Inventory Management: Improve Product Lifecycle Profitability with End-of-Life Progressive Inventory Disposition (Part 2)

Expert Insight: Guest Contribution

By Dr. Edward J. Marien and John Kenny

May 9 , 2007

Inventory Management: Improve Product Lifecycle Profitability with End-of-Life Progressive Inventory Disposition (Part 2)

Focusing on the end of a product's lifecycle can have a dramatic impact on the bottom line, especially for high tech manufacturers; what really drives inventory levels? How should we assign cost to inventory?

Dr. Ed Marien Says:

What do you say? Send us your comments here

For electronics and many other manufacturers with rapid lifecycle products, managing end-of-life (EOL) inventories effectively can have a huge impact on supply chain costs and company and product line profitability.

In Part 1 of this series, we looked at some of the key issues and opportunities, and introduced the concept of Progressive Inventory Disposition (PID), an analytic model that uses a more granular approach to costing over the life of the product, and that fully considers the time value of cash flows associated with invested cash and cash sales flows when making inventory decisions. (See Inventory Management: Improve Product Lifecycle Profitability with End-of-Life Progressive Inventory Disposition (Part 1).

In part 2, we provide explore in more detail what the drivers of inventory levels in high tech, electronics and many other discrete manufacturing companies, and present a model for costing inventory.

Why Excess and Obsolete Inventories? Thresholds of Opportunities!

Before exploring an improved process for managing EOL Slow Moving and Obsolete (SLOBS inventories), let us explore the question: why are excess inventories generated?

The ideal goal is to determine strategies that result in no SLOBS. However, excess inventories in and of themselves are not bad when considering strategic business initiatives, such as new product introductions with possible surges in sales. Seasonality is a major contributing factor for consumer electronics products. Many firms are trying to build to order or build to demand on a short term basis; however, most products are still made to stock or made for postponed modification for sale. Economic inventory lot sizes must be coordinated to overall Product Lifecycle (PLC) profitability. The trick is to do good forecasting over the PLC, but forecasting is difficult when trying to factor in forces and factors that can occur and 70% forecast accuracy stubbornly remains the norm for high tech manufacturers. The tradeoff is higher inventory carrying costs by building inventories versus lost sales due to unavailability.

Lack of coordinated decision-making by all functions in the firm may lead to excess inventories. External agreements as to expected sales with customers plus supplier constraints on product supply availability and services add another dimension of complexity in attempting to forecast sales. In forecasting demand, managers must deal with all types of inventories which lead to much complexity in minimizing associated cash flows. See Table 1 below as to the many types of inventories most firms have to manage.

Table 1.—Types of Inventories Leading to Possible Excesses

Working	Stocks to cover best-guess forecasted levels of sales.
Safety	Stocks to cover uncertainties regarding higher than targeted levels of sales
Seasonal	Inventory build-ups to cover seasonal surges in sales
Promotional Events	Inventory build-ups to cover marketing spikes in sales
Volume Discount Incentives	Seller price breaks providing incentives to buyers to increase order sizes—can be product or transportation volume breaks
Scrap	Inventories deemed unsaleable either new or returns
Raw materials	Inventories to be converted into usable components or products
Components	Inventories to support OEM manufacturing or for replacement parts
Consignment	Inventories positioned by suppliers into customer facilities for use in production or for resale
VMI/SMI/SAMI	Vendor Managed Inventories/Supplier Managed Inventories/Supplier Assistance in Managing Inventories in which the supplier plays a major role in keeping customers in stock. Inventories are usually consigned until products are sold or used in production
Supplier Inventories unpaid and in A/P	Supplier inventories provided to customers with w*which sales occur by customers, cash collected before suppliers are paid
SC Channel Trade Member Inventories	Inventories of products in trade channels made visible to suppliers which often must be cleared before introducing new product upgrades
Returned goods	Recalls, damages, overages, reworks, repairs, upgrades, products not-meeting-specifications that are positioned in customer facilities, third-party systems, and/or supplier facilities for recouperage
Inter-facility, intra-company transfers	Products being moved between facilities via transportation and logistics modes within the same company or organization
SC Intransit transfers between trading parties	Products being moved between SC trading party facilities via transportation and logistics modes and under various SC legal trading party relationships
Remote Private and Outsourced Finished Goods Inventory Accumulation and Deployment Centers	Products stored in remote, market based facilities for expedited delivery to customers for use or resale or to capture inventories that are rejected by customers for various reasons. Product liability concerns by suppliers warrant actions to capture quickly product in order to minimize losses.
Remote Inbound Consolidation Center Invs	Inbound RM, Components and Products for Sales aggregated in remote facilities to take advantage of consolidation opportunities
3PL Local Inbound Consolidation and Assembly Invs	Third-Party Consolidation Centers located close to manufacturing sites for JIT shuttle services for delivery to customer warehouses or to production lines for use.
Excess	Resulting inventories due to various factors in the above list that may be usable functionally but deemed unsaleable by OEM but still can be used by market and greatly reduced prices
Slow-Moving and Obsolete (SLOBS)	Inventories that the firm decides are unsaleable due to competition or when firms introduce new technologies and improved product replacements, including Engineering Changes by the firm

In managing inventories, Table 2 lists many of the business decisions affecting inventory levels. Decision-making often is done on a functional basis with many firms establishing Supply Chain Planners that oversee supply chain strategic initiatives with particular emphasis upon Sales and Operations Planning (S&OP) teams fixing broken front-end inventory planning and execution. Inventory visibility within the firm and across marketing channels and supply chain networks is crucial to minimizing supply chain inventories. This article series focuses upon the reality that many firms have not established sound S&OP and inventory visibility processes and, accordingly, they lack strategies for excess SLOBS inventory management, including more profitable disposition and outsourced processes to make markets for, logistically move, and to finance EOL excess inventories.

Table 2.--Why do We have Inventories?

To support Build-To-Stock (BTS) forecasted demand	Working Inventories and Safety Stocks for finished goods that are deemed saleable as produced
To support Build-To-Order (BTO), Assemble-To-Order (ATO), Engineer-To-Order (ETO) usage requirements	Working inventories and Safety Stocks of raw materials and components to support custom products
Take advantage of Volume discounts	To reduce of costs of components or finished goods, suppliers offer volume discounts to promote larger sales
Take Advantage of Seasonal Discounts	Promotional discounts are offered by suppliers to forward position products in trade channels for seasonal products
Take advantage of Dated deals	Similar to season discounts in which products are sold with lengthy credit payment terms offered by suppliers to forward position products in trade channels for seasonal products
Push strategies to position inventories down channels—use of tiered inventory deployment	Strategies by suppliers to deploy inventories by marketing channels, i.e., Internet B2C direct versus retailer channels
“Event” promotional inventories	Inventories produced to support marketing promotions that are event driven, i.e., weekend promotions
To move inventories intransit between facilities—DCs, retail outlets, Inbound from suppliers and 3PLs’ facilities	Not only are products tied up in intransit inventories, but inventories result to the reliability and length of lead times that products are moved intransit
To take responsibility for Consignment and/or SMI inventories, either for sale or use	Inventories positioned by suppliers to support customer development strategies
To support customers who do not pay for inventories on a timely basis	Days-Sales-Outstanding (DSO) “Order-Cash A/R Receipt with channel customers
To support manufacturing relative to RM, Work-In-Process (WIP), Packaging and Unitizing components used in Finished Goods operations/manufacturing	Various inventories to support manufacturing
To support indirect services relative to office, MRO, IT and other indirect services for the firm.	Various inventories in the firm or in supplier support supply chain processes
To support energy needs	Processed to provide power and energy sources either directly within the firm or in conjunction with SMI.

A Granular Approach to Costing for Good Decision Making

A frequently used economic model for making inventory decisions is the Economic Order Quantity (EOQ) model. This model can give good direction in determining inventory levels on a short-term use but has limited applicability when considering longer time periods, such as those associated with PLCs. The EOQ model does, however, include key cost elements that provide a basis in PLC economic modeling. These costs include: Production cost per unit which includes costs for purchased materials, inbound transportation and logistics costs of supplier fulfillment, the inventory carrying charge, the cost of administering an order plus periodic demand.

The objective is to balance ordering costs with the costs of holding or carrying inventories. Problems arise as to:

fixed vs. variable costs—not all costs are variable as identified in the EOQ model
demand typically is represented in curve, such as in a traditional PLC form to be discussed
ordering costs are not all variable
the inventory carrying charge can be as low as the cost of money to including the items shown in Table 3.

In representing the costs in Table 1 as part of an overall percentage, the assumption is made that these costs vary with the cost of producing items based upon a variable cost. Plus all of the costs may not vary by unit of production but vary by other means, such as by pallet loads. One last point is that carrying costs as defined in the literature often include an obsolescence factor, but not delineated as identified in Table 3. Therefore, a more granular approach to costing is recommended in which these individual cost elements and other costs are represented.

Table 3.—Composition of Costs of Carrying Inventories
Basis for Inventory Carrying Charge Percentage

Cost of Money	Financial costs of capital as determined by corporate treasurers
Insurance	Product, Property and Personal Liability
Taxes	Possible State Corporate Income Taxes and Local Personal and Real Property
Warehousing	In and out handling costs plus possibly outside storage costs if warehousing space unavailable
Product Intra-Company Facility Transfers	Transportation and logistics costs to move products from plants to warehouses and for inter-facility transfers of products to markets of higher demand
Excess & Obsolescence (E&O) —Write Downs	Price erosion as demand subsides, competition increases or new generations of products are introduced
E&O—Channel Inventory Returns	Returns are processed to be used internally by manufacturing firms or to be sold externally to Broker markets—costs for reverse logistics plus lost sales
E&O— Trade penalties and promotional costs	Penalties that retailers and other customers assess for costs on non-compliance or those incurred in displaying products.
E&O—Recouperage	Costs to sort thru products for putting product back into inventory for sale, for donations, for salvage and for scrap
E&O Disposition of Saleable Products	Marketing and Sales Costs associated with E&O Disposition of outdated but usable and saleable products
E&O—salvage	Costs associated with the salvage of materials for reuse or recycling
E&O—scrap	Products sold to scrap dealers to salvage resources

In Part 3 of this series, we’ll provide an improved analytic framework, and present a brief case study that shows the impact of this thinking on one manufacturer’s bottom line.

Edward J. Marien, Ph.D: As emeritus professor, University of Wisconsin-Madison School of Business Executive Education, Ed provides instructional activities at the UW and customized programs for individual firms in a wide array of vertical industries. He has assisted manufacturers, distributors and third-party logistics services providers in developing and implementing business, T&L and SCM strategies to improve service, reduce costs, and increase asset utilization.

John C. Kenny: Prior to his appointment in 2004 as FreeFlow’s President, John spent 28 years in senior global operations positions in Sales, Manufacturing and Supply Chain in both high technology and consumer products industries. John has held senior operations executive positions with 3Com, Hewlett-Packard, Apollo Computer, Joseph E. Seagram & Sons, Inc. and Standard Brands Inc.

Agree or disgree with our expert's perspective? What would you add? Let us know your thoughts for publication in the SCDigest newsletter Feedback section, and on the web site. Upon request, comments will be posted with the respondents name or company withheld.