“Inventory is bad, inventory is evil,” finance and operations professors intone across business schools worldwide. And every B-school graduate knows companies should balance enough inventory to meet customer needs while accommodating shifting preferences. That said, companies face a paradox; holding too much inventory ties up valuable cash, but too little inventory is risky since some suppliers could lose their financial footing. In a global financial crisis, is inventory still evil?
Forecasting sales and inventory levels is probably one of the most difficult jobs of a product and/or supply chain manager as companies need to marry demand signals with supply. Adding more complexity to the mix is global supply chains that span weeks, multiple countries and sometimes oceans. Lots of hand-offs, tons of data to track, and lots of points for things to go wrong.
For many product managers (and the marketing/brand managers that support them) inventory management is a critical task. By not carrying enough inventory, companies can not only lose out on sales but also suffer reputation damage by not meeting customer needs.
Nonetheless, with companies hoarding cash–it seems the last thing companies need is to be stuck with unsold finished goods or piecemeal parts.
Apple’s Chief Operating Officer Tim Cook agrees. In a recent Fortune article, Cook says inventory is “fundamentally evil.” And Cook should know, as he’s in the very fickle consumer electronics business. “You kind of want to manage it like you are in the dairy business,” he says. “If it gets past its fresh date you have a problem.”
Here’s the rub, however. Forces of globalization and tight coupling are magnifying the complexity, impact and frequency of events. Once steady suppliers are going bankrupt, some suppliers cannot get loans in the credit crunch, and disruptions in the supply chain are becoming more commonplace. Your product launch date doesn’t matter much if your suppliers cannot deliver.
But can’t analytical modeling save us? After all, most companies are using advanced planning applications to predict future trends and behaviors, right?
While statistical forecasting techniques can help extrapolate future trends, these methods rely on building models based on historical data. And some executives say in volatile times, historical data can no longer be trusted to accurately model and predict the future.
So what’s the solution? Should we build more redundancy into our supply chains to better manage the risk of suppliers, or stay the course with the trend towards information management and just-in time supply chains that are well optimized and thin?
Better communication is a potential answer says Camille Schuster, President of Global Collaborations. What is needed, she says is, “Proactive contact with suppliers on a regular basis to determine how supplies are doing, what issues are coming up, whether any shortages are foreseen, whether there is any softness in any product area, what changes and/or rumors are floating about.”
For many companies, effective inventory management is a critical component of financial health. With “cash” at a premium in this global financial pandemic, inventory decisions can literally make or break your company.
When it comes to inventory, what level of risk are you comfortable with?
Questions for DailyFix readers:
* Is a little inventory cushion warranted as risks (environmental, political, criminal, financial, reputation, terrorism etc) seem to be increasing in intensity, complexity and frequency?
* In volatile times, should forecasting and inventory management be more focused on “gut” decision making rather than mathematical models?
* Stockouts leave “money on the table” and ultimately reduce customer satisfaction. What is your marketing advice to supply chain, operations and/or engineering executives in these volatile times? Hedge their bets with a little more inventory, or continue to operate “thin”?
* Is inventory still evil? Should it be avoided at all costs?
Tags: analytics, Black Swan, forecasting, inventory control, models, predicting future, prediction, risk management, statistics, supply chain, tight coupling, trends
I believe the B-school fundamentals are right. Inventory is a cost to the business; but it’s an insurance against not delivering to your customers’ expectations. The right level of stock also ensures efficiency in the supply chain. One answer to managing supplier risk is effective analysis of the supply base. Marketers would approach this through segmentation: suppliers should be assessed as to how critical they are to the supply chain and then as to their financial standing. Clearly, those that are important but unstable need to be monitored and a contingency plan put in place. This might involve additional stock cover, finding alternative supply sources and the like.
Paul,
I think you captured the essence of the challenge in that one tiny paragraph in the middle that says “historical data can no longer be trusted to accurately model and predict the future”. If it ever could. Historical data models the future only as much as the future is a replica of the past. Although some trends may repeat, there are always system shocks (larger as we get more interconnected) that are unpredictable based on history, by definition.
Thanks for a thoughtful post on a topic I don’t end up thinking about much lately (inventory in a SaaS software business is not as much of a challenge…)
Jonathan, thank you for commenting. I believe your approach is right on, in that suppliers should be constantly monitored regarding their importance to your company’s supply chain and their financial health. That said, this involves and assumes a degree of trust and transparency in the relationship, especially for suppliers that are private and don’t report their financial results. Net it out however, I like your idea of having a Plan B and possibly Plan C for suppliers deemed to important to your company’s success…
Steven, I appreciate your comment. I also see from your blog that you just finished reading the Black Swan. I must admit, Mr. Taleb’s writings were the inspiration for this post as I started to link the need for companies to effectively counter those “rare and unexpected deviations” with some slack in their processes–in this instance supply chain management.
In a world in which people, companies, countries, economies are more highly correlated and intertwined, sometimes the old rules need rethinking. Can the “past” still effectively model the future? And if not, what then?
Paul,
Excellent post. Inventory is something I don’t have to think about these days and thank goodness for that. For those who do: constant monitoring of the business and feedback are more essential than ever. Monthly forecasting reports are not sufficient. Companies selling basic commodity items, may find it necessary to build in more inventory than the norm. . .but that depends on their lines of credit, doesn’t it? And it depends on the nature of the products, as well. Can’t lay in too much inventory on short-coded products, for example.
For companies in the business of selling non-essential goods, the forecasting task is daunting. The economy is contracting and will continue to. Money is tight and discretionary dollars are being carefully spent. “Excess” is now a dirty word. Added to that, well-heeled consumers are purchasing fewer luxury brands, as well. As sales slow down, factories on the manufacturing end do too. Or they completely shut down. We see that happening in China. Fewer suppliers are able to fill orders and they will want tighter lines of credit. Jonathan Betts is right; back-up plans have to be put in place as other suppliers are found. All of this, as you point out, has repercussions up and down the supply chain and all around the world. There are no easy answers.
We’re living in an extraordinary period and historical data is of limited use. Regular communication with suppliers to gain information about marketplace trends should be the norm–in good times and especially in bad. Staying on top of customer demand and feedback day in and day out is more critical than ever. It’s important to provide service to the customer now more than ever. The cream is going to rise to the top here: every company and every company’s competitors are in the same boat with supply chain and inventory issues. Which ones will use this as an opportunity? Which ones will work to improve customer service and responsiveness?
Claire, thank you for the terrific insights. Both you and Jonathan make great points, and they are well aligned with Dr. Schuster in regards to the need for information management of supplier and customer feedback.
To be sure, there are many supply chains that have slack because they are not optimized to begin with. For these supply chains there is lots of room for improvement to remove “excess” as you aptly point out.
There is also the flip side, of over optimized supply chains with minimal to no slack. For these supply chains, everything must run perfectly to meet market demand–a dangerous route in an extremely volatile world.
Apologies if I skipped this detail in your post, but I didnt see much mention on the customer impact. Yes inventory is a financial burden, but the loss of sales due to outages runs significant risk to a business in my humble opinion, especially when consumer dollars are scarce.
Back when i was still blogging, last Feb i went thru every rack in a menswear shop in vain – the most-common size of black dress pants was out of stock. The manager told me no new delivery could be scheduled – the store was replenished on a two-week frequency no ifs ands or buts. And no purchase from me.
And, just this past holiday season, a local Gap was completely sold out of its best looking striped sweaters (even tho the mannequins were still outfitted with them). The throngs of people picking thru the remains (myself included) leads me to believe Gap forfeited a lot of revenue.
But the guys in the backroom in Finance won’t see that. All they will see is that there is no “excess” of striped sweaters. Well done, guys. Nice financial management.
Poor customer management in my book, however.
Great post, Paul! One little thing, though. In the 5th paragraph, quoting Tim Cook, it says “diary” instead of “dairy”. I don’t think a diary can go beyond its fresh date.
Kevin, as you rightly point out, the customer impact of supply chain management is huge! When I guest lecture at universities, I often bring up the topic of SCM and marketing. Invariably, I’ll see senior marketing students rolling their eyes, or questioning what SCM has to do with marketing.
Accurate forecasting and operations management for products and services has everything to do with marketing and our ability to get the right product, in the right place, at the right time, at the right price, to the right customer.
Thanks for commenting on this post!
Eric, dairy, diary. I’ve had Homer Simpson moments in the past, but yikes! I’ll get Ann to fix this, thanks for pointing it out!
Great discussion. I generally come down on the “inventory is evil” side of the discussion. I strongly agree that SCM has a major impact on customer satisfaction – thus marketing. And, inventory availability is a tool to achieve this goal.
However, today’s supply chains are more globally distributed, are more complex “networks” and have to deal with increasing volatility of demand, supply and product (via shortening product lifecycles) and, thus, have lots of places where inventory collects and quickly becomes excess and obsolete.
In such an environment, inventory can become a huge liability. Too much inventory “handcuffs” the organization and prevents it from having the agility the marketplace demands today, which undermines marketing efforts to gain market share and grow top line performance.
I think the best route is for organizations to build responsiveness into their DNA – it must be a core competency of any supply chain organization. SCM professionals must be armed with the right level of supply chain visibility and the tools for proper risk tradeoff and response to deal with the inevitable unplanned events that are the hallmark of today’s supply chains. Unfortunately, most organizations don’t do this, so they are left to debate whether or not they are going to choose between low inventory levels or high customer satisfaction. Tough choice.
Randy, you make a great point about supply chain visibility, which of course is very data dependent. Consequently, for companies to become more “responsive”, they need to gain a core competency in enterprise data management to effectively track data throughout the entire supply chain. This then, helps them gain the visibility you rightly point out as critical to SCM success.
Sadly, most marketers (and the companies they work for) don’t have any idea what’s in their supply chain at any point in time. This makes it pretty difficult to effectively meet customer demand and keep appropriate inventory levels.
Can we have it both ways?
I would aspire for lean production processes. This is especially important in the case of electronics devices, where technology changes so rapidly that excess inventory must be discounted to be liquidated, if liquidation is even possible.
Excess inventory can be quite an albatross, if alternative uses for the inventory cannot be found.
This isn’t to say that all companies must start here (though it would be nice) — especially with new technologies. Process improvement is a lot of work. However, if companies don’t start here, they should at least have a plan in place for continuous, incremental improvement.
Cam, you make a great point regarding shelf life and obsolescence. These are definite considerations when it comes to forecasting and inventory planning.
That said, there are some instances when such factors don’t come into play. I’ll give an example.
In 2007 a major Japanese automobile manufacturer was forced to shut down many of its plants and delay the delivery of 55,000 automobiles due to an earthquake disrupting one of its key suppliers. In fact, the closure of this one supplier of $1.50 piston rings, “forced nearly 70% of Japan’s auto production to temporarily shut down.”
Might it have been prudent to have a risk mitigation plan for such a critical component? Lean is good and arguably preferred. That said, in a volatile economy where events often snowball and cascade into much larger challenges–isn’t it possible to over optimize?
“Might it have been prudent to have a risk mitigation plan for such a critical component? Lean is good and arguably preferred. That said, in a volatile economy where events often snowball and cascade into much larger challenges–isn’t it possible to over optimize?”
What I’m hearing is that risk mitigation is important in any circumstance; just make sure you identify the mission-critical risks. Is that fair?