July 2005 | Commentary | 3PL Line

The Five Inventories: Invisible to Customers, Crucial to the Bottom Line

Tags: 3PL

Investment sage Warren Buffett once described business as a vehicle in which the rear-view mirror is always clearer than the windshield. He was right, and mismanaged logistics is the reason for the mud on the windshield. Failure to see and manage global supply networks in response to demand makes for muddy business indeed.

In the past, that failure loomed most visible inside the four walls of the enterprise. Procurement didn't talk to engineering; production didn't know what sales was doing; and none of these groups heard a clear demand signal from the end consumer.

Enterprise Resource Planning (ERP) systems helped solve the intra-company problem just in time for the new complexities of global production and outsourced supply and distribution to splash more mud on the windshield. So, we speed down the highway of commerce thinking we've made progress, when Sarbanes-Oxley compliance, recycling mandates, duty management, and other perils fog up the windshield yet again.

Never before has business changed so radically and so quickly. But the overall challenge still amounts to managing supply inventories in response to customer demand. Most companies, however, are not seeing all their supply.

Five key types of supply inventory exist, and most businesses are looking at only one or two.

Take Five

A new kind of supply system built around these five inventories is necessary to serve today's demanding, all-powerful consumer. This system is a network in every sense of the word, with network hardware, networked communication, and networked collaborative management.

These new supply networks eliminate duplicate efforts so businesses can serve customers faster. They offer analytical tools that give better visibility of customer information, and they leverage business processes from raw goods suppliers to recyclers.

What are the five inventories? And why are they such a big deal?

1. Raw materials. Most manufacturers focus on the supply inventory in their factory. But the story really starts with raw materials—the goods that come from your suppliers and their suppliers. If you can't see and manage raw materials, you can't control what you'll make over the next week, quarter, or year.

Recently, for example, a multi-billion-dollar enterprise saw its entire business shut down for four days because it ran out of pallets. Yes, pallets. The company's managers neglected to see pallets as part of its supply inventory, and they paid for that lack of visibility with their jobs.

2. Work in progress. The goods built in your factory—or these days perhaps in a contract manufacturer's factory—constitute the second type of supply inventory. In the 1990s, the push to implement ERP systems was really an effort to begin coordinating this form of supply. But the need to see and control this inventory has grown exponentially with global production and all its regulatory mandates.

3. Finished goods. This third inventory can again be controlled in your own warehouse or by a distributor.

Many of the world's leading companies don't yet have a handle on finished goods. During a recent meeting at one of the Big Three automakers, for example, managers were wringing their hands because they couldn't see finished goods. When customers wanted red instead of blue, satellite radio instead of CDs, four-wheel drive instead of sunroofs, the automaker was helpless to respond.

4. Service inventory. If you thought managing distribution inventory was tough, brace yourself for this fourth inventory. Service is just now being recognized for what it is—another type of supply. Service inventory is crucial, and needs to be expertly managed.

If not, you won't be able to use it to leverage parts sales. You won't be able to use failure analysis to design better products. And you could end up in jail if you can't comply with recycling mandates and other global regulations. If your product ends up as a Superfund site at the bottom of the Rio Grande, for example, it's your problem, not the recycler's.

5. Transportation. The fifth inventory class may come as a surprise to some. Traditionally, the supply chain has been defined as "a set of inventories connected by transportation." But transportation, in reality, is a fifth inventory.

In-transit goods account for somewhere between 5 percent and 20 percent of a company's revenue. In-transit goods are on your books, or the books of your trading partners. It's real inventory that just happens to be sitting on a plane, train, automobile, or ship instead of in a warehouse.

At most companies today, in-transit inventory is managed by a dozen different people, with a hundred different carriers in a thousand different ways, without enterprise-level visibility into the goods.

One company, for instance, nearly missed its quarterly revenue numbers because one shipment hadn't arrived in Dusseldorf. Because it didn't see those goods as inventory, the company wasn't focusing on correct title transfer terms.

Another company saw a huge return shipment arrive on its dock on the last day of the quarter—torpedoing its revenue. Because it lacked visibility, it wasn't prepared for that nasty financial surprise. These are huge issues, for which business is largely ill-prepared. And demand sources further complicate things.

Customer demand is at the core of the new model for supply and demand. In this model, customers still interact with a brand, but their transaction flows directly to whichever source of supply best meets their needs. The demand signal is received without distortion and is served from the most efficient location. All members of the supply system must work together to satisfy the consumer's requirements.

Data is Key

Most importantly, information in this new model no longer has to snake its way up and down a linear chain. This new network is built around information, not around a series of physical facilities. Leading manufacturers must provide the tools to share this data—along with the expertise to leverage it.

With each of the five inventories, opportunities exist to create gains by developing networked, real-time collaboration among all supply partners. Those who build 21st-century supply networks will expand and profit in the new global marketplace, while those who don't get on board may soon find themselves losing customers.

Any company that wishes to remain competitive and profitable must review its entire product lifecycle and begin to embrace all five inventories to achieve the greatest performance and rewards.