Impact on Inventories by Moving Manufacturing Outside America for Domestic Demand

27/10/2011

Moving the manufacturing plant (operations) to outside of our boarders to meet domestic demand has a significant impact on various supply chain flows. The general belief is that inventory levels across the whole supply chain will rise for most of the products in this situation. In this article let’s explore this belief further for one of the most common situation – manufacturing plant is outside of America and it caters to domestic (USA) demand.

Why do we care about inventory levels?

Too many reasons! It is probably one of the most costly item when you consider it in all its forms: Raw material (and components), work-in-process, finished goods at the factory and warehouses, in-transit and finally on the shelf at retailers or other downstream customer warehouses/plants. Inventory is everywhere in the supply chain.

Inventory is not free. You may argue that with long account payable terms to suppliers it does not really cost that much money. At least for raw material inventory. But remember you still have to store it, manage it and it can go obsolete or may have limited shelf life. Even in the case of iron bars if you leave them to nature they would get rusted. If you are processing milk you have just so much time before it goes bad. or imagine that a manufacturer is left with a lot of computers with 6 month old design. The value is probably cut in half.

It is hard to give estimates of the inventory costs for different type of manufacturing. But it suffices to say that this cost is high. Not something a company can take lightly.

High inventory operation also increases the capital requirements of a company. It not only has a direct impact on the bottom line but slows down the growth potential. Think of dancing with a heavy backpack on. Not fun!

Impact on various types of inventories

For this discussion let’s look at the impact on inventory levels across the supply chain — from sourcing of raw material to the finished goods at your customers shop or plant. Contrary to popular believes these inventory levels may not always go up.

Raw material or components inventory

There are rare cases when a company chooses not to be close to the sources of raw materials, or components, when locating the plant outside of America. These can be the situations where there are multiple important raw materials and not all of them available in same geography for example. Also assuming that a company did not make the obvious mistake of locating the plant away from raw material sources for no other compelling reasons. The raw material/component inventories would most probably not go up. In fact, in many situations they may go down as the inbound transportation time decreases. Thus resulting in lower in-transit inventories for raw materials.

We will look at the case of locating a plant in a new geography to meet the local demand (not the US market) there in another article.

Results: Inventory levels – neutral to down

Work-in-progress inventory

If a company can run the plant at the same level of efficiency as at home then there should not be any reason for work-in-progress inventory levels to go up. There are, however, many situations where a company chooses for a lower level of plant automation to reduce the upfront investment and leverage the cheap wages. In this case the inventory levels would generally go up.

Results: Inventory levels – neutral to up slightly

Finished goods inventory at the plant

One of the downside of locating the plant outside of America is the distance a product has to travel before it is ready for selling to final consumers. In most case, a company has to ship an economic order quantity that may be larger than if the plant was located in US. Now with plant outside they may have to ship a container or more at a time for most of the products. The staging and packing operations required at the plant for large and often less frequent shipments requires that a plant hold a larger inventories in its shipping facilities.

There are cases where the product shipped is of high value with low volume like swiss watches or computer chips. The inventory level required at the plant will be hardly larger than normal.

Results: Inventory levels – up

Finished goods inventory in-transit

Except in few rare cases, where companies can ship via air a small quantity, the inventory levels should go up significantly. Imagine a container shipping from China and spending days (if not weeks) at the sea. A manufacturer has to ship a large quantity at a time and that has to spend a lot of time in transit resulting in large in-transit inventory levels.

In cases, where the plant is located in nearby countries like Mexico, the shipping time should still be larger than moving a product across state lines by a truck or rail. Think of custom paper-work, inspections and driving on roads which may not be as good as here at home.

Results: Inventory levels – up a lot

Finished goods inventory in outbound channels

With outbound channels, I refer to the finished goods (ready to sell) inventory which is in warehouses, in-transit to customers and at customers premises like stores. You may be thinking, why count the inventory at the customers locations? Well, it is the inventory in the supply chain irrespective of who owns it. The total supply chain cost goes up and the manufacturer would have to bear a share of this cost.

This inventory level goes up significantly for couple of key reasons. The reduced frequency of replenishing the inventory in the sales channel would require a larger inventory levels than usual. Also, with plant being located far away the ability to meet the volatile demand goes down thus requiring a larger inventory levels to meet the customer service levels. These two issues are somewhat related and easy to calculate once you know the demand volatility, frequency of inbound and outbound shipments etc.

Results: Inventory levels – up a lot

In conclusion…

Locating a plant outside of America to meet the domestic (USA) demand should, in most cases, result in larger inventory of finished goods. The inventory of raw-materials and work-in-progress may, however, not be impacted significantly.

I will leave you with few thoughts to ponder…finished goods inventory is more expensive than anything building up to it and the risk of products going obsolete whether it is due to limited shelf life or with changing nature of demand as in consumer products.

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