What if I told you that you had many thousands, perhaps millions of dollars slowly evaporating on your warehouse shelves? If you are a manufacturer of products that incorporate electronics, this situation almost certainly describes you.
Inventory oversupply, mismatches and material obsolescence are perpetual pain points in the electronics supply chain. It’s a knotty, multi-billion-dollar problem that remains intractable despite the best efforts of the brightest minds in the electronics supply chain. Inevitability aside, there are relatively simple actions that OEMs and contract manufacturers can take to minimize the financial impact by extracting maximum value from excess and obsolete (E&O) inventories.
The problem of E&O inventory is nothing new. E&O reached a painful peak in the 2001 electronics industry downturn. The technology market sagged unexpectedly at the beginning of the century, saddling manufacturers and suppliers with huge amounts of unwanted inventory valued at many billions of dollars. Large batches of these parts were eventually scrapped or written off – many ended up in the gray market, sold to brokers for small fractions of their initial value. Former partners engaged in courtrooms tussles over who was responsible for the E&O components and hence the full weight of the resulting losses.
What is the scale of the problem today? Conservatively, we estimate that between 5 percent and 20 percent of electronic components end up in the E&O category. That’s a lot of money that could potentially end up in the loss column of an income statement. E&O parts are often ignored, discarded, written off or liquidated at a very small fraction (3-5%) of their original acquisition cost.
Excess and obsolete inventories are the unavoidable outcome of a delicate system that must respond to known and unknown factors in the technology industry’s design and supply chains. The factors behind the problem are many and they aren’t all due to carelessness, negligence or other human weaknesses in the supply chain. Here are some of the known causes of inventory imbalance (principally Excess) in the supply chain:
- Demand Forecast Inaccuracy (Volumes And Product Mix)
- Product Change, Redesign/Update
- Product Obsolescence
- Lead-Time Variations
- Minimum Purchase Requirements
- Single-Sourcing of Components
- Supplier Inefficiencies
- Inefficient Order-Management
Toothbrush or Root Canal?
Most people would agree that it’s much more cost effective and less painful to buy a toothbrush as opposed to scheduling a Root Canal. The same holds true for how you deal with E&O inventories.
Predictably, some manufacturers manage E&O component problems much better than others. Companies that do a good job of managing excess inventories are the ones that don’t ignore or hide the problem. They acknowledge it and take firm steps to address it. Unfortunately, many manufacturers don’t acknowledge the problem early or at all, sweeping it under the rug in the hope that things will turn around and the E&O parts will somehow be consumed. The problem typically gets worse as a result. A good analogy might be comparing the problem to oral health.
Inventory Management Partners, LLC (IMP) has identified the four principle ways companies deal with the problem of excess and obsolete materials:
- Leave it on the Books (Do Nothing): Some companies, knowingly or unknowingly, choose the Root Canal. They are either unaware or choose to not acknowledge that they have a problem with E&O inventory. Instead, they treat E&O inventory as a potential asset and “Let it Ride” on the books at full asset value. Unfortunately, electronics inventories rarely appreciate in value. They almost always depreciate over time, and in many cases quite quickly. Doing nothing is arguably the worst way to deal with E&O inventory.
- Write Off: This involves scrapping the materials and writing down the value on the balance sheet. Although this option allows the company to gain a small tax credit it provides the lowest level of return.
- Liquidation: In a Liquidation scenario the OEM or contract manufacturer would sell the components to materials brokers who will buy the materials at a small fraction of the value. In a competitive environment, E&O component buyers typically pay between 3 to 5 percent of the initial purchase price. The OEM or contract manufacturer would collect its money and take a tax write off on any losses. Inevitably, some portion of the liquidated E&O materials are needed again for an unexpected requirement. If that material is still available (it often isn’t) you can be assured the broker will command a hefty profit to sell it back to you.
- Managed Disposition Method: The “managed inventory disposal model” is the approach Inventory Management Partners promotes to our clients because it yields both the highest return on the invested dollar, while offering maximum flexibility if (really when) some of their E&O material is again required. The process involves breaking down the materials and finding a market for them at the highest possible price. The E&O parts are actively marketed simultaneously across multiple channels to a broad audience of users at the right time and for the right price.
This approach yields an average return of about 60 percent of the initial material cost. The only downside to this option is that the marketing of the E&O materials requires a bit more patience as returns may take a couple of months to be significantly generated. In general, within 120 days this method’s return will surpass that of any inventory liquidation.
The lengthy history of the electronics industry suggests inventory imbalance is not a problem that can be completely eliminated. However, proactive manufacturers can lessen the negative impact on their operations by observing the following rules:
- Allocate Adequate Resources to E&O Inventory Management: All too often E&O inventory issues go unaddressed due to lack of focus. The best in class manufacturers understand the tremendous positive financial impact that derives from proactive management of E&O inventories, and allocate resources and attention accordingly.
- Conduct Regular Reviews and Analysis of Inventory Positions: You can’t minimize the impact of a problem you don’t know about. Understand the true extent of the excess or obsolete components problem. Know where your materials are in the supply chain – whether it be in your internal production facility, at your contract manufacturer, or with a channel partner. Determine the level of liability and agree on this with the supplier, contract manufacturer or distributor. It goes without saying that you must respond to the excess inventory problem in a timely fashion. We recommend a quarterly assessment of inventory levels. The option of working with distributors, contract manufacturers and suppliers to find a solution may no longer be available if a manufacturer takes 2 or 3 years to identify or acknowledge the problem.
- Screen, and Dump Unique Parts: Take excess or obsolete components that are unique to your products – such as PCBs, sheet metal, fabricated plastics, and other build-to-print components – and exclude them from any further action. There’s not much that can be done to recover value from a component custom designed for your product. In many cases custom components can be reclaimed or harvested for precious metals and then disposed of or recycled in an environmentally responsible way.
- Partner with Suppliers/EMS Provider/Distributor: Before engaging with a company like IMP you should work with your component manufacturers, distributors and contract manufacturers to minimize the excess materials problem. You might be able to get some of the materials out of your supply chain and put them to use elsewhere. Naturally, your effectiveness will depend heavily on the relationship you have with your supply chain partners and how that relationship is managed over time.
- Engage in Structured Disposal Via a Managed Inventory Partner: After boiling down the inventory to parts that have value in the supply chain, you may want to engage with a company like IMP for a structured disposal. IMP will take and categorize the materials – count, value and conduct market assessment – and determine the expected returns. The components could then be marketed on your behalf.
In the end, it’s all about proactively addressing E&O inventory in a timely manner. Although the problem of E&O inventory cannot be entirely eliminated, with proper resources and attention a manufacturer can recover substantial value.
About IMP: Inventory Management Partners has been working with OEMs and contract manufacturers to resolve their excess and obsolete component problems for nearly 15 years. Over the years, IMP has created and honed a system for extracting the highest value clients can possibly get from swollen inventories, partnering with them to reduce the pressures that arise naturally and through human fallibility in the supply chain.