The pandemic brought many unforeseen challenges in 2020 but out of those situations manufacturers have learned how to adapt for the future.
by Terrence Burns, CPA, manager, The Bonadio Group
As the global health crisis reached further into the United States this spring, organizations in all industries began to feel the impact. Operating a company since then has proven to be full of challenges never before seen or anticipated. However, with nearly a year under our belt, the trials and tests of the pandemic provide an opportunity to assess operational performance and potentially adjust strategies and processes to better position companies for more uncertainty ahead.
Historically, many companies have aimed to decrease their inventory costs by simply reducing the amount of the inventory that they keep on hand. This is traditionally accomplished by shifting towards a just-in-time (JIT) inventory strategy where companies do not buy inventory until it is needed for production or sale. Though many companies are unable to execute a true JIT inventory strategy, many have still managed to carry as little inventory as possible. The JIT inventory concept relies on stable, consistent customer and supplier demand and accurate forecasting to be effective. However, the unforeseen impacts of COVID-19 caused many companies that utilize JIT approach to experience a shortage of critical inventory, which in turn resulted in missed sales, longer manufacturing lead times and dissatisfied customers.
COVID-19 supply chain disruptions have demonstrated the importance of safety stock. Safety stock can apply to all categories of inventory, and it represents the additional inventory above and beyond a company’s forecasted needs. Finished good safety stock provides a buffer for increased customer demand while raw material safety stock may provide a buffer for delivery delays from a supplier. The level of safety stock is a function of a company’s risk appetite as well as the analysis of additional costs to hold that inventory, including storage, handling, insurance, and spoilage versus the hidden cost of stockouts and potential manufacturing downtime. Companies must also remember to assess their maintenance, repair and operating supplies to identify if safety stock is required to keep machines and production up and running if there are shortages or delays in obtaining replacement parts.
Now more than ever before, companies should reassess the risks and costs associated with inventory management to determine if any changes in strategy or safety stock levels are necessary.
Many companies have created a single, linear source for specific material needs in order to reduce inventory costs. By concentrating purchases to few suppliers, companies are often able to leverage buying power to get priority treatment, favorable pricing and payment terms. Vendor concentrations also create additional risks to companies, like increased dependency, especially during turbulent times. This vendor dependency risk may have been at a tolerable level in the past, but now during the pandemic, companies should revisit the advantages and disadvantages of single and multi-sourcing.
Procuring materials and services from multiples sources may lead to decreased vendor dependency, increased flexibility, and better overall vendor performance due to increased competition. At a minimum, companies should consider identifying and prequalifying potential alternate suppliers in the event of additional lockdowns or a specific shutdown at a major vendor’s plant and begin to develop redundancies in their supply chain.
Companies should also reflect on their relationships with existing vendors over the past year and ask the following questions:
- Did my suppliers perform in accordance with our contract?
- Were my orders successfully fulfilled on time?
- Were specified quality standards continuously met?
- Where are my vendors geographically located?
Based on the answers to these questions, a more detailed supply chain analysis may need to be completed, but now is a great time to revisit major contracts and purchase commitments and reset expectations with vendors. Enhanced communication should strengthen these relationships and help companies understand what they can expect if additional shutdowns or disruptions occur.
Inventory management strategy, sourcing, and vendor relationships are just a few of the most fundamental things organizations should reconsider during these turbulent times. Though operating a company during COVID-19 has proven to be full of new challenges, now is the time to reassess strategies and processes across multiple disciplines. Doing so will better position companies for any uncertainties ahead and lead to continued success.
Terrence Burns is a manager in The Bonadio Group’s Commercial Audit division and a Certified Public Accountant. He provides a range of consulting and auditing services to privately held companies in manufacturing, distribution, and food and beverage industries. To learn more visit: https://www.bonadio.com/.