While manufacturers try to avoid it like the plague, excess and obsolete inventory can often result due to unexpected demand or product configuration changes. However, in this age of outsourcing, the new challenge emerging is how to accurately determine the inventory liability between the original equipment manufacturer (OEM) and their contract manufacturer in an environment of rapid changes.
Before delving into this topic, it's important to understand the concept of inventory liability. Historically, inventory was always thought of as an asset given that it's a valuable item of property that factors into an organization's financial standing. However, while it's technically still an asset from an accounting perspective, many organizations now view it as a liability because they have become more and more sensitive to the financial risks associated with having the inventory on-hand. Neither the OEM nor the contract manufacturer wants to take ownership of the excess inventory when demand suddenly drops, which is why it has become such a delicate issue in today's climate. As a result, inventory is now driving behavior and forcing companies to become more demand-driven.
One of the poster children of this new reality is Dell, which has based its business model on the concept that inventory is a liability. While the company ships 20 million products per quarter, it never keeps more than three days of inventory on hand. A main driver of this is frequent demand changes and rapidly evolving products that quickly become obsolete — thus creating a liability if you're stuck with them. As a result of efficiently managing inventory liability, Dell is delivering superior business performance when compared to its less agile competition. According to AMR Research, "Dell is everyone's favorite example of modern supply chain best practices because it has built a $40 billion business that is fundamentally make-to-order — the exact opposite of 1920's era Ford Motor Co." As further validation of its 21st-century supply chain model, AMR claims, "Dell is the world's best example of a Demand-Driven Supply Network."
Another good example is Wal-Mart. As a retailer, Wal-Mart doesn't own its products, but rather sells the products of its suppliers. So Wal-Mart considers actually "owning" inventory to be a liability. As a result, it focuses its "best practice efforts" on providing a highly responsive supply chain so it can maintain a minimal amount of inventory on-site while still being responsive to customer demand. It is forward-thinking companies like these that have realized the importance of aligning their supply and demand chains as closely as possible that have reduced their excess and obsolete inventory, improved service levels and ultimately will increase profitability.
Minimizing inventory within supply chains characterized by short product life cycles, volatile demand and frequent product changes has always presented a manufacturing challenge. Traditionally, even vertically integrated manufacturers have been challenged to communicate the impact of frequent forecast or product changes to their plants and suppliers. As a result, supply chain plans are often executing to an out-of-date forecast, which can result in excess and obsolete inventory.
In today's age of outsourcing, this challenge is only exacerbated by the fact that more and more companies have extended supply chains with plants and partners located across the globe, where demand planning may be performed by the OEM in one location while supply planning is being managed by the contract manufacturer in another. This makes the synchronization of demand and supply (an already difficult problem) even more challenging, with the additional dimension that information concerning supply and demand decisions must be clearly understood by both the contract manufacturer and the OEM. In order to provide a cost effective supply, the contract manufacturer needs to be able to make supply orders based on a forecast, particularly for long-lead time components; however the need to respond to frequent forecast changes can quickly result in excess inventory, which might be either the consequence of poor supply planning or inaccurate forecasts. As a result, it's increasingly difficult to calculate ownership of inventory, which is the heart of the inventory liability problem.