QueBIT Blog: Multi-Echelon Inventory Optimization

Businesses are dealing with very uncertain times in supply chain management, as every aspect is under a microscope. For supply chain executives dealing with these challenges and the resulting disruption, it has become important to manage unpredictable demand efficiently and optimize inventory in the network to support these demands. Over last 2 years, the pandemic has truly challenged traditional processes and shown the importance of optimal inventory across multiple echelons of the supply chain, as effective inventory management is critical to support organizational growth, impacting both top and bottom lines. The strategic understanding and execution of optimal inventory levels not only helps manage unpredictable demand, but also helps mitigate risk, manage disruptions, and support timely and effective decision making. To address these issues, a strategy that allows for improved performance is called multi-echelon inventory policy, where inventory levels of each echelon support enhanced inventory management coordination.

What is multi-echelon inventory optimization strategy?

The goal of both single echelon and multiple echelon inventory optimization strategy is to successfully align supply with demand to support operational efficiency and higher financial returns. The idea is to gain efficiency by setting optimum inventory levels and flow within the network.

Single-echelon inventory strategy focusses on determining the appropriate level of inventory for an individual unit within the supply chain network, while multi-echelon inventory strategy takes a holistic approach by focusing on the correct levels of inventory across the entire network. For example, If the product is sold through one outlet and is received from one of its distribution centers (DC), the DC represents one echelon of supply chain, and the outlet represents another echelon. In a multi-echelon inventory strategy, we need to forecast and manage optimal inventory for both locations.

The optimization technique supports the broader goal of having the right amount of inventory at the right location to support the demand. In this form of supply chain planning, the goal is to clearly identify inventory levels for each location and manage inventory accordingly at each distribution (or customer facing) location. Multi-echelon inventory optimization supply planning optimizes supply, inventory, and timing at each location to meet unpredictable demand. As the organization grows in size and complexity, we continue to add multiple points in the network and refine the inventory optimization strategy to build operational efficiency.

One of the important pillars for a successful inventory strategy is the ability to forecast at different levels, including items such as safety stock. Therefore, the understanding of demand dynamics and forecasting level is critical, as a wrong forecast can make things worse and result in either too much inventory or stock-out situation. Additionally, the breadth, depth, and mix of products offered by echelon (i.e. service level) also has a direct impact on the inventory level in single echelon inventory strategy. Multi-Echelon inventory optimization strategy helps to mitigate the negative impact of unpredictable demand and forecasting error by optimizing stock at all locations.

Benefits of Multi-Echelon strategy

Multi-Echelon inventory optimization strategy uses a comprehensive or a holistic approach to inventory management and helps in answering where and what level of inventory should be stocked. Some of the benefits, which organizations enjoy by integrating multi-echelon inventory optimization strategy are:

• Better alignment between Supply and unpredictable demand
• Improvement in customer service performance and metrics
• Better supplier relationships leading to supply and lead time management
• Optimum inventory at all distribution points
• Effective and optimum network design to support reduction in distribution cost, and improvement in productivity
• Timely and effective cost management leading to better cash flow management
• Improved return on investment, and return on asset utilization

Ineffective inventory strategy impacts the organization negatively and is costly in the long run. Multi-echelon inventory optimization strategy can help the organization gain competitive advantages in their operation by optimizing the flow of products in the supply chain network. Multi-echelon inventory optimization strategy also helps to create end-to-end supply chain processes, developing a strong partnership between upstream and downstream points of the supply chain.