Cost to Carry Manufacturing Process Insurance

The nature of supply chain relationships has dramatically shifted in the last few decades. At the mercy of rising costs and the constant demand to streamline processes, all players within the manufacturing industry have worked tirelessly to reduce the amount of physical inventory they house.

Imagine the supply chain as a river with the OEM manufacturers, distributors, and end user plants (henceforth referred to as “end users”) representing locks and dams along the way. When a certain party holds physical inventory, the locks are closed, and the dams are filled at that level. When a party downstream needs parts, the gates are opened, and the supply moves along.

In this blog, we’ll take a look at the changing relationships and dependencies within the industrial parts network and how end users became flooded with the physical stock that OEM manufacturers once held upstream.

Back in the Day…

OEMs, such as Siemens and Eaton, made parts, and their sales representatives called on distributors and plants to push the products. They sold parts and often serviced their customers with their own equipment. Because distributors had their own sales teams and set of contacts, both players rallied behind a shared goal of selling as many parts as possible for the highest returns. The manufacturer held the entire inventory so distributors who needed parts for their clients (end users) could supply them with little turnaround time. There was a guaranteed safety stock to accommodate everyone.

Over Time…

OEM manufacturers realized they didn’t want to – or have to – carry stock; they could produce parts within a few weeks after orders were submitted, which would be cheaper than making and holding onto inventory. They incentivized distributors to carry more, offering bulk discounts and other perks. As such, manufacturers were able to reduce their inventory to minimal, emergency-only levels.

To improve sales ratios, manufacturer reps simultaneously pushed more physical stock onto distributors, opening the floodgates for OEM manufacturers to move their components downstream to distributors. End users continued to demand that parts be delivered quickly. Caught in the middle of both upward and downward pressure, distributors lost bargaining leverage and took responsibility for holding these critical parts.

As a result of holding more inventory, distributors and service providers accumulated knowledge about manufacturers’ parts and developed an understanding of plant integration within their end users’ systems. Even as the responsibilities shifted, customers demanded lower prices, squeezing margins at every level of the supply chain. Distributors’ expertise continued to replace the sales representative role, and eventually, distributors wanted to cut out sales reps altogether to boost earnings.

Where We Are Today

Distributors were unable to stock everything that manufacturers pushed onto them. Sales were sometimes based on an educated guess, and holding extra inventory became an unsupportable burden. In turn, distributors have opened their locks and dams and pushed end users to carry their own parts. Because OEM manufacturers cannot guarantee immediate spare stock, distributors have chosen to take a step back and act as a lesser version of a value-added middleman, eliminating some of their own risk in the process. Once again, the trend is for components to be pushed downstream.

Now end users are tasked with what was once distributors’ and even manufacturers’ responsibility – holding excess inventory. End users face a new cost-risk tradeoff: If they don’t have the parts on hand, they carry a production risk in the case of equipment failures. Risk is no longer pooled, but rather a “carry what you can” mentality.

As with all business decisions, there are pros and cons in possessing extra stock. While warehouse costs may escalate, there is a certain degree of freedom involved in having immediate access to parts. Now end users have the power to decide when and how to make the most of their excess inventory. And as a result, the painful process of determining the right ratio of spare parts and equipment to have on hand continues to be an uphill battle for manufacturers willing to risk how much insurance they need.