Inventory – Driven Costs

Presentation by Group 07
Background

1990-97 1991 - 93 1997 onwards

2 - Demand grew between 1990 4 -Major revamp in design,
planning and production
6 -Paper thin profit margins
-Many product lines not
and 1997
processes to shorten cycle profitable
times and respond quickly to -Price cuts made insignificant
changes costs critical

1990s 1999
1991 - 93
1 Hard time for the
computer industry 3 -Computer giants started 5 By late 1999, HP became the
world’s 3rd largest PC
slashing prices
- 10 % in 1991 manufacturer
- 26 % in 1992
- 22 % in 1993
 HP’s Problem
 Component Devaluation Cost
-Accounted for the majority share as key components like CPU depreciated as much as
40 percent in their 9-month long life cycle
-Not many realized their perishable and maintained large inventories. Consolidation and
node reduction required to mitigate the cost driver.

• HP realized that their supply chains were  Price Protection costs

flexible but not economically sustainable.
• It saw through its multi layered
manufacturing network where no one was
able to view the big picture.
• HP realized excess inventory being the main
cost driver
• Existing cost metrics to measure Inventory
Driven costs weren’t enough to measure IDC
• Holding cost being not the only one to blame
for the problem
• time an item was in a supply chain and resulted in additional risk for HP
Identified 4 more IDC items at HP
-When dropping the price of a product after its already shipped, HP had to pay
the reimbursement to the sales channel
-To prevent this, ensured channels do not exceed a minimum inventory level.
-Incentivized keeping lower inventory as giving incentives was cheaper than
paying for difference.
 Product Return Costs
-Incurred when distributors return unsold goods back to HP. 100% price
protection costs.
-Apart from giving them additional operational costs, returns prolonged the

 Obsolescence Costs
-PC life cycles were very short and could leave the company with worthless stocks
-HP had to be very careful while introducing a new product in the market
-Included additional marketing costs as well which were needed to push the obsolete
stock out. These costs were not necessarily included in inventory costs
IDC Calculation
Component
Devaluation
Cost
-Can be calculated by
multiplying inventory level
of product with proper
devaluation rate
-Example
Devaluation rate = 60 %
Inventory = $200 million
Revenue = $1 Billion
Product devaluation =
$120 million
Cost as a margin = 12%
Price Protection
Costs
-Can be calculated by
multiplying inventory level
of product with the seller
and price lowered by the
company
-However, the actual sum
may differ because of the
contract details between
the seller and the firm
Product Return
Costs
-Can be calculated by
multiplying inventory level
of product with the seller
and wholesale price paid
by the seller
-Again, the actual sum may
differ because of contract
details between the firm
-Furthermore, the contract
enforcement may depend
on specific circumstances
and the firm may make a
compromise to maintain
good relations
Obsolescence
Costs
-Completely situational
and only arises when a
company retires a
particular product.
-First company must write
in 100% of the existing
obsolete product cost in
the IDC
-Furthermore, it can
analyze individual
components and make the
adjustments accordingly
-Lastly, Marketing costs to
be included as well.
Tracing Costs to the Source
Inventory Driven Cost IDC as a % of Revenues
Product A Product B Product C
Component Devaluation 2.10 4.20 2.20
Price Protection 7.15 2.30 0.80
Product Return 1.15 0.60 0.60
Obsolescence 2.55 0.65 0.40
Holding cost of Inventory 1.30 1.10 0.80
Total 14.25 8.85 4.80

-Inventory of Channel partners represent the -Both B & C need better upstream management with suppliers
largest portion of A’s costs. or with product designers to reduce component devaluation
-Hence it is important to improve SCM risks.
downstream
-Encourage Vendor Managed Inventory (VMI)
and Collaborative Planning, Forecasting and
Replenishment (CPFR) Initiatives
Scenario’s Brief Scenario 1
-Current way of working.
-Involves a 2-step supply chain with a central
manufacturing facility and certain amount of local
integration at regional facilities.

Mobile Computing Division

• MCD believed that no unit can
Scenario 5 Scenario 2
-1 step supply chain -2 step supply chain.
becomes profitable until and unless it -Comprises of one central
consolidated all worldwide -Assumes company will limit
factory where product will inventory costs.
manufacturing at a single location. be directly sent to the -Company will pass on major
• Thus, to justify this strategic change, customer worldwide inventory related
they analyzed their new strategy by responsibility to its SC
using 5 different supply chain partners.
scenarios and compare their cost
differences.

Scenario 4
-1 step supply chain Scenario 3
-Comprises of multiple regional -Same as scenario 2 with
facilities doing both minute changes
manufacturing and local
configuration.
MCD’s Turnaround
Traditional Costs Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5
Manufacturing 100% No change -15.6% -11.1% -21.0%
Distributing 100% No change No change No change No change
Freight 100% No change +7.4% -28.4% +56.8%
Total Costs w/o IDC 100% No change -9.2% -10.2% -6.7%

IDC Costs Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5

Inv Finance 100% -18.5% -29.6% -44.4% -51.9%
InvDevaluation 100% -51.6% -55.7% -58.0% -63.5%
Inv Obsolescence 100% -24.0% -34.9% -52.7% -58.1%
IDC Total 100% -19.2% -29.3% -43.6% -51.2%
Total Costs w/ IDC 100% -15.5% -24.0% -28.1% -28.3%
The Payoff
2. IDC showed hidden details
1. Profitability Management -Made product groups managers’ job a little
-Sophisticated method of managing
Big easier.
p
profitability
b le De ictu -Reflected the implication of a managerial
--Each product is free to choose the supply ta tai re decision on the overall cost.
o fi ls
chain configuration best suited for it. Pr

Inve

king
nto

Ma
ry
5. Inventory Decline 3. Decision Making was easier

ion
Dec
-HP’s personal systems group saw worldwide -Applicable in whole range of decisions, from

is
inventory decline in inventory levels by 50% marketing to R&D

Dec
line
between 2000 and 2002. -Also helps managers decide, how much
-Costs associated with inventory have dropped Goal Alignments flexibility to be built into a new product.
even further, by around 70%

4. Goal Alignment
-IDC linked operational decisions to corporate
goals.
-HP abandoned traditional financial
performance metric of return on sales in favor
of return on net assets (RONA)
Thank You!