdeen’s Sector Insights provide strategic perspective and analysis of primary research results by industry, market segment, or geography

In these times of economic uncertainty and global credit crunch, companies need to actively seek out best practices in how to move from working capital optimization theory to practical initiatives that will improve corporate financial performance while maintaining customer satisfaction. The focus of this sector insight is to highlight the responses of over 60 companies in "Dealer oriented industries" (Inventory Management: 3 Keys to Freeing Working Capital) about how their finished goods and spare parts inventory management is performed. Ninety-three (93%) of respondents in these industries have indicated that their top management has provided recommendations for making inventory related process changes.

Dealer Oriented Industries

The definition of dealer- oriented industries includes:

√ Automotive

√ Industrial equipment manufacturing

√ Industrial product manufacturing

√ Mining Equipment

√ Medical device equipment

Business Context Dealer oriented industries are those whose primary (and often only) channel of sales is the dealer ship network. The products in these industries are characterized by long production lead-times and are extremely durable and long life products. Examples of these products are mining equipment, construction equipment, automotive, etc. The price points of these products are extremely high but the volumes are low. Hence the spare parts business of these companies is key due to two primary reasons: the profit margin associated with spare parts is high and the customers of these products are involved in mission-critical activities and need the parts immediately. In fact, spare parts availability plays a very important role in the customer satisfaction/customer service level metrics and has a direct impact on the sale of new of equipment.

Ninety-three (93%) of respondents in these industries say they have made or been asked to provide recommendations to management in the past six months on how to improve their company’s inventory management processes. Fully 50% of respondents say they have made, or have been asked to make, inventory-related technology recommendations within the past six months.

In terms of the key pressures being faced by the dealer-oriented industries, customer service levels is closely behind the corporate need to improve return on invested capital. This is in contrast to the rest of the sample, where shortage of working capital is in the top 2 pressures. The reason why customer service levels are so critical is due to the mission critical nature of processes in which their customers are involved. Examples include construction, repair, road-building, and mining. Increasing costs within the supply chain is a key concern for these industries as well.

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Figure 1: Key Pressures Faced by Dealer-Oriented Industries

21%

26%

16%

23%

21%

21%

41%

43%

0% 10% 20% 30% 40% 50%

Shortage of workingcapital to support our

operations/expansions

Increasing overallsupply chain costs

Pressure to improveservice levels

Corporate need toimprove return on

invested capital

Percentage of Respondents, n = 61

CriticalVery Influential21%

26%

16%

23%

21%

21%

41%

43%

0% 10% 20% 30% 40% 50%

Shortage of workingcapital to support our

operations/expansions

Increasing overallsupply chain costs

Pressure to improveservice levels

Corporate need toimprove return on

invested capital

Percentage of Respondents, n = 61

CriticalVery Influential

Source: Aberdeen Group, September 2009

The key strategic actions being taken by the dealer-oriented industries are illustrated in Figure 2.

Figure 2: Key Strategic Actions Taken by Dealer-Oriented Industries

33%

55%

62%

69%

71%

0% 20% 40% 60% 80%

Make suppliers more responsible forinventory

Improve Inventory Visibility(including dealership)

Improve replenishment strategies

Improve forecasting accuracy

Optimize how much and where to holdinventory across our network

Percentage of Respondents, n = 61

33%

55%

62%

69%

71%

0% 20% 40% 60% 80%

Make suppliers more responsible forinventory

Improve Inventory Visibility(including dealership)

Improve replenishment strategies

Improve forecasting accuracy

Optimize how much and where to holdinventory across our network

Percentage of Respondents, n = 61

Source: Aberdeen Group, September 2009

From the overall market standpoint, it is important to look at forecast accuracy and inventory optimization as two sides of the same coin and not prioritize one over the other. Gaining high forecast accuracy is only the means to an end – namely gaining higher customer service levels and reduced inventory. It is also to be noted that in these industries

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replenishment-related strategies such as Vendor Managed Inventory and Manufacturer Managed Inventory are also very common. We see that the need to improve visibility of inventory, especially at the dealerships, is a critical action being considered by the companies in these industries.

"Our dealers were almost in shock when they saw how quickly service levels increased, while rush-orders and transport costs plummeted."

~ Jan Paulsson, Global Supply Chain Manager

Volvo Construction Equipment, Customer Support Division

Inventory Management Business Challenges in Dealer Oriented Industries The following are some of the key challenges being faced by organizations in dealer oriented industries:

• Large number of SKU-location combinations: There are a large number of SKUs for which the inventory has to be managed due to the following reasons: deep bill of materials for products resulting in large number of spare parts requirements; need to store inventory for models of products that are old (for instance 10-15 year old models); large number of warehouse locations across which SKUs have to be stored. It is a complex task to manage inventory across hundreds of stocking locations as well as for these large number of SKUs.

• Legacy IT architecture: There is a requirement for integration with independent businesses and many different business systems and applications. 79% of respondents indicate that the supply chain-related technology in their organizations is either partially automated or fully manual. These industries are characterized by a large number of disparate ERP, DMS and legacy systems.

• Lack of well-defined inventory management practices: It is very important to optimize the stocking profile (stock breadth and stock depth) in achieving benefits in these industries. It is also important to perform a multi-dimensional segmentation (e.g. including picks) for the SKUs. However, 74% of these respondents state that they adopt 'rule of thumb' approaches for solving their inventory problems rather than adopting a statistical-based approach.

• Lack of well-defined metrics, measurement and visibility: There needs to be a strong KPI capability and management oversight for managing the spare parts inventory across the dealer network. Unfortunately, only 35% of respondents indicate that they have clearly defined metrics and measurement across their dealer network.

• Dealer collaboration: 80% of respondents have indicated that they lack collaborative capabilities with their dealers, resulting in increased inventories throughout the dealer network. There is also a lack of trust towards the OEM by the dealers further increasing the need to hedge by storing additional parts inventory. There needs to be clear strategies and policies for managing returns policies and “buybacks” that have to be defined. Effective initial

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stock holding polices have to be adopted in order to avoid obsolescence.

The following case study illustrates how these challenges can be resolved through the usage of specific closed loop inventory management processes and technology.

Case in Point - Volvo CE Case Study Volvo Enables Best-in-Class Dealer Inventory Management through a Manufacturer Managed Inventory program.

Company: Volvo CE is a global Industrial Equipment manufacturer, headquartered in Brussels. Its product line includes wheel loaders, compact equipment, wheelmounted and crawler excavators, motor graders, and articulated haulers. The company manufactures its products on four continents and distributes in more than 150 countries via dealerships and rental outlets.

Key Business Pressures: Volvo CE faces challenges that are unique to the dealer oriented industries. Volvo CE has two distinct inventory management needs – one for its finished goods business and the other for its spare parts business. Its dealer network is vast and global and is critical to handle customer relationships. The products in this industry have long cycle times resulting in increased inventory levels for spare parts. Customer service is a key metric for Volvo due to the mission-critical nature of the operations of the customers. With a global dealer network comprising 300 inventory locations and various disparate systems, Volvo CE faced challenges in delivering consistent service parts availability across the world. Aiming for market-leading dealer service levels, Volvo CE saw the need for one common solution to ensure global supply chain visibility.

Actions Taken: Volvo CE realized that their dealers did not have adequate visibility into the global inventory and also that they had excess inventory buffers in their network. Volvo CE also realized that their and their dealer’s technology infrastructure was inadequate to solving the issues outlined above. In order to resolve these challenges, Volvo CE partnered with Syncron, who is a solution provider for spare parts planning and order management solutions. Specifically, the Supply Chain Planning (SCP) solution was implemented.

Also, the solution that was implemented was not just a spare parts planning system. It was part of an extended process called Manufacturer Managed Inventory (MMI). This process resulted in an increased trust between the dealers and the manufacturer wherein the dealers were able to automate the ordering process of parts based on historical information. If in the future these parts are not sold, then based on the agreement with the OEM, these

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parts are bought back. This type of approach has resulted in an increased adoption of the MMI process among Volvo CE’s dealers.

Benefits Gained: The following are some of the key benefits (both quantitative as well as qualitative) that have been gained by Volvo and their dealers.

• Significant improvement in OTC for dealers

• Significant improvement in OTC for Volvo

• Realigned inventory levels to improve customer service levels resulting in an increase in health inventory mix.

• Improved collaboration with the dealers resulting in improved loyalty

• Improved forecast accuracy for Volvo due to enhanced visibility to customer trends

• Reduced freight for emergency orders due to more accurate parts inventory in stock

• Improved ability of the OEM to directly control the availability level to end customer

• Improved overall supply chain visibility (closer to source of demand, see trends at market level)

• Improved capability to redeploy inventory as a result of this visibility (and prepares the way for Distributed Order Management)

• Improved ability to ensure consistency across the dealer supply chain (service levels from global DC, through regional to dealer and customer)

• Improved deployment of parts through the lifecycle (new parts in place before they are needed, reduced risk of obsolescence at end of life)

• Significantly reduced costs of doing business (including logistics costs)

Required Actions The following are some key steps that must be taken by companies in dealer-oriented industries in order to improve their inventory management processes:

• Segment finished goods inventory based on financial performance. Twenty-nine percent (29%) of Laggards have indicated strong process capabilities in optimizing inventory based versus 47% of Best-in-Class companies. The key attributes typically used for inventory segmentation are volumes, picking volumes, complexity of customization, lead-times and profit margins. Given

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the current economic challenges, companies need to segment the finished goods inventory based on profit margins.

• Move away from “rule of thumb” inventory target settings. Thirty-five (35%) of Laggards have indicated strong process capabilities in analyzing demand patterns and creating accurate SKU-level forecasts, versus 63% of Best-in-Class companies. One of the reasons why Best-in-Class companies have been able to achieve this is that they are 1.5-times as likely as Laggards to employ statistical forecasting approaches.

• Collaborate with dealers and create a win-win strategy. Best-in-Class companies are 30% more likely than all others to be managing inventory at the network level, which includes the dealers and other distributors. Organizations that have either provided a single owner of inventory or provide a cross-functional team for managing inventory are better positioned to achieve closed loop inventory management excellence. This is due to the fact that the associated processes are cross-functional in nature and the organization’s structure impacts how the process is executed. In the context of dealer-oriented industries, this means the need for providing global visibility of inventory to the OEM and thus resulting in the ability to share inventory across dealers.

All of the Best-in-Class differentiators outlined are key influencers in achieving closed loop inventory management and are impacting several different organizations and have different frequencies / cadences. The amount of effort required in gaining success in enabling each of these process steps cannot be underestimated. For example, the usage of statistical methods for computing inventory targets can result in unreliable targets unless the correct process and technology enablers are adopted.

For more information on this or other research topics, please visit www.aberdeen.com.

Related Research Technology Strategies for Closed Loop Inventory Management; April 2008 Sales and Operations Planning: Aligning Business Goals with Supply Chain Tactics; June 2008

Inventory Management: 3 Keys to Freeing Working Capital; May 2009 Sales and Operations Planning: Integrate With Finance and Improve Revenue; June 2009

Author: Nari Viswanathan, VP / Principal Analyst, Supply Chain Management (nari.viswanathan@aberdeen.com)

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