Excess inventory management: key issues that drive excess inventory and unanticipated parts obsolescence.

For years, excess inventory management has been a challenge in consumer product projects because of short lifecycles and frequent engineering changes. Longer lifecycle products have faced the very different challenge of maintaining design with little or no change. However, the combination of RoHS legislation and focus on cost reduction throughout the industry is changing that. Suppliers are choosing to eliminate some leaded part options, while cost reduction is driving redesign cycles previously not considered. OEMs with longer lifecycle products are finding their product strategies can be arbitrarily shortened by these trends.

Complicating this is the fact that low- and medium-volume higher-mix products may carry significant hidden inventory liability. This is because these products often require material below minimum-buy quantities. Many EMS providers carry this liability with the assumption it will eventually be consumed. If a significant product redesign occurs, some or all this material must be liquidated or written off.

Assessing excess inventory risks. Typically reeled components, custom fabricated components with minimum-run quantities and any material classified non-cancelable, nonreturnable (NCNR) are the categories with the most potential for excess material.

Some EMS providers charge for minimum-buy quantities upfront. However, this practice isn't widespread because far more are willing to carry excess inventory, provided the customer signs up to liability for the minimum-buy-driven excess in whatever manufacturing agreement is signed. Some companies amortize the cost in the piece price, but this can complicate cost-reduction initiatives. In other companies, minimum-buy material is resolved whenever the part goes inactive for more than a quarter. In upfront discussions, many customers see this as a relatively small cost; however, in a high-mix program that has been in place for several years, what starts as a small liability can grow to a significant number if excess issues are simply postponed until project end or redesign.

Most EMS providers have clauses in manufacturing agreements that address material liability for minimum-buy driven excess inventory. Additionally, some EMS companies identify minimum-buy liability, NCNR and tape-and-reel inventory in the initial quote. While this can be a competitive disadvantage if compared to quotes that simply quote a unit price, it ensures that customers are aware of the issues from project start, rather than surprised when excess parts materialize.

Some EMS providers have internal tracking methodologies specifically focused on excess material. Customers may or may not have real-time visibility into a system depending on the tracking tools and the contractor's information-sharing system. For example, Fawn Electronics (fawn-ind.com/electronics) uses a material authorization procedure to keep a running tab of on-hand and on-order excess for each customer. The firm notes that with current lead-times, often two-thirds of material in its pipeline is not covered by purchase order, although it should be authorized under a customer forecast. By capturing this liability, the company does two things: First, it has a vehicle for keeping customers in the loop on real-time inventory of any product. Second, it has an internal accounting tool that tracks a key cost.

Tracking costs internally is critical because material cost is often 70-80% of an EMS provider's revenue. In mid-tier companies, accounted for excess inventory can be a significant portion of that. Fuzzy accounting of accounted for excess material makes cost resolution at the end of a project difficult. For instance, if an EMS provider amortizes the excess in the piece price, but doesn't accrue the amortization internally, it creates an out-of-sync charge at the end of the program. It can be transparent to the customer from a payment standpoint, but it needs to be properly accounted for internally in ways clearly visible to program management, purchasing and accounting.

Setting ground rules. Ultimately, the better job an EMS provider does of communicating liability upfront and continuing to update status, the less likely a customer is to be surprised later. Reduction of the surprise factor is often key to achieving a win-win resolution in material liquidation because often a portion of the excess cannot be returned or resold, and ultimately has to be written off. To reduce surprises, it is important to:

* Identify liability in the quote.

* Address liability issues in the manufacturing agreement.

* Validate POs against quote volumes and pricing.

* Get commitments that may trigger increases in excess in writing.

* Reinforce potential liability any time minimum-buy exposure is increased.

In the ideal situation, potential excess cost is addressed in the quote and in the manufacturing agreement. Customers can then sign up to liability for excess material that results from procurement practices aligned with their forecasting practices, but wouldn't have liability for any material purchased outside of the agreed upon forecast windows unless specifically authorized. In the Fawn example, a material authorization agreement is required to be signed by the customer anytime liability exists or increases. There is generally a time limit on how long excess will be carried without reimbursement. This process provides customers with visibility into liability cost potential at all times. Greater visibility often increases the options for inventory liquidation rather than write-off.

It is also important to remember the contractor has responsibilities in minimizing liability. Material handling and storage strategies can inadvertently convert material to NCNR because marked or open packages are generally non-returnable. Some material has shelf life or specialized handling requirements. Proper storage and a focus on shelf life requirements help ensure timely consumption or liquidation.

Strategies for resolving excess liability. In higher-mix production, RoHS conversion and engineering change notices (ECNs) drive the biggest excess or obsolete material issues. Other potential drivers of unexpected obsolescence include SMT packaging trends and continuing increases in processing speed. It is important to have an ECN process that captures impact in pipeline, inventory work-in-process and finished goods. Cost impact as of the ECN cut-in day must be understood early in the planning cycle, as one option for minimizing cost is to cut the ECN in after the remaining older inventory is consumed.

Fawn uses an MRP system that shows inventory data and permits "what if" analysis, both in terms of customer excess on hand and in the pipeline. It will also permit analysis of likelihood that other customers may consume some inventory. This is done by imploding the part number to determine how many assemblies on which it is used.

RoHS conversion also drives strong needs for inventory visibility. The company's business model uses reports that segregate products that are RoHS compliant and leaded, and then lists orders, raw material on order and raw material on hand by assembly.

Focusing on excess inventory liability minimization.

Whether identified or not, excess inventory represents a cost in the EMS service model. If not identified, that cost can be larger than anticipated, and if not absorbed by the OEM whose project drove the inventory accumulation, it can become a cost element passed to all customers in increased overhead. The earlier excess inventory is identified and tracked, the more options are available to minimize its accumulation.

In addressing excess material, all options should be on the table. The easiest solution is returning material that suppliers will accept back. As mentioned, in some cases, parts can be transferred to other customers. Brokers may also represent a good source, particularly since unplanned obsolescence often generates a market for niche components.

One other option that can be considered is buying lower quantities at a higher price. This can often be quoted as an option in the initial estimate.

The RoHS arena offers another option. One Fawn customer that converted to RoHS developed a dual production strategy. It now consumes existing leaded inventory in the North American market and ships RoHS-compliant boards to the EU. Serialized part numbers are used to differentiate and segregate the different product categories.

If the project includes repair depot operations, using excess inventory to support repair depot activities may be an option. This is an area where co-located production and repair depot services can be very beneficial.

Finally, if excess material has been generated as the result of a project transitioning offshore, the likely need for onshore support or even transition back of bad fit assemblies should be carefully evaluated before a write-off of hard-to-liquidate material occurs.

Market issues are driving companies to redesign even lower volume, long-life products more often. Even when an EMS provider discusses potential liabilities upfront, there is often a surprise factor when the issue must be resolved. Clear communication throughout the project life on these issues provides the customer with a range of options for minimizing and/or liquidating excess material. It also makes it easier for EMS providers to track and recoup the costs associated with planned excess inventory and contributes to a more financially efficient system that benefits all customers.

Susan Mucha is president of Powell-Mucha Consulting Inc. (powell-muchaconsulting.com), a consulting firm focused on optimizing EMS account acquisition processes, and developer of the EMS Integrated Marketing[TM] and EMS Concentric Selling[TM] training programs; [e-mail].

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