Conventional Wisdom for Manufacturers 2.0 – Rethinking Inventory Levels
April 8, 2020
While the lasting ramifications of the Coronavirus pandemic, both globally and domestically, will not be fully understood for a long time to come, new changes in the conventional wisdom of the manufacturing and distribution industries may already be taking place.
For decades, industry experts preached that manufacturing and distribution companies should run as lean as possible, keeping only the lowest possible inventory on hand. The theory was that minimizing inventory would conserve cash, lower borrowing costs, reduce real estate costs, minimize spoilage or obsolete inventory, and generally promote a lean behavior.
Historically, this lean approach worked well. Companies used demand models to stock just what they needed to deliver just in time without unnecessary costs. However, this theory was based on one broad assumption: that nothing could disrupt the supply chain. That theory was proven indisputably false with the spread of the Coronavirus pandemic.
The virus quickly shut down China’s ability to distribute raw materials that many other companies relied on during production. Then, ports started to shut down globally, and air cargo capacity diminished as passenger traffic decreased. The supply of materials was effectively cut off. But the disruptions weren’t only attributable to failures in supply. As the need for quarantine and social distancing became more prevalent, many manufacturing and distribution companies lost key employees in their workforce. Additionally, companies observed unpredictable changes in demand. Without the supply of raw materials, and without any inventory stockpiles, companies were suddenly paralyzed and unable to meet demand.
Grocery stores were perhaps the best illustration of this effect. The stores that stocked only enough toilet paper based on traditional demand models ran out quickly and lost out on potential sales. The only companies that weathered the surge in demand were those with the surplus supply.
This observation then begs the question: should manufacturing and distribution companies adhere to a new conventional wisdom? One that prioritizes flexibility over leanness to encourage opportunistic behavior. On the one hand, following a lean-as-possible approach will always conserve cash and allow companies to invest that capital in other areas of the business. But on the other hand, those cash conservations are proving to be inadequate in the current crisis.
The long-term economic effects of the Coronavirus pandemic are yet to be seen, but companies are feeling the impact immediately. Now is the perfect time for many businesses in the manufacturing and distribution industries to begin considering whether a new approach to inventory management would be appropriate. Changes to consider include building a cushion into the supply chain, carrying more inventory than immediately necessary, and investing in flexibility such as additional cross-training and more flexible machinery. While these changes are not a short-term strategy for responding to the current crisis, it may provide a long-term opportunity for maximizing profits.
Aprio’s expert advisors are evaluating this theory for a new conventional wisdom with current clients and are prepared to help any business determine if this new approach is appropriate. Regardless of whether taking a more flexible approach is possible for your business, it is undeniable that all manufacturing and distribution companies need to be better prepared for another global event like the Coronavirus pandemic. Work with Aprio’s advisors to help you determine what’s best and what’s next for your business. Get started by contacting us here.
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About the Author
David Siegel works closely with CFOs and business owners of high-growth domestic and international businesses to plan and execute exit strategies, improve EBITDA, and prepare for transactions. He’s passionate about helping innovative companies with complex business models navigate challenges and achieve business goals.