Your planning team is trying to determine how many servers will need to be purchased next year. Unfortunately, the supply chain team cannot locate the servers. They know that the servers exist but they cannot find them or verify that the servers they have found are the ones purchased last year. Your auditors hear about this problem and start asking for the whereabouts of all your servers.
Finding hardware that your company has purchased, even a simple item like a chair, can be made problematic when attention is not paid at the point of purchase. If your company builds or sells materials, the acquisition of these materials becomes essential. Suddenly, not only do you have the issue of attention to detail in budgeting and purchasing, you have an information tsunami that could wreak havoc on the management of your supply chain as well as your financial reporting.
Why is hard to pay attention to the purchase of materials? Simple – because other people do it. As with a child and his toy, the child wants to play with the toy but does not care how it was acquired. Their ability to overlook the logistics of how it arrives is similar to the awareness they have to other activities deemed mundane and out of their control, like breathing.
There is another, even more fundamental reason to ignore the purchase of items – It’s boring. It has to do with the amount of effort required to store and retrieve information in any system, and the problems it creates for your business.
The problem with purchasing information is that it is costly, in the form of time and effort, to obtain, record, store, manipulate and retrieve. Think about how hard it would be for your family if it had to perform these tasks for every tangible good and service it purchased every year for tax purposes (which, quite frankly, they should!). You would have to retain every receipt for every purchase you made, including all the food you had eaten, all the clothes you purchased, and all the items or services you purchased for your residence, including the gas you put in your car. Then you’d have to transfer the information included on the receipts, in detail, to a database or spreadsheet that was organized by type of purchase, purchase location, and current location. Finally, you’d need to retrieve data from this tool to pay each individual tax authority in all the cities in which you purchased or used the goods. Would you do this if it were not required? Go ahead, look at your tax file right now – that pile of papers you’re going to get around to? How’s that going? Maybe next month, you say? Definitely January? Surely not March or April, when 98% of all tax documents are filed and submitted. Based on the recorded history of human behavior, you know how you behave if you are not held responsible for work and it involves effort. You’d ignore it.
A Company cannot ignore this data: evasion is not a winning strategy, and denial will lead to catastrophe. A solution is to provide your Board and Management team with the consequences of not collecting the data. Tell them about the Companies that had their inventory held in customs for months or years until they paid correct duties on what had been shipped into Europe. Let them know about the Country Managers who were arrested for tax fraud in Latin America. Explain how not knowing where all of your equipment and parts are located could end up costing millions or – if you are really successful – even more in obsolete, lost or stolen property. In all of these examples, the adverse publicity surrounding the issue can damage the company as much as the punishment or loss, especially if it ends up in your annual report.
The practice portion of the solution can be summarized in a narrative you need to create. The first part is a mnemonic in the form of an alliteration: If you perform the three “Ps” of proper procurement: place, part, and purchase order (PO), you can eliminate the four punishments parceled out for non-compliance: prosecution, penalties, prohibition, and publicity.
The second part of the narrative is also a mnemonic: the four “Vs” of operations. The four “Vs” enable operations teams to measure their costs and inventory. The four “Vs” are the value of your inventory, the volume of purchases you make for each part bought or manufactured, the velocity of inventory or construction in process (often measured in turns), and the volatility of supply and demand for key inventory items.
Let’s first examine the three “P”s. Place matters because what you pay in tax and duties is based on where and from whom you purchase materials, where you transformed or built the materials and where you sell or deploy them. You can pay a significantly different amount of taxes and duties on a server bought in Asia, transformed in America and sold in Europe than on that same server purchased from a vendor in Texas and deployed in your tax free data center in Iowa. If you cannot support your purchases or deployments, each local tax agency will demand the maximum amount due plus interest and penalties.
Part Identification matters. A part number and commodity code must be assigned for every item your company completes. The vendor part and serial numbers should be retained for every purchase. These numbers enable you to track and value your inventory as it moves through your supply chain. They also enable you to quickly return purchased parts under warranty if the parts turn out to be defective.
Finally, Purchase Order information matters. Each requisition and Purchase Order should include individual line items and pricing for top level component purchases. PO information validates the cost of your materials and, along with part identification and place information, allows the parts to be simultaneously tracked, valued and analyzed. The PO can be matched to the vendor’s invoice and receipt to ensure you received what was ordered at the price agreed upon.
Plotting and analyzing the four “Vs” for your merchandise will help the operations team understand the relationships between these variables and timing needed to manage your supply chain. Knowing the relationships between the velocity of your manufacturing process, the lead times from vendors, the value of parts, and the variability of demand for each part will help you to develop an inventory management strategy by commodity code and part. This analysis can dramatically reduce overall inventory, scrap, and write-offs for obsolescence. It can also minimize stockouts (when you run out of inventory) during peaks in demand. However, none of this can happen if you do not implement the three “Ps” of purchasing.
- Takeaway Questions –
- When is the last time you have performed an inventory of your inventory and capital assets? How many items were you unable to locate?
- How often do you experience stockouts for your inventory or assets? Do you have a replacement strategy for equipment based on usage and lead times from vendors?
- How much inventory or assets have been in your possession for more than six months? Are they obsolete? And how much are you paying to store items that will not be used in the next 60 to 180 days?
- Have you encountered a similar problem? How did you deal with it? Share your story.