By – Dr. McKay (CEO MJMcKay Corporation, MJMcKay.com) May 7th 2013
Last month I wrote about the need to learn how successful manufacturers in the past have dealt with rising labor costs and changing global business conditions. This month I want to think about one of those successful strategies: supply chain partnerships.
I will describe a supply strategy that I see again and again. I almost always recommend against this strategy, because really it is just a bad habit that is hard to break. Then I will describe how to make a better supply strategy.
In your factory, do you use some kind of commodity as a raw material? Maybe it is steel, copper, cotton, lumber, or something else. Do you try to “beat the market” by buying large quantities of this raw material when prices are low, so that you will be well-stocked when prices are high? Please stop that. In the long run, it is a losing strategy. The most successful companies in advanced manufacturing do not use this strategy.
This may be a surprise, but you quite likely would be much better off if you purchase your commodity only as you need it, from a highly-qualified supplier.
Commodity trading is an industry all to itself. In London, Hong Kong, New York, Dubai and 100 other financial centers around the globe, highly-trained traders work constantly to win the commodities game. They buy low and sell high. They understand how to use complicated options to hedge their bets. They are supported by entire teams of analysts in buildings full of super-computers. Are you really that good? You need to be brutally honest with yourself about this. Can you really beat those guys at their own game? If you can, then congratulations, and maybe you should be closing your factory so that you spend all your time in commodities. But maybe you are not that good? Maybe the professional commodity traders see you just the same way a professional card player sees the tourist in the casino. If maybe you are not quite that good in your commodity bets, and if maybe you should instead be trying to make money with the value-add you perform in your manufacturing, then you should stop trying to finance your cash-flow needs by winning at such a risky game. It is gambling, there is no other name for it, and it would not be much different if you told yourself that a trip to Las Vegas or Macau was a business investment.
So what is the alternative? Find a supplier who will absorb the commodity risk for you, and deliver these raw materials in small quantities ready-to-use. Instead of buying enough material for an entire month, imagine that you might buy enough material only for one day. Imagine the material being delivered ready to use, exactly as your worker needs it. Imagine the delivery driver bringing raw materials all the way into the factory, right up to the machine where you will first do something with it. We call this “point-of-use” delivery. It has many advantages, here are just a few:
1) You will free up all the cash you now have tied up in raw material inventory.
2) You will gain flexibility with your customers, because you will not be trying to push them into buying the old stuff you have in your warehouse. You can move with agility as demand moves from one product type to another.
3) You can demand perfect quality from your supplier, because you will immediately see whether raw material meets requirements.
4) Your supplier can perform the low margin and low skill value-add to the raw material that is not profitable for you. (I call these the “commodity activities”.)
5) You can focus your own management expertise on the core business where you really earn your money.
6) You can simplify communication on your factory floor and back to your supplier. When everyone sees exactly what should be done, the boss no longer has to tell them to do it. Or to make another example, when the delivery driver sees what material needs to be delivered, you don’t need a purchasing manager to tell him to do it.
Obviously, you need a supplier you can trust to adopt this strategy. Find one. As China moves into higher-skill processes, the companies that try to play the supply game the old way will soon find themselves left out in the cold.
Know your skill, and focus on that skill. It is your core competency. Do not be envious when you hear about someone else who earned millions by placing all the right bets on aluminum, plastics, chromium, or whatever. Of course there will be a lucky few, just as there are a lucky few who hit the jackpot at the casino. But those beautiful casinos did not get built without suckers who lost at the game. Have you ever seen how beautiful are the offices of a big-city commodities trader? Don’t be the sucker at that game either.