November 2008 | Commentary | IT Matters

Successfully Managing Long-Tail Inventories

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The concept of the long-tail retail environment refers to the extended downward slope of a unit sales curve that, when illustrated graphically, depicts a "long tail" as demand wanes toward zero.

Introduced by Wired Editor in Chief Chris Anderson in 2004, the term originally described Internet-based companies, such as iTunes or Amazon.com, whose environments are less affected by physical constraints of manufacturing, production, and distribution. But today, brick-and-mortar companies also operate in long-tail environments as they deal with more SKUs and slow-moving items with unpredictable demand.

For example, among Fortune 1000 businesses, one automotive aftermarket parts company has nearly 98 percent of its SKUs in the tail, while a consumer goods company has 86 percent of SKUs in the tail. A globally branded beverage company with the shortest tail still has nearly half its SKUs in the tail.

WHAT'S DRIVING LONG TAILS?

Customer demand that is geographically scattered, occurs in smaller quantities, and requires specialized products is the main driver of long tails. But there are other trends at work, including:

  • Product proliferation. Companies introduce more products and variants, causing SKUs to increase faster than sales, and reducing average sales per individual SKU.
  • More frequent replenishment. More frequent deliveries allow companies to be more responsive to demand changes, but also lead to more demand variability. One SKU may look like a fast mover (stable demand) when observed in monthly buckets, a slow mover in weekly buckets, and intermittent or "lumpy" at the daily level.
  • Total supply chain focus. Manufacturers, distributors, and retailers are collaborating more. Manufacturing companies that once focused on stocking big regional distribution warehouses now focus on minimizing out-of-stocks on retail shelves. Demand is disaggregated into individual end-node streams, increasing demand and slow-moving behaviors.

While these trends create longer tails, increased customer service expectations exacerbate the problem. Whether measured by perfect-order fill rates or retail-shelf product availability, industry standards and expectations have risen steadily. In fact, inventory levels have not dropped significantly despite advances in supply chain planning and execution achieved during the past decade.

WHY IS THIS A PROBLEM?

The long-tail environment is more challenging than a high-volume mainstream business. Demand is intermittent. Supply chain noise increases. Demand signals are harder to read.

In this environment, forecasting and inventory management become more challenging because traditional systems weren't designed for the tail. Where demand variability is high and demand distribution skewed, classic forecasting and inventory models do not perform well.

"In this scenario, traditional inventory techniques—safety stock logic based on normal demand distribution—just don't work," agrees Lora Cecere of AMR Research.

The presence of many slow-moving items often produces significant gaps between planned and actual results. Companies are inclined to overreact and create overstocks, causing a bullwhip effect that shifts working capital from active stock to slow and even dead stock.

As a result, inventory mixes in a long-tail environment become misaligned. Some products are over-served, others under-served, and both impact the top and bottom lines. The tail consumes significant working capital, without delivering desired service levels.

THE ELEMENTS OF A SUCCESSFUL LONG-TAIL STRATEGY

It is possible to make the most of this long-tail environment—and even to succeed. Successfully managing inventories and achieving high service levels requires two simple, yet difficult to execute, elements:

  • Accurate demand and inventory models to support reliable service level and inventory management.
  • Highly disciplined processes that eliminate manual interventions and bullwhip behavior, which can be achieved only by gaining confidence in the underlying systems to maintain desired service levels.

These requirements apply to any company that wants to operate efficiently in a long-tail environment—even fast-moving CPG companies—and especially to retailers. They can be satisfied by applying the appropriate inventory optimization technology and techniques.

The key is to have the systems and processes in place that effectively manage the long tail. This must be done without taking convenient shortcuts, which can simplify the problem while creating inaccurate models and leading to erroneous decisions.

By taking a no-shortcuts approach and mastering the full probability distribution of both demand and inventory across a wide range of possible behaviors, you can reach unprecedented efficiency and service level excellence in an increasingly challenging long-tail world.

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