Managing Upside Risk in Purchasing and Inventory Management

HCS Consulting Newsletter

December 2003

As the year draws to a close, most economic indicators show that the economy is heading in the right direction. Manufacturing activity as tracked by the Institute of Supply Management is also showing signs of recovery. I thought it might be a good idea to focus this edition of my newsletter on "upside" risk, a term we have not had to think about much for the last few years. From a purchasing and inventory management perspective, here are some actions that you might want to consider for your business.

Purchasing

• Identify and review critical purchased raw materials and components. These are items that have either a high value relative to total product cost, high risk in terms of availability, or both. I would include any single source item in this review. As you look at requirements for these items in 2004, address the question: "What if this commodity gets tight?" This may be a good time to consider giving that new supplier who has been trying to get a share of your business a chance to perform. If your requirements are going up, you can introduce the alternate source without penalizing your current suppliers.
• I suggest that you review all open contracts for '04 and beyond with the idea in mind of possibly extending these in terms of length and/or firming up current price levels for as long a period as the supplier will accept. No one is forecasting a significant increase in inflation, but, after several years of flat pricing, suppliers will try to raise prices if they sense an opportunity.
• Schedule a meeting with each of your key suppliers to discuss with them their view of their industry and company looking ahead to next year. What upside risk do they see and are there that plans you can make together to manage risk for your requirements?
• If you have a commodity or supplier that is considered a problem for any reason, now would be a good time to focus some attention on resolving the issue, whatever it is. If the problem cannot be resolved in the short term, then review possible alternate materials, designs, suppliers, etc.

• Your sales and marketing groups have developed a plan for next year. Inventory management people should meet with them to review the sales volume forecast for the next 12-24 months. Are there new products, customers, or programs built into the plan that would be at risk if any purchased commodity or industry capacity were to get tight? Is there an upside factor that should be built in to the volume forecast based on the market that your company serves.
• Capacity has not been an issue for most companies recently. This is a good time to dust off the capacity plan and look at critical equipment, processes, and manpower. None of these are easily increased in the short term, so a review of options is in order.
• If you have an ABC analysis of your finished goods items, you should update it with the latest data available in your system. Then a review of target stock levels for at least the A and B items should be completed.
• Have you relied on sub-contractors in the past when business was good? If these relationships have been dormant due to recent business conditions, an update with those companies is in order. If sub-contractors are always part of your production process, then a capacity discussion with them should be held soon.
• If any of the above leads to the need to increase inventory levels, or even if it doesn't, have someone review your excess and obsolete items. Maybe there will be an opportunity to move some of the stuff that is costing you money and taking up space.

• While you are addressing some of the questions listed above, I suggest that from an over-all supply perspective, purchasing and inventory people review and update current system parameters (i.e. lead time, planning values), critical commodities, inventory targets, and anything else in your business where good planning against the upside will reduce your risk.

Thanks for taking the time to read this newsletter. If you know of someone else who might find it of interest, please pass it on to them. If you have any questions or comments, please send me a reply. If you do not wish to continue to receive future editions, let me know by return email.

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