Question

What is the danger of over supply of raw materials?  

Answer 1

Raw materials are the substances or unfinished goods used by a company in order to produce final or finished goods. In order to ensure that the quantity of raw material matches the actual demand of goods by the end customers, it is important for the organizations to continuously forecast and monitor demands. Managing raw materials in its supply chain is an important function of the organizations that affects their profitability. When the raw materials are supplied in quantities more than what is actually needed to meet the forecasted demand, it may lead to unnecessary additional costs for the manufacturer or company in the form of added Inventory costs and also in the wastage of raw materials if it remain un-utilized during a particular production cycle.

Take the example of a McDonald’s outlet. Suppose the supply of the buns used in making the burgers is higher than what can actually be consumed in the particular outlet depending on the customer demand. The store will have to make additional arrangements to accommodate the exceeded supply of buns. This may result in increased inventory holding costs and labour costs for the outlet. Also, if the buns are preserved for a longer period of time than its shelf life, owing to the lower demand of the burgers in the outlet, the buns may become rotten and unsuitable for consumer consumption adding to further losses for the outlet.

In case the outlet decides to sell burgers at a lower cost (known as the salvage value) in order to induce demand for burgers, the outlet may still suffer losses because of overage costs. Overage costs is defined as the costs incurred because of over-ordering of raw materials. Overage cost is calculated as, Actual value - Salvage value.

Therefore, it is important that the companies incorporate suitable forecasting methods to accurately forecast demand and accordingly manage their raw materials in the supply chain management in order to remain profitable and increase their profit margins by saving above discussed costs.