Reducing Supply Chain Waste with Demand Driven Strategies
Every year, billions of dollars of excess inventory are moved through the supply chain at a great expense to the manufacturers, distributors and retailers selling the goods. In addition to the drag on corporate earnings, excess inventories also have a negative contribution to the environment by unnecessarily consuming energy during the manufacturing, transportation and warehousing efforts.
How Much Excess Inventory Exists?
Estimates range from $100 Billion to over $1.5 Trillion depending on the geographic region and scope of product categories considered. There has been significant analysis of excess inventory in the consumer goods segment. The greatest excesses can be attributed to a few specific categories such as non-perishable foods; seasonal apparel; consumer packaged goods; and consumer electronics. Some product lines struggle with higher percentages of overstocks than others. For example, in the apparel segment excess inventory represents 7% of annual revenues on average. By contrast, in non-perishable foods excess inventory only represents 2-3% of annual sales. Any waste above 1% of sales is noteworthy enough to gain the attention of senior management, if not the board of directors.
What happens to Excess Inventory?
The fate of excess inventory depends upon the type of product and the reason it was not sold. Some products may be returned to the manufacturer. For example, many book retailers have contractual arrangements with publishers to return excess inventory that is not sold within a pre-defined period of time. Book publishers have to reclaim the unsold copies and credit the buyer for the returns. In such cases, much of the product can be re-circulated into active inventory for sale through another channel.
If a product was damaged, expired or no longer retains any useful value then it will likely be destroyed. Products with relatively low market value such as discontinued food items may be donated to charities. Destruction, donations and returns, however represent the minority of outcomes for excess inventory.
Most overstocks are liquidated through secondary channels. Such techniques are popular for product categories that retain value and usefulness over a longer period of time. Examples include apparel, footwear, hardware, sporting goods and consumer electronics. Overstocked merchandise is sold, often at a significant price reduction, to online and offline discount retailers.
Middlemen such as brokers and wholesale distributors provide services to place excess inventory with different customers around the world. Some of the middlemen are purely virtual leveraging electronic marketplaces which auction overstocked goods online. During the dot com era over twenty new start-up marketplaces were launched specifically for sales of excess inventory. The more successful exchanges were later acquired by larger vendors as part of a consolidation scheme. Others marketplaces have discontinued operations due to a failure to realize their business plan. Nonetheless, significant efficiencies were introduced to the liquidation process through online auctions. Marketplaces increased price transparency through expanded information flow amongst buyers and sellers.
Globalization has expanded efficiencies in the marketplace for excess inventory as well. Many overstocked products are sold overseas buyers, which resell the merchandise in foreign markets. The factors driving sellers to liquidate in foreign markets are not related to consumer demand, but rather contractual and regulatory structures in the retail value chain. Manufacturers of consumer products typically will place “anti-dumping” terms and conditions in contracts with retailers. As a result, retailers have a minimum price below which they cannot sell the merchandise. Such terms ensure that a manufacturer’s brand value is not degraded by aggressive discounting. For inventory which must be heavily discounted to sell, the only alternative is to transfer the product to a foreign market for resale.
The high tech industry has one of the most complex supply chains due to the growing level of configuration required for consumer electronics. Consider the following product categories each of which require different configurations for individual countries or consumer categories:
Root Causes of Excess Inventory
Excess inventories derive from a number of root causes including deliberate overproduction, short product lifecycles and SKU proliferation.
Deliberate Over Stocks
In certain scenarios, manufacturers deliberately stock the channel with excess inventory as a strategy to optimize their cost elements or to increase customer satisfaction.
- Optimizing Manufacturing – Some manufacturers intentionally overproduce in order to optimize their own labor staffing or factory capacity. For example, extra units of a SKU will be produced to ensure that all raw materials and parts are used or to fill a complete work shift schedule. The result of such a strategy to manufacture in quantities independent of actual demand is often excess inventory.
- Buffer Inventories – Many companies intentionally overproduce goods in order to buffer their supply chains with safety stock. Supply chain planners, lacking insights into end-customer behaviors, decide they would rather have too much of a particular product than not enough. Customer satisfaction is often the driver for a buffer inventory strategy. Suppliers can differentiate themselves through high levels of product availability and rapid order fulfillment.
Short Product Lifecycles
Manufacturers often have overly optimistic sales forecasts for their products. Root causes for forecasting errors include unexpected changes to customer demand caused by deteriorating macroeconomic conditions, disruptive technological innovations, changing consumer tastes or unexpected weather patterns. In such scenarios, the supply chain is not able to distribute and sell sufficient quantities of a particular SKU before its replacement product is introduced. Certain merchandise categories are more prone to excess inventory than others.
- Consumer Electronics – Products such as mobile phones, personal computers and digital cameras are often challenging to forecast due to the extremely short lifecycles of the products. The rate of technology innovation in software, semiconductors and memory drives rapid acceleration of new capabilities. As a result, many product lifecycles for consumer electronics are as short as six months.
- Seasonal Apparel Merchandise – Apparel items, which are specific to a particular season of the year, are challenging products to derive sales forecasts for. Short-sleeved shirts, bathing suits and men’s sandals go out of fashion in August for most of the Northern Hemisphere. Winter coats, gloves and sweaters enjoy peak demand in autumn and winter, but rarely sell after February.
Environmental Impacts of Excess Inventory
Technology and globalization have enabled the consumer products industry to become extremely efficient at finding buyers for excess goods in the past ten years. However, the tremendous volume of excess inventory in the market today indicates that the end-to-end supply chain is grossly inefficient. Liquidation of excess consumer goods through the secondary market results in double the supply chain effort with, at best, only half of the desired financial contribution. Consider a lot of 500,000 men’s short-sleeved shirts which are over-forecasted by 50%. The apparel is produced in China by a contract manufacturer on behalf of a US department store chain. To manufacture the goods raw materials such as cotton and plastic must be produced. Energy is required to performing the cutting and sewing processes. The apparel is then transported via a series of ocean and ground freight systems to the retailer’s distribution center in the US. From there, batches of the shirts are carried via less-than-truckload freight to individual retail stores throughout a four state area. At the end of the season following periods of aggressive discounting, 50% of the initial inventory remains unsold. To liquidate the excess inventory the retailer contracts with a third party broker. After several sales attempts the distributor identifies a buyer in Latin America that will purchase the goods for 10% of the retail list price. The apparel is returned from each of the stores to the US distribution center for consolidation. The repackaged goods are then shipped via ground freight to a nearby airport. The apparel is transported via air freight to Argentina where it is unloaded then distributed to a local retailer’s distribution center. By the end of the trip, the 250,000 shirts have traveled approximately 12,000 miles and been stored for a total of 120 days before finally reaching the end-consumer.
Excess inventory will never be completely eliminated, but it can certainly be reduced substantially by more efficient supply chain practices. Retailers and manufacturers can avoid significant overstocks by building the right products and ensuring the right quantity exists in the supply chain. Best-in-class retailers and manufacturers are collaborating on activities such as new product development, demand planning and marketing campaigns. Two of the more effective techniques for reducing excess inventory are demand driven replenishment models and late-stage postponement.
Demand-Driven Replenishment Models
In a demand driven model manufacturers align their supply chains with actual end-consumer behaviors. Goods are replenished in a continual fashion based upon recent sales volumes and current inventory positions. Adjustments to manufacturing, distribution, pricing and marketing activities are made weekly, daily or hourly based upon the latest consumer purchasing behaviors. Product categories such as non-perishable food items, consumer packaged goods and entertainment (music, movies and video games) lend themselves to such an approach.
The demand driven approach to replenishment is in stark contrast to the push-oriented, build-to-stock models that dominated much of the supply chain strategy throughout the twentieth century. Historically, manufacturers chose production volumes for individual products based upon factors such as ensuring 100% utilization of available labor and manufacturing plant capacity. The result was usually that either too much or too little of a particular product was manufactured.
Success with demand driven models require that buyers and suppliers be able to share large volumes of quantitative data with each other electronically in near real-time. Most retailers share point-of-sale transactions and distribution center level inventories with suppliers. However, increasingly more extensive data sets such as loyalty card, market basket, consumer demographics, retail pricing and trade promotions information are being exchanged as well. Once demand signal data is received it is fed into supply chain planning applications. Manufacturers can calculate with a high degree of accuracy the replenishment quantities to send to each store in order to avoid out-of-stocks. The end result is that supply is more closely aligned with demand. There are not too many or too few products, but rather just enough. Of course, by matching supply with demand, excess inventory quantities will be significantly reduced.
Late Stage Product Configuration
New supply chain techniques, called late stage configuration or postponement, can be used to alleviate many of the challenges associated with oversupply of apparel and electronics. Apparel and electronics share many common supply chain characteristics. First, both are manufactured in offshore centers a significant distance from the end-consumer. Second, both apparel and electronics have very short product lifecycles of six months or less. Third, both have a high degree of SKU proliferation and customization. Apparel items such as sweaters are offered in numerous colors and sizes. Electronics such as the mobile phone are increasingly being personalized and configured to meet individual consumer tastes.
The proliferation of SKUs combined with the short lifecycle and offshore production compound forecasting challenges by orders of magnitude. Apparel retailers must predict not only which types of sweaters will be in fashion, but exactly how many Olive, crew-neck men’s sweaters will sell this winter in Northern California. Mobile phone manufacturers must forecast not only which types of 3G phones will be popular, but exactly how many silver flip phones will be sold by T-Mobile in Switzerland during the three month product lifecycle. The result of such forecasting efforts is a large disparity between actual sales and pre-season estimates. Manufacturers and retailers are burdened with excess inventories which must be unloaded.
Late stage configuration techniques offer a solution that enables manufacturers to leverage the reduced costs of offshore production while retaining the flexibility to respond to changing demand patterns. With postponement models, products are built in a generic form then distributed to regional warehouses at which they can be configured into their final format. End user sales are monitored by the postponement specialists through point-of-sale data feeds from retailers. The final product is then configured and packaged as appropriate based upon actual consumer demand patterns. For example, the postponement specialist can rapidly respond to demand for mobile phones by configuring different color variations along with the appropriate accessories, packaging and instruction manuals.
A successful postponement strategy requires tight integration between a manufacturer and the third party configuration specialist. ERP applications must be connected to facilitate the exchange of real-time data about orders, inventory, sales and logistics. Initial costs to redesign products and setup late-stage configuration centers can be significant. However, substantial return on investment is achieved over a longer term by minimizing waste and excess inventory.