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Brute force inventory reductions will no longer work in the current environment of global supply chain management (SCM), and enterprises will need to find tools that can help them make informed decisions in a timely and more-intelligent manner. This research will highlight several types of SCM applications that should be in the arsenal of global SCM organizations.
Key Findings: In previous economic downturns, enterprises could rely on brute force approaches, such as a hard 20% inventory cut across all items and locations, to reduce inventories as demand waned, but with the long lead time of modern global supply chains, businesses will need to employ more-sophisticated approaches. The extended multiparty global supply chain can have as much as a year lag time between actual demand and when supply inventories first enter the pipeline, making adjusting inventories for demand fluctuations problematic. By the time the depth of the economic downturn is understood, many enterprises are already committed to inventories, even though these might not be needed any longer (such as retailer Christmas stock). Knee-jerk reactions to "cutting inventory" in the current globally connected supply chain runs the risk of harming your business more than the apparent benefits of cutting inventory in the short term.
Recommendations: Given the preponderance of global supply chains, enterprises have to reconsider the SCM applications they use so that they can better monitor and react to economic conditions, extending their forward view a year or more into the future.
Brute force approaches to inventory reduction will no longer work in global supply chains, so enterprises need to look at SCM technologies (such as sales and operations planning (S&OP), long-range forecasting and inventory strategy optimization) to help mitigate issues cause by economic volatility.
Historically, when supply chains were more localized, enterprises had greater flexibility in responding to demand and supply volatility caused by economic conditions. If demand slowed, they could cancel orders with suppliers on short notice; if demand increased, they could place new orders with suppliers and be assured that suppliers could respond in a reasonable period of time. The reasonably short lag time in this process (days or weeks) enabled organizations to let conditions evolve a bit longer, allowing for a clearer understanding of demand before taking action. This said, however, the downstream effects of this, often referred to, as the "bullwhip effect," were still traumatic to trading partners; even so, the response time was shorter than with global supply chains. When able to cancel an order with a day's notice, businesses could wait until things got pretty bad before they had to worry. The inventory reduction programs that many companies instituted during the past decade, or strategies such as just-in-time, demand-driven or lean, were built on the premise that the end company held minimal amounts of inventory, assuming they could get what they needed quickly.
Pipeline Levels of Inventory: Although supply chain globalization principally pursued lower costs, globalization has exposed organizations to greater risk in volatile economic conditions. Demand-driven has been the SCM mantra for several years, but, paradoxically, as organizations became more global, they made becoming truly demand-driven less achievable. The ability to let current "real" demand drive inventory replenishment only works if the demand and resupply lead times are similar. However, in global supply chains, demand lead times can be measured in days, while resupply lead times can be measured in months. Consequently, by the time an organization sees a downturn in demand, it likely has too much inventory already in the pipeline.
One problematic issue for enterprises today compared with 15 or 20 years ago is that, given the prevalence of global offshoring, cutting inventories is much more difficult. First, some of the inventories that enterprises are sitting on are the buffer stocks needed to cover the longer international lead times companies have today. Short of selling what they have, possibly at a steep discount, there's no easy solution. Long lead times, often eight weeks or longer, required for resupply are creating another dilemma, as this inventory is often owned or under contractual obligations for businesses to buy.
Although some channel masters might be able to negotiate their way out of this situation, most buyers will be stuck with this in-transit inventory once it arrives. There could also be owner transfer issues with this in-transit inventory, depending on the INCOTERMS--the abbreviation for "International Commercial Terms" published by the International Chamber of Commerce, which is a set of rules for the interpretation of commonly used trade terms in foreign trade--in place between the supplier and the customer. Regardless of ownership of in-transit inventories, someone will likely be assuming the cost of this inventory if demand drops precipitously, as is expected in some product areas.
Timeliness of Response: The next problem impacts upstream trading partners that often take actions months in advance of their customers placing firm orders to be prepared to support future demand. For example, factories that produce intermediary goods started building products many months ago, which means that raw-material or producer-owned intermediary goods inventories will also increase if upstream businesses cancel their orders. This situation is often referred to as the bullwhip effect, where oscillating upstream demand is magnified as it ripples through the multiple echelons in the extended supply chain. In global supply chains, this ripple effect will take longer to play out than it did in the past, again because the end-to-end, resupply lead time is so long. In all likelihood, upstream suppliers will hold additional inventories that there is no longer demand for.
On the back-side of the crisis, the long lead times of global supply chains will also negatively impact turnaround times, because it will take significantly longer to get goods flowing again once things improve. In good times, the lead time from raw material to consumer can be a year or more, which suggests that, in some industries, there could be upward of a year-long lag time to turn things around once demand improves.
Supply Chain Leaders Face Key Decision Points: In this climate of economic uncertainty, brute force methods of inventory reduction (for example, a hard 20% inventory cut across all items and locations) and supply chain cost containment will be ineffective and possibly dangerous. Unconstrained cancellation of supplier orders could destroy trading-partner trust and put suppliers at greater business risk, neither a good outcome if these could be mitigated. Additionally, since inventory is likely already in the pipeline, there is little that organizations can do to stop the flow, so they must think about what to do once the goods arrive. Making the wrong move might solve a short-term problem, but it may make recovery that much more difficult.
The long-term trend in SCM has been to push inventory risk and cost up the supply chain by making suppliers responsible for inventory costs and replenishment efforts. Suppliers were ready and willing to take this inventory risk because, as long as demand continually increased, there was no realized risk, only a theoretical risk. Few suppliers got burned in these relationships, because even if there was an order cancellation, they could, many times, sell the inventory elsewhere. Now that demand is volatile, accepting inventory risk has a real cost. We expect that some suppliers will be less willing to accept this risk or will charge for taking on this risk, which could reverse this long-term trend in SCM. No longer will a legitimate supply chain strategy be to blindly push risk upstream, because offloading that risk will start to entail real costs. Instead, what will be required is a more thoughtful approach. Enterprises should ask which enterprise is in the best position to manage inventory risk, because that will be the enterprise that can most efficiently hold the risk. Then, relationships should be structured so that the enterprise best positioned to hold the risk does.
Technology can become a critical weapon in managing inventories and uncertainty in a global supply chain during uncertain, as well as prosperous, economic conditions. Companies should augment their SCM application portfolios with tools that can help them monitor, plan and react to volatile conditions in their global supply chains. In fact, some of our recommendations fly in the face of traditionally accepted practice. For example, many firms have dropped to shorter-term forecasting (or even none), because they were so focused on short-term response; but globalization demands that this be reversed, and organizations need to look further into the future and share more of their plans--considering issues like risk and confidence levels. Some technologies that enterprises should consider for addressing issues related to global SCM are:Long-Term Forecasting--The long lead time, pull-based, international supply chain demands that companies get much better at forecasting in the long term. Emphasis has been on demand planning as of late, and leaders will be those organizations that do a better job responding to the longer-term forecast, say beyond three months, but more likely six to 12 months out. S&OP with a long-range view will be critical.
Strategic Sourcing Optimization--Purchase price has and continues to be the primary driver of global outsourcing decisions. The current crisis emphasizes the need for significantly more-robust strategic sourcing capabilities that take into account true delivered cost, as well as balancing the risks of too little or too much inventory.
Inventory Strategy Optimization (ISO) and Strategic Network Design (SND)--Using ISO and SND solutions as part of the sourcing process will be critical, although many solutions currently lack some of the needed data that includes trade compliance rules and content (such as duties, taxes or international transportation costs). SND tools were historically used for longer-term strategic planning (one to five years) to determine the overall optimal physical supply/demand network, taking into consideration costs and service goals and objectives. More recently, these tools have been enhanced for use in tactical business planning scenarios (less than one year) to answer questions such as, "What is the impact of switching suppliers or global sources of supply, taking into consideration long lead times?" ISO tools are used to help determine the total inventory level for all locations simultaneously, taking into account all the various dependencies, constraints and sources of demand/supply variability across the entire network. All policies are modeled and evaluated from a storage, sourcing, safety stock and replenishment point of view.
Global Inventory/Shipment Visibility--Because inventory is in transit for longer amounts of time, knowing what and how much is on the way, and where it is, is increasingly important. Today, many companies are incapable of realistically predicting exactly what their inventory positions will be even a few weeks in advance, because a large amount of inventory is not yet on their books but is in transit. Additionally, having visibility into global inventories and shipments allows companies to make decisions more rapidly as conditions change, such as diverting a shipment while en-route based on new information.
Product Portfolio Analysis--Product proliferation makes forecasting more difficult, and can cause inventories to vacillate uncontrollably because there is significant overlap and the potential for product substitution. Weeding out underperformers or places where the marginal advantage of having a product extension is overshadowed by inventory risk is beneficial.
Supply Chain and Product Performance Management (PPM)--Continuously monitoring and evaluating the condition and performance of your supply chain is always prudent, but this becomes critical in volatile economic conditions. As stated previously, too many companies are incapable of answering the question, What is my total inventory position, including in-transit stock? Even fewer companies are able to monitor supply chain conditions so they can project how things will be in days or weeks. A critical new question that enterprises must be able to answer is, What part of the supply chain is the most-efficient owner of risk at each part of the supply chain--and how much is that risk worth? Part of the issue is that SCM information is often housed in multiple siloed applications, and there is no place where this information can be aggregated to answer fundamental questions or provide analysis of conditions across the extended supply chain. Enterprises need SCPM solutions that pull information into a common place, extracting data from all underlying SCM applications and then allowing continuous analysis of this information.
All these activities should be evaluated with a risk management layer applied. Long-term forecasting and S&OP can be evaluated with an embedded confidence-level metric to explain to partners, and departments, what part of the plan is firm, tentative or highly suspect. This risk mitigation strategy will help partners adapt in a more aligned fashion, and will reduce the "knee-jerk" reactions we tend to see today.
Providing more transparency to what's going on in the global supply chain right now is a critical need. Another critical need is having more-robust analytic tools that can help organizations make the right decisions. This research outlined a representative, although not an exhaustive, list of tools that can be employed to help decision makers wrestle with these challenges.
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