The Importance of Effectively Managing Raw Materials InventoryInventory Optimization & Management
In today’s world, the system of vendors, activity, and data required to source, produce, and deliver products to customers is increasingly complex. And the supply chain represents the steps required to make this happen. But as product companies extend their reach globally to capture the lowest material and operating costs, managing the supply chain has become increasingly difficult.
One major component in any supply chain is raw materials, the unprocessed materials, components, or partially finished assemblies that are required to build or produce a product. These are both the building blocks and the starting point for any final product and ensuring adequate supply and proper management of raw materials is critical. Moreover, they represent an investment that affects the cash flow and financial health of an enterprise as the cost is accrued at the point of acquisition and is listed as a current asset on a company’s balance sheet. As a result, it is important to use best practices for managing raw material inventory.
There are two basic subcategories of raw materials. Direct materials are those that are incorporated into the final product. Whereas indirect materials (often referred to as supplies or consumables) are not included in the final product but include things such as oils, rags, cleaners, markers, gloves, support material, and many other items used in the making of the final inventory items. Both types must be included in materials planning to ensure enough material is on hand to build the required number of units to fit the sales position or sales projection. It is also critical to plan for any established “safety stock” to address quality fallout, returns, or buffer stock against sudden increases in demand.
Materials planning is the method used to determine the requirements and quantities of raw materials to implement production. Many companies use traditional Material Resource Planning (MRP) systems to help calculate the requirements for the current product mix. Materials planning may also include data based on past consumption. And in many cases, while it is always better to calculate than to predict, materials planning may include forecasting due to seasonality, market volatility, or other external factors.
Purchasing is also a key fundamental in maintaining the correct level of raw materials inventory. As material requirements take shape, purchasing must coordinate the flow of materials into the production process on time and in the right quantities. And in a global economy that utilizes far-flung supply chains, this is no easy task. Factors that complicate the purchase, and therefore influx, of raw materials, include:
Lead Time: Lead time can affect delivery depending on what is purchased. In some cases, such as in complex subassemblies or electronics components, the vendor’s component lead times for their production cycle will be a necessary factor to consider.
Mode of Production: A company’s mode of production can also impact the purchasing plan and the raw material level. For Make to Stock (MTO) goods, consistent and established patterns can be leveraged to plan purchasing. But for Make to Order (MTO) items, where materials are not purchased until needed, raw material is more episodic. As a result, different practices and expectations are employed to maintain an appropriate level of stock to allow production to remain steady.
Long/Short Supply Chain Legs: A reality of the global sourcing economy is that purchasing is further complicated by long and short supply chain legs. Purchasers of raw materials must balance locally sourced materials with low minimum requirements against materials purchased from overseas suppliers that will likely carry higher minimums. This further complicates material costing as “landed costs” must be factored into the cost structure if not the valuation of the raw material. This creates an imbalance of low- and high-volume materials that must be closely managed.
All these factors come into play and bring focus to the importance of keeping track of raw materials inventory. As a critical part of a delicately balanced ecosystem, managing raw materials inventory can make or break the supply chain effort. As the material plan and purchasing coordinate to deliver raw materials, there are several issues to watch for and manage tightly:
Overstock: Overstocking can result from many factors outside of the traditional slowdown in order position, including:
- Overly optimistic forecasting from sales.
- Early arrivals against quoted lead times from overseas volume vendors.
- Miscalculation of safety stock based on historical data that is no longer valid or on the anecdotal or “gut” instinct of planners.
Understock: Understocking too can result from several different factors and threaten productivity through work stoppage. These factors include:
- Under-forecasting due to missed seasonal trends.
- Longer than quoted lead times due to weather, or due to freight, customs, or transportation issues not factored into the materials plan.
- Shortages from “short leg” supply vendors who may be local but are not given enough time to react when orders ramp up as schedulers and planners defer these purchases on a more JIT basis.
Quality and Compliance Issues: Quality management and traceability should be built into any supply chain. But when it isn’t, quality rejections for raw materials can cause severe shortages or increased costs due to expediting. Compliance issues are also a concern for assemblies and subassemblies for parts such as electronics and automotive parts where full traceability is often regulated by the receiving country’s government.
These concerns are important for any company, but small to medium-sized companies often face a heightened level of exposure when raw materials are not adequately managed. Each variable adds cost through higher warehousing costs, added labor, or paused production. And many SMB organizations do not have the ready cash flow and reserved resources to recover from excess inventory nor the resources to expedite when faced with shortages. In addition, the skillsets deployed within SMBs may also be of concern as these functions may often be done using staff that “wear many hats” and perform several functions.
Overcoming Challenges with Data Management
In seeking to answer the challenges of modern inventory management within a global supply chain, companies should assess their methodology. If the optimal frequency for ordering materials is determined using a combination of disparate spreadsheets and a collection of “tribal knowledge”, it is possible that the company will not be able to handle the complexity of raw materials management. Likewise, if the calculation of safety and buffer stock levels is inconsistent and not formalized or data-driven, then chances are there will be shortages. And finally, if the calculations used to generate the materials plan and procure materials isn’t really a “calculation” at all, but instead consists of multiple, incomplete, and overlapping spreadsheets, then there will be gaps in the inventory in various degrees.
Fortunately, with the increased complexity of the modern supply chain, data management software has come of age to help formalize and manage raw materials inventory and to optimize inventory control and eliminate these gaps.
Software for effective data management of raw materials inventory should have several key features:
Planning and Forecasting: Today’s planning software can combine firm orders with forecasting. Combining the elements that can be computed and calculated with the more subjective elements in forecasting, means inventory management is less likely to experience spikes and shortages.
Data-Driven Management: Planning software can help move a company’s calculating ability for inventory from multiple spreadsheets to powerful computational models that can be envisioned across production requirements. Historical data, current confirmed orders, and projected sales can all be incorporated at the click of a button.
Advanced Analytics: Software today can also offer advanced analytics to calculate economic order quantities and factor in lead times and stock levels needed to support existing and forecasted orders. Modern systems also support reporting by revenue, cost, units, and other configurations to give decision makers accurate tools at their fingertips to move away from “gut feeling” decision making and archaic spreadsheet-based plans.
Cost Reduction: With the right planning software, raw materials can be managed and optimized at a professional level while reducing overall inventory costs by 25% or more.
Keeping an eye on raw materials inventory can provide a significant competitive advantage as well as a cost advantage for most companies. With the challenges faced by small and medium companies as globally sourced supply chains continue to become more complex, data-driven, analytically capable software, such as DemandCaster, is the best option for managing raw materials inventory without losing track.