multinational inventory management

Inventory in the form of raw materials, work in process, or finished goods is held (i) to
facilitate the production process by both ensuring that supplies are at hand when needed
and allowing a more even rate of production and (2) to make certain that goods are
available for delivery at the time of sale. Although, conceptually, the inventory
management problems faced by multinational firms are not unique, they may be
eaggerated in the case of foreign operations. !or instance, "#$s typically find it more
difficult to control their overseas inventory and reali%e inventory turnover ob&ectives.
'here are a variety of reasons( long and variable transit times if ocean transportation is
used, lengthy customs proceedings, dock strikes, import controls, higher duties, supply
disruption, and anticipated changes in currency values. )roduction *ocation and
Inventory $ontrol "any +.,. companies have eschewed domestic manufacturing for
offshore production to take advantage of both low-wage labor and a grab bag of ta
holidays, low-interest loans, and other government largess. .ut a number of firms have
found that low manufacturing cost isn/t everything. Aside from the strategic advantages
associated with +.,. production, such as maintaining close contact with domestic
customers, onshore manufacturing allows for a more efficient use of capital. In particular,
because of the delays in international shipment of goods and potential supply
disruptions, firms producing abroad typically hold larger work-in-process and finished
goods inventories. 'he result is higher inventory-carrying costs. Advance Inventory
)urchases In many developing countries, forward contracts for foreign currency are
limited in availability or are noneistent. In addition, restrictions often preclude free
remittances, making it difficult, if not impossible, to convert ecess funds into a hard
currency. 0ne means of hedging is to engage in anticipatory purchases of goods,
especially imported, items. 'he trade-off involves owning goods for which local currency
prices may be increased, thereby maintaining the dollar value of the asset even if
devaluation occurs, versus forgoing the return on local money market investments. !or
eample, suppose that 1olkswagen do .rasil is trying to decide how many months/ worth
of components to carry in inventory. 'he present price of a component is 2" 344, and
this price is rising at the rate of 4.56 monthly. 'he 2eutsche mark holding cost is
estimated at 3 6 monthly, including insurance, warehousing, and spoilage, but ecluding
the opportunity cost of funds. +nder these circumstances, where holding costs eceed
anticipated cost increases by 4.56 monthly, 1olkswagen should maintain the minimum
parts inventory necessary to achieve its targeted output in .ra%il. Assume now that
1olkswagen has ecess cru%eiro balances in .ra%il on which it is earning a nominal
monthly rate of 26. 7owever, under .ra%il/s system of mini-devaluation, the cru%eiro is
epected to devalue against the 2eutsche mark by 86 in each of the net three months,
26 in the fourth month, and 36 thereafter. ,ince other investment opportunities are
limited or noneistent because of currency and financial market controls, 19/s
opportunity cost of funds in 2eutsche marks (the 26 nominal rate it earns on cru%eiros
less the epected devaluation) for the net si months, month by month, equals "onth
0pportunity $ost of !unds (6) 3 -3 2 -3 8 -3 : 4 5 3 ; 3 Adding this opportunity cost of
funds to the previously given monthly holding costs of 3 6 yields the total monthly
individual and cumulative 2" costs of carrying inventory for the net si months(
.eginning "onth 'otal "onthly $arrying $ost (6) $umulative $arrying $ost (5 mos.)
$umulative )rice Increase (6) 3 4 4 4.4 2 4 4 4.5 8 4 4 3.4 : 3 3 3.5 5 2 8 2.4 ; 2 5 2.5
.ased on the cumulative carrying costs and price increases, it is now apparent that the
eistence of anticipated cru%eiro devaluations, unmatched by correspondingly higher
nominal interest rates<that is, the international !isher effect is not epected to hold<
should lead 1olkswagen do .rasil to hedge a portion of its cash balances by purchasing
four months/ worth of inventory at today/s prices (and at today/s 2" ( cru%eiro echange
rate). In other words, it will pay 1olkswagen to purchase this amount of inventory in
advance in order to minimi%e losses in the real value of its cru%eiro cash balances.
Inventory ,tockpiling .ecause of long delivery lead times, the often limited availability
of transport for economically si%ed shipments, and currency restrictions, the problem of
supply failure is of particular importance for any firm that is dependent on foreign
sources 'hese conditions may make the knowledge and eecution of an optimal
stocking policy, under a threat of a disruption to supply, more critical in the "#$ than in
the firm that purchases domestically. 'he traditional response to such risks has been
advance purchases. 7olding large amounts of inventory can be quite epensive, though.
In fact, the high cost of inventory stockpiling<including financing, insurance, storage,
and obsolescence<has led many companies to identify low inventories with effective
management. In contrast, production and sales managers typically desire a relatively
large inventory, particularly when a cutoff in supply is anticipated. ,ome firms do not
charge their managers= interest on the money tied up in inventory. A danger is that
managers in these companies may take advantage of this situation by stockpiling
sufficient quantities of material or goods before a potential cutoff in order to have close to
a %ero stock-out probability. ,uch a policy, established without regard to the trade-offs
involved, can be very costly. !or eample, >In ,ingapore possible curtailment in
shipments of air conditioners led to such heavy advance ordering that for the net two
years the market was completely saturated because the warehouses were full of air
conditioners. ,uch an asymmetrical reward structure will distort the trade-offs involved.
'he profit performances of those managers who are receiving the benefits of additional
inventory on hand should be ad&usted to reflect the added costs of stockpiling. It is
obvious that as the probability of disruption increases or as holding costs go down, more
inventories should be ordered. ,imilarly, if the cost of a stock-out rises or if future
supplies are epected to be more epensive, it will pay to stockpile additional inventory.
$onversely, if these parameters move in the opposite direction, fewer inventories should
be stockpiled.
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