In many organizations, the opportunities to reduce inventory costs are often not addressed at all or are not completely exploited. However, smart managers understand that they can reduce supply chain costs by spending more on transportation. The easiest way to reduce supply chain costs is to hold less inventory. The safest way to reduce your inventory levels is by buying additional transportation.
Although, the primary objective of a supply chain is to supply the products that their clients want and when they want it, but many times supply chains underestimate the role of Inventory management in the whole process. The biggest mistake most manufacturers make today is to equate reduction in transportation costs with overall supply chain savings. However, in reality there is no correlation between them.
Large inventory increases supply chain costs
For most industries, the cost of transportation for manufactured products is only two to five percent of the total cost. However, the cost of components, subassemblies and raw materials are usually close to 55 to 75 percent of the total cost. This data is enough to explain that implementing supply chain solutions that reduce raw material and finished goods inventories will result in huge savings in operational cost. Therefore, it’s the inventory levels, which increase supply chain costs.
In 2001, Herbert W. Davis conducted the Logistics Cost Survey, in which he found that the difference between the 50 percent companies that increased the cost and the 20 percent companies that reduced the cost, could be explained by analyzing their performance in maintaining inventory levels. This study is a strong proof that while managing supply chains nobody can ignore the strong correlation between inventory carrying costs and total supply chain costs.
Inventory management in current economic scenario
Many companies are facing financial pressures in current economic scenario. These pressures are forcing some companies to look for logistics cost savings by buying transportation at lowest possible price. However, this practice of saving cost is resulting in neglect of inventory management. Most companies who encourage these cost reductions consider their transportation department as a cost center and don’t involve them in inventory management. Therefore, they define their success by the amount of discounts they were able to negotiate from carries. This further increases the mismanagement of their inventory.
Most times companies make compromise on service levels while negotiating for lower logistics cost. Reduced service levels result in reduced frequency of transportation, or in some cases, switching to less-reliable and slower transporters. All these actions result in an increase of inventory holdings and many times the cost of this increase in inventory holdings is more than the logistics cost savings. Therefore, reducing logistics cost is a false saving.
Using logistics to actually reduce costs
Calculating the changes in carrying costs of inventory and measuring amounts of inventory are highly challenging tasks. This encourages most companies to take the easier option of reducing transportation costs. This inability of the companies, to measure the amount of inventory in their supply chain is the primary reason behind their failure to achieve inventory savings.
However, many companies have been able to achieve lower supply chain costs by utilizing modern strategies for inventory management and safely reducing their inventory. Companies must follow a two-step strategy for inventory management. Firstly, they must combine their logistics and inventory management operations. Secondly, they should install technologies, which will allow them to get detailed inventory visibility throughout their supply chain. Following the above mentioned steps is a prerequisite, if a company wants to reduce their inventory and supply chain costs.
Avoiding false savings
Managers must avoid false savings by measuring and managing all costs together. It’s important for the managers to remember that transportation decisions that don’t improve inventory management will often result in increasing overall costs, which means false savings. Managers must realize that false savings are counter productive and thus it’s important to avoid them.
Most companies trying to achieve logistics cost savings need to accept the fact that it’s wise to pay high transportation costs in exchange for lower carrying costs and inventory levels. To achieve success in reducing supply chain costs, managers must concentrate on the overall cost of the supply chain instead of reducing cost of logistics. Companies should measure their performance in inventory investment and carrying costs, and then focus on hiring services of a reliable and fast transporter.