David Rudd and Ian Armstrong, joint heads of origination at Benteler Trading International (BTI), discuss how original equipment manufacturers are outsourcing production and inventory ownership to reduce costs and improve efficiencies. They highlight the evolving roles of vendor-managed inventory providers and contract manufacturers and the impact that the setup of trading companies can have on supply chains.

 

Increasingly, across more and more industries, from automobiles to technology, FMCG and industrials, original equipment manufacturers (OEMs) have chosen to outsource production and inventory ownership to reduce costs and improve efficiencies.

In the case of inventory ownership, many have contracted suppliers to own inventory at or near production sites in an arrangement known as vendor-managed inventory (VMI). Often, this goes a stage further to include engagement with specialist companies known as contract manufacturers (CMs), who provide value-added services in addition to simply holding the inventory.

These CMs have developed sites strategically positioned globally in free trade zones or low-cost economies in the likes of South America and the Far East. They have done this to efficiently orchestrate complex international trade flows. This, in turn, increases supply chain efficiency, minimising the product cost for their clients and thus generating additional value, all against a volatile geopolitical backdrop.

Probably the most well-known example of the outsourcing of manufacturing is Apple and the iPhone. Many of the technology CMs such as Foxconn, Jabil and Flex have become giant companies in their own right, offering not just manufacturing capability but a plethora of complex supply chain services, including procurement, VMI, postponement and fulfilment solutions.

These supply chains involve significant transit and manufacturing times, and in a world where end demand is becoming more and more volatile and part availability and procurement more and more challenging due to supply constraints, questions are raised around who ultimately carries the working capital burden.

The OEMs, in many cases highly successfully, try to push material ownership down the supply chain so that their valuable working capital is not tied up by goods in transit or in CM warehouses awaiting transformation. However, as inventory levels grow on the back of both soaring demand as well as increased safety stocks, there are constraints on just how much inventory can be held by supply chain participants both in terms of financing it, and also around physical storage and insurance. From the CM perspective, senior management in finance, procurement and supply chain consistently report that working capital constraints limit their ability to grow their client base.

The benefits for companies using CMs and VMI can be summarised as strengthened strategic supply chains with reduced costs, protected inventory supply, minimised outages and increased efficiencies, all with improved service levels, which increases profitability and surety of supply. However, with these supply chain structures, the burden of funding and controlling supply is simply transferred to a few key suppliers. What is often missed is that these suppliers may be asked to execute different service levels and conditions of supply to each of their customers. This complexity can add new risks, such as:

The setup of these hugely rewarding programmes is extremely detailed and takes time across multiple areas of both the buyer and suppliers’ businesses. With dependencies in operations, procurement, IT, finance, audit and marketing, in fact, most areas are critical to a successful implementation.

Loss of control. The buyer is now reliant on a third party; they need to share proprietary data, which, in turn, has security and control implications. Priority changes to buyer processes need to be quickly adapted by their suppliers, and it is clear that change happens at the pace of the slowest inventory supplier to effectively execute the correctly documented change requests.

An often-unmissed effect of inventory sitting in CMs and VMIs is that the cost of that asset lies outside the buyer’s balance sheet and alongside the inventory of many other buyers also using the same supplier. This total increase in inventory on the CM’s and VMI’s balance sheets may have a negative effect on their credit quality, given the drag on their balance sheet, which directly affects their gearing. This could lead to potential funding cost increases at the CM and VMI level, which then potentially manifests itself in price increases to the buyers.

For these reasons, the challenges placed on CMs and VMI providers have led to the evolution of traditional inventory management models, using trading companies (TradeCos) and knowledgeable funders to further reduce costs and mitigate risks.

Efficiently shifting the working capital to a TradeCo can add significant value through the entire supply chain.

TradeCos such as those operated by Benteler, add real value for both buyers and suppliers as they step into supply chains and work directly with the selected CMs and VMI to hold inventory independently, releasing payments to suppliers and relieving balance sheet pressure. In these structures the TradeCo will hold products on either the input or output side and own raw materials or finished goods until required by the buyer. With the balance sheet relief, TradeCo’s actually operate at attractive costs compared to the prevailing situation, whilst leaving the physical flow of goods unchanged. Effective TradeCos can seamlessly take title to goods while not disrupting the existing nexus of important customer-supplier relationships.

The Asset as a Service (AaaS) model

A further area of TradeCo co-operation with the CM and VMI world is in the traditional manufacturing business. As OEMs look to shift manufacturing from their own production sites to a CM, the long-term contract often includes a significant capex requirement. The CM may need to buy an existing production line from the OEM that involves large cash outlays for the upfront equipment and ongoing materials, maintenance repair and operation (MRO) spares, and servicing.

An example of this would be the maker of electronic products such as toothbrushes, where the existing machines making the product have a long life remaining. The Benteler TradeCo buys the machine from the OEM and appoints the CM as its agent to operate the flow. Utilising this TradeCo structure, all raw materials, MRO spares and consumables can be held until needed, but the VMI and other suppliers will be paid by favourable terms to improve their cashflow and gearing. The TradeCo then charges for each unit of output, thus creating the variability in return, which is needed for the off-balance accounting treatment.

Introducing Benteler Trading International AG (BTI)

Having originated from Benteler Distribution, BTI is a trading firm headquartered in Zug, Switzerland, with operations in London and New York. It was initially formed to own the Benteler Group’s inventory. BTI has operated and funded supply chains for over 15 years, first as part of the Benteler Group and since 2016 as a standalone business, offering its products to global industrial customers.

The company provides true off-balance sheet solutions for inventories (with endorsement from the big four firms), which free up cash flow and improve our customers’ working capital.

Please feel free to contact us and we will be delighted to discuss the topic in more detail:

David Rudd, CFA, Origination

david.rudd@benteler-trading.com

+44 7502 666 487

Ian Armstrong, Origination

ian.armstrong@benteler-trading.com

+44 7738 332 561