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:
Reassess 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.
Calculate 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.
Compare 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?
Reassess 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.