Solutions to avoid inventory Carrying?

In general supply chain innovations or improvements focussing on inventory optimization target either lead time reduction or cost savings and in some cases both.  The bottom-line for these concepts is to reduce or eliminate inventory and minimize the impact of inventory carrying costs on the P&L and to reduce the lead time.

If I were an entrepreneur involved in manufacturing, I would love to own inventory that is just required for that day’s production needs.  If I am big reseller I would like to buy material that is just required to meet day’s demand.  If I am a big buyer, I would prefer suppliers to carry inventory that is required by me.  The reason for all these demands is that Inventory costs money and its money to carry the same.  And that is the reason everyone would like to differ the inventory carrying.  Do we have solutions to meet this requirement within Supply Chain?  And that is the reason we are here to find out the solutions.

Some of the solutions that could answer the questions raised above include the following:

1. Vendor Managed Inventory
2. Consignment Inventory
3. Inventory Financing
4. Cross-Docking

Vendor Managed Inventory (VMI):

This is a very popular concept in Asia and majority of High Tech/IT manufacturers use this solution.  What is VMI?  The title indicates the meaning and objective of the solution.  The inventory that is required by the manufacturer is managed and maintained by the supplier at the back yard of the manufacturer. The objective of VMI is that by pushing the decision making responsibility further up the supply chain, the manufacturer will be in a better position to support the objectives of the entire integrated supply chain resulting in a sustainable competitive advantage.  This solution creates a transparent supply chain enabling supplier and buyer to avoid uncertainties in supply.  Centralizing and automating the replenishment decision also helps reduce the distortions in ordering introduced when there are several intermediaries that place orders in a supply chain.  The big change to supply chain is that VMI transforms push supply chain to pull supply chain thus avoiding wastages and uncertainties.

As you can see from the above graphical presentation, in a VMI environment three parties are involved.  The first one is the Vendor, the second one is the manufacturer or the buyer and the third one is the 3PL appointed by the buyer to store, manage and supply vendor material to the production line as and when required.  The buyer provides indicative yearly consumptions and allows the vendor to develop safety stocks and reorder points to ensure that the VMI hub never runs out of inventory.  One can notice the responsibility of inventory planning is shifting to the vendor instead of buyer.  This model also provides the certainty to the Vendor with regard to demand for their product.  This model is very popular in raw material supply environment.  However, this model can be customised to a finished goods environment.

Some of the benefits of VMI:

1. At K-mart, customer service measures have gone form the high 80s to the high 90s.  Inventory turns on seasonal items have gone from 3 to between 10 and 11, and for the non-seasonal items form 12-15 to 17-20.
2. ACE Hardware, the large hardware cooperative, has seen fill rates rise 4% to 96% in the past few years.
3. Fred Meyer, the 131-unit chain of super-centres in the Pacific Northwest, reduced inventories 30% to 40%, while sales rose and service levels increased to 98%.  This was due to a VMI program implemented with two key food vendors.
4. Grand Union, a New Jersey-based grocery retailer with more than 100 stores and three DCs, improved inventory turns by close to 80% and achieved 99% service levels.

Source: Fernando del Cid, Roger Gordon Brian Kearns, Paul Lennick, and Andreas Sattleberger.

The Consignment Inventory:

This is something similar to VMI with subtle difference.  In this case there are only three parties involved, that is the buyer and the seller.  Under this model, Inventory owned by the supplier is held by the buyer and the ownership of goods transfer to the buyer only at the point of consumption.  Consignment stock arrangements are usually put in place to assure continuity of supply to the customer or to reduce the customer’s working capital or both. While much of the benefit is to the customer, the supplier also benefits because the customer is tied to his product, he does not have to hold stock, and has more freedom in choosing when to manufacture or procure additional supplies to replenish the consignment stock.

Having worked in mining industry, I have seen many suppliers dealing with mining products enter into an consignment inventory agreement with the mining companies to supply inventory to the mining companies on consignment basis and generally billed at the end of the month when consumption is accounted.  This allows suppliers to tie the buyer to their product and the buyer is assured of continuous supply without investing in the inventory carrying and avoids the cost of inventory carrying which could be up to 25% per annum.

Some of the risks associated with consignment inventory model includes,

1. Increase in overall inventory carrying with in supply chain.
2. The pressure to reduce inventory is indirect.
3. Due to lack of inventory planning by the buyer could lead to obsolete inventory for the supplier.
4. Suppliers are likely to incur extra costs by carrying out stock audits on customer’s premises.
5. A very high quality of stock rotation and record accuracy is required to be maintained by the customer’s employees when dealing with the suppliers’ inventory.

Inventory Financing:

 In short, finance provided to the borrower against the inventory as collateral. Inventory Financing companies are willing to finance against the inventory/purchases up to 70% to 90% of their value with a repayment period of 120 days. This allows the buyers to choose their suppliers based on their products, prices and service, rather than on the credit availability they offer.

In the present e-commerce environment where “cash to cash” cycle is shrinking for the big players, it is also imposing a financial stress on the smaller players who happened to be suppliers.  In order to understand the cash to cash term well, let me quote the definition provided by SCOR, “Cash-to-Cash Cycle Time is a continuous measure that is defined by adding the number of days of inventory to the number of days of receivables outstanding and then subtracting the number of days of payables outstanding. The result is the number of days of working capital your organization has tied up in managing your supply chain.”

More and more organizations are looking for solutions to differ inventory ownership.  The vendor managed inventory, JIT delivery are the examples of operating without carrying inventory.  These solutions may work well for the buyer but what about the seller who may be a small player.  This means that the suppliers are made to wait long to convert inventory into cash.  In case of JIT delivery solution, the supplier has to carry inventory at his facility which results in increasing storage and operational expenses and in case of VMI the suppliers are expected to pay the 3PL charges.  This kind of challenging expectations makes the suppliers non-competitive. This could only lead to ill-will among the suppliers and result in high cost of material, poor quality or even could lead to bankruptcies.

In an attempt to lessen this cash burden on the smaller suppliers, some of the service providers and Bankers are providing several trade-financing alternatives.  These alternatives could be driven at the behest of the major client of the 3PL, in which case the credit rating of this entity is used to compute the cost of money to the smaller suppliers – thus providing a win-win situation for all concerned.  Alternatively, these deals can be structured independently for either the large corporations or the smaller suppliers.  In either case, the cost and benefits would depend on each individual case.  However, it will prove a definite win for all concerned.

3PL would pay suppliers (finished goods supplied): In this case, if a supplier gets paid by the buyer in 60 days as per the commercial terms negotiated, 3PL can step in and pay the supplier in7 days’ time (imaginary).  The supplier gets the money fast and hence would offer a cash discount to 3PL.  On the 60th day, the buyer would pay 3PL the full value of the invoice, as they do currently.  In this scenario, this is transparent to all in the process. The supplier gets paid faster and therefore can afford to give a cash discount from 1 to 3%.  This enables the buyers to use their credit limits to handle their core requirements.  The discount rate would be less than the supplier’s cost of capital as 3PL would most probably be charging an interest rate that applies to buyer’s credit rating.  The savings for the buyer; would be that they can minimize their back office activities such as account payable to some extent.  They can afford to do this as the rates and quantities are already checked and vouched for by 3PL.

Finished Goods Inventory Financing: In another instance where 3PL may buy the finished goods inventory from their clients.  The clients would then be able to recognize revenues immediately and also get these assets off their balance sheet.  At the same time, their customers would be able to buy these products and thus put them on their balance sheet only when they absolutely have to do.  This would help clients in a “Vendor Managed Hub” situation and clients who need to get sales revenue recognized at the end of a quarter to meet their financial goals.  The risk of obsolescence would be borne by the client (would be treated as sales returns) and any shrinkage or losses would be borne by 3PL and/or client.  The benefits for the clients are phenomenal as can be imagined.  As part of this package, 3PL would also be willing to purchase up all the inventories of a client and “park” these assets on their balance sheet.  The immediate impact on cash flow and lines of credit for a client is immense.

Raw Materials Purchase: 3PL would also, as part of these activities, help finance the raw materials or finished goods (trading) for a client directly from the suppliers.  In this instance, 3PL would pay cash for the raw materials and put these assets on 3PL balance sheet.  The advantage for the client would be that the client can negotiate a bulk/cash rate from their suppliers and take advantage of the lower cost.  The client will then pay 3PL for the materials as and when they draw from this inventory.  Here again, the cash flow is a significant impact for the client as well as opening up the lines of credit for other core activities.  It is needless to add that the obsolescence is borne by the client and warehousing charges for holding the inventory will be paid by the client.

Best of the breed:  In this model they use a financial institution and 3PL act as a custodian of the inventory.  The material purchased by the 3PL client will be paid by the financial institution as per agreed commercial terms.  This helps the suppliers to get their payments quickly and is willing to offer cash discounts to the buyer (in this case 3PLs client).  3PL will release inventory to their client based on the amount of payments cleared and on the instructions of the financier.  However, the buyer (3PL client) will own the inventory and be accountable for the obsolescence.  This will help the buyer to have additional line of credit on top of working capital already borrowed based inventory held by them.

The main objective of inventory financing is to reduce burden on supplier and at the same time differ the inventory ownership for the buyer.  In the process, buyer end with low finance costs and 3PL add value to the business by owning inventory.  The author worked with major corporates who hates to own inventory at any part of the business process.

Cross-Docking

Four major functions of warehousing include, receiving, storage, pick-n-pack, and shipping, it is estimated that 70% of warehouse costs are incurred for the storage and pick-n-pack activity, storage because of inventory holding costs, and order picking because it is labour intensive.

Cross-docking is a logistics technique that eliminates the storage and order picking functions of a warehouse while still allowing it to serve its receiving and shipping functions. The idea is to transfer shipments directly from incoming to outgoing trailers without storage in between. Shipments typically spend less than 24 hours in a cross-dock, sometimes less than an hour.

Different types of Cross – Docking:

1. Manufacturing cross-docking – the main function of this activity is to receiving and consolidating inbound supplies to support Just-In-Time manufacturing.
2. Distributor cross-docking – consolidating inbound products from different vendors into a multi-SKU pallet, which is delivered as soon as the last product is received
3. Transportation cross-docking – consolidating shipments from different shippers in the LTL and small package industries to gain economies of scale
4. Retail cross-docking – receiving product from multiple vendors and sorting onto outbound trucks for different stores

 Success Story:

“The “warehouse concept” made famous by Costco is all about reducing logistics costs, and cross-docking is at the centre of the strategy. Because the outlet (itself a warehouse) displays pallet quantities, cross-docks in the Costco system receive and ship pallet quantities. At one distribution centre in California, 85% of all pallets move across the dock in tact; the remaining pallets are broken down and sorted by case in a lay down area. By not breaking most pallets at the distribution centre, Costco saves labour costs that other retailers have to pay for order picking, packing, and shipping.

Costco currently uses a post-distribution system, meaning that they attach labels to pallets after receiving them. In the future, they hope to have their vendors attaching those labels for them, so they can avoid all touch labour in the warehouse.”

The urge to produce and sell goods at a very competitive price is on top of the agenda for the organizations due to global competition, dynamic market conditions, product proliferation and scrambled merchandizing.  There is no end to this drive.  Someone in some corner of the world is always exploring the ways and means of bringing down the cost of the product by implementing supply chain improvements to meet the customers’ expectations.  Some ideas take a shape and get experimented and implemented and some go into cold storage.  However, the quest for innovation never ends and thus makes Supply Chain Management a challenging and intelligent task. I strongly believe that all supply chain professionals are part of that elite group of individuals who strive every day to produce that magic called innovation to bring down the cost of the goods and the cycle time to deliver.

 

 

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