Minimize inventory liability across supply chain echelons

Examine the balance sheet of any manufacturing firm, and one would notice that inventory
accounts for 20 percent to 60 percent of its total assets. True, inventory has a definite financial
value; a comprehensive and effective inventory management policy can result in increased
revenues and enhanced efficiencies. Nonetheless, is inventory really an asset or could it toll the
death knell for an organization?

Factors like demand volatility, shorter product lifecycles, rising customer service expectations,
increasing global competition, diminishing brand loyalty, shrinking margins, and globally distributed
supply networks have made quick response to marketplace changes critical to a company's
success. This has led to different echelons within the supply chain network resorting to safety stock
accumulation to maintain customer satisfaction levels. While inventory is necessary for the smooth
functioning of business, high inventory exposure could mean financial losses due to high carrying
costs including warehousing costs, and even worse, product obsolescence. Unforeseen events like
natural disasters, disease outbreaks, terrorist attacks, etc can change market dynamics almost
instantaneously. The current decade itself has been witness to several such instances - 9/11,
SARS, equine flu, the Tsunami, and now the H1N1 influenza outbreak. Market research, however,
shows that more than 50 percent of companies in the FMCG sector take over a month to sense
shift in demand while more than 80 percent suffer opportunity costs due to inability to sense and
respond to these changes.

This can have significant financial repercussions including opportunity costs or inventory write-offs.
While these external factors cannot be controlled, today, tools and technologies are available that
can effectively manage supply chain complexities and reduce inventory while simultaneously
increasing customer service levels. This paper discusses the various inventory related challenges
organizations generally face and the measures they can take to respond to the same with minimal
bottom line impact.



Factors that Hinder Effective Inventory Management
Traditional planning systems forecast demand based on past performance. It does not take into
account deviations that can occur as a result of various internal or external influences. The system
lacks the ability to predict the impact of an unforeseen occurrence on the supply chain. Products with
extremely short product lifecycles, perishables, and those with long lead times stand the greatest risk
of lost market revenues and write-offs. And in a global environment where an organization's supply
chain network comprises multiple echelons a static system cannot disseminate critical information in
real-time. By the time organizations can recognize the problem, analyze its impact, and take counter
measures, the inventory at obsolescence risk has generally already built up within the network.
First, let's look at the various aspects under the direct influence of a manufacturer that an
organization can control by leveraging available technology.

Demand Shifts: To respond to demand shifts resulting from launch of newer, better products by
competitors, manufacturers may in turn make changes in their own product design. This could result
in obsolescence of certain components leading to dead inventory.

New Launches: This is closely connected to the issue mentioned above one. However, here the
threat is from internal sources in the form of cannibalization of a successful product through the
launch of updated versions.

Supply Shortage: Lack of multi-echelon visibility could lead to situations where a particular
component on the supply chain network might foresee supply shortage and so increase safety stock
levels to hedge shortfalls. This could lead to unnecessary stock build up especially is that component
is available in another echelon in the network.

Increased Lead Time: Globalization has led to geographically dispersed, highly complex supply
networks with multiple touch points from the handling of raw materials to the delivery of finished
goods resulting in longer and more variable lead time and increased inventory risks. On the other
hand, increased competition and fickle customer loyalty has placed pressure on organizations to
reduce time-to-market and fulfill market demands instantaneously.

Disconnected Internal Systems: A single, integrated view of the organization is necessary to
anticipate change and take measures to respond quickly to it. The lack of system integration can,
however, lead to a scenario where organizations are incapable of predicting demand and supply
situations. Organizations should have the necessary tools and technologies to sense changing
demand and quickly take necessary action to reduce inventory exposure.


Overcoming the Challenges
Accurate evaluation of inventory risk and liability is a complex process. Traditional supply chain
solutions focus on inventory as a post-performance metric leading to huge liabilities during demand
fluctuations. What is, however, required is a solution that measures and evaluates the potential
inventory risks lurking in the supply chain rather than the actual inventory, a solution that ensures
near real-time detection of inventory risks and liabilities, a solution that can sense changes in
market demand and help companies adjust inventory targets accordingly. Such a solution should be
able to track and trace inventory throughout the supply chain and make the network more flexible to
market changes.

Inventory in balance sheets do not reveal committed components, sub assemblies at supplier
locations and potential product returns from retailers and distributors. To evaluate the actual
exposure, organizations need to first know the exact location of the entire inventory within the
network i.e. an Inventory Liability & Risk Management Dashboard that provides real-time / near realtime
financial value of inventory liability across the supply network.
Enterprises can take two approaches for inventory liability analysis; namely 'Inventory Exposure' and 'Valuation of Multi Echelon Inventory Obsolescence'.

Inventory Exposure
A simple way of gauging inventory exposure is by understanding the amount of money at risk at any
given point in time. The inventory exposure metric should provide a near real-time view of the
amount of committed inventory within the network based upon expected demand and the cumulative
lead time associated with the current supply chain.

The design and engineering teams should have visibility into standing inventory levels. Better coordination
between operations and design could mitigate inventory obsolescence due to premature
introduction of a new product thus saving significant financial losses due to write-offs.
Prior to increasing safety stock levels or ordering from another supplier to hedge shortages at the
preferred suppliers' end, organizations should look at inventory within the network. This will help
curb unnecessary inventory exposure and alleviate financial risk when a product reaches the end
of its lifecycle.




Valuation of Multi Echelon Inventory Obsolescence

Companies need to look at the whole supply chain and take decisions that are appropriate for the
entire network and not just a single echelon. If each echelon holds a certain level of inventory as
safety stock there is the possibility of an inventory build up across the supply chain. This is nonworking
capital which is not contributing to the bottom line, and worse, is at risk of obsolescence.
A multi-echelon view of inventory helps cut down on excess inventory in the form of redundant
safety stock, reduces stock-outs and end customer service failures, and provides more accurate
demand projections.

Valuation of Multi Echelon Inventory Obsolescence judges the benefit of inventory analytics in
postponing the accrual of inventory in the supply chain downstream by aligning production schedules
of components manufacturers and suppliers to the demand for the finished good. Companies should
shrink the product manufacturing lead time by relooking at the entire production process to identify
opportunities to reduce lead time and improve inventory exposure.


In Conclusion
Thanks to globalization, supply chains across industry verticals have become highly complex in
nature. Market conditions, however, do not permit organizations to wallow in its size or the global
nature of its business or its technological prowess. Today's supply chains have to exhibit a high
degree of adaptability and responsiveness to changing market conditions, and proactively respond
to shorter, more dynamic product life cycles.

Inventory liability puts companies at financial risk. A comprehensive valuation, in monetary terms,
can provide a more accurate picture of the financial implications of a company's inventory exposure
and enable it to take more informed business decisions. Companies can derive significant financial
value by leveraging multi-echelon visibility to rapidly respond to changes that could negatively
impact the business. Companies can reduce inventory while maintaining stringent customer service
level requirements by optimizing product mix at each location.

By analyzing inventory liability through metrics like 'Inventory Exposure' and 'Valuation of Multi
Echelon Inventory Obsolescence' companies can gain enterprise-wide visibility, analyze impact of
events on a near zero-time basis, and thereby reduce lead times and variability, enable lower
inventory investment, improve customer satisfaction and cut supply chain costs.
Inventory Liability


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