There are two ways a company can increase profit margins. The first includes having a proactive sales team that is well trained in negotiation and uses that training to maximize gross profit on sell prices.
The second includes making sure your company is adopting some simple cost-cutting supply chain strategies, ones that allow you to increase profit by eliminating inventory cost drivers.
Most companies focus on improving the skill-set of their sales team in order to increase profit margins. However, we’ll show you how focusing on some simple supply chain strategies can help increase profit and improve your bottom line.
1. Consignment Inventory
Negotiating a consignment inventory agreement with your vendors allows you to eliminate the high costs of inventory stock outs.
You’ll have the inventory you need every time, while also being able to reduce your incoming freight charges on materials and finished goods.
Consigned inventory will help you avoid vendor surcharges for rush deliveries when you suddenly faced with an “out-of-stock” (OOS) situation. You won’t incur expedited freight charges to rush parts into your warehouse because the stock levels are maintained.
You won’t have to deal with overtime in manufacturing, or with your warehouse employees, as both your operators and machinists sit idle waiting for that all-important delivery.
You’ll receive one large shipment of product and will only be invoiced for what you use when you use it. That means you’ll benefit from lower prices, lower freight costs on incoming shipments, and most importantly, you’ll reduce overtime simply because you always have the inventory readily available.
2. Vendor Consolidation
Vendor consolidation programs reduce the number of vendors your company purchases from. Amalgamating vendors allows you to combine volumes and use those volumes to reduce your pricing, your freight costs on incoming parts, while also increasing your negotiating position. However, don’t go with a single source on an all-important raw material.
Make sure you have a minimum of two or three sources. You’ll still have to rely upon your main incumbent supplier, but will have to keep those other two sources in the mix just in case shortages occur, or your main source of supply falls short.
Procurement Best Practices: Vendor Consolidation
3. Running the Right Supply Chain Strategy
Companies are enamored with Just in Time (JIT) supply chains because they allow companies to reduce their cost of capital on inventory by purchasing just enough to meet demand. Min-Max is sometimes viewed unfavorably due to the high carrying costs associated with retaining a minimum and maximum inventory count. A Push-Pull strategy is a possible solution as it allows you to pre-manufacture most of a finished good and then finish off the remainder based on a customer’s specific requirements.
Unfortunately, very few manufacturers, and or companies, can run JIT successfully simply because they lack the economies of scale and position of importance with the vendor base to dictate how vendors should maintain inventory counts. Min-Max is ideally-suited to cyclical sales patterns, ones where companies must have inventory ready as soon as customer demand spikes upwards. Finally, a Push-Pull strategy works when a company can push products to customers and allow those customers to pull demand by specifying different options on the final finished good.
Ultimately, choose the strategy that best suits your company. It’s surprising to think that this one single issue causes so many problems, but it does.
4. Identifying Inventory Cost Drivers and Eliminating Them Altogether
Your carrying costs in your warehouse have a huge impact on your bottom line. However, if you haven’t taken the time to identify which cost drivers are causing the most damage, then you’ll never eliminate them, never reduce costs, and most importantly, you will never improve your profit margins.
Your procurement team must identify those all-important areas of concern. This includes itemizing your company’s costs of inventory, while also calculating your costs to have inventory for every square foot of your warehouse. First, itemize each cost driver. Second, determine your monthly costs of having inventory. Third, isolate areas of concern and fourth, measure your progress over time.
The excel sheet on the left is an example of how a company would go about tracking their monthly and or yearly costs of capital (money) or costs of financing, costs of damaged or ruined inventory, costs of inventory obsolescence, costs of electricity, costs of lost customers due to inventory stock outs, cost of pilferage (theft), costs of dead stock and or slow moving inventory, and finally, costs of overtime and counting.
5. Favorable Payment Terms and Improving Negotiation
There are two ways to focus on payment terms. One is to insist on extended terms like net-45 or net-60 days. This is common for companies who service a market where collecting on their own receivables is often a 90 to 120 day process. The other strategy is to secure discounts, price reductions and rebates for prompt payment. Either way, your company is saving money on its inventory costs.
In terms of negotiation, your procurement department must be able to hold their own with your vendor’s salespeople. Negotiation is just as important for purchasing as it is for sales. However, for whatever reason, companies focus on making sure their sales team can negotiate, while completely ignoring the types of concessions that purchasing can secure with the right mindset.
The best cost-cutting supply chain strategy is to start by itemizing your costs of inventory. Afterwards, you isolate which cost drivers can be reduced and or eliminated. Some of the aforementioned strategies like consolidation and consignment inventory agreements will help you do exactly that, but you won’t know until you take the time to itemize what your specific cost drivers are.
If you have decided to run Min-Max, then here's an article about maintaining the proper amount of inventory in order to avoid stock outs. Determining Safety Stock & its Impact on Inventory Holding Costs
The above pie chart is taken from Warehouse Carrying Costs Per Square Foot: Three Simple Steps