November 2005 | Commentary | IT Matters: Logistics & Supply Chain Technology

Does RFID Pass the Return on Assets Test?

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Proponents rarely discuss RFID without claiming dramatic inventory savings. These savings, however, require businesses to invest in RFID and wait to reap returns.

When evaluating investments—such as RFID—aimed at reducing inventory and working capital, consider the impact on Return on Assets (ROA), a proven indicator of an investment's financial impact. ROA is calculated as revenue minus expenses, divided by assets.

Assets, in turn, are calculated as inventory plus working capital (accounts receivables days outstanding plus treasury funds), plus property, plant, and equipment value.

Measuring ROA helps drive a sustainable competitive business model. Specifically, the objective is to maximize profits and minimize required financial assets, such as working capital, property, and inventory.

Managing trading partners' inventory before it becomes theirs is one way for companies to dramatically improve ROA. This type of cross-enterprise inventory management is key for companies seeking ROA, and RFID's role in this value proposition has been overstated.

It is fair to assume most firms advanced enough to consider RFID are adept at managing their "owned" inventory in company warehouses, plants, and retail locations. Their ability to manage inventory flowing in and out of their facilities, however, is less certain.

Using RFID tags instead of bar codes holds value for internal warehousing efficiencies, but the returns are likely to be small expense reductions rather than dramatic inventory savings. How does RFID fare in the more compelling challenge of cross-enterprise inventory management?

Consider this example: One company has a bill of material, or "kit," of 10 parts that make up a complete item or customer order. Five of the kit's parts are made in Asia, and the rest come from North American suppliers.

The company hires a logistics service provider to coordinate shipments from these suppliers, and the partner successfully delivers nine of the 10 components to the right location at the right time. The partner's performance claim is 90 percent—pretty good, right?

Wrong. Ensuring nine out of 10 components arrive on time does nothing but increase non-saleable assets (inventory) on the company balance sheet, with no incremental sales. This is a poor outcome with negative ROA.

To solve this inventory management challenge, it is important for the global inventory manager to get an accurate view of all 10 kit items in the supply chain. The manager needs to know about the delayed 10th part to mitigate the impact on ROA by either locating an alternate item, or potentially delaying the purchase of the other nine items.

While RFID assists with a more precise view of specific points in this supply chain, it cannot provide global accuracy of all the items required because RFID tags and supporting technologies only work in homogeneous, structured environments.

The good news is that technologies that help with global inventory coordination are available today at a low cost, and they offer nearly immediate ROA. These solutions can adapt rapidly to varying user roles in the supply chain.

In contrast, for RFID to be successful, all involved parties must use compatible RFID technologies and the same Electronic Product Code standards.

Currently, cross-enterprise inventory management is the best way for companies to achieve their desired business value. While RFID plays a role, it is by no means the answer to this problem.

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