Managing inventory with ERP amid disruptions

In today’s business world, the success of a firm depends not only on its sales but also on the ability to manage its supply network and ensure it has the inventory it needs to deliver customer orders. Disruptions that have occurred during the pandemic have shown how many manufacturers have not managed their supply chains appropriately and have reaped the consequences in terms of insufficient inventory. There are ways to manage a supply chain amid disruptions but they require changes in the way the business works.

Disruptions are not uncommon

A report by McKinsey noted that the value of intermediate goods traded globally tripled to more than US$10 trillion annually since 2000, and at the same time, disruptions have become a regular occurrence. McKinsey calculated that companies should expect supply chain disruptions lasting at least a month to occur every three years.

Since 2000, businesses have implemented programs such as just-in-time (JIT) inventory and lean operations to improve profitability. However, these business models have led to unintended consequences, such as not getting inventory when it is needed. To weather the shocks, companies need to understand their supply chain exposures and vulnerabilities.

A new supply chain operating model

In the past 18 months, many companies have increased their inventory levels. This has meant higher inventory carrying costs, reduced levels of free cash, and generally reduced profitability. All this to ensure the right inventory is available when it is needed.

When it comes to managing supply chains and inventory, manufacturers ought to be looking at a new operating model. Instead of JIT and Lean, the mantra should be Risk, Transparency and Resilience.

Managing Inventory Risk

Companies should now focus on risk management when it comes to inventory. This involves:

1. identifying what the critical components are;
2. ensuring that these components can be sourced from multiple suppliers.

The Theory of Constraints (TOC), a well-known process improvement methodology, can be applied to analyzing the supply chain. The basic idea is that every process is limited by some kind of constraint.

Inventory supply can become a constraint if the right components are not available in time. A method to de-risk this aspect of inventory is to introduce buffers. Buffers need to be classified in terms of their position in the supply chain. For example, how much inventory is in transit, what is on the factory floor, and what is in rework, as opposed to just finished products? Having a sufficient backup inventory of key parts and safety stock at various buffer stages is critical in terms of minimizing the financial impact of disrupted supplies.

The TOC steps to optimize the supply chain are:

1. identify the weakest link (constraint) in the supply chain;
2. decide how to reduce the constraint without committing to expensive changes;
3. adjust the rest of the supply chain processes so that the constraint can operate at maximum effectiveness;
4. take whatever action is required to eliminate the constraint;
5. once the first constraint is fixed, look for other constraints to continuously improve the supply chain.

Running stress tests is another way to manage supply chain risk. These tests involve simulations that analyze cash and working capital so that organizations can understand where supply chain issues in the future could affect the running of the business. This involves scenarios such as how breaks in the supply chain affect cash flow and profitability.  Other scenarios would be a significant increase in the cost of raw materials and the impact on production capacity of another epidemic-induced shutdown.

After assessing the results of stress tests, businesses would be able to identify:

• the critical suppliers in the supply chain;
• where replacement stock could be sourced to make up for a shortfall;
• which stock codes should be held in larger quantities;
• how to spread buffer stock across the supply chain;
• what the impact would be to redirect production to other lines at short notice;
• the effect on payment, receipts, cash flow and profitability.

These tests can typically be run over several weeks or months using the company’s ERP system to visualize the outcome.

Managing Inventory Transparency

When it comes to supplier stock, many companies only look at their Tier 1 suppliers. By only considering this level, businesses have limited transparency as they are unable to see potential risks coming from second-tier suppliers, which is where several problems have occurred recently.

Transparency also means working with suppliers, from Tier 1 down, to understand how different demand forecasts will impact their abilities to deliver. Manufacturers should also implement a supplier portal so that suppliers can see the company’s stock levels and stock movements for the items they supply and plan their operations accordingly.

A new concept that has been shown to help manage supply chain problems is the supply chain control tower. The control tower provides real-time visibility of factors in the supply network and allows manufacturers to manage inventory as a more holistic integrated function. It does not necessarily involve new technology but can be incorporated into a dashboard that different functions can use.

Resilience

By addressing the issues of what are critical components and from where those components are sourced, companies can make their supply chain more resilient to disruption. Disruptions have occurred in the past, but recent ones have lasted longer than expected, which disrupts inventory and that then has a cumulative knock-on effect down the supply chain.

Adjusting supply chains for disruptions

Over the next decade, companies can expect disruptions to erase half a year’s worth of profits or more, according to the McKinsey report. Companies therefore need to adjust their practices to become more agile and flexible when disruptions occur. By integrating inventory management, demand management, and procurement through an ERP system, processes can be optimized and new procedures can be adopted to enable manufacturers to plan for disruptions and modify their operations to withstand them.