- Risk Management
Supply Chain Frontiers issue #35. Read all articles in this issue.
The global economic crisis has highlighted the risks associated with supplier failures, but customers can also throw a supply chain into disarray. Buy-side risks, particularly those related to payment problems and obsolete inventory, were discussed at a recent symposium on the link between supply chain and finance organized by the MIT Center for Transportation & Logistics (MIT CTL).
A plastics manufacturer regularly reviews all of its “customers-at-risk,” even on a daily basis when necessary. The company has insurance on most of its account receivables, but when this measure is not feasible—such as insuring receivables from risky automotive customers—the manufacturer uses early payment discounts to encourage customers to pay on time.
Obsolete or remnant inventory and wide fluctuations in demand pose serious problems for some companies. A consumer goods manufacturer tracks and measures customers on remnant inventory, and is working on reducing SKU churn. Since 2006, the company has reduced remnant inventory from 12% to 4–5%.
A supplier of food products used SKU simplification to improve both financial and operational performance in one of its main divisions. It reduced the number of SKUs from around 800 to 500. The company analyzed product and customer profitability to cull its bloated SKU base and simplified its production lines.
This strategy not only yielded a reduction in COGS (cost of goods sold) of 10%, but also improved profit margins by up to 7%. The company also captured some non-financial benefits. Simpler production processes increased factory capacity by 20% and with fewer SKUs to handle and deliver, the company’s trucks improved their on-time delivery performance.
Thinning the number of SKUs it supported also helped the manufacturer to cope with the trend toward fewer product choices in the grocery business. Large retailers are reducing product assortments in an effort to cut costs and serve a more frugal clientele. One company measures its SKU simplification in terms of growth in yearly sales per SKU; it would rather generate more sales from a smaller number of SKUs than vice versa. Over the past five years, the company has nearly tripled sales per SKU, while trimming the number of SKUs by almost 50%.
Cell phone parts are subject to extreme demand swings over short time intervals; the production life of a phone might be only six months, and volumes can vary from 100,000 to 2 million units, according to a manufacturer at the symposium. When the company negotiates contracts for the supply of custom-made molded parts for these items, it has to deal with product end-of-life issues. The manufacturer mitigates such risks by renting equipment for flux capacity, rather than buying all the machinery needed to meet upside demand estimates. If demand fails to materialize, then the company does not have surplus capacity on its books.
The growth in outsourcing and contract manufacturing has created a new set of customer-side risks for many companies. Take, for example, contracts for the supply of relatively simple yet high-volume items, such as bottle caps, to a large customer with a well-established track record. At first glance, the contract appears to be a safe bet, but the product might actually be supplied to a small co-packer in China, which is a much riskier customer. Moreover, the co-packer may have been unknown to the manufacturer when the original contract was signed with the primary buyer. In this case, the manufacturer’s risk mitigation approach is to seek some form of guarantee from the larger customer or to enlist its help in performing due diligence on the co-packer.
Large customers can provide much-needed volume, but there is the risk that the seller becomes over-reliant on such dominant players. Diversifying the customer base helps reduce the likelihood that a single large customer might run into financial problems or make flawed sourcing decisions. In fact, one attendee admitted that it actually fired a big customer that provided a sizeable chunk of business, because the company’s supplier management policies became intolerable.
MIT CTL’s “The Changing Dynamics of Supply Chain and Finance” symposium took place on October 21, 2009. For more information on the event, contact Dr. Bruce Arntzen, barntzen@mit.edu or Dr. Jarrod Goentzel, goentzel@mit.edu. MIT CTL has launched a major project to research how companies in different countries handle supply chain risk. See the “Updates” item, “Global Risk Management Project Under Way” in this issue of Frontiers for details on how to participate in the project’s international risk survey. For more information on MIT CTL’s risk research, contact Dr. Bruce Arntzen.