Inventory-Driven Costs

In the 1990s, Hewlett-Packard's personal computer business was struggling to turn a dollar, despite the company's success in winning market share. By 1997, margins on its PCs were thin, and some product lines had not turned a profit since 1993. The problem had to do with the PC industry's notoriously short product cycles and brutal product and component price deflation.

by Luk Van Wassenhove, Régine Slagmulder, Gianpaolo Callioni, Linda Wright and Xavier de Montgros

In the 1990s, Hewlett-Packard's (HP) Personal Computer (PC) business was struggling to turn a dollar, despite the company's success in winning market share. By 1997, margins on its PCs were thin, and some product lines had not turned a profit since 1993. The problem had to do with the PC industry's notoriously short product cycles and brutal product and component price deflation.

A common rule of thumb was that the value of a fully assembled PC decreased 1% a week. In such an environment, inventory costs become critical. But the standard "holding cost of inventory" accounted for only about 10% of HP's inventory costs. The greater risks, it turned out, resided in four other, essentially hidden costs, which all stemmed from mismatches between demand and supply leading to excess inventory: component devaluation costs for components still held in production; price protection costs incurred when product prices drop on goods distributors still have on their shelves; product return costs that have to be absorbed when distributors return and receive refunds on overstock items; and obsolescence costs for products still unsold when new models are introduced.

By developing metrics to track those costs in a consistent way throughout the PC division, HP has found it can manage its supply chains with much more sophistication. Now, each product group chooses the supply chain configuration that best suits its needs.

Harvard Business Review, March 2005

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