Even prior to the COVID-19 pandemic, inventory levels had been increasing across industries. As many know only too well, the pandemic exacerbated volatility in supply chains. Companies responded by increasing inventories even further. The end of the pandemic has not yet reversed this situation. Inventories continue to be at much higher levels than previously.
There might well be good reasons for this. Supply chains continue to face major challenges. Recent crises such as the Suez Canal blockade, significant price rises in raw materials, and semiconductor shortages have led companies to increase risk aversion and maintain higher levels of stock keeping units (SKUs).
Analyzing raw material inventory levels for the 30 companies with the highest revenue in the selected industries shows that while the weighted days on hand for raw materials over all industries stagnated or dropped slightly in 2023, the values are still 30% above their pre-COVID levels.
There is little hope that the ongoing instability causing this situation will right itself any time soon. Resilience will continue to be key.
As a result, there are twin pressures on supply: There is a need to control inventory cost while at the same time increasing supply resilience. This has turned the supply chain and inventory control into a major strategic challenge for the majority of companies, one in which it is imperative for reputational reasons to get the balance right. Supply and inventory have suddenly become a critical differentiator for companies (Exhibit).
Taking a strategic view of inventory management and costs
As reasonable a response as increased inventory might be to today’s continued uncertainties in supply, it entails higher costs. The C-suite is focused on keeping these costs within bounds. Prices have limited elasticity.
In the short term, adopting a more analytical approach to supply can shift the focus to setting realistic inventory targets for each SKU. Inventory inflows can be reduced by regularly reviewing the company's open purchase order book and ensuring that planners only place orders for items their businesses actually need. These measures will provide some much-needed short-term relief to the organization, allowing it to focus on medium- to longer-term measures that will both increase supply chain resilience and reduce inventory levels.
Longer-term inventory and resilience improvements require a strategic view that spans across functions. This centers around how functions such as engineering, product management, sales, and procurement work together to achieve common goals. Done right, the impacts of these improvements can reach much further than pure inventory or resilience improvements. They can also improve a company’s overall culture and profitability. From our recent project experience, we have seen a number of levers for doing so.
Four levers to help optimize inventory and resilience
Lever 1: Reduce product variants to minimize operational cost
In many industries, the number of variants of any single product tends to grow over time. One reason for this proliferation is that sales is incentivized to respond to customer demands, which quickly get translated into recommendations and fed through to product planning and design. This is as it should be. However, this does not mean that everything the customer wishes for is viable over the longer term.
Reducing the number of variants reduces operations costs significantly for a variety of reasons, including eliminating costs due to the number of different SKUs being procured and the number of production lines needed to assemble the variants. Reducing the number of variants enables production to increase batch sizes and makes it easier to harmonize takt times. In one case, by focusing on the relatively few options that their customers truly care about, as determined through customer surveys and demand analysis, we were able to reduce the number of variants produced by a tool developer from 125 to 16.
Lever 2: Engineer modular components to streamline production
The nature of how designs are engineered can also proliferate SKUs. Engineering is often incentivized to design for the lowest possible cost. Although this makes sense at the individual product level, it can sometimes miss the bigger picture and lead to engineering developing specialized solutions for every product.
Engineering needs to be incentivized to focus on those areas where there is potential commonality or overlap between products. This means creating modular designs for multiple components. Modularization can increase the re-use of components between different products and thereby reduce the number of raw and intermediate material SKUs in stock.
Not only can modularization increase purchasing power with regard to suppliers, but it can also provide greater flexibility when responding to short-term changes in demand from customers. Component modules from one product line can be switched to another when demand dictates. Automotive OEMs have been applying this strategy for several decades in their modular design of car platforms.
Lever 3: Use purchasing power to enhance procurement
Procurement becomes a strategic function when it takes the bigger picture into account and focuses on finding opportunities that will increase purchasing power. This can be as simple as the bundling of orders, of course.
A more sophisticated response, though, is to leverage specialist suppliers. This approach demands re-focusing purchasing and working with production to identify exactly where the company’s core manufacturing competencies lie. The objective is for in-house manufacturing to focus on the areas of competitive distinctiveness, enabling standard components to be outsourced to specialized suppliers. In one case, a wind turbine manufacturer applied this approach successfully to their control cabinets. Instead of producing them in-house, they outsourced their manufacture to a major player with greater purchasing power. This enabled the company to procure the necessary electronic components even during the supply chain disruptions witnessed during the COVID pandemic.
To ensure that such collaboration with suppliers is as effective as possible, a company must prioritize inventories for SKUs that it identifies as revenue drivers and as being critical to production. All other SKU inventories can be reduced.
Lever 4: Create a de-risked supply chain for improved resilience
The bigger picture when seeking to balance risk and inventory needs to include the creation of a de-risked supply chain in addition to the existing one. This redundancy can act as a production fallback option during times of trouble but also provides additional “near-sourced” offerings to customers.
One place to start in developing such a model is to design a de-risked production line for one particular product. To achieve this objective, the product’s supply chain will need to be independent of global transport and geopolitical risks. The simplest solution to realizing this is to start with “localization,” ensuring that all the components are sourced from local suppliers and are manufactured close to the centres of demand.
When localization is done correctly, it can result in greater profitability overall. For instance, one high-end furniture manufacturer used this concept to increase revenues, through the development of a new premium line, as well as resilience, ensuring that it could continue to supply the furniture during the COVID pandemic. It offered the new product line as one that promised the customer greater availability and lower lead times while entailing reduced emissions.
Collaboration across functions is essential for successful deployment
There is no function that can solve the challenges by itself: Achieving both greater resilience and lower inventories requires the full commitment and attention of the C-suite leaders, who need to moderate the different interests.
To improve the situation requires taking a strategic view of how these functions can better work together to increase efficiency and improve supply chain resilience. These changes demand the adoption of a cross-functional mindset throughout the organization, enabling the new ways of working that lie at the heart of each of the four levers described here.