Manufacturing companies build a safety stock to help them handle any emergencies or contingencies. While a consequent safety stock does theoretically help respond to all customer requests and supply contingencies, its costs weigh heavily on competitiveness. This article explains why it is important for manufacturing companies to optimise their safety stocks in 2022, while demand is more variable than ever.
Why is stock necessary?
Stock refers to warehousing goods for later use. For commercial or manufacturing companies, stock represents the goods and finished products intended for sale, or the raw materials that will be used in the manufacturing process. It is imperative to have sufficient stock to meet future demand, and therefore a given stock level will be needed to guarantee the firm’s survival and sustainability.
Thus, good stock management means having the right quantity available at the right time. Too little stock runs the risk of facing shortages should unforeseen events arise, which will negatively impact manufacturing capacity. On the other hand, too much stock is expensive to store (cost of storage space, software, equipment, personnel, insurance…), before even considering depreciation over time.
Why limit stock levels?
Every firm should keep a safety stock, i.e. have a minimum quantity of products always on hand. The aim is to avoid shortages by responding to random fluctuations in the supply or demand of goods. This doesn’t, however, mean overstocking, which would carry the risk of being left with unsold stock, should demand decrease or cease altogether over a given period.
What then about firms that carried excess stock prior to Covid? Does their stock still have value two years on? Does obsolescence kill business? Two years later, what happens to stocks of 4G smartphones, non-touch screens, or car parts for diesel engines in an increasingly electric world?
It is easy to see how such scenarios can have a devastating impact on a firm’s finances, with money tied up in stocks effectively turning into a dead loss. A firm seeking to preserve its financial health should avoid tying up money at all costs. It is far better to have 10 million euros available to pay wages, R&D or build up safety cash flow, than to have it tied up in stock that loses value over time and can rarely be used up unless sold. In contrast, shortages linked to exceedingly low stock levels will impact production, but will not jeopardise a firm’s finances (unless a major customer leaves following significant and recurring delays).
That is why companies ought to optimise their safety stock to enable them to respond flexibly to customer requests without affecting their financial balance by carrying too much stock.
Optimal stocks as key to competitiveness and agility
Supply management has a direct impact on activity. Shortages are more likely in the face of contingencies if the safety stock is limited. This would require calling on an express transporter for a quick delivery, which generates additional logistics costs. It is then a case of weighing the extra logistics costs linked to stock levels kept intentionally low, against the annual cost of keeping higher stock levels.
As a guide, annual storage costs usually amount to c. 20% of the goods value. As such, goods worth 1 million euros would cost around 200,000 € in storage each year. A firm deciding to reduce its safety stock would thus save 100,000 € for every 500,000 € of reduced stock. This is a considerable saving in a world where any competitive gain can make a difference!
Those who have totted it all up will quickly realise that the extra logistics costs only represent a fraction of the savings achieved by reducing stocks.
The most competitive firms therefore choose a demand inventory replenishment model, by which stock replenishment occurs as customer orders are placed. This drastically reduces the locking of capital as well as the cost of storing goods. Such a model allows demand to be met without understocking, overstocking, or running out of supplies.
This still requires holding sufficient safety stock for the circumstances – the logistics challenges of the current, unprecedented climate would justify some adjusting. In 2022, one would expect to see firms increasing stocks of the most strategic components, like semiconductors or precious metals. One should, however, bear in mind the overall cost of stocks, namely the locking of capital that restricts the firm’s cash flow and, consequently, its ability to invest and bounce back after a crisis. Close attention should also be paid to the risk of depreciation and unsold stock, both of which can negatively affect financial balance.
It is now clear that the cost of tied up stock is much higher than it first appears. Achieving optimum stock levels assures more cash flow availability, is less resource and space intensive, and reduces the risk of depreciation and unsold stock. This allows companies to spend in proportion to sales volumes, and thus to minimise risk at a time when demand volatility has never been higher. 2022 is the year when one needs to keep a close eye on one’s stock levels.
Safety stocks – About the author
Air Time Critical® is a forwarder specialising in emergency air freight for French and European manufacturers. In addition to transport services, Air Time Critical® advises customers on administrative procedures and offers turnkey solutions, such as door-to-door shipments, customs clearance, advice, liaison with foreign suppliers, and proactive information. The Air Time Critical® teams are ready to advise you and coordinate your urgent shipments from your suppliers or to your customers abroad.