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The Hidden Impact of Inventory

Many managers complain that senior executives do not understand the importance of supply chain management (SCM). At supply chain conferences and educational seminars, the phrase “I wish my boss were here to listen to this” is commonplace. There is no question that supply chain management can have a dramatic impact on profitability and cost; all too often, however, managers often fail to communicate this relationship effectively to their senior management. With IT budgets shrinking, material managers are struggling to obtain resources for systems that have the potential to dramatically improve profitability. To overcome this barrier, managers must be able to make a business case for such systems, by mapping business processes and understanding the role that systems play in improving communication between different participants in the supply chain.

Think of this process as a medical exam for your business. Before the doctor makes a diagnosis on a patient and prescribes therapy or medication, the physician will conduct a thorough medical exam to determine the critical measures (pulse, temperature, blood pressure), interview the patient to review symptoms, and identify location of aches and pains. In a similar manner, managers must do a complete assessment of physical and information flows within their supply chain, to determine the current “As Is” state of the system. Before determining the systems requirements to “fix” the malfunctioning supply chain flows, a complete assessment of business processes is required to determine where problems lie (symptoms), as well as to establish the status of critical supply chain metrics (inventory levels, cycle times, customer complaints, quality rejects). This is often done by literally “stapling” oneself to a customer order, and interviewing all of the participants involved along the way through the system!

In almost every project of this type the Supply Chain Resource Consortium ( has worked on with partner companies, the analysis has identified significant opportunities for improved communication between downstream customers, internal business functions, and upstream suppliers. In most cases, this lack of communication can be traced back to a root cause: a lack of alignment between business requirements, supplier and customer contacts, and information systems. Before embarking on an expensive supply chain system implementation, managers need to clearly delineate how the system will help close these gaps. In assigning costs to the impact of poor communication, managers can establish a clear business case that illustrates how systems can improve supply chain performance. Just like a physician who treats a patient, the diagnosis must be justified based on hard data (metrics) as well as qualitative symptoms, with a diagnosis and treatment prescribed to address the hypothesized ailment. Specifically, managers must establish how new information systems can result in reduced inventory, improved product development cycle times, reduced material costs, reduced transaction costs, and improved customer satisfaction. One manager at Bechtel, a private engineering and construction firm, noted that “A senior executive at a supply chain meeting stood up to share his solution to a problem we were experiencing. When he was unable to provide data to back up his solution, he was asked to come back when he had some to share with the group!” By translating supply chain solutions for reducing inventory, improving cycle times, etc. into financial terms such as economic value-added, IT managers stand a much greater chance of convincing senior management to invest in their proposed system.

One of the biggest opportunities for creating improved financial performance is by reducing the amount of inventory in a supply chain. If you were to look at the financial statements of an average organization, how much would you guess the company spends on goods and services? In manufacturing, the figure is astonishingly high: the average manufacturer spends approximately 56 cents out of every dollar of revenues involves managing purchased goods and services – often in the form of inventory located in warehouses, in-transit, or even on location with customers. For some industries, such as retailing or wholesaling, this figure can be even higher. In high-tech industries, inventory obsolescence is a major problem. One IBM manager noted that “our inventory is worth its weight in gold – since its value depletes at an average rate of 3-5% per month”. Add up the numbers: 36 – 60% annually, not including other material handling and holding costs!

In a tight economy, senior executives are desperately looking for opportunities to reduce operating expenses. With 50 to 60 percent of the cost goods sold consumed by materials and services, it is no wonder that supply chain management has suddenly become en vogue.