Four Enablers to Achieve a Balanced Approach to Inventory Management

As CFOs deepen their collaborations with supply chain leaders to deploy and improve revenue assurance models, they’re seeking reassurance that “just-in-case” approaches will not lead to excess inventories or trigger working capital and cashflow management risks.

Supply chain leaders can assuage these concerns by acquainting corporate finance leaders with the new processes and protocols they are putting in place to strike an optimal balance between resilience and cost efficiency.

CFOs likely will appreciate these improvements. While finance leaders obviously want to avoid the financial pain of carrying excess inventory, they are well aware of the need for new and better inventory management and supply chain risk management approaches. They also recognize that some dysfunctional behaviors have arisen in response to supply shortages during the past 24 months. For example, when a customer ordered 100 widgets and a supplier responded by saying that only 50 widgets were available, some customers subsequently started ordering 200 widgets (despite only needing 100). As a larger portion of buyers doubled their orders in hopes of receiving the smaller number they needed, demand statements and forecasts became less trustworthy, making suppliers less certain of what numbers they needed to manage to.

Despite its dominance over the past several decades, the just-in-time, low-cost-sourcing model worked well only when global business operated with minimal interruptions. When modest to substantial disturbances erupted, that sourcing model’s inherent fragilities proved too costly, as was displayed prior to the COVID-19 pandemic (e.g., the 2011 Tōhoku earthquake and tsunami, and the tariff squabble between the U.S. and China in 2018), during the pandemic, and more recently as a result of Russia’s war on Ukraine.

CFOs also may have some discomfort with just-in-case inventory management for reasons that extend beyond working capital management risks. Letting components languish in warehouses can become a larger burden and cost when changes in product engineering make those components obsolete.

To allay these types of concerns, supply chain leaders should focus on four enablers of a balanced approach to inventory management:

• More visibility and transparency: Suppliers are seeking more insights into their customers’ larger trading and business ecosystems. When a customer requests 100 doors from a supplier by, say, the first of the month, the supplier may dig deeper by determining whether the customer also has access to the lumber and labor required to frame and hang those 100 doors. If those components will not be available by the first of the month, the customer may be able to delay the order. Suppliers are seeking access to deeper and broader context than the traditional order statement provides. This visibility can generate a more realistic picture of both quantity and timing.
• More collaboration: Rather than relying exclusively on order information contained within ERP feeds, more trading partners are collaborating more frequently and deeply in the pursuit of greater transparency. For example, after reviewing the order information, suppliers are picking up the phone to ask additional, probing questions about order volume and timing. Those conversations can lead to mutually beneficial adjustments.
• More trust: In response to a spike in unnecessarily large orders, more suppliers are rewarding their customers for accurate demand statements. Suppliers are measuring and monitoring demand statement accuracy, and then providing those buyers who provide more precise information with complete orders or higher portions of their desired goods (when supply is limited). These types of incentives dissuade the use of inaccurate large orders while helping buyers strike a healthier balance between resilience and efficiency.
• Fewer SKUs: Prior to the current era of supply chain volatility, producing a high numbers of SKUs helped companies differentiate themselves from competitors. There was a widespread sense that having anything anyone could possibly want was a good thing: If my competitor has 500,000 SKUs, I’ll hold 1 million. As global supply chain disruptions have increased in frequency and magnitude, however, that previous advantage has translated into a major cost. From an integrated business planning perspective, the time, effort and cost required to manage all the way down to the SKU level is substantial, even when supplies are plentiful and global supply chains are flowing without any hiccups. When supplies constrict and major disruptions occur, the time, effort and cost of maintaining SKU-level visibility becomes overwhelming. More suppliers and distributors are churning through SKU profitability analyses and then using those insights to pare down their offerings.

While the era of lowest-cost sourcing and just-in-time inventory is quickly receding, resilience-first supply chain management and just-in-case inventory management are not without their risks. Supply chain and finance leaders should recognize those risks and work together to mitigate them. When this collaboration succeeds, it can help replace the traditional cost center efficiency model of supply chain management with a revenue assurance model. Doing so requires a new set of inventory management inputs along with more visibility, transparency, collaboration and trust among trading partners.