The Delicate Balance

As business people we are constantly trading risk for cost.  When we remove cost from our businesses we can watch our risks increase dramatically.  Conversely, mitigating risk by necessity will involve some increase in cost. 

Examples of this phenomenon are plentiful.  Managing inventory is a constant struggle for this balance.  If we cut back on our on-hand quantities to lower our carrying costs, we will suddenly find ourselves at increased risk of stock outs.  Depending on your type of business, this can mean anything from lost opportunity costs (not having the item when the customer wants it) to shutting down the production line.  If we increase our on-hand quantities to reduce the stock out risk, our costs rise to pay for it. 

Just to make matters worse, even were we to find the perfect balance, conditions change quickly and dramatically.  Effective management requires constant review and frequent adjustments.

Leveraging the supply chain is a way to obtain significant cost savings while sharing the risks with your partners.  One of the easiest ways to handle this is to share information with your suppliers.  Consider the fact that some portion of your inventory is a defensive mechanism.  You keep that additional inventory as a hedge against your lack of information about what and when your customers will be ordering.  This, as I pointed out above, will by necessity increase your costs.  By the same token, your suppliers suffer from the same lack of information and are forced to take the same defensive posture.  The same is true for the suppliers your suppliers buy from, and so on, all the way back to the very beginning of the supply chain.  Clearly, this significantly magnifies the costs of your components and impacts your price or your profitability or both.

It isn’t too great a leap to suppose that if your customers are willing to share their projected purchasing, and you could communicate that information back up the supply chain, then everyone would require less ‘defensive’ inventory therefore lowering costs for each and every partner along the way. 

The most common objection to doing this is that your customers will not cooperate.  However, your leverage is your ability to offer them a lower price.  The longer and more complicated the supply chain, the greater the potential for cost savings and therefor the more the opportunity to offer a lower price.

Of course, your customers’ requirements will inevitably change.  When this happens, everyone in the supply chain will need to step up to meet the demand.  The relationships and good will that you build by sharing information tightens the integration with your suppliers  and makes the entire supply chain work more efficiently.