The Next Supply-Chain Challenge Isn’t a Shortage — It’s Inventory Glut
Posted 11th October 2023 • Written by PS Subramaniam on hbr.org • • • • • •
It’s March 2020. Store shelves sit empty, without any toilet paper or cleaning supplies in sight. Tablets and electronic devices are out of stock. Consumers are clamoring for the basics they need to suddenly work and learn from home and live under quarantine. Meanwhile, on Zoom calls and in email threads, company leaders around the world are racing to put in giant orders with their suppliers to speed up supply-chain lags and get products to customers. In the supply-and-demand equation, demand seems infinite.
Now, three-plus years later, we’re seeing the stark aftereffects of that spike in demand. After the race to order key components and manufacture products, suppliers are left with mountains of excess inventory as growth has slowed to normal levels. In the tech industry, it’s common for warehouses to be full of now-outdated semiconductors and other technology components. When those components were ordered, they were in hot demand. Now, companies are dispositioning excess electronic components (selling them at lower prices, scrapping them, using them in alternate products, and trying to sell them back to suppliers) to get them off their balance sheets.
Beyond the obvious environmental cost, an inventory glut of high-end electronics components is an expensive problem. Excess inventory is a $250+ billion problem in the U.S. alone, according to a 2023 Kearney study. On a global scale, U.S. census data shows excess inventory amounts to trillions of dollars. Someone pays for all that extra inventory.
And this problem isn’t a pandemic-era anomaly. New demand spikes are coming our way — you only have to consider the seemingly “infinite” demand for electric vehicle batteries or the boom of chipsets that drive AI-powered technology to see how similar cycles could play out in the near future.
As we look ahead at a new age of operations, leaders have the opportunity to address the current inventory problem and be stewards of a healthy, sustainable industry ecosystem. Players in every part of the value chain (from component suppliers to manufacturers) have a key role in preventing this kind of waste in the future. We see the opportunity for forward-thinking leaders to blaze a trail, modeling a more sustainable way of collaborating for shared success.
How Inventory Gluts Occur
Inventory challenges aren’t new. Electronics littered shelves in 2001 after the dot-com bubble burst. Then, in 2009, the financial crash left manufacturers with excess inventory when consumer buying power suddenly dropped. And now, the high-tech industry is feeling the weight of a volatile market that has led to excess component inventory.
Excess inventory can happen at any part of the supply chain. Here’s a hypothetical example: As cloud computing booms, a company selling servers (also known as an original equipment manufacturer or OEM) gets a giant order for server equipment. The OEM, in turn, sends an order to their contract manufacturer for this server. (“We need as many as you can make!”) The contract manufacturer starts sourcing all of the parts they need to make those servers, including two kinds of semiconductors (we’ll call them “A” and “B” semiconductors). The contract manufacturer searches high and low for those semiconductors; getting the parts could take a year. Once all the parts are finally in hand, surprise! The original order has changed. The technology has advanced, and the demand has shifted. Now those same servers use “B” and “C” semiconductors. The contract manufacturer is stuck with warehouses full of the outdated semiconductors “A” and excess quantities of “B,” creating a very expensive and very wasteful problem.
The key problem is in the original order. Demand is never actually “infinite” or fully predictable given technology changes. Every manufacturer must creatively collaborate with their customers to understand realistic demand for what they will manufacture. There’s also an opportunity for suppliers, manufacturers, and distributors to creatively work together to return components that do not get used and get them in the hands of someone who needs them.
How One Manufacturer Is Turning the Tide on Excess Inventory
Let’s look at how one contract manufacturer we have worked with is managing the problem of excess inventory. The manufacturer’s excess inventory was steadily inching toward unsustainable levels, while external factors like increasing interest rates created an intractable problem.
Company leaders started applying the concept of “Inventory Momentum,” a forward-looking metric based on the classic momentum equation: current inventory x rate of inventory change. In other words, having a large inventory isn’t a problem. But when the inventory rate increases, the combined momentum creates a major headache. And when you’re talking about billions of dollars in electronic components that have an expiration date driven by technology transitions, the headache is expensive.
Once they understood their inventory momentum, the leadership team took five key actions to reduce excess inventory, stem the rate of inventory change, and prevent the situation from happening in the future:
- They reduced incoming materials. Instead of ordering all components in advance, the company only ordered the components needed to make finished goods in the short term. The procurement teams delayed orders for components that would not be immediately used in manufacturing.
- They set more accurate planning parameters. Investing in real-time systems provided stakeholders with information on how much inventory they had across all factories and suppliers’ books. This data allowed the company to simulate changes to inventory levels when planning parameters like lead time, safety stock levels, and minimum order quantities.
- They disposed of excess and obsolete inventory. The company collaborated with suppliers and distributors to find alternative customers for stranded components.
- They collaborated with their customers. Leaders worked out agreements with customers that if orders changed, the company wouldn’t get stuck with excess components — and arranged working capital advances to get paid in advance for critical materials. Customers could optimize their consumption of excess components by modifying product lifecycles or working with suppliers to design alternative applications.
- They prioritized revenue for customers. By prioritizing customers with a backlog of large orders, they maximized customer revenues by building the mix of products where components were already on hand.
The results: The company reduced the total inventory number by more than 10% in just a few short weeks and reduced inventory momentum.
Creating a More Sustainable Inventory Ecosystem
This real-world example isn’t an outlier — it’s the canary in the coal mine. The liability of excess inventory affects every business in the value chain. To create a more sustainable environment, every business needs to start thinking differently about the burden of excess inventory.
To start, leaders must reconsider the narrative of “infinite” demand. Every demand spike will eventually end in an inventory glut. It’s up to the companies placing orders to temper that demand with a dose of reality.
If suppliers maximize revenues and OEMs order more than what they can reasonably sell, contract manufactures get stuck in the middle. That dynamic isn’t healthy or sustainable. Value chain partners like OEMs, contract manufacturers, and suppliers need to be aligned on optimizing inventory. Suppliers should be able to redistribute excess components that are still perfectly useful for another application. Getting products into the hands of people who need them is ultimately good for everyone.
Finally, as new industries emerge, prioritize creating healthy ecosystems from the start. The growing realm of AI represents a major opportunity for high-tech manufacturers — but it’s also an opportunity to build a healthy ecosystem. To do so, we can’t assume an “infinite” demand for AI-powered applications. The same is true of the electric vehicle industry. If the ecosystem over-produces parts for EVs, there’s a high risk those parts will be outdated or unusable by the time demand eventually materializes.
Inventory management is a critical problem that should be on the radar of anyone in an industry with volatile demand and long lead times. And it requires a careful, collective solution. No single company stands alone. Instead, we’d all be well served to consider the broader business ecosystem, making decisions that will serve our bottom lines and the health of all the companies connected to us.
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