Balancing Supply Chain Risks Against Costs: Four Reasons to Pay More for Components

Supply Chain Technology Components Availability Risks

Price has long been the primary consideration by manufacturers in their selection of suppliers of necessary components. Supply chain disruption in the wake of Covid-19, however, has caused many companies to re-examine every aspect of their purchasing process, including the true cost of a component, relative to its inherent risks.

When selecting a source for a low-value commoditized component, such as a cable, cost is typically the primary driver. That type of product is often widely available, and its suppliers don’t add incremental value. So why would a company pay more for something like a cable? One reason is supply chain risk.

With the increased supply chain complexity, failure to properly assess risk when sourcing a product can sometimes end up costing more than the anticipated savings in buying the cheapest product. Even a low value component such as a cable can become mission critical if, for a range of unforeseen reasons, availability or quality of the cable becomes an issue that affects production or client satisfaction.

So how should product / component risk be assessed and balanced against price? Consider these four factors.

PRODUCT IMPORTANCE

Determine how critical the component is to the finished good that’s being manufactured. Is the component core to its operation? Will not having this component cause costly shipping and sales delays? If those risks exist, then it’s important to buy from a dependable supplier, even if the price is higher.

PRODUCT SPECIFICATION

Examine the specification document to determine if the component can be easily swapped for an identical or similar component. If a particular OEM or part number is specified, there may be less flexibility in switching from one part to another. In that case, a higher price may be justified to ensure supply.

PRODUCT SOURCING

Identify where the product can be sourced. If it’s far from your location, there will likely be higher shipping costs as well as transportation risks. The greater the distance, the more likelihood there will be shipping disruptions, or trade and political issues. Again, a higher priced supplier closer to your location may prove to be less expensive in the long run.

SUPPLIER RELIABILITY

Evaluate the dependability of suppliers based on their past performance. Do they understand your business and the impact they have on its manufacturing capability? How strong are their relationships with component manufacturers, and will they advocate for you if there are constraints? Will they help you mitigate risk? Peace of mind based on these factors can justify paying higher prices for components.

The old expression “cheap is dear” rings true in the current supply chain environment. Manufacturers no longer can afford to assign cost as the primary factor in selection of product / component suppliers without examining all of the inherent supply chain risks.

Just-In-Time Inventory Management May No Longer Be Viable. What’s Your Strategy Now?

Just-in-Time Inventory Management

Lead times required for all types of products are now several times longer than pre-Covid. A product that took 4 weeks to procure might now take 20 weeks. Some products have no defined lead times. As supply chain disruption continues across all industries, OEMs are re-examining the viability of their longstanding system of Just-in-Time (JIT) inventory management.

Established as part of the lean manufacturing movement in the 1950s, JIT inventory management was adopted as a cost saving, capital conserving strategy. OEMs could minimize the overhead related to inventory storage, financing and management, freeing up the capital required to stockpile parts.

For JIT to be effective, however, OEMs needed to predict demand accurately, and order just enough supply to meet their near-term requirements. The inherent risk of JIT was that a part might not be delivered on time, and production could be stalled. When an OEM adopted JIT, they assumed that the cost of maintaining inventory outweighed the risk of a stock-out situation.

But COVID has changed the inherent balance in that risk / reward equation. The pandemic’s disruption of supply chains has greatly increased the risk to OEMs’ ability to manufacture their products. For the foreseeable future, JIT may be too costly and too risky as an inventory management strategy. So what should OEMs do?

Four Ways to Address the Loss of JIT Inventory Management

Regardless of industry, there are four ways that OEMs can address the loss of JIT inventory management:

Supply Chain Demand ForecastReassess the Demand Forecast

Manufacturers need to measure their demand forecast, both in terms of its accuracy, and how conservative it is. They should consider increasing the forecast, or pressing their sales organization to provide greater accuracy and transparency on customer demand.

Supply Chain Stock-out RiskCalculate the Cost of Stock-Outs

In the current economic climate, with demand spiking, the cost of losing sales, based on failure to deliver, could be very high. In addition to the immediate revenue loss, those companies may lose permanent market share as well as shareholder value.

Just-in-Time Inventory Cost ComparisonCompare Potential Revenue Loss with Inventory Holding Costs

Determine when this ratio begins to balance out. Is holding 4 weeks, 2 months or 6 months of inventory less expensive than the loss of sales? Think of the cost of holding inventory as the cost of an insurance policy. How much insurance coverage do you need, and how much will you pay for it?

Just-in-Time SuppliersReassess the Supply Base

Work with suppliers that will provide transparency into their supply chains, which will help to assess risk related to demand. Moving beyond a transactional relationship and building deeper engagement with suppliers enables companies to focus on sustainability and resiliency of their supply base. Always consider the strategic cost of sourcing a good at a higher price from a dependable supplier against the cost of the same good at a lower price from an unreliable source.

Over the past 70 years, JIT was a smart and efficient way for companies to manage inventories in a relatively safe and predictable world. Up until now, JIT has succeeded in keeping costs down. However, COVID has forced OEMs to reassess the current and long-term risks to their supply chains. As those risks continue to increase in an interconnected world, smart organizations will begin to invest greater focus and effort to ensure that risk mitigation strategies are applied as consistently and effectively as cost management.