In 1997, several product lines at Hewlett-Packard had not been turning a profit since 1993. They reviewed their operations and discovered that excess inventory was a driver of rising PC costs. Inventory-driven costs were scattered across many different functions and regions and recorded in several accounting conventions. While the specifics of HP’s plight might not directly apply to pharmaceutical manufacturing, the general principles do.
The Threat of Inventory Costs on Manufacturers
Whether you’re a consumer electronics manufacturer or a contract manufacturing organization (CMO) serving the pharmaceutical industry, inventory costs can pose a significant threat. Risk aversion about meeting client deliveries can be a key cause of excess inventory. It’s a trap anyone could fall into. Many CMOs experience inventory turns of just one or less, when industry best practice is three or more. Stock outs are unacceptable in today’s environment so if you can’t meet your customer’s demand, they’ll probably go to a competitor. Fearing this outcome, decision makers fall for the illusion of safety provided by high inventory levels. In reality, high inventory levels weigh you down and eat up cash flow. Cash flow you could use to develop new offerings and services that could set you apart in a hypercompetitive market. While you’re devoting resources to preventing stock-outs, your competitors might be cultivating the next cutting edge technology that will leave you in the dust.
Visibility is Critical for Inventory Management
Another cause of excess inventory is a lack of visibility. Some contract packaging companies don’t have full visibility into their inventories until it hits the receiving docks. Sometimes they lack full line of sight into production goods moving through manufacturing. It’s a problem that affects companies large and small. Newer, smaller CMOs often use in-house solutions to gain visibility, but with employee turnover and rapid growth, things can easily get lost. Large enterprises have parallel issues on a greater scale. HP had a complex, multitiered manufacturing network made up of diverse entities. Visibility becomes especially convoluted with companies going through mergers or acquisitions and even more so when companies go global and must reconcile financials in different currencies and accounting standards.
How HP Solved their Inventory Issues
For HP, solving their inventory problem meant reducing supply chain nodes, consolidating facilities and embracing a Just-In-Time (JIT) system. They also encouraged their partners to improve demand forecasting. After making corrective changes, inventory-driven costs dropped from 18.7 percent of total revenue in 1997 to 12.2 percent in 1998. They dropped further to 3.8 percent of total revenue in 1999 and that year, HP displaced IBM as the world’s third largest PC manufacturer.
So if there is a lesson to be learned from HP, it’s that competitive advantage can come from a variety of sources and inventory management is make or break, no matter what industry you’re in. Watch our video to learn more about the paths to operational excellence for CMOs.