Tuesday, July 14, 2009

Managing inventory and related overheads

The past few months have witnessed one of the worst economic downturns in the world’s history. This downturn, originating from the US and spreading across the globe has not spared anyone. Margins have decreased, profits have declined considerably and wealth has vanished like never before. Such are the times when the true mettle and the fundamentals of any organization are put to test. This is the time to improve upon operational efficiency to fight the sharp fall in selling prices and subsequently thinning profits. Organizations standing strong in these tough times will ultimately emerge as winners.

Same is the case with the steel industry too. So, one is required to examine all possible areas for reducing costs. While man-power reduction, cutting down expenses across the board, putting expansion plans on hold, shutting down plants, etc. are the traditional means of reducing expenditure and costs, one area that remains largely unexplored is the inventory being maintained with respect to the current production at various steel plants.

Source: Metal Bulletin Research

Fig 1: Global steel production cost over the years

A close examination of the ground situation reveals that the levels of inventory currently maintained at most of the steel plants are much higher than the required amount. This leads to cash getting unnecessarily blocked, leading to higher manufacturing costs and space requirements. It is here that solutions like Vendor Managed Inventory (VMI) come into the good use.

VMI is the process where the vendor assumes the task of generating purchase orders to replenish a customer’s inventory. It is the vendor’s task to ensure that optimum levels of inventory of the customer are maintained at all times, thereby preventing piling up of stock or sudden shortfall of goods at any point of time. Generally, there are five points that need to be agreed uponefore considering implementation of VMI.

1. Proper communication between the customers and their vendors.

2. Commitment from the customers to share all relevant information with vendors.

3. Assurance of reliable transmission, receipt, and use of information by the vendors.

4. Treatment of implementation as a process and not a project.

5. Plan to spend sufficient time and money to make it work.

Few steps for implementing VMI in the steel industry are:

1. Planning and forecasting – The steel producers need to detail out their production plans based on which raw material requirements can be forecasted. This along with agreement on levels of safety stock, inventory turns, fill rates and transaction costs form the basis of any VMI agreement.

2. Procuring software to be used for the purpose.

3. Monitoring of actual activities against the above mutually agreed objectives with the help of periodic report generation.

There are quite a few benefits of VMI. Following are some of them:

1. Improvement of service rates as well as inventory turns. Providing service means having the material there when it is needed (inventory) while inventory turns is a measure of output versus on-hand inventory.

2. Reduction in lead time – A shorter lead time reduces inventory and improves accuracy.

3. Reduction in safety stock due to sufficient planning.

4. Increase in sales due to improvement of operational efficiency.

5. Releasing of blocked cash leading to reduction in operational costs.

Fig 2: VMI brings improvement to turns and fill rate

It is needless to say that though this economic downturn is turning out to be very painful, for the steel industry, it is not a downturn; it rather is a slowdown which in due course of time will change as growth takes over and demand starts increasing since we all know that development can never stop forever and steel forms the basis of all development. So, instead of worrying over the slowdown, steel producers should look at it as an opportunity to prepare themselves for the impending growth in the coming years. After all, someone has correctly said:


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