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Running inventory like a Deere

Comment
By restructuring the supply chain for one of its divisions, John Deere cut inventory and reduced freight costs to better manage assets and enhance shareholder value.

Excess inventory can act as a drag on financial performance. Yet any company has to have enough products in its dealers' showrooms to generate sales. The trick is to optimize the delivery of product so that the bare minimum is maintained yet enough product is available in the stores to support sales.

Moline, Illinois-based Deere & Company, better known as John Deere, tackled this problem head-on over the past five years in its $4 billion Worldwide Commercial and Consumer Equipment (C&CE) division. It restructured that division's supply chain to trim inventory and freight costs, thereby improving the company's financial performance for its shareholders. Across the company, Deere has been able to reduce its overall assets-to-sales ratio compared with the same quarter of the previous year for 29 consecutive quarters.

Article Figures
[Figure 1] Recommended inventory: Budget vs. software analysis
[Figure 1] Recommended inventory: Budget vs. software analysis Enlarge this image
[Figure 2] Percentage of annual shipments to dealers by month
[Figure 2] Percentage of annual shipments to dealers by month Enlarge this image

To accomplish this in the C&CE division, John Deere applied advanced software to figure out how to better align its production with demand and reduce inventory. "Our overall strategy was to use better science to address our challenge," says Loren Troyer, director of order fulfillment at Deere's C&CE division. "We recognized that optimization tools could help us do that."

Taking a cue from the top
The supply chain transformation was guided by Deere's overall financial strategy. When Robert W. Lane took over as CEO of John Deere in 2000, he emphasized the importance of improving shareholder value—that is, delivering better financial performance with fewer assets. Lane also wanted to make Deere more successful through all business cycle fluctuations. Because the company's largest business is agricultural machinery and services, in the past, its fortunes often rose and fell with those of the U.S. farm economy. "If farmers were not doing well, we didn't do well because they didn't have the money to buy our equipment," Troyer explains.

Today Deere offers three product lines: agricultural, commercial and consumer, and construction and forestry. For decades, the company has been growing its nonagricultural divisions and expanding sales worldwide, reducing its dependence on the U.S. farm economy.

Under Lane, the company set higher performance goals and required its divisions to implement strategies that would gain a better return for shareholders' invested capital. Deere also began emphasizing the importance of "shareholder value added," which is determined by subtracting an asset charge from operating profits.

"Because of the focus on return on assets and shareholder value added, it became very important to manage our assets better," Troyer explains. "And a very big part of our assets in the C&CE division is finishedgoods inventory, both in our factories and in our dealers' hands."

Determined to trim inventory as a way to free up capital, John Deere began an inventory-reduction initiative in the fall of 2001. At that time, finishedgoods inventory in the commercial and consumer division amounted to an estimated $1.4 billion, and the company expected inventory to reach $2 billion to support anticipated sales growth. "Our goal was to take that down to about $1 billion by offsetting the need for new inventory and reducing the current amount of stock on hand," Troyer says.

Dealing with dealers
In 2001, about 70 percent of the C&CE division's finished-goods inventory was at John Deere's 2,500 independent dealers while the remaining 30 percent sat in C&CE division warehouses. Under this structure, dealers can pay for the product either when they sell it or at the end of an interest-free period, whichever comes first. They also have the option of paying interest for an interim period.

"The inventory that's with the dealers is technically classified as a receivable," says Troyer. "But it is still money tied up like it was our inventory. We carry those receivables to the dealer interest-free for a period of time."

Deere's commercial and consumer dealers were uncomfortable with the company's inventory-reduction proposal. That's because many of the products sold by the division, such as commercial and residential lawn mowing equipment, utility vehicles, and golf course maintenance equipment, are things that customers like to sit on, touch, and try out before finalizing their purchase.

The seasonal nature of the sales cycle complicated the division's inventory-reduction efforts; 65 percent of retail sales of lawn mowers occur between the months of March and July. "If the customer walks into a dealership in April or May and the dealer does not have product, the customer will buy somewhere else because his grass is growing," Troyer says. "Our sales and marketing people were very concerned that the inventory gains would be offset by a loss of sales."

To see whether the inventory-reduction goals were feasible, Deere asked Carnegie Mellon professor Sridhar Tayur to conduct a study. Tayur is also the CEO of SmartOps, a vendor of supply chain software for inventory optimization, forecasting, replenishment planning, and capacity planning and optimization.

Tayur's analysis concluded that the C&CE division's management was on the right track—the division could reduce inventory to $1 billion or even lower if it held the right amount at the right location at each point throughout the year. (Figure 1 shows the difference between SmartOps' suggested inventory levels and the original budgeted levels for riding lawn mowers.)

Because of the dealers' concerns, however, the C&CE division decided to reduce inventory by $250 million each year over a four-year period in a process dubbed "stair-stepping." "If we went too far too fast, the dealers would lose confidence, and they would order additional inventory because they would be afraid of running out of a critical product," Troyer says.

Fast, flexible manufacturing
Even though C&CE planned to cut back its inventory over an extended period, it would have to change its supply chain processes in order to ensure product was available to meet demand. In fact, C&CE would have to react more swiftly to marketplace changes because it would have less inventory to buffer demand swings.

The division began by reducing target inventory levels, which required a change in the production schedule at its five factories located throughout North America. Those inventory targets historically had been set high to compensate for the factories' inability to respond quickly to changes in demand.

To set production schedules that could adjust to demand, C&CE needed to implement a more robust planning process. Inventory targets are set at the product family level, which typically encompasses five to six stock-keeping units (SKUs). C&CE works with product families because planning at the SKU level for the dealers and warehouses introduced too much forecasting error and resulted in the division's carrying more, not less, inventory. Thus, demand planners set inventory targets by product family and determine the mix with input from the master schedulers based on the product category.

Each month, the division updates its retail sales forecast, its inventory plan, and its production schedule. The monthly sales and operations planning (S&OP) process ensures that the retail sales forecast reflects actual sales activity. It then monitors execution toward the updated plan each week and adjusts the production schedule if sales are not occurring to plan.

In addition to adjusting production scheduling, the five factories that manufacture product for the C&CE division changed their assembly practices. Prior to 2000, the factories engaged in batch building on the assembly line. To respond more quickly to demand, factories moved to building every model every day. This change required C&CE factories to set up the assembly lines so that components for all models are available at all times. Building every model every day allows mix changes to be made more quickly than is possible in a monthly batch build environment; there is no longer any need to wait until the next scheduled build of a particular SKU to increase the quantity for that model.

Another key change in strategy was to build closer to seasonal demand. Before, C&CE's factories would turn out 50 percent more product per week in the peak sales season than they did at other times. As shown in Figure 2, today those plants make two or three times as much product in the peak production period (February through July) as they do in the off season (August to January).

To keep the factories churning out enough product during peak production times, the division has also worked with its suppliers to respond more quickly to factories' requests for parts. "We've invested manufacturing engineering time with our suppliers to help them shorten their lead time, and it's paying big dividends," says Troyer. Sometimes suppliers still can't meet C&CE's lead-time needs. In such cases, the factories carry some buffer inventory of purchased parts that have long lead times. "It's cheaper to carry a small buffer of long-lead purchased components than finished-goods inventory," Troyer says.

Adding more but paying less
The C&CE division also restructured its distribution network to both speed up product flow from factories to dealers and reduce transportation costs. The division wanted to cut the order cycle time—the period from the time the dealer places an order until it arrives at the dealership. In the past, the order cycle time generally was 10 days. The average for the division is now five days.

To enable that quick turnaround, the division added another layer to its distribution network. In the past, C&CE had five distribution centers, located adjacent to or near its factories. The division now has five additional regional distribution centers, or temporary merge centers. These DCs store inventory for about five days before merging shipments from different factories. The DCs then ship those products to the dealers as needed, shortening the order-to-delivery cycle time. "Instead of product coming out of our Tennessee factory, dealers in the Ohio Valley might now get product from a warehouse located in Columbus, Ohio," Troyer explains.

The shortened delivery cycle was primarily intended to encourage dealers to carry less inventory and thereby support the division's overall asset management and reduction strategy. Consolidated shipments of products from multiple factories also cut down on the number of trucks arriving at the dealerships, reducing the number of interruptions dealers experienced—something that's especially important during peak sales season.

Initially, C&CE piloted the program for a year with one merge center and one product. The following year it expanded the program to another regional DC, and from there the network has grown to include five warehouses, located in Columbus, Ohio; Edison, New Jersey; Davenport, Iowa; Salt Lake City, Utah; and Southaven, Mississippi. About 30 percent of the division's annual sales volume passes through the merge centers. Used only six months out of the year, these facilities primarily handle residential and commercial lawn mowers, which have the highest sales volume.

At first glance, it might seem that an additional layer of distribution facilities would increase logistics costs. But the establishment of merge centers actually reduced freight charges a bit for C&CE. One reason is that the division was able to get more product onto its trucks. Prior to the creation of the merge centers, C&CE shipped multiple orders in the trucks, but trailers were only 85 percent full on average. Now when C&CE ships to the merge centers, it pre-plans the loads so that the trucks are fully utilized. "The savings in freight from having perfectly cubed trucks pays for the warehouse space and handling at the temp sites," says Troyer. "It's actually a slight savings for us."

The addition of five more nodes to the distribution network did necessitate holding some additional inventory. C&CE now holds five days' worth of planned shipments in the regional DCs, as it would take only two or three days to resupply each of those warehouses from a factory. "You want enough inventory to cover the next orders coming in," says Troyer. "You want product flowing in to match the flow out of the temp warehouses."

As a result, the amount of inventory in the factory warehouses plus that in the merge centers is slightly higher than what the division would have had without the merge centers. However, overall inventory (factory warehouse plus merge center plus dealer inventory) is down because the dealers carry less inventory now that replenishment is much faster.

The merge centers have not been the perfect solution in all situations. In a few cases, C&CE has stopped using them because it could not find costeffective backhaul rates in certain traffic lanes; the division has gone back to direct-from-factory shipments for those situations.

C&CE has made other changes to optimize its distribution network and save on transportation and warehousing, which represents some $250 million a year for that division alone. For example, C&CE is analyzing its use of break-bulk terminals. In the past, the division shipped some orders in consolidated truckloads to break-bulk centers, where the lots were broken down into individual orders. A less-thantruckload (LTL) carrier then delivered the individual orders to the appropriate dealers.

Now C&CE tries to send as many dealer-bound shipments as possible through the merge centers during the peak sales season. The division still uses break-bulk terminals, but it now relies on fewer of them. Using SmartOps' Dynamic Network Optimization tool, C&CE weighed the cost of shipping through the break-bulk centers versus multiplestop truckload delivery. Although a truckload carrier charges extra for making a series of deliveries at different locations, in certain cases that turned out to be less expensive than shipping truckload to a breakbulk center for final delivery by an LTL carrier. "That analysis of shipping to the right number of break-bulk terminals in the right locations helped us reduce our freight costs by about 5 percent," says Troyer.

Support enables change
Six years after the inventory-reduction program got under way, the supply chain restructuring has paid off handsomely. Prior to the changes, C&CE had 170 days' worth of inventory at dealer locations and another 70 days of inventory in its warehouses. Today, it has half that amount of inventory in its supply chain pipeline. The division also has improved customer service. Instead of taking 10 days to get orders into a dealer's hands, it now takes five days on average—and C&CE is aiming to get 80 percent of its high-volume SKUs to dealers in three days during the peak season. By reaching its $1 billion inventory-reduction goal, moreover, the division has boosted shareholder value added by $120 million.

At this point, Troyer's division has probably achieved most of the benefits that could come through inventory reductions. But C&CE will continue its push to achieve lower costs without compromising service. "It will be much more of an effort on our part and on our dealers' part to take inventory lower and still have plenty of products for customers to come in and look at," he observes.

John Deere has learned that operating a supply chain with less inventory means paying close attention to its internal production and distribution processes. In that regard, software has helped the company gain more control. "If you want to operate effectively at lower inventory levels," says Troyer, "you need more refined processes and more refined tools to do that."

According to Troyer, these achievements would have been impossible without the changes put in place by senior management as well as their commitment to the asset-reduction strategy. "We've moved the needle significantly," he says. "The key to moving that needle is having management buy-in. You have to have the right processes and the systems tools to support change. And it does take time."

James A. Cooke is a supply chain software analyst. He was previously the editor of CSCMP's Supply Chain Quarterly and a staff writer for DC Velocity.

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