Improving supply chains: Investing in efficiencies, growing capacity and building in redundancies
Production bases, freight routes, ports and storage facilities all pose risks to the security of supply chains and investment in these can also boost capacity and resilience.
4 minutes to read
Many logistics hubs, ports and airports have adapted to the strains placed on them and are now able to process cargo more efficiently, by better managing the capacity they do have.
Infrastructure investment can improve capacity and investment in technologies; such as artificial intelligence (AI) and the Internet of Things (IoT); is providing greater visibility and optimisation in the supply chain. Inventory management systems can help firms track lead times and make better decisions on stock levels. Research by supply chain platform Blue Yonder shows that 83% of organisations have increased investment into their supply chain recently to reduce disruption in the future, with one in 10 organisations investing more than US$25 million.
While improving capacity or visibility can reduce the impact of choke points that exist, it cannot solve issues of fracturing or decoupling of supply chains. Supply chains can be weaponised, particularly by countries that are prominent sourcing hubs. Geopolitical tensions pose a different type of risk that requires a different strategy.
Just-in-time vs Just-in-case
Improvements may also mean building in redundancies or holding more inventory. Long, lean, just-in-time supply chains have evolved to maximise cost efficiencies, taking advantage of locations with low labour costs through low shipping costs. But these supply chains have risks. The just-in-time paradigm, which relies upon predicting order requirements well in advance, has been weakened by trade tensions, labour shortages and Covid-related shutdowns and shipping disruptions. Spikes in demand or supply-side shocks can have a knock-on impact on outputs and order books.
There has been a shift, with firms adopting a 'just-in-case' approach. Despite additional storage costs, firms are looking to hold additional buffer stock, or safety inventory, enabling them ride out any blips in supply.
Typical safety stock policies include holding safety stock equal to a fixed percentage of lead time usage (typically 50%) or a specific number of days’ supply is maintained as safety stock (typically 7-14 days’ worth of sales). There are various, more complex formulae but broadly speaking, the amount of safety stock a firm looks to hold is calculated based on average and maximum lead times, and maximum and average sales. Lead times can vary significantly across sectors and between suppliers, longer supply chains where more suppliers are involved, the longer the lead time is likely to be.
Where a lead time is 10 days and average daily sales are 20 units, a firm could cover its lead time by setting safety stock at 200 units. Using the 50% rule, it would mean setting safety stock at 100 units. However, if lead times rose to 14 days, this would raise the safety stock requirement to 140 units, a 40% increase in lead time and a 40% increase in safety stock.
Safety Stock Calculation: Average – Maximum Formula
Safety Stock Formula = (Max. Lead Time * Max. Sales) – (Ave. Lead Time * Average Sales)
NB: The above formula is reasonably simple method for calculating safety stock. However, there are variations. Where there is a high level of uncertainty/volatility, a standard deviation of the lead time distribution and/or demand/sales can 6be used.
As per the formula above, we can see that an increase in maximum lead times, generates a higher safety stock requirement. On the above calculation, a 30% increase in the maximum lead time (ceteris paribus), would mean a 40% increase in safety stock requirements. This could have a significant impact on storage space requirements, particularly for sectors with long, lean supply chains where lead times spiked dramatically over the past couple of years.
Safety stock typically accounts for around 10-20% of a firm’s total inventory, though it can account for 50%. If we assume safety stock accounts for 20% of UK-held inventory and firms need to increase this stock by 40% to account for longer lead times, it would mean firms need to raise their total inventory holdings by around 8%.
With firms potentially needing to increase their safety stock holdings in order to protect their order books, they may require additional warehouse space. Firms with long supply chains may have the largest increase in safety stock requirements. However, the additional warehousing costs, coupled with the costs and risks associated with ordering and holding more stock, may lead them to consider moving or diversifying their supplier base in order to reduce lead times and limit uncertainties.