Supply chain management in a more volatile world

4 min read

As consumers, we have got in the habit of being impatient. For better or worse, we are the ‘I want it, and I want it now’ generation.

Our expectations about the interval between conceiving a desire for something manufactured, and seeing it delivered to our door, have changed enormously in the past five years alone. Next-day delivery is now the norm; with the potential development of home delivery by drones, perhaps next-hour delivery is to be the new standard in the not too distant future. The market is offering us the pleasure of instant gratification.

The business press has had much to say about the impact of this shift in consumer expectations on retailers, particularly those with a large bricks-and-mortar estate. Less widely noticed, but equally profound, is the effect on the manufacturing supply chain.

In the good old days, consumers would visit shops, place an order for a manufactured item such as a kitchen appliance, and then be content to wait for three or four weeks for it to arrive. This had a crucial benefit for OEM operations directors: they had genuine, accurate visibility of future demand, and therefore of future materials requirements. It was not exactly the case that every manufacturer could 'build to order'. But there was a valuable lag between changes in the level of demand for a product, and the need for the manufacturer's production line to respond to those changes.

And so when manufacturers made a forecast of materials requirements for the next four weeks, the whole of its supply chain could rely on the forecast, ordering and stocking components with confidence that actual component purchases would closely match the OEM's forecast.

In many sectors of industry, this rule no longer applies. The need for instant gratification means that the slack in the system has been tightened almost to nothing. Yet manufacturing industry and its supply chain continue to use forecasts of materials requirements as though nothing had changed.

The truth is, however, that most forecasts are not worth the paper they are written on. In reality, many OEMs do not know how many units the market will need next week, let alone next month or next quarter. It's not that they have suddenly forgotten the art of forecasting: it's that the world has become faster, more volatile and more random.

Of course, the supply chain can bury its head in the sand. Relying on OEMs' forecasts, it can continue to manage stocks of components on a daily basis and keep inventories across the supply chain – the buffer stocks – down to a few days' supply. This has the advantage of enhancing apparent efficiency, because it keeps the requirement for working capital to a bare minimum, and almost eliminates the risk that the OEM or distributor will be left with stocks of unwanted, unused parts.

But it's a false economy. The apparent savings in working capital are made at the risk of catastrophic losses. We know that forecasts of materials requirements are unreliable in an 'I want it now' world. So sooner or later, thin inventory levels are going to fall short when an unexpected spike in demand occurs. A shortage of a single component can bring an OEM's entire production line to a halt. In a volatile world, such shortages are far more likely to happen when the supply chain is operating with buffer stocks of just a few days' supply.

Who is going to hold stock?

If the supply chain is to be robust and resilient, then, there has to be a build-up of stock somewhere in the system. In the electronics component market, a good place for this build-up is distributors' warehouses. That's because distributors are, by the nature of their operations, experts in inventory management, and distributors can efficiently aggregate demand for individual parts over a broad customer base, smoothing the daily peaks and troughs in demand.

Distributors have various ways to build the right stock of the right components in answer to market needs. For instance, Future Electronics offers Bonded Inventory Management (BIM) to key customers and holds a dedicated buffer stock of at least 12 weeks' supply of a BIM customer's electronics materials requirement. This guarantees permanent next-day availability of components from stock, and provides a minimum 12-week buffer for the company to react to changes in the component manufacturer's supply. This gives a large degree of resilience even to severe shocks such as a natural disaster (such as an earthquake or flood) wiping out an entire factory.

On top of the customer-specific BIM programme, Future Electronics has a general policy of holding large quantities of a wide range of components. This is an advantage of being a privately-held company, not answerable to Wall Street. It can optimise customer service by holding large stocks and turning its inventory on average just four times a year. By contrast, publicly-owned distributors must optimise returns to shareholders: they typically turn inventory nine or ten times a year, which means that they hold a far smaller buffer of 'available to sell' inventory, and therefore are far less resilient to shocks or to sudden changes in demand.

This different financial mindset is also in evidence elsewhere in the standard model of distribution service. Conventionally, distributors seek to optimise their own cashflow by keeping the period between shipping components to a customer, and demanding payment for those components, as short as possible.

Again, as a private company Future has the freedom to invest in superior customer service by doing the exact opposite: offering extended credit terms to long-term, committed customers. It is not unusual to agree sales terms which give the customer 120 days, 150 days or even 180 days of credit. This is commercially beneficial for both parties: cash-flow problems are the biggest cause of failure for otherwise profitable and successful manufacturers. By helping to keep our customers financially healthy, Future Electronics also helps itself.

This investment in up-front costs for the benefit of both customer and distributor can extend also into logistics service. The principle of Future Electronics' operations is to optimise our service solution to fit each customer's profile. This is evident in various ways:

  • consolidating the supplier base by handling on the customer's behalf the supply arrangements with remote third-party suppliers
  • providing system design services to enable the seamless end-of-life replacement of obsolete components with functionally-equivalent parts that have a long predicted lifespan
  • providing value-added services in addition to normal component shipments. These include KANBAN, programming, labelling and marking.
  • customised documentation and compliance arrangements, to reduce the customer's administrative overhead

In all these cases, the immediate pay-off for the distributor is nil. Like the holding of large buffer stocks, the provision of extra service for no extra revenue makes no sense in a business environment driven by the need to produce quarterly shareholder returns.

But a different financial model, a model with a longer-term outlook, can help to deliver better operational performance as well as better returns for OEMs, component manufacturers and distributors alike.