SCM as a Method of Inventory Control

SCM as a Method of Inventory Control

SCM and Inventory Control

This paper examines the use of supply chain management (SCM) as a tool for inventory control. SCM, which coordinates and integrates the activities of supply chain members, plays an increasingly important role in companies' reducing their costs and making better informed decisions. Companies benefit from SCM and inventory control by better meeting customer demands for product availability and pricing, and by competing more effectively and efficiently through more profitable operations.

Inventory is important to profitability. The faster a company turns its inventory, the greater the company's profitability. Inventory is a significant component of SCM success. Customers demand that their orders be completed on time and accurately, which requires that companies have the right inventory at the right price at the right time. Therein lies the challenge for SCM, being able to successfully manage inventory. These challenges apply to all types of inventories, including finished goods, raw materials, parts and components, and work-in process; to the entire product mix, including new and existing products; and to all types of businesses, including manufacturers, distributors, wholesalers, retailers and others in nearly every industry (Craig, 2002).

The goal of SCM is driving out inefficiencies, particularly excess inventory. At the same time though, inventory serves as a buffer against uncertainty, which is itself challenging to forecast. The collaboration that SCM introduces between supply chain partners contributes to reducing uncertainty by helping companies respond and react more quickly, however it does not eliminate uncertainty altogether (Craig, 2002).

Supply chain visibility helps to reduce uncertainty and to manage inventories. Achieving this visibility requires that a company know what inventory it has and where it is in the supply chain. Effectively managing inventories requires companies to use the proper processes, people and technology. Effective inventory control requires integrated SCM from the suppliers' doors to the customers' docks. Inventory management is pivotal for SCM success, as well as contributing to company profitability and shareholder value (Craig, 2002).

Using SCM to control inventory involves overseeing materials, information and finances as they flow in a process from supplier to manufacturer to wholesaler to retailer to consumer. SCM works to coordinate and integrate these flows within the firm and between firms. The ultimate goal of an effective SCM system is inventory reduction, with the given that products are available when needed to meet customer demand (Rouse, 2010).

Understanding how SCM works helps to explain its ability to control inventory. SCM flows can be classified into three main categories, the product flow, information flow and the finances flow. Product flow describes the movement of goods from supplier to customer, including customer returns and service needs. Information flow includes the process of transmitting orders and updating delivery status. The financial flow includes credit terms, payment schedules, as well as consignment and title ownership arrangements. Companies use SCM tools and software to control these flows. SCM tools assist companies with optimizing these flows and result in improved inventory control. SCM tools produce information that when shared upstream with a firm's suppliers and downstream with the firm's customers, helps companies to improve the time-to-market of products, reduce costs including inventory, and plan for future requirements (Rouse, 2010).

Several factors account for the widespread use of SCM. These factors include increased competition and globalization. Likewise, the speed with which technology, products, and markets change continues to increase and are also responsible for driving the use of SCM. This rapid evolution leads to requirements for management decisions on short notice with incomplete information with escalating penalty costs. More competitors, domestic and foreign, enter markets even while, at the same time, customers demand faster delivery, state-of-the-art technology, along with enhanced products and services (Handfield, 2011).

Challenges such as these require that companies aggressively defend their market share from a range of competitors. Managers in turn look for ways to grow their global presence. They attempt to manage inventories so that products are readily available when customers want them, at the right price and in the desired quantity. Performing at this level is a constant challenge for most companies, and is possible only when all the supply chain members function effectively (Handfield, 2011).

To maximize their performance, companies must manage relationships not only with their downstream customers, but with their upstream suppliers as well. Customer demands and competitive pressures provide firms with an incentive to better manage their operations and improve their supply chains. Consequently, firms are focusing on their need for relationship management within the context of improving supply chain performance (Handfield, 2011).

In the past supply chains focused almost exclusively on predicting consumer demand and cutting the costs of operations, but SCM systems today accomplish even more. In addition to increasing overall efficiency and lowering inventory costs, SCM also helps a company identify gaps and problems within a supply chain.

Inventory control is critical to successful SCM. Companies are increasingly focused on managing their inventories and driving down inventory costs. Customer service is also a focal point as companies seek to differentiate themselves from their competitors based on value creation for consumers. Given the current environment, companies hold inventory primarily for two reasons: to reduce costs and to improve customer service. Companies have different incentives to meet both requirements, given that the problem of having too much inventory can lead to higher costs, while the problem of having too little inventory can lead to customer dissatisfaction and lost sales.

Typically, SCM achieves cost savings primarily through reductions in inventory. For example, businesses in the food manufacturing and grocery industry have reported a drop in inventory costs of about 60% since 1982, along with a decrease in transportation costs of 20%. The possibility of achieving such costs savings motivates firms to implement inventory reduction strategies as part of their supply chain operation. If companies are to develop an effective logistical strategy, then they need to grasp the nature of product demand, inventory costs, and supply chain capabilities (Dooley, 2006).

In general, companies use three approaches to managing inventory. Retailers typically use an inventory control approach by which they monitor inventory levels by item. Manufacturers tend to be more focused on production scheduling, and therefore use flow management to manage inventories. Other firms, particularly those involved in processing raw materials or in the extractive industries as well as the agribusiness industry, do not actively manage inventory.

Even though they do not actively engage in inventory management does not mean that such firms ignore inventory. Instead, they hold large inventories because potential savings from inventory reductions are outweighed by related reductions in production, procurement, or transportation costs. Frequently, economies of size may cause long production runs which cause inventory to accumulate. Factors such as seasonality or unit trains and other forms of bulk shipping discounts also lead to inventory buildups. Nonetheless, companies with these supply chain characteristics have to be able to respond to changing conditions, which means they also need more precise inventory management techniques. For example, concerns over food safety, organic food markets, or food labeling may all require identity preservation that necessitates stricter inventory control (Dooley, 2006).

Other factors affect a company's ability to effectively control its inventory. Demand impacts inventory levels. When companies cannot be certain of demand for a product, they may carry extra units or safety stock to reduce the chances of stockouts. The ability to manage this uncertainty is important for both reducing inventory levels and meeting customer expectations too. Companies use supply chain coordination to reduce the uncertainty associated with intermediate product demand, which in turn allows them to reduce inventory costs (Dooley, 2006).

Even though managing the uncertainty associated with safety stock is critical, in today's competitive environment, lowering safety stock requirements is challenging. Some buyers, particularly large retailers, require higher customer service levels which raises safety stock levels. Also a number of firms have a product mix that includes more new products having corresponding increased demand variability. As a result, companies who want to reduce safety stock are able to do so only by concentrating on cutting lead times (Dooley, 2006).

Another aspect of inventory reduction is the cost of lost sales when there is no inventory on hand. These costs decline as customer service and inventory levels rise. A company's inventory levels are also influenced by demand uncertainty, customer service expectations, and supply chain flexibility. Improved supply chain management may be required if a company is going to meet a desired customer service level (Dooley, 2006).

As consumers demand more customer service up and down the supply chain, these demands affect the SCM function. Firms that are capable of providing higher customer service levels may achieve a competitive advantage over firms that are without supply chains in place or that are without the ability to manage them. Companies that understand the characteristics of their demand and their stockout costs and that carry appropriate inventory levels are better positioned to manage their inventory and give their customers the desired service levels. The importance of providing exceptional customer service and being competitive is becoming more and more important for companies and their supply chains (Dooley, 2006).

Another important component of SCM and inventory control is managing the information that tracking systems provide and using that information to control the supply chain network. Looked at from the financial perspective, inventory control is not insignificant. In fact, inventory is often the largest asset item on the balance sheet of manufacturers and distributors. Consequently, firms put emphasis on keeping inventory levels down to minimize consuming cash. Reducing cash consumption and minimizing inventory can be done by improving the supply chain processes.

The supply chain must be integrated for each segment, procurement, production and distribution, to achieve optimum results. Technology is the component that enables the supply chain to become integrated and as a result reduce inventory requirements. An example of technology that enables SCM includes the transmission of purchase orders using electronic data interchange (EDI) which provides more timely and accurate data to suppliers. Another example of SCM technology involves freight tracking systems used to manage the movement of goods. This flexibility helps companies react more quickly to changes in internal and external needs, such as changes in production schedules or customer product delivery requirements (Alade, Sharma & Sharma, 2004).

To eliminate wasteful and expensive inventory requires that the supply chain be integrated to include the coordination of logistics, distribution and production. Typically companies hold inventories of raw materials, parts, work-in-progress, or finished products as a hedge against uncertain supply and demand or to take advantage of economies of scale related to manufacturing or acquisition of products in large batches. Likewise, inventories may be required to build up reserves for seasonal demands or promotional sales. However, advances in SCM allow companies to not just adopt just-in-time-inventory practices but to achieve more integrated supply chain management. These advances help to create processes that reduce or eliminate inventories primarily by reducing or eliminating the uncertainties that make additional inventory necessary. Such reductions may be at least partly motivated by the recognition that measurements describing how well a company's inventory management practices perform can be significant indicators to shareholders concerning the company's efficiency and therefore its profitability (Alade, Sharma & Sharma, 2004).

Even so, maintaining lower transaction costs and optimizing inventory control management involves costs and tradeoffs. The stock market punishes companies whose inventories have resulted in writedowns following missed sales forecasts or product shortages due to ineffective inventory management, as happened with Dell Computers and Liz Claiborne in 1993, and IBM in 1994 (Alade, Sharma & Sharma, 2004).

As a consumer and as a student, the best and most accessible example that comes to mind of how SCM functions is Wal-Mart. The principles of SCM and inventory control affect just about every aspect of their operation. Because Wal-Mart's value proposition is summed up by their tagline "everyday low prices," Wal-Mart selects suppliers and sources products to meet customer demand for low prices. This marketing strategy causes shipping and logistics to take on even more significance for their successful operation and profitability. Wal-Mart would not have been able to function as effectively, nor have grown to such popularity and profitability if they could not use technology to track and coordinate the huge amount of information involved in their operation. Given the range of products that they carry, their inventory costs would increase significantly if they did not use information technology to coordinate with their suppliers and shippers. One does not need to be an expert in accounting or economics to appreciate how well their SCM works and how effectively the company manages all the aspects of inventory control.