Stop relying on excess inventory as an insurance policy

Supply chain management is a discipline that emerged to streamline the materials management process. But over the years, inertia set in and supply chain managers relied on old, tired strategies instead of trying to come up with new ones.

This has become the default strategy of many supply chain managers: hoard inventory to ensure that the needs of the business and those of its customers are met. But at what cost ? And is there an alternative?

The situation has only gotten worse over the past two years, when supply chains have been tested like never before. The COVID-19 pandemic has caused supply and demand shocks, and the war in Ukraine has wreaked havoc on supply chains. Over the past few months, a two-headed monster of peak inflation combined with fears of recession have emerged to further complicate the situation.

For some supply chain managers, the upheavals of recent years have vindicated their entrenched approach of relying on excess inventory as an insurance policy. After all, they say, they need insurance to protect against high risk.

“That’s really what everyone else has been doing,” says Paul Noble, founder and CEO of Verusen, a hardware intelligence company. “Supply chain managers realized they were tying up their company’s working capital and warehouse space to hold excess inventory. But they did so because they couldn’t effectively balance capital and risk decisions. They didn’t have a complete picture.

There is another way to look at the predicament facing supply chains today, one that finds in the current situation an opportunity to move in a different direction. Supply chain organizations can reinvigorate their missions by embracing innovations that help make business operations more efficient and agile, even in these challenging times.

The practice of keeping excess inventory often forces companies to write off some of it — sometimes, in the case of larger companies, up to tens of millions of dollars a year. “It’s an expensive proposition,” says Melissa Dietz, customer success manager at Verusen.

And it’s a strategy that often falls flat. “The fundamental reason a manufacturer stocks up is because they’re afraid they’ll run out of parts,” Dietz says. “But sometimes the parts have been in the warehouse for so long that they are now obsolete. I’ve seen situations where companies kept parts for a piece of equipment they retired five years ago.

In many cases, companies actually budget for annual inventory write-offs. “They plan to cancel 5% or 10% of their inventory every year,” says Baljeet Bolina, industry adviser at Verusen. “They’re running their budget in failure mode, instead of thinking about how they could redirect all that working capital.”

“There is so much waste and inefficiency in the system that people have become used to it,” comments Noble. “They see it as a cost of doing business.”

The expense companies incur in writing off inventory suggests the need to optimize risk more appropriately. Eventually, CFOs look at their balance sheets and ask, “Why do we have so much inventory? How can we reduce this number? As with many business challenges today, the solution lies in deploying the power of data and automation.

“Many companies still rely too heavily on manual processes,” says Noble. “These companies are right to fear that they won’t be able to make decisions and execute them fast enough to weather the next storm.”

The alternative is represented by a new set of emerging smart technologies that allow companies to create virtual networks and run what-if scenarios and models. “By running predictive and future scenarios, companies are able to see results before an event occurs,” says Noble. “That way they will be positioned not to be stuck in a bad situation.”

The essential quest is to balance the risk of fluctuating lead times with inventory allocations. “As lead times increase, you don’t get caught out because your inventory levels are too low,” says Dietz. “And conversely, when they shorten, we are not too busy.”

“It doesn’t have to be an either/or decision,” adds Noble. “You should be able to balance risk and inventory, pull the leverage you need at all times.”

This strategy has implications for many areas of business, from contracting decisions and procurement spend to inventory strategies. For example, a contract for a part critical to a manufacturer’s operations may be awarded to the supplier with the most consistent delivery record. Less critical parts, and those for which there are multiple sources of supply, could be awarded to the lowest bidders.

“Data visibility allows sourcing professionals to think strategically about their supplier base,” says Dietz.

The same visibility enables supply chain managers to hold suppliers accountable to their performance guarantees. If a supplier guarantees a delivery time of two weeks and the data shows that it fluctuates between two and six weeks, managers can take steps to remedy the situation.

Intelligent systems that provide data visibility across networks also allow organizations to source critical parts internally. It is not uncommon when companies are looking for a particular item to find what they need in a sister facility within their own company. But to do that, they need end-to-end inventory data visibility.

“When I ask companies if they’re able to source parts in-house when they need them, the usual response is ‘sometimes,’” Bolina says. “So they’re not able to find parts, but they keep $30 million in inventory. There is a disconnect here.

It is sometimes not possible to obtain the required inventory quickly from a third party, and it is often less expensive to obtain it in-house. “A manufacturer had a facility down due to engine failure and was losing $100,000 a day, plus opportunity costs,” Bolina says. “The lead time from their suppliers was five weeks, which would have meant nearly $3 million in lost revenue. But they were able to identify the part under a different name at another facility, get it through the night, and they were up and running again on the third day. They avoided 36 days of downtime, and they did so by finding a differently labeled piece within their own network.

What allowed the company to identify the part, even though it had a different name in a second company system, came from the capabilities of smart materials technologies. By applying artificial intelligence and machine learning, these platforms, in addition to providing data visibility, are also able to understand divergent data formats, without having to go through the time-consuming and costly process of cleaning and data normalization.

According to Bolina, many of the supply anomalies and price increases caused by COVID-19 and the war in Ukraine are the result of unnecessary panic. “Very often companies felt they had to go to the spot market, where prices were skyrocketing, because they didn’t know they had the product in another facility within their own company. “, he explains. “But with proper visibility and planning, they would know what inventory they had and could have negotiated supply contracts in advance and saved a lot of money. You don’t need to pay the spot market price when you have supplier contracts in place with a sustainable, continuous supply of incoming material. By establishing strategic relationships, companies can benefit from price and supply stability.

This same visibility allows companies to optimize inventory across their businesses at a strategic level. “A company might find that it has 20 identical parts at three different locations,” Dietz says. “If they consider the risk, they may decide they only need five parts stored at one site and move them elsewhere if necessary. This way they reduce their use of working capital without increasing risk, which is really what supply chain organizations should be looking for. »

Ultimately, holding excess inventory is not a winning strategy for businesses. If the inventory is no longer usable or obsolete, then the expense of acquisition and carrying, often over several years, represents a deadweight loss for the business. In many industries, such as electronics, parts and inventory quickly become obsolete as new generations of technology are introduced.

“The safety stock they think they’re buying doesn’t really offer safety,” Bolina says. “The insurance they think they’re buying doesn’t provide the protection they’re looking for.”

“Sometimes you need a big event to trigger change,” says Noble. “COVID and the war in Ukraine, followed by concerns about the state of the global economy, spurred awareness and a desire to do things that people knew they could and should do, but that they weren’t driven to do it earlier.”

Over the past two years, many companies have been rocked by their inertia. They have learned the hard way that the old ways are no longer enough. And they have taken the necessary steps to optimize their supply networks by deploying smart material systems.

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