Situation: A company has been offered the opportunity to buy a container of raw material from China at what may be a favorable price compared to local supply. This raw material will last 6-12 months at current and anticipated production rates. Does it make sense to purchase 6-12 months of raw material inventory in advance? How much inventory should you carry?
Advice from the CEOs:
- This is a fairly straightforward economic question. What are the risks and costs of purchasing this large lot of inventory vs. purchasing month-to-month? Here are the factors to include in your evaluation:
o What is the cost difference of a container versus local supply?
o Another option is to commit in advance to 6-12 months’ supply from the current supplier. What pricing will the local supplier offer for committed regular purchases?
o How many months of inventory are required if you need to change suppliers?
o What is the viability of the local vs. the foreign supplier? If you cease purchasing from the current supplier for 6-12 months will they remain a viable supplier? Similarly, can you count on the foreign supplier long-term?
o What is your cost of capital, and what is the tax effect of significant inventory at the end of the tax year?
o If you purchase a container, what is the exposure to overstock of certain sizes of product? What is the carrying cost of this overstock?
- Do the numbers and negotiate between the two suppliers.
Category: Manufacturing & Operations
Key Words: Inventory, Purchase, Advance, Container, Carry, Cost, Commit, Supplier, Tax, Negotiate